What If You Want To File Your Taxes But Can’t Afford To Pay Them?

It’s a common conundrum: You want to file your taxes on time, but you anticipate or already know that you will owe money you can’t afford to pay right now. As a result, you put off filing your tax return under the assumption that the IRS can only bill you if they receive your latest outstanding tax return that’s due.

If you want to file your taxes right now, you should!

Am I Required to File a Tax Return?

You may want to file a tax return, but you are not actually required to. Generally, the gross income filing requirement is based on the standard deduction plus personal exemption for your filing status. The IRS has a tool to determine if you are required to file a tax return based on your income alone. Notably, taxpayers who are married and filing separately have a gross income filing requirement.

Regardless of the total reported income on your tax return, there are other situations in which you must file a tax return. If you owe self-employment tax on net self-employment income of $400 or more, you are obligated to file a tax return. It’s easy to go past this amount if you drive for Lyft or Uber, are giving freelance work a try, or have any other form of self-employment income that nets out to $400 or more after your deductible expenses.

You also must file a tax return if you receive Affordable Care Act subsidies for your health insurance, and if you have any recapture payments such as the First-Time Homebuyer Credit. Any early distributions taken against an IRA or 401(k) also require you to file a tax return even if you had no other income, and the same is true if you reach age 70 1/2 during the tax year and were required to make required minimum distributions (RMDs) from your retirement plan, but did not actually start these payments yet.

Even if you are not mandated to file a tax return, you may still want to file one to get a tax refund. If you aren’t due a tax refund, it’s still a good idea to have a tax return on file with the IRS. Tax returns are commonly requested when applying for a lease or mortgage, or to show proof of income and demonstrate ability (or inability) to pay for higher education and other important aspects of life that may arise.

Filing a Tax Return vs. Paying Your Actual Tax Bill

A common misconception is that you need to pay all taxes due when you file your tax return. While it’s prudent to do so, you are not actually required to. Filing your actual tax return is still the very first thing you should do no matter how much you owe, even if you’re filing it late. Doing so will prevent steep penalties from being incurred if you were required to file a tax return. Additionally, if you put off filing your tax return for too long, the IRS can file a substitute return that won’t apply any tax benefits and will make their assessment against you larger than it actually should be.

Even if you can’t afford to put anything toward your tax bill right now, the very least you should do is file your tax return before the deadline every year. If you want to file your taxes despite being unable to pay your bill right now, you can still do so.

Receiving an Automated Tax Bill  From the IRS

If you are unable to pay your taxes, you should still file a tax return without including payment. You can also include a partial payment of any size, even if it’s a small amount like $20. The IRS will not issue a judgment that quickly after you file your return, and even a small payment can help you save some money on interest.

If you do not pay your entire tax bill upon filing your return, the IRS will send an automated bill by mail. You can pay your balance before the bill arrives if you have the money to do so, but getting the bill in the mail doesn’t mean you are facing a lien against your bank account.

Interest will accrue on the unpaid balance as long as it goes unpaid, but owing money is a separate concept from filing your tax return on time, so you can and should file even if you can’t pay.

Hobby or Business? It Makes a Difference for Taxes – Now More than Ever

Article Highlights:

  • For-Profit Businesses
  • Not-for-Profit Businesses
  • Nine Determining Factors
  • Profit Presumption

Taxpayers are often confused by the differences in tax treatment between businesses that are entered into for profit and those that are not, commonly referred to as hobbies. Recent tax law changes have added to the confusion. The differences are:

Businesses Entered Into for Profit – For businesses entered into for profit, the profits are taxable, and losses are generally deductible against other income. The income and expenses are commonly reported on a Schedule C, and the profit or loss—after subtracting expenses from the business income—is carried over to the taxpayer’s 1040 tax return. (An exception to deducting the business loss may apply if the activity is considered a “passive” activity, but most Schedule C proprietors actively participate in their business, so the details of the passive loss rules aren’t included in this article.)

