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TaxLaw
2020 TaxEase, LLC
10 HOUR CONTINUING EDUCATION
2020 TAX LAW COURSE
IRS COURSE NUMBER: B8FQK-T-00035-20-S CTEC COURSE NUMBER: 3064-CE-0063
See Page II for “Online” exam instructions
See Page III for “Fax or Email” exam instructions
PHONE NUMBER: 512-256-5812 WEBSITE: www.taxeaseed.com
FAX NUMBER: 510 779-5251 EMAIL: [email protected]
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Online Instructions
The "Online Exam" allows you to add one more choice to how you complete your annual
continuing education. If you use the online system, each section will be graded immediately.
When you pass the exam with 70% or better any incorrect questions will be displayed. Please
read the following instructions before clicking on the link.
To access your exam go to www.taxeaseed.com and click on “Access Online Exams” on the
home page.
Returning Students: Enter your Login and Password you created in a prior year. You must have
your 2020 Order Number* to complete the login. Use either the Login you created last year or
your email address as your Login. You must enter your Order Number to continue.
*The 2020 Order Number is found on your Confirmation Email.
New Students: Setup your account by clicking Register on the login screen and following the
prompts. You must have your TaxEase 2020 Order Number and PTIN Number to complete the
login process. If you are a CTEC Registered Tax Preparer, you must also have your CTEC
number, for TaxEase to report your continuing education.
Click on the “Choose Program” button then click on the exam that you wish to take
2020 TAX LAW COURSE (10-Hours CE)
You are allowed to stop, restart and resume the exams. You are allowed to login and logout. Be
sure to logout and close your browser, you must enter through our website www.taxeaseed.com
and select “Access Online Exams” from the home page to return to your exam.
A copy of the exam questions is found in the back of the syllabus. You do not have to take the
exams in order. You can print your Certificate after successfully completing each of the exams
within the bundle. All students taking the 10 Hour Tax Law Course online will receive your
score at the end of each exam. You may retake any of the exams you do not pass. Once the exam
is passed, you cannot retake.
TaxEase will notify CTEC and the IRS of your successful completion of each exam within 10
days. You must successfully pass all four exams before registering with CTEC.
Your feedback is very important to our development of our courses. We would greatly appreciate
if you would take a few moments and complete our TaxEase Course Evaluation.
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Fax or Email Instructions
1. The Final Exam Questions, Final Exam Answer Sheet, Personal Information Form and
Evaluation Sheet are found at the back of this syllabus. The exam is open book; all the
answers are included in the text.
2. There is only one correct answer per question. Mark an “X” in the correct answer box on the
Final Exam Answer Sheet provided. All questions in all sections of the Final Exam must be
completed before submitting the answer sheet to TaxEase. Only TaxEase answer sheet will
be accepted.
3. Email or fax the following items: Answer Sheet, Personal Information Form and the Course
Evaluation. TaxEase no longer accepts mailed answer sheets.
Fax: 510-779-5251
Scan and email: [email protected]
4. TaxEase will grade the final exam. A score of 70% or better in each part is passing. Submit
ONLY the Answer Sheet, Personal Information Form and Evaluation Page.
5. If you do not pass the test the first time, you may retake the test at no additional charge.
6. Paper certificates are available instead of email certificates for $15 each. Paper certificates
are ordered on the Personal Information Form at the time the exam is submitted.
7. Students must provide TaxEase with their current CTEC number. No tests will be reported to
CTEC unless the CTEC number is on the TaxEase Personal Information Form. If your
registration is not current with CTEC, do not complete this course for CTEC continuing
education. TaxEase will report your 20 hours of continuing education to CTEC within 10
days of successful passage of this course.
8. TaxEase will report 15 hours of continuing education to your PTIN account upon successful
passage of this course if a valid PTIN is entered on TaxEase Personal Information Form.
TaxEase reports continuing education to the IRS within the required timeframes.
9. TaxEase provides the answers to the incorrect questions upon successful passage of the
exam, if the exam is taken “Online”. Incorrect answers will not be provided on exams
submitted by fax or email.
Advantages to Taking Your Exam Online Instant Grading
After You Pass the Exam - Know the Questions You Missed
Instant Printed Certificate
Retake the Test Without Waiting for Manual Grading
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TaxEase “20 Hour CTEC CE Bundle” Designed to meet the requirements for California Registered Tax Preparers (CRTP)
This is an intermediate course, designed for seasoned tax preparers, who have the basic
knowledge of tax. TaxEase objective is to:
Provide continuing education for seasoned tax preparers
Provide the student with comprehensive learning material, including examples and
interactive questions and answers to assist in the learning process.
Give an update and review of current tax matters.
Supply material that will give a wealth of information for use as a reference.
Meet all the requirements for a CTEC registered tax preparer
Meet all IRS voluntary continuing education requirements to receive an IRS Record of
Completion.
Specific objectives are stated at the beginning of each chapter.
The authors of this publication are offering a continuing education program only. TaxEase LLC
and the authors are not rendering any legal, accounting or other professional advice whatsoever.
There is always the possibility of error in every publication, though we try to avoid it. If a
significant error comes to our attention, you will find a correction on our website
www.taxeaseed.com. Your own research is always recommended. All tax situations and facts
differ. We strongly recommend that you do additional research and refer to IRS code and
publications in all situations. We do not take responsibility for any professional advice given to
you or given by you to others.
Tax preparers can use this course to meet their 15-hour federal continuing education
requirement. TaxEase is required to report continuing education hours that a student successfully
completes to the IRS if a valid PTIN is provided on TaxEase Personal Information Form (paper
exam) or the User Information screen (online exams).
This Continuing Education class is a CTEC-approved course, which fulfills the 20-hour
“continuing education” requirements for tax preparers in California. A listing of additional
requirements to register as a CTEC tax preparer can be obtained by contacting CTEC at P.O.
Box 2890, Sacramento, CA, 95812-2890, by phone at (877) 851-2832, or on the Internet at
www.ctec.org. TaxEase, LLC is an approved education provider.
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2020 Tax Year
This text will be continually updated to put in the 2020 tax law changes as they become
effective. The references made to 2019 are for examples where information for 2020 is not
available.
Course Update Policy
Tax Law is always changing. TaxEase endeavors to keep up by updating the Update Section of
our syllabus. We will do this whenever there is a significant change. If you already purchased the
course, you will receive an email and all new information will be posted on the Update Page of
our website. www.taxeaseed.com
Assignments
This is an intermediate course, designed for seasoned tax preparers, who have the basic
knowledge of tax law. This course references the Internal Revenue Code, tax publications and
tax case law. TaxEase recommends that you use IRS publications available on the IRS website
for additional information, though they are not needed to complete this course.
