May 2019 Business Due Dates

May 10 – Social Security, Medicare and Withheld Income Tax

File Form 941 for the first quarter of 2019. This due date applies only if you deposited the tax for the quarter in full and on time.

May 15 – Employer’s Monthly Deposit Due

If you are an employer and the monthly deposit rules apply, May 15 is the due date for you to make your deposit of Social Security, Medicare and withheld income tax for April 2019. This is also the due date for the non-payroll withholding deposit for April 2019 if the monthly deposit rule applies.

May 2019 Individual Due Dates

May 10 – Report Tips to Employer

If you are an employee who works for tips and received more than $20 in tips during April, you are required to report them to your employer on IRS Form 4070 no later than May 10. Your employer is required to withhold FICA taxes and income tax withholding for these tips from your regular wages. If your regular wages are insufficient to cover the FICA and tax withholding, the employer will report the amount of the uncollected withholding in box 12 of your W-2 for the year. You will be required to pay the uncollected withholding when your return for the year is filed.

May 31 –  Final Due Date for IRA Trustees to Issue Form 5498

Final due date for IRA trustees to issue Form 5498, providing IRA owners with the fair market value (FMV) of their IRA accounts as of December 31, 2018. The FMV of an IRA on the last day of the prior year (Dec 31, 2018) is used to determine the required minimum distribution (RMD) that must be taken from the IRA if you are age 70½ or older during 2019. If you are age 70½ or older during 2019 and need assistance determining your RMD for the year, please give this office a call. Otherwise, no other action is required and the Form 5498 can be filed away with your other tax documents for the year.

How QuickBooks Protects Your Data, and How You Can Help

The data in your QuickBooks company file contains some of the most sensitive information on your computer. Make sure it’s secure.

Your customer list is gold. And those Social Security and bank card numbers in your payroll, client, and vendor records need to be protected from intruders and only viewed by authorized employees.

It’s not just large corporations and financial institutions that get hacked. That’s what the bad guys want you to think. In reality, small businesses are often the victims of data breaches because their owners think they’re immune from data theft and destruction.

Even if you’re password-protecting your PCs and running antivirus and anti-malware software, there’s more you need to do when it comes to your accounting records. Here’s what we suggest.

Restrict access by setting up user permissions.

If you have multiple staff members using QuickBooks, don’t share the same user name and password. That obviously gives everyone access to all data and activity. If something goes awry, you have no way of knowing when or how it happened, and who was responsible. To protect yourself and everyone else who logs in, it’s critical that all users have their own unique logins. They should only be allowed to access information and functions that relate to their job duties.

 

You can restrict QuickBooks users to certain screens and activities.

To assign these permission levels, open the Company menu and click on Set Up Users and Passwords, then Set Up Users. This opens the User List window, where you should be identified as the Admin. Click Add User. Enter a user name and password for an employee who needs access (this can be changed later). Check the box in front of Add this user to my QuickBooks license.

Tip: Not sure how many users are allowed under your current license? Click F2 and look in the upper left corner. If you need to add licenses, let us know.

Click Next. The next screen lists three options. You can grant access to all areas or to selected areas. You can also create a login for us as your external accountant, which lets us see everything except sensitive customer data. Select the second option and click Next. You can see in the image above that you can give the employee different levels of responsibility. When you’ve made your choice, click Next. The subsequent nine screens deal with different areas of QuickBooks and their related activities.

Tip: When you need to change your password, which you should do at a minimum every three months, go to Company | Set Up Users and Passwords | Change Your Password.

Save your company file elsewhere.

You should always be backing up your company file to an external storage device (like a CD or thumb drive). To set this up, open the File menu and select Back Up Company, then Create Local Backup. This window will open:

The Create Backup window

Make sure Local backup is selected, then click the Options button below (not pictured here). Click Browse to see a directory of your PC and select the correct destination. Leave the two boxes below it checked; this will add the backup date/time to the filename and limit the number of backup copies to three.

By default, QuickBooks will remind you to back up your file every fourth time you close your company file; you can change this number if you prefer. Leave the Complete verification option checked and click OK, then Next. Specify when you want to save your backup copy and click Next again. You can schedule regular backups of your company file on the next screen if you’d like. When you’ve completed this screen, click Finish.

You should also consider saving a copy of your company file to the cloud. Intuit offers its own service for this; it costs $9.95/month or $99.95 annually, but it gives you 100 GB of storage space, so you can back up other critical business files, too. If you can’t swing this financially, at least store your backups to a portable device that you can carry offsite.

Warning: If you already pay for cloud storage from another vendor, don’t assume you can just copy your QuickBooks file to it. Talk to us.

Other Steps

There are other things you can do to protect your QuickBooks data, including:

  • Insist on strong passwords. Yes, it’s a pain to create and remember them, but it’s critical here.
  • Keep everything updated. That includes your operating system and anything else that requires updates.
  • Minimize web browsing on work computers and remind employees about smart email behaviors.

We strongly recommend that you consult with us as you’re setting up any kind of backup system for QuickBooks. The software’s instructions are straightforward, but we don’t want you to do anything that would jeopardize the integrity of your company file.

So, You’ve Made a Mistake on Your Tax Return. What Happens Now?

Generally speaking, tax return mistakes are a lot more common than you probably realize. Taxes are naturally complicated, and the paperwork required to file them properly is often convoluted. This is especially true if you’re filing your taxes yourself — and all of this is in reference to a fairly normal year as far as the IRS is concerned.