Hobbies – Hobbies, on the other hand, are not entered into for profit, and the government currently does not permit a taxpayer to deduct their hobby expenses but does require the income from the activity to be declared. (Prior to the changes included in the Tax Cuts and Jobs Act of 2017, hobbyists were allowed to deduct expenses up to the amount of their hobby income as a miscellaneous itemized deduction on Schedule A. Being able to take this deduction is suspended for years 2018 through 2025.) Thus, hobby income is reported on Schedule 1 of their 1040 and no expenses are deductible.

So, what distinguishes a business from a hobby? The IRS provides nine factors to consider when making the judgment. No single factor is decisive, but all must be considered together in determining whether an activity is for profit. The nine factors are:

(1) Is the activity carried out in a businesslike manner? Maintenance of complete and accurate records for the activity is a definite plus for a taxpayer, as is a business plan that formally lays out the taxpayer’s goals and describes how the taxpayer realistically expects to meet those expectations.

(2) How much time and effort does the taxpayer spend on the activity? The IRS looks favorably at substantial amounts of time spent on the activity, especially if the activity has no great recreational aspects. Full-time work in another activity is not always a detriment if a taxpayer can show that the activity is regular; time spent by a qualified person hired by the taxpayer can also count in the taxpayer’s favor.

(3) Does the taxpayer depend on the activity as a source of income? This test is easiest to meet when a taxpayer has little income or capital from other sources (i.e., the taxpayer could not afford to have this operation fail).

(4) Are losses from the activity the result of sources beyond the taxpayer’s control? Losses from unforeseen circumstances like drought, disease, and fire are legitimate reasons for not making a profit. The extent of the losses during the start-up phase of a business also needs to be looked at in the context of the kind of activity involved.

(5) Has the taxpayer changed business methods in an attempt to improve profitability? The taxpayer’s efforts to turn the activity into a profit-making venture should be documented.

(6) What is the taxpayer’s expertise in the field? Extensive study of this field’s accepted business, economic, and scientific practices by the taxpayer before entering into the activity is a good sign that profit intent exists.

(7) What success has the taxpayer had in similar operations? Documentation on how the taxpayer turned a similar operation into a profit-making venture in the past is helpful.

(8) What is the possibility of profit? Even though losses might be shown for several years, the taxpayer should try to show that there is realistic hope of a good profit.

(9) Will there be a possibility of profit from asset appreciation? Although profit may not be derived from an activity’s current operations, asset appreciation could mean that the activity will realize a large profit when the assets are disposed of in the future. However, the appreciation argument may mean nothing without the taxpayer’s positive action to make the activity profitable in the present.

There is a presumption that a taxpayer has a profit motive if an activity shows a profit for any three or more years within a period of five consecutive years. However, the period is two out of seven consecutive years if the activity involves breeding, training, showing, or racing horses.

All of this may seem pretty complicated, so please call this office if you have any questions or need additional details for your particular circumstances.

School’s Out – Who Is Going to Take Care of the Kids?

Article Highlights:

  • Child Age Limits
  • Employment-Related Expense
  • Married Taxpayer Earnings Limits
  • Disabled or Full-Time-Student Spouse
  • Expense Limits

Summer has just arrived, and there is a tax break that working parents should know about. Many working parents must arrange for care of their children under 13 years of age (or any age if disabled) during the school vacation period. A popular solution — with a tax benefit — is a day camp program. The cost of day camp can count as an expense toward the child and dependent care credit. But be careful; expenses for overnight camps do not qualify. Also, not eligible are expenses paid for summer school and tutoring programs.

For an expense to qualify for the credit, it must be an “employment-related” expense; i.e., it must enable you and your spouse, if married, to work, and it must be for the care of your child, stepchild, foster child, brother, sister or stepsibling (or a descendant of any of these) who is under 13, lives in your home for more than half the year and does not provide more than half of his or her own support for the year. Married couples must file jointly, and both spouses must work (or one spouse must be a full-time student or disabled) to claim the credit.

The qualifying expenses are limited to the income you or your spouse, if married, earn from work, using the figure for whoever earns less. However, under certain conditions, when one spouse has no actual earned income and that spouse is a full-time student or disabled, that spouse is considered to have a monthly income of $250 (if the couple has one qualifying child) or $500 (two or more qualifying children). This means the income limitation is essentially removed for a spouse who is a student or disabled.