Thorough reading of this syllabus is required. All courses include review questions which we
call “What Do You Think?” to help guide the student. This course contains all answers to the
final exam questions.
To receive Internal Revenue publications, forms or instructions call or visit their website:
IRS: (800) 829-3676 www.irs.gov
CTEC rules require all students to renew their CTEC registration by October 31, 2020 (CTEC
allows late registration between Nov. 1, 2020 and Jan 15, 2021).
Course Refund Policy
All continuing education must be paid for in advance. We offer a full money back guarantee, if
requested within thirty (30) days of date ordered and prior to submission of any answer sheet for
grading. TaxEase will not exchange any courses for the following year. NO REFUNDS FOR
THIS COURSE WILL BE ISSUED AFTER JANUARY 15, 2021.
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About the Authors
Sue Tornberg, EA is one of the owners of TaxEase and the author of TaxEase courses. Sue has
over 30 years of tax experience.
She started her career working for a computerized tax company, in the capacity of Technical Tax
Manager. That company processed over half a million tax returns for accountants. At that time,
Sue was in charge of writing and speaking at workshops that were given to clients. These
workshops explained the bridge between tax law and the computer input forms.
In 1999, Sue became the co-owner and Chief Financial Officer of The Tax Company, which
processed tax returns for over 300 accountants. While at The Tax Company, Sue qualified as a
CTEC provider for qualifying and continuing education. As the course administrator, she was
responsible for the writing and implementation of all course material. Sue has been writing the
course material for Tax Company and TaxEase for over 20 years. Tax Company and TaxEase
have passed every 3-year review from CTEC during that time. TaxEase is very pleased to keep
many of the same students year after year.
Jan Cusumano has been a CTEC Registered Tax Preparer for 20 years. She is the co-founder of
TaxEase; not only is she active in the preparation of tax returns each year, but also is an expert in
payroll and withholding issues, which our tax clients rely on. Jan actively researches, reviews,
and edits these courses each year.
Sue and Jan founded TaxEase LLC in 2007. They also have a private tax practice in Northern
California where they prepare approximately 500 individual, estate and trust, and business
returns annually.
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Contents
Online Instructions .............................................................................................................................. 2
Fax or Email Instructions ................................................................................................................... 3
Advantages to Taking Your Exam Online ..................................................................................... 3 TaxEase “20 Hour CTEC CE Bundle” ............................................................................................. 4
Assignments ..................................................................................................................................... 5 About the Authors ........................................................................................................................... 6
Contents ............................................................................................................................................. 7 Chapter 1 – Filing ................................................................................................................................. 13
2020 Economic Impact Payment .................................................................................................. 13
Filing Season Statistics Cumulative Statistics Comparing 4/20/18 and 4/19/2019 ........ 14
Tax Brackets Thresholds ............................................................................................................... 15
Gross Income Threshold For Filing Form 1040 ....................................................................... 16
Exemptions Repealed by TCJA .................................................................................................... 16
Maximum Rates on Capital Gains and Qualified Dividends ................................................. 17 Amended Returns ............................................................................................................................ 18
What Do You Think? ....................................................................................................................... 19
What Do You Think? - Answers ................................................................................................... 20
Net Investment Income Tax ........................................................................................................... 22
TCJA Changes to Adjustments to Income ................................................................................ 24
Repeal of Deduction for Moving Expenses .............................................................................. 24
Student Loans ................................................................................................................................... 24
Recharacterization of an IRA ........................................................................................................ 26 Child Tax Credit 2020:..................................................................................................................... 26
“Earned Income” Formula for Computing the Additional Child Tax Credit ..................... 27
What Do You Think? ....................................................................................................................... 29
What Do You Think? – Answers .................................................................................................. 30 Chapter 2 – Itemized Deductions ..................................................................................................... 31
Standard Deductions versus Itemized Deductions ................................................................ 31 Medical Expenses ............................................................................................................................ 32
Capital Expenses Deductible as Medical Expenses ............................................................... 37
What Do You Think? ....................................................................................................................... 38
What Do You Think - Answers ...................................................................................................... 39
Schedule A Taxes ............................................................................................................................ 40 Real Estate Taxes ............................................................................................................................ 41
Personal Property Tax .................................................................................................................... 41 Mortgage Payment Forbearance .................................................................................................. 41 Home Mortgage Interest ................................................................................................................. 42
Mortgage Interest Statement......................................................................................................... 44 Loan Origination Fees - Points..................................................................................................... 46
What Do You Think? ....................................................................................................................... 48 What Do You Think? – Answers .................................................................................................. 49
Charitable Contributions ................................................................................................................ 50 Partial Above-the-Line Charitable Contribution Deduction .................................................. 50 Temporary Suspension of Contribution Limitations .............................................................. 50
TCJA Increase of Cash contributions ........................................................................................ 53
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Noncash Contributions .................................................................................................................. 54
Donated Goods Valuation Chart .................................................................................................. 57
Contribution Carryovers ................................................................................................................ 58 TCJA Casualties and Theft ............................................................................................................ 59
Casualty Losses ............................................................................................................................... 60 Miscellaneous Itemized Deductions ........................................................................................... 60
Gambling Winnings and Losses .................................................................................................. 61 What Do You Think? ....................................................................................................................... 63 What Do You Think? – Answer..................................................................................................... 64
Chapter 3 – Education and Related Issues ................................................................................... 65 American Opportunity Credit ........................................................................................................ 65
American Opportunity Credit or Lifetime Learning Credit (2020) ....................................... 67 Form 8863........................................................................................................................................... 68
Fees, Books Supplies and Equipment ....................................................................................... 68 What Do You Think? ....................................................................................................................... 70 What Do You Think?-Answers ..................................................................................................... 71
Qualified Tuition Plan or §529 Plan ............................................................................................. 72 Allowing 529 plans to be used for K-12 tuition ........................................................................ 72
Recapture of Education Credit ..................................................................................................... 73 QTP and Coverdell ESA ................................................................................................................. 75
ABLE Accounts ................................................................................................................................ 76 U.S. Savings Bonds Interest Exclusion ..................................................................................... 77
Student Loan Interest ..................................................................................................................... 79
Student Loans Discharged on Account of Death or Disability ............................................ 80 MAGI when using Form 1040. ....................................................................................................... 80
What Do You Think? ....................................................................................................................... 81
What Do You Think? - Answers ................................................................................................... 82 Chapter 4 –Relevant Pass-through Entities (RPE), Rental Activities and Qualified Business Income (QBI) ....................................................................................................................... 84
Regulations Regarding Section 199A......................................................................................... 85
Form 1040........................................................................................................................................... 90
Schedule C and QBI Worksheet ................................................................................................... 94
Form 8995........................................................................................................................................... 99
What Do You Think? ...................................................................................................................... 99 What Do You Think? _Answers ................................................................................................... 101
Calculating the Qualified Business Income Deduction below the Threshold ................ 101 Trade or Business Requirement for QBI; Rental Real Estate Activities ........................... 102 QBI Rental Example – Form 8995 ................................................................................................ 105