The 2018 tax year, however, certainly does not qualify as a “normal year.”

With the passage of the Tax Cuts and Jobs Act, even seasoned financial professionals are having a hard time digesting all of the changes that they and their clients are now dealing with. All of this is to say that if you’ve just discovered that you’ve made a BIG mistake on your tax return this year, the first thing you should do is stop and take a deep breath. It happens. It’s understandable. There ARE steps that you can take to correct the situation quickly — you just have to keep a few key things in mind.

Fixing Tax Return Mistakes: Here’s What You Need to Do

All told, you have three years from the date that you originally filed your tax return (or two years from the date you paid the tax bill in question) to make any corrections necessary to fix your mistakes. If nothing about your return ultimately changes, you probably don’t have anything to worry about — in fact, there’s a good chance that the IRS will catch the mistake and fix it themselves. This is especially true in terms of math errors, or if you’ve left out an important document. The IRS will probably send you a letter letting you know what happened and what you need to do to correct it.

If fixing the mistake ultimately results in you owing more taxes, you should pay that difference as quickly as possible. Penalties and interest will keep accruing on that unpaid portion of your bill for as long as it takes for you to pay it, so it’s in your best interest to take care of this as soon as you can afford to do so.

If you’ve made a much larger mistake (like if you understated or overstated your income, for example), you’ll need to file what is called an amended tax return. This is essentially your “second chance” at getting things right, and the timetable above still applies. Understand, however, that ALL errors must be corrected in the amended return. This means that if you find three errors that will reduce your tax liability and two that actually increase it, you are legally required to correct all five. You can’t correct only the mistakes that benefit you.

An amended return can be used to correct a variety of issues, including but not limited to ones like:

  • Overstating or understating your income
  • Changing an incorrect filing status
  • Accounting for dependents
  • Taking care of discrepancies in terms of deductions or tax credits

If any of the above apply to the error you’ve just discovered, you can — and absolutely should — file an amended return.

A sudden increase in your tax liability notwithstanding, it’s again important to understand that even “major” errors on your income taxes aren’t really worth stressing out about. The IRS understands that sometimes mistakes happen, and they have a variety of processes in place designed to help make things right.

This does, however, underline how valuable it can be to partner with the right financial professional to do your taxes next year. You’ve got a career and a life to lead — you’re probably not going to be up to date on every small change that rolls out in the tax code. A financial professional will, as it is literally their job to do so.

If nothing else, this will help generate some much-needed peace-of-mind regarding the accuracy of your return. You won’t have to worry about whether or not the IRS is going to find some big mistake down the road because you’ve dramatically reduced the chances of those mistakes happening in the first place.

Tax Benefits for Members of the Military

Article Highlights:

  • Service Member Residence or Domicile
  • Service Member Spouse’s Residence or Domicile
  • Non-Taxable Allowances
  • Combat Zone Exclusion
  • Home Mortgage Interest Deduction
  • Home Property Tax Deduction
  • Home Sale Gain Exclusion
  • Moving Deduction
  • Death Gratuity Payments
  • Child Credit
  • Earned Income Tax Credit
  • IRA Contributions
  • Reservist’s Travel Expenses
  • Qualified Reservist’s Pension Withdrawals
  • Retired Military Disability Compensation

Military members benefit from a variety of special tax benefits. These include certain non-taxable allowances, non-taxable combat pay, and a variety of other special tax provisions. Here is a rundown on the most prominent of the tax benefits.

Service Member Residence or Domicile – A frequent question by service members is “What is my state of residence for tax purposes?” since one’s duty station may change multiple times while serving. Luckily, the government passed a law to solve this issue. A service member continues to retain his or her home state of residence for tax purposes, even when required to move to another state under military orders. This also applies to other tax jurisdictions within a state, such as for city, county, and personal property taxes. Thus, a service member will continue to file tax returns for his or her home state and not the state where he or she is stationed.

Service Member Spouse’s Residence or Domicile – In order to simplify the tax-filing requirements of military couples, the Military Spouses Residency Relief Act of 2009 allowed military spouses to claim the same state of domicile as their service member for tax purposes, provided they had also established domicile there.

As an example, say Chris resides in California with his spouse, who is in the military, and Chris has earned income in California but had established domicile with his military spouse in Virginia. Chris would be subject to Virginia income tax laws instead of those of California, and the couple would need file only one state return – in this case, Virginia. They have no obligation to file a California return.

Unfortunately, spouses who had not established domicile in the same state as their service member spouse and who had earned income in the state where their spouse was stationed were still forced to file with both states (assuming both states have income tax).

New for Years Beginning in 2018 – Thanks to the Veterans Benefits and Transaction Act of 2018, an individual married to a military member now has more choices. Under the act, a spouse can elect to have the same state of domicile as their service member spouse, even if they didn’t previously have the same domicile. If the non-military spouse doesn’t make that election, they can continue to choose to file in their own domicile state.

Making these choices can significantly impact the amount of state tax the spouse might have to pay. As an example, a spouse of a service member stationed in a high-income-tax state can elect to use the state of residency of the service member whose residence state has no or low state income tax and not be subject to the state taxes where his or her spouse is stationed.

Careful – It is tempting for a service member or their military spouse to declare their state of domicile to be without any state income tax such as Texas, Nevada, Florida, etc. That can get them in hot water if they do so without any connections to the state.