The qualifying expenses can’t exceed $3,000 per year if you have one qualifying child, while the limit is $6,000 per year for two or more qualifying persons. This limit does not need to be divided equally. For example, if you paid and incurred $2,500 of qualified expenses for the care of one child and $3,500 for the care of another child, you can use the total, $6,000, to figure the credit. The credit is computed as a percentage of your qualifying expenses; in most cases, 20%. (If your joint adjusted gross income [AGI] is $43,000 or less, the percentage will be higher, but it will not exceed 35%.)

Example: Al and Janice both work, each with earned income in excess of $40,000 per year. Janice has a part-time job, and her work hours coincide with the school hours of their 11-year-old daughter, Susan. However, during the summer vacation period, they place Susan in a day camp program that costs $4,000. Since the expense limitation for one child is $3,000, their child credit would be $600 (20% of $3,000).

The credit reduces a taxpayer’s tax bill dollar for dollar. Thus, in the above example, Al and Janice pay $600 less in taxes by virtue of the credit. However, the credit can only offset income tax and alternative minimum tax liability, and any excess is not refundable. The credit cannot be used to reduce self-employment tax or the taxes imposed by the Affordable Care Act.

If the qualifying child turned 13 during the year, the care expenses paid for the child for the part of the year he or she was under age 13 will qualify.

If you have questions about how the childcare credit applies to your particular tax situation, please give this office a call.

Would a Mid-Year Tax Checkup Benefit You?

Article Highlights:

  • Procrastination Can Lead to Unneeded Taxes & Penalties
  • Events That Create Tax Problems & Opportunities
  • Mid-Year Tax Checkup

If you are inclined to procrastinate until the end of the year or, even worse, until tax-filing season to worry about your taxes, you may be missing out on opportunities to reduce your tax and avoid certain penalties. The following are some events that can affect your tax return; you may need to take steps to mitigate their impact and avoid unpleasant surprises after it is too late to address them.

  • Did you get married, get divorced, or become widowed?
  • Did you change jobs or has your spouse started working?
  • Did you have a substantial increase or decrease in income?
  • Did you have a substantial gain from the sale of stocks or bonds?
  • Are you considering an investment in a Qualified Opportunity Fund to defer tax on capital gains?
  • Did you buy or sell a rental?
  • Did you start, acquire, or sell a business?
  • Did you buy or sell a home?
  • Did you retire this year?
  • Are you on track to withdraw the required amount from your IRA (age 70.5 or older)?
  • Are you taking advantage of the IRA-to-charity transfers (age 70.5 or older)?
  • Did you refinance your home or take out a second home mortgage this year?
  • Were you the beneficiary of an inheritance this year?
  • Did you welcome a new child into your family? Time to consider a tax-advantaged educational savings plan!
  • Are you taking full advantage of retirement savings plans?
  • Have you made any significant equipment purchases for your business?
  • Are you planning to purchase a new business vehicle and dispose of the old one?
  • Are your cash and non-cash charitable contributions adequately documented?
  • If your expenses eligible for itemizing are less than the standard deduction, have you considered bunching charitable contributions so you can itemize this year and then use the standard deduction next year?
  • Did you, or are you planning to, make energy-efficiency improvements to your main home or install a solar system for your main or second home this year?
  • Are you paying college tuition for yourself, your spouse or dependent(s)?
  • Are you keeping up with your estimated tax payments or do they need adjusting?
  • Did you purchase your health insurance through a government insurance marketplace and qualify for an insurance premium subsidy? If your income subsequently increased, you may need to be prepared to repay some portion of the subsidy.
  • Do you have substantial investment income or gains from the sale of investment assets? If so, you may be hit with the 3.8% surtax on net investment income and need to adjust your advance tax payments.
  • Did you make any unplanned withdrawals from an IRA or pension plan?
  • If you are a business owner, do you need to change how the business is organized to take full advantage of the 20% of qualified business income deduction?
  • If you are an employee that incurs job-related expenses that aren’t deductible for years 2018 through 2025, have you arranged with your employer to participate in an accountable reimbursement plan for these expenses?
  • Have you stayed abreast of every new tax law change?