Rental Activity Defined ................................................................................................................... 106 Different Rules Apply at Different Levels of Taxable Income .............................................. 108
Reasonable Compensation and Guaranteed Payments Are Not QBI ................................ 108 Calculating W-2 Wage Limitation................................................................................................. 114
Unmodified Box Method................................................................................................................. 116 Modified Box 1 Method ................................................................................................................... 116 Tracking Wages Method................................................................................................................. 116
Form 8995-A, Qualified Business Income Deduction ............................................................ 117
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Overall limitation applied after combined QBI is calculated ................................................ 118
QBI Deduction – Specified Service Trade or Business ......................................................... 126
Estates and Trusts ........................................................................................................................... 130 What Do You Think? ....................................................................................................................... 132
What Do You Think? – Answers .................................................................................................. 133 Unmodified Box Method................................................................................................................. 135
Modified Box 1 Method ................................................................................................................... 135 Tracking Wages Method................................................................................................................. 135 Rental Income ................................................................................................................................... 136
Rental Expenses............................................................................................................................... 137 Material Participation ...................................................................................................................... 140
Passive Activity Rules .................................................................................................................... 140 Rental Activity Treated as a Business ....................................................................................... 144
What Do You Think? ....................................................................................................................... 146 What Do You Think? - Answers ................................................................................................... 147
Chapter 5 –Depreciation and Cost Basis....................................................................................... 148
Listed Property ................................................................................................................................. 153 Original Use Requirement for Bonus Depreciation and IRC §179 ...................................... 153
IRC §179 .............................................................................................................................................. 153 Section 179 at a Glance for 2020 ................................................................................................. 155
Luxury Autos ..................................................................................................................................... 156 What Do You Think? ....................................................................................................................... 159
What Do You Think? – Answers .................................................................................................. 160
Cost Basis .......................................................................................................................................... 161 Purchase of a Trade or Business ................................................................................................ 162
Adjusted Basis .................................................................................................................................. 163
Inheritance ......................................................................................................................................... 165
Dividend Reinvestment .................................................................................................................. 166
Basis of Bonds ................................................................................................................................. 168 Sales and Other Dispositions ....................................................................................................... 170
Involuntary Conversion .................................................................................................................. 172 Like-Kind Exchange ........................................................................................................................ 173
What Do You Think? ....................................................................................................................... 175 What Do You Think? – Answer..................................................................................................... 176
Chapter 6 – Clergy Tax ....................................................................................................................... 187
Definition of Minister under the Regulations ........................................................................... 187 IRS and Judicial Determinations ................................................................................................. 189
Employees of Churches ................................................................................................................. 189
Employees of Church-Affiliated Organizations ....................................................................... 190
Housing Allowance/Parsonage .................................................................................................... 192 Classification as Employees or Independent Contractors ................................................... 195
What Do You Think? ....................................................................................................................... 196
What Do Your Think – Answers ................................................................................................... 197 Chapter 7– Miscellaneous Items ...................................................................................................... 199
Digital Signatures............................................................................................................................. 199 Virtual Currency ............................................................................................................................... 199
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Gamers ................................................................................................................................................ 200
Insolvency .......................................................................................................................................... 201
Estate and Trust Tax Rates and Brackets ................................................................................. 208 Increase in Estate and Gift Tax Exclusion ................................................................................ 208
What Do You Think? ....................................................................................................................... 209 What Do You Think? – Answers .................................................................................................. 210
Alternative Minimum Tax ............................................................................................................... 211 AMT risk factors ............................................................................................................................... 211 Kiddie Tax. ......................................................................................................................................... 212
The Kiddie Tax Before 2018 and After 2025 .............................................................................. 213 The Kiddie Tax 2018 through 2025 .............................................................................................. 213
Final Regulations Expand Use of Health Reimbursement Arrangements ....................... 214 Foreign Earned Income and Housing Exclusion ..................................................................... 217
FinCen ................................................................................................................................................. 219 Foreign Account and Asset Reporting....................................................................................... 219 FinCEN Form 114 ............................................................................................................................. 220
Due Date for FinCEN ....................................................................................................................... 222 FinCEN Form 114 Penalties .......................................................................................................... 222
What Do You Think? ....................................................................................................................... 223 What Do You Think? -Answers .................................................................................................... 224
Chapter 8 - Business Related Changes ......................................................................................... 225 Paycheck Protection Program ...................................................................................................... 225
Paycheck Protection Loan Forgiveness Application - EZ .................................................... 225
PPP Flexibility ................................................................................................................................... 226 Excess Business Losses -TCJA .................................................................................................. 227
Net Operating Loss -TCJA ............................................................................................................. 230
Net Operating Loss – CARES Act ................................................................................................ 231
Extended Time Limit for IRS Levy ............................................................................................... 233
Applying for an EIN ......................................................................................................................... 233 What Do You Think? ....................................................................................................................... 235
What Do You Think? – Answers .................................................................................................. 236 Chapter 9– Affordable Care Act ....................................................................................................... 237
Requirement to Have Health Insurance ..................................................................................... 237 Premium Tax Credit Eligibility ...................................................................................................... 239
Shared Policy Allocations ............................................................................................................. 242
Coverage Reporting Requirements ............................................................................................ 242 Form 1095-B ...................................................................................................................................... 243
1095-C ................................................................................................................................................. 243
Form 1095-A ...................................................................................................................................... 243
Self-Employed Health Insurance Deduction ............................................................................. 245 What Do You Think? ....................................................................................................................... 247
What Do You Think? – Answers .................................................................................................. 248 2020 TAX UPDATE ....................................................................................................................... Error! Bookmark not defined.