Non-Taxable Allowances – Members of the military benefit from a number of non-taxable allowances including:

  • Living allowances – Basic allowance for housing (BAH), housing and cost-of-living allowances abroad whether paid by the U.S. Government or by a foreign government and overseas housing allowance.
  • Family allowances – certain educational expenses for dependents, emergencies, evacuation to a place of safety and separation.
  • Death allowances – Burial services, death gratuity payments to eligible survivors, and travel of dependents to burial sites.
  • Moving allowances – Including for relocation, move-in housing, moving household and personal items, moving trailers or mobile homes, storage, temporary lodging and temporary lodging expenses, and military base realignment and closure benefits.
  • Travel allowances – Including annual round trips for dependent students, leave between consecutive overseas tours, reassignment in a dependent-restricted status, transportation for military taxpayers and dependents during ship overhaul or inactivation, and per diem.
  • State benefit payments – Any bonus payment made by a state or political subdivision to any member or former member of the U.S. uniformed services, or to his or her dependent, only because of the member’s service in a “combat zone,” is generally treated as a “qualified military benefit” excludable from gross income.
  • Other payments – Defense counseling, disability (including payments received for injuries incurred as a direct result of a terrorist or military action), group term life insurance, professional education, ROTC educational and subsistence allowances, survivor and retirement protection plan premiums, uniform allowances, and uniforms furnished to enlisted personnel.
  • In-kind military benefits – Including legal assistance benefits, space-available travel on government aircraft, medical/dental care, and commissary/exchange discounts.

Combat Zone Exclusion – A member of the U.S. Armed Forces who serves in a combat zone can exclude certain pay from income. This pay includes active duty pay earned in any month served in a combat zone; imminent danger/hostile fire pay; a reenlistment bonus, if the voluntary extension or reenlistment occurs during a month served in a combat zone; accrued leave pay earned in any month served in a combat zone; awards for suggestions, inventions, or scientific achievements the service member is entitled to because of a submission made in a month served in a combat zone; and student loan repayments attributable to the period of service in a combat zone (provided a full year’s service is performed to earn the repayment). Any part of a month in a combat zone counts as an entire month. Periods when one is hospitalized as the result of wounds, disease, or injury in a combat zone are also excluded, provided the hospitalization begins within 2 years of combat zone activities. The hospitalization need not be in the combat zone. Generally, combat pay is not included in the individual’s pay reported on Form W-2.

Commissioned Officers – Commissioned officers may exclude their pay; however, the amount of their exclusion is limited to the highest rate of enlisted pay (plus imminent danger/hostile fire pay received).

Home Mortgage Interest Deduction – Military taxpayers who receive a non-taxable housing allowance and also own a home can deduct the mortgage interest on their home as an itemized deduction, even if they are paid with the nontaxable military housing allowance pay. However, the home mortgage interest is still subject to the general rules for deducting home mortgage interest, meaning that for years 2018 through 2025, only home acquisition debt interest is deductible. Home acquisition debt is debt used to acquire, build, or substantially improve a home. Equity debt interest is no longer deductible for years 2018 through 2025.

Home Property Tax Deduction – Even though they receive a non-taxable housing allowance, a military taxpayer can still deduct their home’s property taxes as an itemized deduction. However, the tax reform limits real property tax and state/local income or sales tax deductions to $10,000 annually for years 2018 through 2025.

Home Sale Gain Exclusion – Most taxpayers can exclude up to $250,000 ($500,000 if filing married joint) of home gain if the home was owned and used as their main home for 2 of the 5 years preceding its sale. However, a military taxpayer may choose to suspend the 5-year test period for ownership and use during any period when the taxpayer (or spouse) serves on qualified official extended duty as a member of the Armed Forces. This means that the 2-year use test may be met even if, because of military service, the taxpayer did not actually live in his or her home for at least the required 2 years during the 5-year period ending on the date of sale.

For this exception to the usual test period, a taxpayer is on qualified official extended duty when at a duty station that is at least 50 miles from his or her main home, or while residing under orders in government housing for more than 90 days or for an indefinite period.

The suspension period cannot last more than 10 years and can be revoked by the taxpayer at any time. The 5-year period cannot be suspended for more than one property at a time.

Example – Sarge bought and moved into a home in 2011 that he lived in as his main home for 2½ years. For the next 6 years, he did not live in the home because he was on qualified official extended duty with the Army. He sold the home for a gain in 2019. To meet the use test, Sarge chooses to suspend the 5-year test period for the 6 years he was on qualifying official extended duty – he disregards those 6 years. Sarge’s 5-year test period consists of the 5 years before he went on qualifying official extended duty. He meets the ownership and use tests because he owned and lived in the home for 2½ years during this test period.

Moving Deduction – The tax reform suspended the moving deduction for all moves except for certain members of the Armed Forces, for years 2018 through 2025. Military taxpayers who are still allowed a moving deduction are those who are required to move because of a permanent change of station. However, the deduction is limited to the actual cost less any non-taxable moving allowance provided.

A permanent change of station includes a move from home to one’s first post of duty when appointed, reappointed, reinstated, called to active duty, enlisted or inducted; a move from one permanent post of duty to another permanent post of duty at a different duty station, even if the service member separates from the Armed Forces immediately or shortly after the move; and a move from one’s last post of duty to home or to a nearer point in the U.S. in connection with retirement, discharge, resignation, separation under honorable conditions, transfer, relief from active duty, temporary disability retirement, or transfer to a fleet reserve, if the move occurs generally within 1 year or the termination of active duty.