If you anticipate or have already encountered any of the above events or conditions, it may be appropriate to schedule a mid-year tax checkup and consult with this office— preferably before any of the events listed, and definitely before the end of the year.

Gift Tax Treatment of Tuition Plans

Article Highlights:

  • Purpose of Qualified Tuition Plans
  • Gift Tax Implications
  • Special Five-Year Election
  • Change of Beneficiary
  • Eligible Expenses
  • Direct Payment of Tuition

Qualified tuition plans (QTPs) provide a means for family members and others to save for the future educational needs of children. Investment earnings within a QTP account are tax deferred and not taxable when withdrawn if used to pay qualified tuition and certain other expenses.

Each individual’s contribution to a QTP (also sometimes referred to as a “Section 529 plan”) on behalf of a designated beneficiary is treated as a gift subject to the normal gift tax rules. Thus, no gift tax return is required for any contributor if the contribution is equal to or less than the amount of the gift tax annual exclusion for the year of the gift, which for 2019 is $15,000.

Special Election – When a donor’s total contribution to a QTP for the year exceeds the annual exclusion amount, the donor may make a special election treating the contributed funds as if they had been contributed ratably over a five-year period starting with the year of the contribution.

Example: Grandpa Lee contributes $75,000 to granddaughter Whitney’s QTP in 2019. By using the election, grandpa’s contribution is treated as if the contribution was made equally over a five-year period – that is, as if he’d contributed $15,000 in each of 2019, 2020, 2021, 2022 and 2023. If grandpa makes any more QTP contributions during those years, those contributions would then exceed the annul gift limit and require a gift tax return to be filed. The same would be true if grandpa makes other gifts to Whitney.

To make the five-year election grandpa must file a Form 709, Federal Gift Tax Return, for the calendar year in which the contribution is made.

The election is available only with respect to contributions not in excess of five times the annual exclusion amount for the calendar year of the contribution. Any excess is treated as a taxable gift in the calendar year of the contribution. However, that does not necessarily mean any gift tax will be owed since there is also a unified gift and estate tax lifetime exclusion (currently in excess of $11 million) that will shield most taxpayers like grandpa from any gift tax.

If grandpa were married, he and grandma could make an election under the gift-splitting rules for the QTP contribution to be made one-half by each of them, thus allowing them to double up on the annual and the special 5-year amounts.

If in any year after the first year of the five-year period, the amount of the gift tax annual exclusion is increased for inflation, the donor may make an additional contribution in any one or more of the four remaining years up to the difference between the exclusion amount as increased and the original exclusion amount for the year or years in which the original contribution was made.

Example: In 2017 when the annual gift tax exemption was $14,000, grandpa made a $70,000 contribution to his granddaughter’s QTP and made the 5-year election. For 2018 the annual gift tax exemption was increased to $15,000. Thus, grandpa can make an additional $1,000 contribution for each of the remaining 4 years of the 5-year election period.

Change of Beneficiary – A change in the designated beneficiary, or a rollover to the account of a new beneficiary, is treated as a taxable gift if the new beneficiary is assigned to a generation below the generation of the old beneficiary. Such a transfer isn’t a taxable gift if the new beneficiary is a member of the family of the old beneficiary, and is assigned to the same generation, as the old beneficiary.

If the new beneficiary is assigned to a lower generation than the old beneficiary, the transfer is a taxable gift from the old beneficiary to the new beneficiary, regardless of whether the new beneficiary is a member of the family of the old beneficiary.

In addition, the transfer would be subject to the generation skipping transfer tax (GST) if the new beneficiary is assigned to a generation which is two or more levels lower than the generation assignment of the old beneficiary. The five-year averaging election may be applied to a transfer.

Example: Suppose Whitney had not used the funds from the QTP or has finished her higher education and had some funds left over in the plan, and grandpa (or the trustee of the account if grandpa is not the trustee) decides to change the account beneficiary to his great-granddaughter Annabelle. Since Annabelle is in a generation lower than Whitney, the change of beneficiary represents a gift from Whitney to Annabelle. However, the five-year averaging election may be applied to the gift.