Final Exam – Tax Law ..................................................................................................................... 31
2020 Answer Sheet .......................................................................................................................... 42 2020 PERSONAL INFORMATION FORM .................................................................................... 43
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2020 TaxEase Course Evaluation ................................................................................................ 44
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2020
TaxEase, LLC
10 HOUR CONTINUING EDUCATION
2020 TAX LAW IRS COURSE NUMBER: B8FQK-T-00035-20-S CTEC COURSE NUMBER 3064-CE-0063
PHONE NUMBER: 512-256-5812 WEBSITE: www.taxeaseed.com
FAX NUMBER: 510 779-5251 EMAIL: [email protected]
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Chapter 1 – Filing
2020 Economic Impact Payment
(CARES Act) The Coronavirus Aid, Relief, and Economic Security Act (CARES Act)
provides Economic Impact Payments (EIP) to taxpayers (subject to income limits) as a credit1
of $1,200 per individual ($2,400 for married couples filing a joint return) plus $500 per
qualifying child who is under age 17. The EIP is reduced by 5% of the taxpayer’s adjusted
gross income in excess of $75,000 ($112,500 for head of household; $150,000 for joint filers).
The payment will fully phase out when income reaches $99,000 for single filers, $146,500 for
head of households with one child and $198,000 for joint filers.
Eligible taxpayers include anyone except:
• Nonresident aliens
• Any taxpayer who does not have a Social Security number (SSN) or Adoption
Taxpayer Identification number (ATIN)
• Taxpayers who qualify as a dependent of another taxpayer2
• Estate or trust
Individuals who have no income, as well as those whose income comes entirely from non-
taxable benefit programs, such as Social Security benefits also qualify for the advance
payment. Joint filers are each treated as having received one-half of the advanced payment.
The eligibility for the payment is based on the taxpayer’s 2019 tax return, or if the taxpayer has
not filed a 2019 return, eligibility is based on the 2018 return. If no returns were filed in 2018
or 2019, information from 2019 Forms 1099-SSA and 1099-RRB will be used.
The EIP is also considered an advanced refund for tax year 2020. The 2020 tax returns include
a computation for reconciling any EIP received during 2020 (using 2019 or 2018 information).
If the EIP amount is less the advance refund amount because a qualifying child was born to the
taxpayer during 2020, the taxpayer can claim the difference as a refundable credit against 2020
income tax liability. If, however, the result is that the taxpayer's AGI was higher in 2020 and
was in the phase out range, the taxpayer's 2020 tax liability is not increased. In addition, a
taxpayer that did not receive an EIP is entitled to claim the recovery rebate amount on his or
her 2020 income tax return. Failure to reduce the recovery rebate amount by any advance
refund amount is treated as a mathematical or clerical error. Otherwise, the EIP has no effect
on income tax returns filed for 2020; the amount is not includible in gross income, and it does
not reduce withholding or employers wages. See examples in the Update Section of this
Syllabus.
1 §6428 2 IRC §151
Objective:
Discuss 2020 CARES act issues.
Discuss Filing of 2020 returns
Compare the 2019 tax returns to 2020.
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A very common question, taxpayers are asking of tax preparers this year regards getting an
Economic Impact Payment for a dependent.
Example: Parents have a son, age 23, who is a full-time student and a dependent of his
parents. The son's only income in 2019 was $2,800 from a part-time summer job. The
parents want to maximize their benefit. They have not yet filed their 2019 tax return
and are hoping to file quickly so the IRS will use the 2019 return to determine the
amount of their stimulus checks.
The parents ask if they can forego claiming their son so that he can claim himself. They
believe that if they file this way, instead of them receiving a $500 stimulus check for
the dependent son, that he can claim himself and receive a $1,200 stimulus check. Can
they do this to achieve a higher stimulus amount for the son?
If the parents do not claim the son, this does not change the fact that the son is still a
dependent under §151. Dependents under §151 may not claim themselves and,
therefore, are not eligible for the $1,200 advanced stimulus tax credit. The other time a
question commonly comes up similar to this with AOTC, when the parents’ income is
too high to qualify for the education credit; they often ask to drop the child as a
dependent. IRC §151 is the guiding force in these matters, the classification of a child
as a dependent is not an option.
Filing Season Statistics Cumulative Statistics Comparing 4/20/18 and 4/19/2019
2018 2019 % Change
Individual Tax Returns
Total Returns Received 136,919,000 137,233,000 0.2
Total Returns Processed 130,477,000 130,775,000 0.2
E-Filing Receipts
Total 124,515,000 126,264,000 1.4
Tax Professionals 70,983,000 70,476,000 -0.7
Self-Prepared 53,532,000 55,788,000 4.2
Total Refunds
Number 95,434,000 95,737,000 0.3
Amount $265.326 Billion $260.919 Billion -1.7
Average Refund $2,780 $2,725 -2.0
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Tax Filings
As of Dec. 27, 2019, the IRS had received 155.8 million tax returns for the 2018 tax year and
of those, 138.2 million were filed electronically. Of e-filed returns, tax professionals prepared
80.6 million of them; the remaining 57.6 million were self-prepared.
There were about 111.8 million refunds issued totaling $320.1 billion, with the average refund
being $2,869, a 1.4 percent drop from $2,910 the previous year. Of the refunds, more than 92
million were direct-deposited, which is a 2.1 percent increase from the previous year when
slightly more than 90 million refunds were direct-deposited.
Tax Brackets Thresholds
The income tax bracket thresholds are all adjusted for inflation after December 31, 2018, and
then rounded to the next lowest multiple of $100 in future years. Unlike tax brackets prior to
TCJA (which uses a measure of the consumer price index (CPI) for all-urban consumers), the
inflation adjustment uses the chained consumer price index3 for all-urban consumers (C-CPI-
U). The chained consumer price index results in lower inflation adjustments, which means
smaller annual increases than with the current tax.
Chained CPI is a variant of the traditional CPI. Both are reported monthly by the U.S. Labor
Department’s Bureau of Labor Statistics, and both track the prices of a "basket" of 80,000
goods and services bought by consumers in urban areas. Chained CPI adjusts for substitution
bias by recognizing that consumers tend to shift their purchasing behavior as the relative prices
of things change.
For example, when the price of Granny Smith apples increases, people may buy Gala apples
instead. As a result, chained CPI shows a slower pace of price gains, or inflation, than
traditional CPI. The gauge’s official name is the Chained Consumer Price Index for All Urban
Consumers, or C-CPI-U. Using chained CPI will decrease the rate of inflation.
3 TCJA §11002
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Gross Income Threshold For Filing Form 1040
Gross Income Threshold4 2020 2019
Single and under 65
Single and 65 or older
Married Filing Jointly, under 65 (both spouses)
Married Filing Jointly, 65 or older (one spouse)
Married Filing Jointly, 65 or older (both spouses)
Married Filing Separately, any age*
Head of Household, under 65
Head of Household, 65 or older
Surviving spouse with dependent child, under 65
Surviving spouse with dependent child, 65 or older
$12,400
14,050
24,800
26,100
27,400
5
18,350
20,300
24,800
26,100
$12,200
13,850
24,400
25,700
27,000
5
18,350
20,000
24,400
25,700
* If either spouse files separately, the other spouse is required to file a return, without
exception.