Death Gratuity Payments –Military death gratuity payments and amounts received under the service members’ group life insurance program are not taxable to eligible survivors. In addition, these amounts may be rolled over to a Roth IRA or Coverdell education savings account without regard to the limits that otherwise apply to other taxpayers.

Child Credit – Excluded combat pay is treated as earned income for purposes of determining the refundable portion of the child credit.

Earned Income Tax Credit (EITC) – A taxpayer may elect to treat combat pay that is otherwise excluded from gross income as earned income for purposes of the EITC. Making this election for EITC purposes may or may not be advantageous. If the taxpayer has earned income below the maximum amount of earned income on which the credit is calculated, including the combat pay will increase the credit amount. On the other hand, if the taxpayer’s earned income is already in the phase-out range, electing to include combat pay as earned income will decrease the amount of credit that can be claimed.

IRA Contributions – For 2019, individuals can contribute up the $6,000 ($7,000 if age 50 or over) to their IRA accounts, subject to phase-out limits for certain higher-income individuals. However, any contribution is limited to the individual’s earned income for the year. For service members, their combat pay, even though it is not taxable, is treated as earned income for purposes of an IRA contribution.

Reservist’s Travel Expenses – Armed Forces reservists who travel more than 100 miles away from home and stay overnight in connection with service as a member of a reserve component can deduct travel expenses as an adjustment to gross income. Thus, this deduction can be taken even by taxpayers using the standard deduction. However, the expenses themselves are subject to certain limitations. Transportation, meals (subject to a 50% limit) and lodging qualify, but the deduction is limited to the amount the federal government pays its employees for travel expenses, i.e., the general federal government per diem rate for lodging, meals and incidental expenses applicable to the locale and the standard mileage rate for car expenses plus parking and ferry fees and tolls.

Qualified Reservists Pension Withdrawals – Qualified reservists are permitted penalty-free withdrawal from IRAs, 401(k)s and other arrangements if ordered or called to active duty.

A “qualified reservist distribution” is any distribution to an individual if the individual was, by reason of his being a member of a “reserve component”, ordered or called to active duty for a period in excess of 179 days, or an indefinite period and the distribution is made during the period beginning on the date of the order or call to active duty, and ending at the close of the active duty period.

Retired Military Disability Compensation – Disability compensation, as distinguished from retirement payments, are tax free and made by the Department of Veterans Affairs. Some misinformation has circulated indicating that the disability is included in the retirement benefits paid by the Defense Finance and Accounting Services. That is not true since the disability payments are made by the Department of Veterans Affairs and those amounts are NOT included on a Form 1099-R issued by the Defense Finance and Accounting Services.

If you have questions related to military tax benefits, please give this office a call.

Tax Treatment of a Room Rental

Article Highlights:

  • Vacation Home Rental Rules
  • Order of Deductions
  • Loss Limitations
  • Expense Prorating

With the shortage of affordable housing these days, many homeowners are renting out rooms in their homes, providing themselves with some additional cash. Questions that are often raised in regard to room rentals include: Is the income taxable? If so, how is it reported? What deductions are allowed? Can a loss be claimed? Answers to these questions follow.

If a taxpayer rents rooms or other space in a home and the rented portion does not have facilities (a bathroom and a kitchen) that would make it a dwelling unit on its own, the taxpayer and the renter may be considered to be occupying one dwelling unit. Thus, the “landlord” is mixing personal expenses with business expenses, a situation in which the tax code does not permit a loss.

As a result, the income and expenses are treated under the same rules as vacation home rentals and are reported on Schedule E, with prorated expenses deductible against the rental income in a specific order and no loss being allowed.

The deductions are claimed in the following order:

  1. First, mortgage interest and taxes.
  2. Next, operating expenses (examples: advertising, repairs, utilities, maintenance, insurance).
  3. Finally, depreciation.

If the result is a loss, the expenses are only allowed until the income is reduced to zero.

But some unusable expenses may be carried over to the next year, where again they and the next year’s expenses will be limited to the next year’s rental income.

Because the expenses are taken in a specific order, home mortgage interest and property taxes paid for the home (which, for many taxpayers, would be deductible anyway) are first deducted from the rental income. Next come the operating expenses, of which only $1,300 of $1,417 is deductible in this example because that amount reduces the rental income to zero. Thus, $117 of the operating expenses and the depreciation are not deductible.

Any reasonable method for dividing the expenses may be used. The two most common methods for allocating expenses, such as mortgage interest and heat for the entire house, are based on the number of rooms in and square footage of the home.

If you have questions related to renting a room or a vacation home, or about short-term rentals of your home, please give this office a call.

Tax Reform Muted the AMT: Holders of Incentive Stock Options, Take Note

Article Highlights

  • Alternative Minimum Tax
  • Deterrent to Tax Shelters
  • Tax Reform Changes
  • Tax Deductions and Preferences
  • Incentive Stock Options
  • Tax Planning Opportunity

Although Congress, as part of the recent tax reform, promised to do away with the alternative minimum tax (AMT), it only did so for C corporations; as a result, the AMT still applies to individuals.