Eligible Expenses – Distributions from QTPs, including earnings on the amounts contributed to a QTP, aren’t taxed for income tax purposes if they are used to pay qualified higher-education expenses of the account beneficiary. In addition to tuition, eligible expenses include the following:

  • Fees;
  • Books;
  • Supplies;
  • Equipment;
  • The purchase of computers or peripheral equipment, computer software, or internet access and related services that will be used primarily by the beneficiary while the beneficiary is enrolled at an eligible educational institution;
  • Room and board if the beneficiary is attending a qualified school at least half time; and
  • A special needs student’s expenses that are necessary to enable the student to enroll or attend an eligible educational institution.

When distributions exceed eligible expenses, the beneficiary of the QTP is the one who would include the nonqualified distributions in his or her income. The calculation of the taxable amount of the distribution can be complicated if the beneficiary received a tax-free scholarship. In some cases a 10% penalty also applies on the taxable distribution that is included in income.

While QTPs are generally intended to be used for higher education expenses, for years after 2017, up to $10,000 distributed from a QTP for tuition expense (but not for related other expenses) paid so the beneficiary can attend an elementary or secondary school (kindergarten through grade 12) is considered a qualified education expense that would be tax-free. However, some states have not recognized this provision, and so such distributions would be at least partially taxable for state purposes.

Direct Payment of Tuition – Some potential contributors to a QTP for family members may wish to pay for the tuition when it is actually incurred rather than saving for it in advance. If that individual makes the tuition payment directly to a qualified school, college or university the gift tax does not apply.

If you have questions related to QTPs in general or changing beneficiaries, please give this office a call.

What is an IRS Penalty Abatement and Am I Eligible for One?

There are different types of IRS penalties that can be assessed against you. The most common penalties include those for failing to file a tax return, filing your return late, or accuracy-related penalties if you didn’t correctly state items on your tax return. But were you aware that sometimes, the IRS can issue penalty abatements if you believe you’ve been penalized unfairly?

Civil penalties for underpayment, late filing, or erroneous inaccuracy may be eligible for abatement, but criminal penalties for tax protest and willful violations of the law are not. There is also the first-time penalty administrative waiver program (FTA) that applies in certain cases. Here’s what you need to know about successfully fighting IRS penalties and determining eligibility for the waiver program.

What a Penalty Abatement Does NOT Include

Regardless of whether you are trying to secure an ordinary penalty abatement or relief under the FTA program, penalty abatement procedures are only for the penalties themselves. They do not include interest on unpaid taxes, the amount of the taxes themselves, or any related processing fees such as installment agreement setup charges.

If your abatement request is successful, only the interest charged on the penalty would be abated, opposed to interest on unpaid taxes.

Proving Hardship for Failure to File or Failure to Pay Penalties

The failure to file penalty kicks in if you file your tax return late, or not at all, and is based on 5% of your unpaid taxes every month (up to 25% of your total balance due). The best way to avoid this penalty is to file for a six-month extension prior to the tax filing deadline if you don’t think you’ll get your return filed on time. The extension won’t waive interest, taxes, or penalties for failure to pay or deposit, but it will eliminate the failure to file penalty, which is much higher.

The IRS will consider penalty abatement requests provided that you have reasonable cause for not being able to file or pay your taxes in a timely manner. Valid hardships, such as hospitalization, natural disasters, or fleeing domestic violence, are factored into reasonable cause to get certain civil penalties waived.

Failure to pay penalties result from having an unpaid balance due, with 0.5% being charged every month. Simply lacking funds to pay your taxes doesn’t necessarily equate to hardship to file your tax return on time or pay your tax bill. However, if you have a continuous lack of funds due to disability or chronic illness, a death in the family, or similar hardships, you may be eligible for relief from the failure to pay penalty.