Gross income5 means all income received in the form of money, goods, property, and services
that is not exempt from tax, including any income from sources outside the United States or
from the sale of the taxpayers main home (even if an exclusion applies on part or all of it).
Taxable portion of Social Security Benefits are included. Gross income includes gains, but not
losses, reported on Form 8949 or Schedule D. Gross income from businesses, farms, or rentals
means income prior to expenses, for example, the amount on Schedule C, line 7.
Exemptions Repealed by TCJA
Personal exemption amount is -0-. TCJA repeals6 the deduction for personal exemptions for
tax year 2018 - 2025.
In addition, the provision modifies the requirements for those who are required to file a tax
return. In the case of an individual who is not married, the individual is required to file a tax
return if the taxpayers’ gross income for the tax year exceeds the applicable standard
deduction. Married taxpayers’ are required to file a return if that the taxpayers’ gross income,
when combined with the spouse's gross income for the tax year is more than the standard
deduction for a joint return, provided that:
The taxpayer and spouse, at the close of the tax year, had the same household as their
home;
Neither the taxpayer nor spouse file a separate return.
4 TCJA 5 IRS Pub 501 6TCJA §11041 repealing IRC §§151-153
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Filing Status
Filing status is an essential component of tax computation. The following is a review of the
filing status; for the most part the filing status requirements have not changed under TCJA. The
Child Tax Credit and the enhanced Standard Deduction are designed to take the place of the
repealed exemptions.
Maximum Rates on Capital Gains and Qualified Dividends
TCJA generally retains the present-law maximum rates on net capital gain and qualified
dividends. The breakpoints between the zero- and 15-percent rates ("15-percent breakpoint")
and the 15- and 20-percent rates ("20-percent breakpoint") are the same amounts as the
breakpoints under current law, except the breakpoints are indexed using the Consumer Price
Index for all Urban Consumers (C-CPI-U) in tax years beginning after 2018.
Individual Long-Term Capital Gain Rates
Rate Income Level Breakpoint (2020) Income Level Breakpoint (2019)
0% Single: $40,000
MFS: $40,000
MFJ/SS: $80,000
HOH: $53,600
Single: $39,375
MFS: $39,375
MFJ/SS: $78,750
HOH: $52,750
15%
Single: $441,450
MFS: $248,300
MFJ/SS: $496,600
HOH: $469,050
Single: $434,550
MFS: $244,425
MFJ/SS: $488,850
HOH: $461,700
20% No Breakpoint No Breakpoint
Unrecaptured Code Sec. 1250 gain generally is taxed at a maximum rate of 25 percent, and
Collectibles are taxed at a maximum rate of 28 percent.
Standard Deduction Amounts 2019 2020
Filing Status
Single $12,200 $12,400
Head of Household $18,350 $18,650
Married Filing Jointly $24,400 $24,800
Surviving Spouse $24,400 $24,800
Married Filing Separately $12,200 $12,400
Additional Amount for Aged or Blind* $1,300-1,650
__________
* The additional standard deduction for a spouse age 65 or older, or blind is
$1,300. These amounts are increased to $1,650 if the taxpayer is also unmarried
and not a surviving spouse
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Amended Returns
For the first time the IRS will be able to e-file Form 1040-X, Amended U.S Individual Income
Tax Return, using available tax software products. Making the 1040-X an electronically filed
form has been an ongoing request from the nation's tax professional community and a
continuing recommendation from the Internal Revenue Service Advisory Council (IRSAC) and
Electronic Tax Administration Advisory Committee (ETAAC). The new electronic option
allows the IRS to receive amended returns faster while minimizing errors normally associated
with manually completing the form. This service is expected in late summer 2020.
19
TaxLaw
What Do You Think?
Q1. The 2020 tax returns include a computation for reconciling any Economic
Impact Payment received during 2020 (using 2019 or 2018 information). Which
of the following is not correct?
A. If the recovery rebate amount is less the EIP because a qualifying child
was born to the taxpayer during 2020, the taxpayer can claim the
difference as a refundable credit on the 2020 return.
B. If the taxpayer's AGI was higher in 2020 and was in the phase out range
the taxpayer's 2020 tax liability is not increased.
C. Failure to reduce the recovery rebate amount by any EIP is treated as a mathematical or
clerical error.
D. The EIP is includible in gross income.
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TaxLaw
What Do You Think? - Answers
Answer is D
Q1. The 2020 tax returns include a computation for reconciling any EIP received
during 2020 (using 2019 or 2018 information). Which of the following is not
correct?
A. If the recovery rebate amount is less the EIP because a qualifying child
was born to the taxpayer during 2020, the taxpayer can claim the difference as a
refundable credit on the 2020 return.
B. If the taxpayer's AGI was higher in 2020 and was in the phase out range the taxpayer's
2020 tax liability is not increased.
C. Failure to reduce the recovery rebate amount by any EIP is treated as a mathematical or
clerical error.
D. The EIP is includible in gross income,
The EIP is also considered an advanced refund for tax year 2020. The 2020 tax returns include
a computation for reconciling any EIP received during 2020 (using 2019 or 2018 information).
If the EIP amount is less the advance refund amount because a qualifying child was born to the
taxpayer during 2020, the taxpayer can claim the difference as a refundable credit against 2020
income tax liability. If, however, the result is that the taxpayer's AGI was higher in 2020 and
was in the phase out range, the taxpayer's 2020 tax liability is not increased. In addition, a
taxpayer that did not receive an EIP is entitled to claim the recovery rebate amount on his or
her 2020 income tax return. Failure to reduce the recovery rebate amount by any advance
refund amount is treated as a mathematical or clerical error. Otherwise, the EIP has no effect
on income tax returns filed for 2020; the amount is not includible in gross income, and it does
not reduce withholding or employers wages.
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TaxLaw
Limitation on Deduction for State and Local Taxes (SALT)
TCJA limits the deduction for state and local property, income, and excess profits
taxes7 to $10,000 ($5,000 in the case of a married individual filing a separate return),
unless the taxes are paid or accrued in carrying on a trade or business8 or an activity
relating to expenses for the production of income. TCJA also repeals the deduction for
foreign property taxes. As under current law, taxpayers may elect to deduct state and
local sales taxes in lieu of state and local income taxes.