Congress originally developed the AMT in 1969 as a means to prevent high-income individuals from using tax shelters to reduce their taxes. For the AMT, federal income tax is calculated without certain deductions and tax preferences. This tax applies if it is greater than the regularly computed income tax. Although it has since been indexed to inflation, the AMT at one point began to apply to middle-income taxpayers, who are not the intended targets of this punitive tax.

The AMT computation includes a tax-exempt amount, but this amount begins to phase out for taxpayers whose adjusted gross income (AGI) exceeds a certain threshold (depending on their filing status). Although the tax reform did not eliminate the AMT, it did mute that tax considerably by increasing the AMT exemptions and by substantially raising the exemption-phaseout thresholds, as illustrated below. The exemptions and AGI phaseout thresholds will be inflation-adjusted in future years.

AMT EXEMPTIONS ($)
Status20172018
Married Filing Jointly or Surviving Spouse84,500109,400
Single or Head of Household54,30070,300
Married Filing Separately42,25054,700

 

EXEMPTION-PHASEOUT AGI THESHOLDS
Status20172018
Married Filing Jointly or Surviving Spouse160,9001,000,000
Single or Head of Household120,700500,000
Married Filing Separately80,450500,000

These are the tax deductions and preferences that most often affect the average taxpayer:

  • Some itemized deductions are allowed for the regular tax computation but not for the AMT computation.
  • Tier II miscellaneous itemized tax deductions are not allowed for the AMT computation; in addition, for the years 2018 through 2025, they are also not allowed for the regular tax computation. This category primarily includes employee business expenses, investment expenses, and legal fees. As these expenses aren’t currently deductible in either tax calculation, there is no adjustment for the AMT calculation.
  • The AMT computation does not allow the itemized deduction for interest on home-equity debt; such debt also is not deductible in the regular computation through 2025, which eliminates another difference in the two computations.
  • Employee incentive stock option tax preferences are also handled differently in the two computations, as is discussed in more detail later in the post.

As a result of the increased exemptions, the higher AGI thresholds for the exemption phaseout, and the reduction or elimination of differences in deductions, the AMT typically no longer affects average taxpayers.

Incentive stock options – Employers sometimes grant employees qualified stock options (i.e., incentive stock options), as motivation to become more involved in the company’s success and to share in the company’s stock appreciation.

For these options, the employer grants the employee an opportunity to purchase the company’s stock at a preset price on a future date. An option is usually accompanied by a vesting schedule that details the date when the options can be exercised (i.e., when the stock can be purchased). Once the employees has held these shares for more than a year—and for at least two years after the option was granted—any subsequent gains from sales of the stock are subject to the capital-gains tax instead of the ordinary (less favorable) income tax.

The Catch – The catch for incentive stock options is that, in the year when the employee exercises the option and purchases the stock, the difference (often referred to as the “bargain element”) between the stock’s current market value and the price that the employee paid as part of the option is treated as a tax preference. Thus, this difference is added to the employee’s AMT income but is not included in the regular tax income. In the past, this usually triggered the AMT, which meant that the employee had to pay tax on the phantom income in the year of the option, even though there was no actual stock sale. As a result, many employees have shied away from taking full advantage of incentive stock options; rather than holding the stock for the required qualifying period, they have been selling the stock in the year when they exercised the option, resulting in the profit being classified as ordinary income.

(Note that nonqualified stock options are not eligible for the beneficial tax treatment that incentive stock options are afforded. When a nonqualified option is exercised, the bargain element is included in the employee’s wages as ordinary income for the year when the option is exercised. However, this ordinary income is not a preference item for AMT purposes. Most employees who exercise nonqualified stock options immediately sell the stock so that they have money to pay the payroll taxes related to the resulting ordinary income. The paperwork that the employer provides when awarding the option states whether the option is qualified or nonqualified.)

Opportunity – The changes in the AMT present low- to moderate-income taxpayers with an opportunity to exercise incentive stock options without triggering the AMT.

If you hold incentive stock options, it may be possible to develop a plan—perhaps a multiyear plan—that will allow you to exercise your options without incurring phantom income in the AMT calculation. Please call this office for assistance in developing such a plan.

Court of Appeals Rules for Clergy

Article Highlights:

  • Internal Revenue Code Section 107
  • Court Ruling
  • Employee Status
  • Self-employed Status
  • Parsonage Allowance
  • Self-employment Tax
  • Exemption from Self-employment Tax

If you read our previous article related to a Wisconsin District Court ruling, you will recall that the judge in that case had ruled that Sec. 107(2) of the Internal Revenue Code was unconstitutional.

Section 107 of the Internal Revenue Code provides that a minister’s gross income doesn’t include the rental value of a home provided by the house of worship. If the home itself isn’t provided, then a rental allowance paid as part of compensation for ministerial services is excludable. This benefit is generally referred to as a parsonage allowance. Thus, a minister can exclude the fair rental value (FRV) of the parsonage from income under IRC Sec. 107(1), or the rental allowance under Sec. 107(2), for income tax purposes. The Sec. 107(2) rental allowance is excludable only to the extent that it is for expenses such as rent, mortgage payments, utilities, repairs, etc., used in providing the minister’s main home, and only up to the amount of the home’s FRV.

Good news for clergy members: a 3-judge panel of the 7th U.S. Circuit Court of Appeals has unanimously overturned the lower court’s decision and ruled that Sec. 107 is constitutional; therefore, housing allowances continue to be excludable from income tax.

It is unknown whether those who brought the suit will ask the full 7th Circuit to review the case or appeal it to the U.S. Supreme Court and, if so, whether the Supreme Court will take it up.