First-Time Penalty Administrative Waiver (FTA Program)

Under the FTA program, you can have failure to file, failure to pay, and failure to deposit penalties waived if you were never assessed penalties in the past three tax years or had them relieved because of reasonable cause. Estimated tax penalty (deposit penalty), as is common with self-employed taxpayers, is the only allowable penalty to bear.

You must also be current on all of your current tax returns or extensions and paid any taxes due (or arrangements like payment plans). If your charges include failure to pay penalties, it’s a good idea to wait until you’ve paid the entire balance before requesting FTA waivers since you don’t need to prove hardship and can get more waived.

FTA waivers are the best option if you meet the above requirements as this request takes less time to process than ordinary penalty abatement, because you don’t need to establish reasonable cause or hardship.

Why Tax Basis Is So Important

Article Highlights:

  • Definition of Tax Basis
  • Cost Basis
  • Adjusted Basis
  • Gift Basis
  • Inherited Basis
  • Record Keeping

For tax purposes, the term “basis” refers to the original monetary value that is used to measure a gain or loss. For instance, if you purchase shares of a stock for $1,000, your basis in that stock is $1,000; if you then sell those shares for $3,000, the gain is calculated based on the difference between the sales price and the basis: $3,000 – $1,000 = $2,000. This is a simplified example, of course—under actual circumstances, purchase and sale costs are added to the basis of the stock—but it gives an introduction to the concept of tax basis. The basis of an asset is very important because it is used to calculate deductions for depreciation, casualties, and depletion, as well as gains or losses on the disposition of that asset.

The basis is not always equal to the original purchase cost. It is determined in a different way for purchases, gifts, and inheritances. In addition, the basis is not a fixed value, as it can increase as a result of improvements or decrease as a result of business depreciation or casualty losses. This article explores how the basis is determined in various circumstances.

Cost Basis – The cost basis (or unadjusted basis) is the amount originally paid for an item before any improvements and before any business depreciation, expensing, or adjustments as a result of a casualty loss.

Adjusted Basis – The adjusted basis starts with the original cost basis (or gift or inherited basis), then incorporates the following adjustments:

  • increases for any improvements (not including repairs),
  • reductions for any claimed business depreciation or expensing deductions, and
  • reductions for any claimed personal or business casualty-loss deductions.

Example: You purchased a home for $250,000, which is the cost basis. You added a room for $50,000 and a solar electric system for $25,000, then replaced the old windows with energy-efficient double-paned windows at a cost of $36,000. The adjusted basis is thus $250,000 + $50,000 + $25,000 + $36,000 = $361,000. Your payments for repairs and repainting, however, are maintenance expenses; they are not tax deductible and do not add to the basis.

Example: As the owner of a welding company, you purchased a portable trailer-mounted welder and generator for $6,000. After owning it for 3 years, you then decide to sell it and buy a larger one. During this period, you used it in your business and deducted $3,376 in related deprecation on your tax returns. Thus, the adjusted basis of the welder is $6,000 – $3,376 = $2,624.

Keeping records regarding improvements is extremely important, but this task is sometimes overlooked, especially for home improvements. Generally, you need to keep the records of all improvements for 3 years (and perhaps longer, depending on your state’s rules) after you have filed the return on which you report the disposition of the asset.

Gift Basis – If you receive a gift, you assume the doner’s adjusted basis for that asset; in effect, the doner transfers any taxable gain from the sale of the asset to you.

Example: Your mother gives you stock shares that have a market value of $15,000 at the time of the gift. However, your mother originally purchased the shares for $5,000. You assume your mother’s basis of $5,000; if you then immediately sell the shares, your taxable gain is $15,000 – $5,000 = $10,000.

There is one significant catch: If the fair market value (FMV) of the gift is less than the doner’s adjusted basis, and if you then sell it for a loss, your basis for determining the loss is the gift’s FMV on the date of the gift.

Example: Again, say that your mother purchased stock shares for $5,000. However, this time, the shares were worth $4,000 when she gave them to you, and you subsequently sold them for $3,000. In this case, your tax-deductible loss is only $1,000 (the sales price of $3,000 minus the $4,000 FMV on the date of the gift), not $2,000 ($3,000 minus your mother’s $5,000 basis).