Generally, only foreign income taxes qualify for the foreign tax credit.9 Other taxes,
such as foreign real and personal property taxes, do not qualify for the foreign tax
credit. However, a taxpayer may be able to deduct these other taxes even if he or she
claims the foreign tax credit for foreign income taxes. Taxpayers generally can deduct
these other taxes only if the taxes are expenses incurred in a trade or business or in the
production of income. However, for tax years before 2018 and after 2025, a taxpayer
can deduct foreign real property taxes that are not trade or business expenses as an
itemized deduction on Schedule A (Form 1040). No deduction is allowed for 2018-
2025 for foreign real property taxes.10
Limitation on Mortgage Interest Deduction
TCJA provides that a taxpayer may treat no more than $750,000 as acquisition
indebtedness ($375,000 in the case of married taxpayers filing separately) for purposes
of the mortgage interest deduction11. This applies to new home loans after December
14, 2017. In the case of acquisition indebtedness incurred before December 15, 2017,
the limitation is the same as it is under current law: $1,000,000 ($500,000 in the case of
married taxpayers filing separately). If the taxpayer owns two personal residence, the
total amount of acquisition indebtedness cannot exceed $1,000,000 ($500,000 in the
case of married taxpayers filing separately).
TCJA repeals the deduction for home equity indebtedness. Points not related to home
acquisition are no longer deductible.
Treatment of Mortgage Insurance Premiums as Qualified Residence Interest
For 2018, 2019, and 2020, the taxpayer can treat amounts paid during the year for
qualified mortgage insurance as qualified residence interest. The insurance must be in
connection with acquisition debt for a qualified residence.12
7 TCJA §11042 8 IRC §212 9 IRC §901(b) 10 IRC §164(a)(6)(A) 11 TCJA §11043 12 Taxpayer Certainty and Disaster Relief Act of 2019 – Division Q
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TaxLaw
The federal Further Consolidated Appropriations Act, 2020, signed by the president
on December 20, 2019, extends the Qualified Principal Residence Indebtedness (QPRI)
exclusion through the year 2020. This exclusion allows some taxpayers who've had
mortgage debt forgiven—like after a foreclosure, loan modification, short sale, or deed
in lieu of foreclosure—to exclude the canceled amount from their income for federal
tax purposes.
If a 1099-C (Cancellation of Debt) form is issued from the mortgage lender for the
2019 tax year, or if the taxpayer filed a tax return for the 2018 tax year that included
income from mortgage loan forgiveness, pay close attention to this extension. If the
QPRI exclusion applies, the taxpayer does not have to report the forgiven principal as
income on their tax return.
Exclusion from gross income of discharge of qualified personal residence indebtedness,
discharges up to $2 million of mortgage debt on taxpayer’s main home. This provision
has been retroactively extended through Dec. 31, 2020.
Raising the Limits on Deductions for Cash Charitable Contributions During 2020 The CARES Act temporarily modified the percentage limitations on the income tax
charitable deduction for cash contributions to certain charities available to individuals
who are itemizers and corporations if these taxpayers elect to have these provisions
apply for the 2020 tax year. For 2020, individuals may deduct qualified contributions to
the extent of their contribution base (i.e., the individual's 2020 adjusted gross income
without regard to any net operating loss carryback to 2020). This provision is very
favorable to those donors who wish to make large cash contributions in 2020, the
deductibility of which might otherwise have been curbed due to the percentage
limitations. The election would allow much more to be deducted in 2020 and less
carried forward for deduction in future years.
Net Investment Income Tax
TJCA retains the 3.8 percent net investment income tax (NIIT) without changes.
The net investment income tax apply only to citizens or residents of the U.S. The NIIT is 3.8%
of the lesser of:
Net investment income of the year.
The excess of modified adjusted gross income (MAGI) over the threshold amount of
$250,000 for MFJ and QW; $125,000 for MFS; and $200,000 for HH and Single.
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In general, net investment income for purpose of this tax, includes, but is not limited to:
Interest, dividends, certain annuities, royalties, and rents (unless derived in a trade or
business in which the NIIT does not apply),
Income derived in a trade or business which is a passive activity or trading in financial
instruments or commodities, and
Net gains from the disposition of property (to the extent taken into account in
computing taxable income), other than property held in a trade or business to which
NIIT does not apply.
The NIIT applies to income from a trade or business that is (1) a passive activity13, of the
taxpayer; or (2) trading in financial instruments or commodities14.
The NIIT does not apply to certain types of income that taxpayers can exclude for regular
income tax purposes such as tax-exempt state or municipal bond interest, Veterans
Administration benefits, or gain from the sale of a principal residence on that portion that is
excluded for income tax purposes.
Modified adjusted gross income (MAGI), for purposes of the NIIT, is generally defined as
adjusted gross income (AGI) for regular income tax purposes increased by the foreign earned
income exclusion (but also adjusted for certain deductions related to the foreign earned
income). For individual taxpayers who have not excluded any foreign earned income, their
MAGI is generally the same as their regular AGI.
Section 529 Plan (Qualified Tuition Programs) Distributions and Rollovers
TCJA modifies Section 529 plans to allow such plans to distribute not more than $10,00015 in
expenses for tuition incurred during the tax year in connection with the enrollment or
attendance of the designated beneficiary at a public, private or religious elementary or
secondary school. This limitation applies on a per-student basis, rather than a per-account
basis. Thus, under the provision, although an individual may be the designated beneficiary of
multiple accounts, that individual may receive a maximum of $10,000 in distributions free of
tax, regardless of whether the funds are distributed from multiple accounts. Any excess
distributions received by the individual will be treated as a distribution subject to tax.
TCJA also allows rollovers between 529 plans and other qualified 529 accounts owned by the
beneficiary. These rollovers are considered part of the total contributions. Any amount rolled
over that is in excess of this limitation will be includible in the gross income of the
distribution.16
13 IRC§469 14 IRC §475 (e)(2) 15 TCJA §10032 16 IRC §72
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TCJA Changes to Adjustments to Income
Repeal of Deduction for Moving Expenses
TCJA repeals the deduction for moving expenses for tax year 2018 through 2025.
However, under the provision, rules providing for exclusions of amounts attributable to
in-kind moving and storage expenses (and reimbursements or allowances for these
expenses) for members of the Armed Forces of the United States (or their spouse or
dependents) are not repealed.
Repeal of Deduction for Alimony Paid
Generally, effective for any divorce or separation instrument executed before January 1,
2019, amounts received as alimony or separate maintenance payments are includible in
income in the year received and are deductible by the payer in the same year. For these
divorces, the Social Security Number of the spouse and the date of the divorce is
required.
As a result of changes made by the Tax Cut and Jobs Act of 2017 (TCJA), effective for
any divorce or separation instrument executed after December 31, 2018 or modified
after that date, if the modification expressly provides that the TCJA changes apply to
such modification, alimony and separate maintenance payments are excluded from the
payee's income and no deduction is allowed to the payer.