Here is an overview of how members of the clergy (from all faiths) are taxed on their income. When we refer to “church” in this article, please read that to include mosques, synagogues, temples, etc. Members of the clergy are taxed on not just their salary but on other fees and contributions that they receive in exchange for performing services such as marriages, baptisms, funerals, and masses. As a result, clerics will generally report their income in two ways:

As an Employee – As an employee, clerics will receive a W-2 from the church showing the amount of their income that is subject to tax, any amount paid as a nontaxable housing allowance (discussed later), and any withholding.

Any expenses incurred as a W-2 employee are included on Form 2106 (Employee Business Expenses) and if the cleric also receives a nontaxable parsonage allowance, the expenses must be divided between the taxable W-2 income and nontaxable parsonage allowance. Unfortunately, for years 2018 through 2025 the deduction for employee business expenses has been suspended by tax reform. The suspension affects all employee business expenses, not just those of clergy employees.

As a Self-Employed Individual – Income received other than as an employee of a church is reported as self-employment income. Typically, this would include all income that is not included in the W-2 from the church, including fees charged for services, such as weddings, funerals, and other gatherings. This income and any expenses associated with it are reported on Schedule C and are subject to the self-employment tax.

Parsonage Allowance – As was discussed previously, as the subject of the court ruling, a member of the clergy can qualify to have a rental allowance excluded from his or her taxable income if that allowance is provided as remuneration for services that are ordinarily the duties of a minister of the gospel. The following are the qualifications and details of the parsonage allowance:

  • It is only excludable to the extent that it is used for expenses related to the minister’s housing (e.g., for rent, mortgage payments, utilities, and repairs).
  • The rental allowance is not excludable to the extent that it exceeds reasonable compensation for the minister’s services.
  • The allowance only applies to the minister’s primary residence.
  • The allowance cannot exceed a home’s FRV, including furnishings and appurtenances such as garages, plus the cost of utilities.
  • In advance of the payment, the employing organization must designate the allowance by an official action. If a minister is employed by a local congregation, the designation must come from the local church, instead of from the church’s national organization.
  • The portion of the minister’s business expenses that is attributable to tax-free income is not deductible. This rule does not apply to home-mortgage interest or to taxes that are deductible in full if the minister itemizes deductions.
  • Retired clerics can exclude a home’s rental value or a rental allowance if the home is furnished as compensation for past services and authorized under a convention of a national church organization. However, this exclusion does not extend to the widow or widower of a retired cleric.

Although it is not subject to income tax, a parsonage allowance is subject to the self-employment tax unless the minister is exempt (as discussed below).

Self-Employment Tax – A minister who hasn’t taken a vow of poverty is subject to self-employment tax on income from services performed as a minister.

An ordained minister may be granted an exemption from the self-employment tax for ministerial services only. To qualify, the church employing the minister must qualify as a religious organization under Code Section 501(c)(3). The application for an exemption is filed with Form 4361 (Application for Exemption from Self-Employment Tax for Use by Ministers, Members of Religious Orders, and Christian Science Practitioners).

To claim an exemption from the self-employment tax, the minister must meet all of the following conditions and file Form 4361 to request exemption from the self-employment tax. The minister must:

  • Be conscientiously opposed to public insurance because of his or her individual religious considerations or because of the principles of his or her religious denomination (not because of general conscience).
  • File for noneconomic reasons.
  • Inform the church’s or order’s ordaining, commissioning, or licensing body that he or she is opposed to public insurance, if he or she is a minister or a member of a religious order (other than a vow-of-poverty member). This requirement doesn’t apply to Christian Science practitioners or readers.
  • Establish that the organization that ordained, commissioned, or licensed him or her (or his or her religious order) is a tax-exempt religious organization.
  • Establish that the organization is a church (or a convention or association of churches).
  • Not have previously filed Form 2031 (Revocation of Exemption from Self-Employment Tax for Use by Ministers, Members of Religious Orders, and Christian Science Practitioners) to elect for Social Security coverage.

Form 4361 must be filed on or before the return’s extended due date for the second tax year when the individual has net self-employment earnings of $400 or more (part of which is from services as a minister). A late application will be rejected.

The time for applying starts over when a minister who previously was not opposed to accepting public insurance (i.e., Social Security benefits) enters a new ministry (e.g., joins a new church and adopts beliefs that include opposition to public insurance). However, the IRS has said that there is no second chance to apply for exemption if a minister is ordained in a different church but does not change his or her beliefs regarding public insurance (i.e., the minister opposed the acceptance of public insurance in both faiths).

Careful consideration should be made before applying for an exemption from the self-employment tax, as once the decision is made, the election is irrevocable.

If you have questions related to any of these issues or how they may apply to your situation, please give this office a call.

Employees’ Fringe Benefits after Tax Reform

Article Highlights:

  • Qualified Parking
  • Transit Passes
  • Bicycle Commuting
  • Commuting
  • Moving Deduction
  • Achievement Awards
  • Group Term Life Insurance
  • Dependent Care Benefits
  • Qualified Educational Assistance Programs

Tax reform made a lot of changes, some of which impacted employees’ fringe benefits. This article reviews the most frequently encountered fringe benefits, including those that were and were not impacted by tax changes. These changes can affect both a business’s bottom line and its employees’ deductions.