Inherited Basis – Generally, a beneficiary who inherits an asset uses its FMV on the date when the owner died as the tax basis. This is because the tax on the decedent’s estate is based on the FMV of the decedent’s assets at the time of death. Normally, inherited assets receive a step up (increased) in basis. However, if an asset’s FMV is less than the decedent’s basis, then the beneficiary’s basis is stepped down (reduced).

Example: You inherit your uncle’s home after he dies. Your uncle’s adjusted basis in the home was $50,000, but he purchased the home 25 years ago, and its FMV is now $400,000. Your basis in the home is equal to its FMV: $400,000.

Example: You inherit your uncle’s car after he dies. Your uncle’s adjusted basis in the car was $50,000, but he purchased the car 5 years ago, and its FMV is now $20,000. Your basis in the car is equal to its FMV: $20,000.

An inherited asset’s FMV is very important because it is used when determining the gain or loss after the sale of that asset. If an estate’s executor is unable to provide FMV information, the beneficiary should obtain the necessary appraisals. Generally, if you sell an inherited item in an arm’s-length transaction within a short time, the sales price can be used as the FMV. A simple example of not at arm’s length is the sale of a home from parents to children. The parents might wish to sell the property to their children at a price below market value, but such a transaction might later be classified by a court as a gift rather than a bona fide sale, which could have tax and other legal consequences.

For vehicles, online valuation tools such as Kelly Blue Book can be used to determine FMV. The value of publicly traded stocks can similarly be determined using Website tools. On the other hand, for real estate and businesses, valuations generally require the use of certified appraisal services.

The foregoing is only a general overview of how basis applies to taxes. If you have any questions, please call this office for help.

Forget Something on Your 2018 Return?

Article Highlights:

  • Tax Reform Problems
  • Corrected 1099s and K-1s
  • Overlooked Income and Deductions
  • Marital Issues
  • Mitigating Penalties
  • The Need for Prompt Amendments

If you forgot to include necessary information on your 2018 return, you are not alone. In addition, you may have received a revised 1099 or K-1 since filing your return. The IRS has struggled to deal with the enormity of the changes in the recent tax reform; despite significant pressure to update its regulations, forms, and publications, the IRS could not finish all of its tax-reform updates in a timely manner. Some IRS publications still have not been updated for 2018, and others even include errors. The new tax regulations have been dribbling out, but the IRS still has not provided sufficient guidance for some issues.

As a result of this uncertainty, you may receive a corrected 1099 or K-1. You may also need to update your return because, like most taxpayers, you did not fully comprehend all of the provisions of the new tax law thus failing to include an item of income, deduction, or credit. You also may have simply overlooked an item of income or missed a significant deduction. These mistakes happen, which is why the IRS and state tax agencies allow for amended tax returns.

A failure to report an item of income will generate an IRS inquiry; this typically happens a year or so after the filing of the original return—which is after the interest and penalties have built up. On the other hand, if you forgot a deduction and are owed a refund, you should not let that go by the wayside.

In some cases, marital problems lead taxpayers to file incorrectly—for instance, by incorrectly claiming children or not allocating income correctly. These and myriad other issues can be corrected by amending the returns. As warning, please note that, if you are married and filed a joint return, you cannot amend to file separate returns. However, a married couple’s separate returns can be amended into a single joint return.

Regardless of the issue, the solution is to file an amended return as soon as possible. This will minimize the penalties and interest in the case of omitted income and will also prevent you from getting those annoying letters from the IRS. Amended returns can also be used to claim an overlooked credit, to correct your filing status or number of dependents, to report an omitted investment transaction, to submit a delayed K-1, or to include any other information that should have been on the original return.

If an overlooked item results in a tax increase, filing the amended return quickly will mitigate the penalties and interest. Procrastination will lead to further complications when the IRS eventually determines that information is missing, so it is always best to take care of the issue right away.

Generally, to claim a refund on an amended return, you must file the amendment within three years of the date when you filed the original return, or within two years of the date when you paid the tax—whichever is later.

If any of these issues apply to you, please give this office a call so that we can prepare the necessary amended returns.

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.

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.