Student Loans
Treatment of Student Loans Discharged Due to Death or Disability
TCJA modifies the exclusion of student loan discharges.
Loans eligible for the exclusion under the provision are loans made by
The United States (or an instrumentality or agency thereof),
A state (or any political subdivision thereof),
Certain tax-exempt public benefit corporations that control a state, county, or
municipal hospital.
An educational organization that originally received the funds from which the
loan was made from the United States, a State, or a tax-exempt public benefit
corporation; or
Private education loans (for this purpose, private education loan is defined in
Section 140(7) of the Consumer Protection Act).
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TaxLaw
(CARES Act) Student Loan Interest Deduction
The CARES Act has two different items that may be of assistance to those who owe
student loans:
1. The CARES Act includes automatic suspension of principal and interest payments
on federally held student loans (does not apply to student loans held privately) from
March 13 through September 30, 2020, the interest rate is set to 0% and payments
are suspended for student loans owned by the federal government. The federal
student loan servicer will suspend all interest and payments without any action from
the taxpayer. There is no need for the taxpayer to contact the student loan servicer.
If a payment of federally held student loans made after March 13, the borrower can
request a refund from the student loan servicer. All payments during this period will
apply directly to principal. The loan cannot be for a dependent and cannot be
through a private lender.
2. The CARES Act17 amends the existing code section to provide an exclusion18 from
income for payments of interest or principal made by an employer on any qualified
education loan incurred by an employee for the education of the employee. The
amendment applies to payments made after March 27, 2020, and before January 1,
2021. Payments of principal and/or interest by the employer to the employee or to
the lender will be tax-free. The exclusion from income is up to $5,250 in employer-
paid educational assistance.
Previously any student loan payments made by an employer was part of wages and
subject income tax and FICA.
The maximum allowable Student Loan Interest Deduction for 2019 and 2020 is $2,500. The
student loan income phase-out ranges are:
Filing Status 2020 Phase-out 2019 Phase-out
Married Filing Jointly $140,000-170,000 $140,000-$170,000
Qualifying Widow(er) $70,000-85,000 $70,000-$85,000
Head of Household $70,000-85,000 $70,000-$85,000
Single $70,000-85,000 $70,000-$85,000
Married Filing Separately N/A N/A
17 §2206 18 IRC §127(c)1
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TaxLaw
Recharacterization of an IRA
The taxpayer can convert the entire balance of a traditional IRA account to a Roth account,
paying the taxes that are owed on this conversion. In the past, it was legal for the taxpayer to
change their mind and recharacterize that Roth conversion back to a traditional IRA account.
However, the Tax Cuts and Jobs Act of 2017 banned recharacterizing a Roth conversion back
to a traditional IRA.
To recharacterize a regular IRA contribution, the taxpayer must tell the trustee of the financial
institution holding the IRA to transfer the amount of the contribution plus earnings to a
different type of IRA (either a Roth or traditional) in a trustee-to-trustee transfer or to a
different type of IRA with the same trustee. If this is done by the due date for filing the tax
return (including extensions), the taxpayer can treat the contribution as made to the second IRA
for that year (effectively ignoring the contribution to the first IRA).
Child Tax Credit 2020:
The increases in the Child Tax Credit is an essential component of TCJA, it was designed to
make up some of the difference
TCJA increases the child tax credit to $2,000.
TCJA iincreases the adjusted gross income phase-out thresholds to $400,000 for
married taxpayers filing joint returns and $200,000 for other individuals. The phase-out
thresholds are not indexed for inflation.
The credit is refundable up to $1,400 in 2020 (indexed).
Earned income threshold is lowered to $2,500,
Retains maximum age for a qualifying child (age 16) from present law.
Any qualifying child claimed for the credit is required to use a Social Security number
as that child’s taxpayer identification number.
A child permanently and totally disabled does qualify as a dependent but does not
qualify for the child tax credit because there is no exception for the age test. A child
must be under 17 regardless of any disability.
Keep in Mind: The child must be a dependent of the taxpayer to qualify for the Child Tax
Credit. The child must be a U.S. citizen, a U.S. national, or a U.S. resident alien (the Child Tax
Credit is not allowed for nonresident alien children residing in Canada or Mexico even if they
qualify as dependents. He or she must have a Social Security number; the credit cannot be
claimed if the Social Security Number is obtained for the child after the filing of the return.
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TaxLaw
“Earned Income” Formula for Computing the Additional Child Tax Credit
To the extent, the child credit exceeds the taxpayers’ income tax liability; the taxpayer is
eligible for a refundable credit (also referred to as "the additional child tax credit") equal to the
lesser of $1,400 for each qualifying child or 15 percent of earned income in excess of a
threshold dollar amount (the "earned income" formula). For 2020, the inflation-adjusted
amount is $1,40019 the same as 2019. The threshold amount for years 2018 through 2025 is
$2,500.20 Families with three or more children may determine the additional child tax credit
using the "alternative formula," if this results in a larger credit than determined under the
earned income formula. Under the alternative formula, the additional child tax credit equals the
amount by which the taxpayers’ social security taxes exceed the taxpayers’ earned income tax
credit21 (EITC).
Earned income is defined as the sum of wages, salaries, tips, and other taxable employee
compensation plus net self-employment earnings. Unlike the EITC, which also includes the
preceding items in its definition of earned income, the additional child tax credit is based only
on earned income to the extent it is included in computing taxable income. For example, some
ministers' parsonage allowances are considered self-employment income, and are considered
earned income for purposes of computing the EITC, but the allowances are excluded from
gross income for individual income tax purposes, therefore it is not considered earned income
for purposes of the additional child tax credit since the income is not included in taxable
income. However, there is exception to this rule for combat pay excluded from gross income.
Even though excluded from income, the taxpayer may treat it as earned income for purposes of
the additional tax credit.22
Example: For 2020, Sarah is a single taxpayer with two qualifying children. She has
adjusted gross income and earned income of $8,000 and a total tax liability of $300.
Because of the tax liability limitation, Sarah is allowed a nonrefundable child tax credit
of only $300. However, she is eligible for an additional child tax credit (i.e., a
refundable credit) of $825, which is equal to the lesser of:
(1) $3,700 (the child tax credit not allowed due to the tax liability limitation
($4,000 - $300)); or
(2) $825 (15% × ($8,000 - $2,500)).
A taxpayer with three or more qualifying children can use an alternative computation. In
computing the additional child tax credit, such a taxpayer can use the amount by which the
taxpayers’ social security taxes for the tax year exceed his or her earned income credit for the
year in lieu of 15 percent of the amount by which the taxpayers’ earned income exceeds
$2,500.