BENEFITS IMPACTED BY TAX REFORM

Qualified Transportation Fringe Benefits – Qualified transportation fringe benefits include parking, transit passes, commuter (van pool) transportation, and bicycle commuting.

  • Qualified parking – The tax-free fringe benefit for qualified parking is still available to employees and is capped at $265 per month for 2019, up from $260 in 2018.
  • Transit Passes – The tax-free fringe benefit for transit passes is also still available to employees, up to $265 per month for 2019, an increase from $260 in 2018.
  • Bicycle Commuting – Unfortunately, tax reform did away with the $20-per-month tax-free reimbursement for the cost of an employee commuting to work on a bicycle.
  • Commuting – Tax reform killed the monthly commuting fringe benefit (which was $260 in 2018) except when necessary for ensuring the safety of an employee. When allowed, the maximum amount is the same as the transit pass fringe benefit.

However, even though they are excludable fringe benefits for employees, after 2017, employers can no longer deduct their expenses for parking or mass transit passes or commuter highway vehicle transportation provided to their employees.

Moving expenses – Before 2018 and after 2025, taxpayers who move because of a change in work location who meet certain distance and time requirements are able to deduct their moving costs in excess of any tax-free reimbursement from their employer. However, that deduction is suspended for 2018 through 2025, and any employer reimbursement is taxable and included in the employee’s W-2.

There is one exception: moving expenses are still deductible for military members on active duty for moves pursuant to military orders.

Achievement awards – Employee achievement awards are excludable from income only to the extent that the award does not exceed $400 for any one employee or $1,600 for a qualified plan award. A qualified plan award means an employee achievement award awarded as part of an established written plan or program of the business that does not discriminate in favor of highly compensated employees.

Tax reform added the provision that to be tax-free, the award must be a tangible item. So awards of the following would be taxable to the employee recipient: cash, cash equivalents, gifts cards, gift coupons, gift certificates (other than if the employer pre-selected or pre-approved a limited selection), vacations, meals, lodging, tickets for theater or sporting events, stock, bonds, or similar items.

BENEFITS NOT IMPACTED BY TAX REFORM

Group Term Life Insurance – The first $50,000 of group term life insurance coverage provided by an employer is a tax-free fringe benefit that does not add anything to the employee’s overall tax bill. But the cost of employer-paid group term coverage in excess of $50,000 is treated as taxable income and added to the employee’s W-2. The cost of that insurance coverage is based on an IRS table and is frequently higher than the employer is actually paying for the insurance, which creates phantom income.

For older employees, the after-tax cost of the additional coverage frequently exceeds the cost for an individual term policy. It may be appropriate for certain employees to only utilize the first $50,000 in coverage and acquire an individual policy for any additional needed coverage.

Dependent Care Benefits – Employers can establish dependent care assistance plans for the exclusive benefit of their employees. The payments received under the plan that are used by employees to pay dependent care expenses are excludable from employees’ income, up to the lower of:

  1. The employee’s earned income (for married employees, this is the earned income of the lower-paid spouse) or
  2. $5,000 ($2,500 for married filing separate).

Dependent care assistance that exceeds the limits must be included in an employee’s income for the year the dependent care is provided, even though it is not paid to the employee until later.

Qualified Educational Assistance Programs – If an employer has a written qualified educational assistance program, an employee may receive, on a tax-free basis, up to $5,250 each year for any form of instruction or training that improves or develops his or her capabilities, whether or not it is job-related or part of a degree program. However, no deduction or credit may be taken by the employee for any amount excluded from the employee’s income as an education assistance benefit.

These are just a few of the fringe benefits that may have tax consequences. Please give this office a call if you have any questions related to them or other possibly excludable fringe benefits.

Gift and Estate Tax Primer

Article Highlights:

  • Exemptions from Gift and Estate Taxes
  • Annual Gift-Tax Exemption
  • Gifts for Medical Expenses and Tuition
  • Lifetime Exemption from Gift and Estate Taxes
  • Spousal Exclusion Portability
  • Qualified Tuition Programs
  • Basis of Gifts

The tax code places limits on the amounts that individuals can gift to others (as money or property) without paying taxes. This is meant to keep individuals from using gifts to avoid the estate tax that is imposed upon inherited assets. This can be a significant issue for family-operated businesses when the business owner dies; such businesses often have to be sold to pay the resulting inheritance (estate) taxes. This is, in large part, why high-net-worth individuals invest in estate planning.

Exemptions – Current tax law provides both an annual gift-tax exemption and a lifetime unified exemption for the gift and estate taxes. Because the lifetime exemption is unified, gifts that exceed the annual gift-tax exemption reduce the amount that the giver can later exclude for estate-tax purposes.

Annual Gift-Tax Exemption – This inflation-adjusted exemption is $15,000 for 2018 and 2019 (up from $14,000 for 2013–2017). Thus, an individual can give $15,000 each to an unlimited number of other individuals (not necessarily relatives) without any tax ramifications. When a gift exceeds the $15,000 limit, the individual must file a Form 709 Gift Tax Return. However, unlimited amounts may be transferred between spouses without the need to file such a return – unless the spouse is not a U.S. citizen. Gifts to noncitizen spouses are eligible for an annual gift-tax exclusion of up to $155,000 in 2019 (up from $152,000 in 2018).

Example: Jack has four adult children. In 2019, he can give each child $15,000 ($60,000 total) without reducing his lifetime unified exemption or having to file a gift tax return. Jack’s spouse can also give $15,000 to each child without reducing either spouse’s lifetime unified exemption. If each child is married, then Jack and his wife can each also give $15,000 to each of the children’s spouses (raising the total to $60,000 given to each couple) without reducing their lifetime unified tax exemptions. The gift recipients are not required to report the gifts as taxable income and do not even have to declare that they received the gifts on their income tax returns.

If any individual gift exceeds the annual gift-tax exemption, the giver must file a Form 709 Gift Tax Return. However, the giver pays no tax until the total amount of gifts in excess of the annual exemption exceeds the amount of the lifetime unified exemption. The government uses Form 709 to keep track of how much of the lifetime unified exemption that an individual has used prior to that person’s death. If the individual exceeds the lifetime unified exemption, then the excess is taxed; the current rate is 40%.

All gifts to the same person during a calendar year count toward the annual exemption. Thus, in the example above, If Jack gives one of his children a check for $15,000 on January 1, any other gifts that Jack makes to that child during the year, including birthday or Christmas gifts, would mean that Jack would have to file a Form 709.

Gifts for Medical Expenses and Tuition – An often-overlooked provision of the tax code allows for nontaxable gifts in addition to the annual gif-tax exclusion; these gifts must pay for medical or education expenses. Such gifts can be significant; they include

  • tuition payments made directly to an educational institution (whether a college or a private primary or secondary school) on the donee’s behalf – but not payments for books or room and board – and
  • payments made directly to any person or entity who provides medical care for the donee.

In both cases, it is critical that the payments be made directly to the educational institution or health care provider. Reimbursements to the donee do not qualify.

Lifetime Exemption from Gift and Estate Taxes – The gift and estate taxes have been the subject of considerable political bickering over the past few years. Some want to abolish this tax, but there has not been sufficient support in Congress to actually do that; instead, the inflation-adjusted lifetime exemption amount has been increasingly annually. In 2019, the lifetime unified exemption is $11.4 million per person. By comparison, in 2017 (prior to the recent tax reform), the lifetime unified exemption was $5.49 million. The lifetime exemption for the gift and estate taxes has not always been unified; in 2006, the estate exclusion was $2 million, and the gift exclusion was $1 million. The tax rates for amounts beyond the limit have varied from a high of 46% in 2006 to a low of 0% in 2010. The 0% rate only lasted for one year before jumping to 35% for a couple of years and then settling at the current rate of 40%.

This history is important because the exemptions can change significantly at Congress’s whim – particularly based on the party that holds the majority.

Spousal Exclusion Portability – When one member of a married couple passes away, the surviving member receives an unlimited estate-tax deduction; thus, no estate tax is levied in this case. However, as a result, the value of the surviving spouse’s estate doubles, and there is no benefit from the deceased spouse’s lifetime unified tax exemption. For this reason, the tax code permits the executor of the deceased spouse’s estate (often, the surviving spouse) to transfer any of the deceased person’s unused exclusion to the surviving spouse. Unfortunately, this requires filing a Form 706 Estate Tax Return for the deceased spouse, even if such a return would not otherwise be required. This form is complicated and expensive to prepare, as it requires an inventory with valuations of all of the decedent’s assets. As a result, many executors of relatively small estates skip this step. As discussed earlier, the lifetime exemption can change at the whim of Congress, so failing to take advantage of this exclusion’s portability could have significant tax ramifications.

Qualified Tuition Programs – Any discussion of the gift and estate taxes needs to include a mention of qualified tuition programs (commonly referred to as Sec 529 plans, after the tax-code section that authorizes them). These plans are funded with nondeductible contributions, but they provide tax-free accumulation if the funds are used for a child’s postsecondary education (as well as, in many states, up to $10,000 of primary or secondary tuition per year). Contributions to these plans, like any other gift, are subject to the annual gift-tax exclusion. Of course, these plans offer tax-free accumulation, so it is best to contribute funds as soon as possible.

Under a special provision of the tax code, in a given year, an individual can contribute up to 5 times the annual gift-tax exclusion amount to a qualified tuition account and can then treat the contribution as having been made ratably over a five-year period that starts in the calendar year of the contribution. However, the donor then cannot make any further contributions during that five-year period.

Basis of Gifts – Basis is the term for the value of an asset; it is used to determine the profit when an asset is sold. The basis of a gift is the same for the giver and the recipient, but this amount is not used for gift-tax purposes; instead, the fair market value is used.

Example: In 2019, Pete gifts shares of stock to his daughter. Pete purchased the shares for $6,000 (his basis), and they were worth $22,000 in fair market value when he gifted them to his daughter. Their value at the time of the gift is used to determine whether the gift exceeds the annual gift-tax exclusion. Because the gift’s value ($22,000) is greater than the $15,000 exclusion, Pete will have to file a Form 709 Gift Tax Return to report the gift; he also must reduce his lifetime exemption by $7,000 ($22,000 – $15,000). His daughter’s basis is also equal to the asset’s original value ($6,000); when she sells the shares, her taxable gain will be the difference between the sale price and $6,000. Thus, Pete has effectively transferred the tax on the stock’s appreciated value to his daughter.

If Pete’s daughter instead inherited the shares upon Pete’s death, her basis would be the fair market value of the stock at that time ($22,000) is she sold them for $22,000 she would have no taxable gain.

This is only an overview of the tax law regarding gifts and estates; please call this office for further details or to get advice for your specific situation.