19 Rev Proc 2018-57 20 IRC §24(h)(6) 21 IRC §24(d)(1)(B)(ii) 22 IRC §24(d)(1)(B)(i)
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The amount of the additional child tax credit taken reduces the amount of the nonrefundable
child tax credit allowable before application of the tax liability limitation. In other words, the
total of a taxpayers’ nonrefundable child tax credit and additional child tax credit cannot be
greater than the amount of the nonrefundable child tax credit allowable before application of
the tax liability limitation.
Remember, the TCJA says the refundable portion of the credit is up to this amount. The refund
is actually equal to 15% of the earned income over $2,500. A taxpayer would need earned
income of approximately $12,000 a year to qualify for and receive the full $1,400 refund:
$12,000 less $2,500 is $9,500, and 15% of $9,500 works out to $1,425. At $12,000 in earned
income, the taxpayer would forfeit that extra $25 because the refundable portion of the credit
caps out at $1,400.
NOTE: The Child Tax Credit (CTC) is included in the due diligence requirement. Form 8867,
Preparer’s Due Diligence Checklist includes the Child Tax Credit. For an in-depth discussion
of Due Diligence, see the TaxEase Ethics Section.
29
TaxLaw
What Do You Think?
Q1. Jack works for Corp. in 2020 and has withholding of $6,850 for CA and SDI of
$1,150. His property tax for the year was $5,400. What is the total amount of state
and local taxes deduction included on Schedule A for Jack, who itemizes deductions
for tax year 2020?
A. $13,400
B. $12,700
C. $10,000
D. None of the above
Q2. Which of the following is correct for 2020?
A. In 2020 Amended returns can be electronically filed.
B. TCJA retained Net Investment income at 3.8%.
C. Payments of student loan principal and/or interest by the employer to the employee or
to the lender will be tax-free from March 13 through September 30, 2020.
D. All of the above are correct
30
TaxLaw
What Do You Think? – Answers
.
Answer Q1. Jack works for Corp. in 2020 and has withholding of $6,850 for
CA and CA SDI of $1,150. His property tax for the year was $5,400. What is
the total amount of state and local taxes deduction included on Schedule A for Jack, who
itemizes deductions for tax year 2020?
A. $13,400 – A and B are not correct because State and local taxes for tax years 2019 –
2025 cannot exceed $10,000
B. $12,700
C. $10,000 – The amount that would be deducted if not for the $10,000 limitation is
$13,400. $6,850 of CA withholding plus $1,150 of CA State Disability Insurance
and $5,400 in property tax.
D. None of the above
Answer Q2: D is the correct answer.
Q2. Which of the following is correct for 2020?
A. In 2020, Amended returns can be electronically filed.
B. TCJA retained Net Investment income at 3.8%.
C. Payments of student loan principal and/or interest by the employer to the employee or
to the lender will be tax-free from March 13 through September 30, 2020.
D. All of the above are correct
A is correct because the IRS will be able to e-file Form 1040-X, Amended U.S Individual
Income Tax Return, using available tax software products. Making the 1040-X an
electronically filed form has been an ongoing request from the nation's tax professional
community and a continuing recommendation from the Internal Revenue Service Advisory
Council (IRSAC) and Electronic Tax Administration Advisory Committee (ETAAC). The new
electronic option allows the IRS to receive amended returns faster while minimizing errors
normally associated with manually completing the form. This service is expected in late
summer 2020.
B is correct because TJCA retains the 3.8 percent net investment income tax (NIIT) without
changes.
C is correct because the CARES Act includes automatic suspension of principal and interest
payments on federally held student loans (does not apply to student loans held privately) from
March 13 through September 30, 2020, the interest rate is set to 0% and payments are
suspended for student loans owned by the federal government.
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TaxLaw
Chapter 2 – Itemized Deductions
Standard Deductions versus Itemized Deductions
As mentioned previously, TCJA has eliminated
exemptions. The standard deduction has been increased
significantly. The Child Tax Credit has been increased, to
help make up for the loss of exemptions. Child Tax Credit
is for dependents under age 17. There is also a small credit
for dependents other than children of $500. Keep in mind neither of these credits or
exemptions are available for the taxpayer or spouse. The higher of itemized deductions or the
standard deduction can be taken on the tax return; whichever results in the lower tax.
Standard Deduction Amounts 2019 2020
Filing Status
Single $12,200 $12,400
Head of Household $18,350 $18,650
Married Filing Jointly $24,400 $24,800
Surviving Spouse $24,400 $24,800
Married Filing Separately $12,200 $12.400
Additional Amount for Aged or Blind* $1,300-$1,650
__________
* The additional standard deduction for a spouse age 65 or older, or blind is $1,300. These
amounts are increased to $1,650 if the taxpayer is also unmarried and not a surviving spouse
Medical Expense Deduction Floor
The reduction in the medical expense deduction floor from 10% to 7.5% expired for tax
years ending before Jan. 1, 2019. This provision is extended through Dec. 31, 2020.23
23 Taxpayer Certainty and Disaster Tax Relief Act of 2019 Subtitle A.
Objectives:
• Review itemized deductions for
2019 and 2020.
• Discuss CARES Act and other
Covid-19 legislation in
relationship to itemized
deductions.
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TaxLaw
Tax Deduction for Long-Term Care Insurance24
The rates have steadily increased each year. The deductible limits are includable as a
medical deduction on Schedule A. For taxable years beginning in 2018, the
limitations25 regarding eligible long-term care premiums includible in the term
"medical care," are as follows:
Age before Close of Taxable
Year
2020 Deduction
Limits
2019 Deduction
Limits
40 or less $430 $420
More than 40 not more than 50 $810 $790
More than 50 not more than 60 $1,630 $1,580
More than 60 not more than 70 $4,350 $4,220
More than 70 $5,430 $5,270
Medical Expenses
The CARES Act repeals the Medicine Cabinet Tax provision of the Affordable Care Act
(ACA), expanding the list of qualifying expenses that can be purchased with health savings
accounts (HSAs), health reimbursement arrangements (HRAs) and flexible spending accounts
(FSAs).
Under the CARES Act, the definition of a qualifying medical expense now includes certain
over-the-counter medications and products. Specifically, the act treats additional over-the-
counter medications, along with menstrual care products, as qualified medical expenses that
may be paid for using HSAs or other tax-advantaged accounts.
A taxpayer may deduct unreimbursed medical expenses26 paid for medical care of the taxpayer,
his or her spouse, and dependents. After 2018 and before 2026, the medical expense deduction
or both regular tax and AMTI is limited to the excess amount over 7.5 percent of the taxpayers’
adjusted gross income,
The CARES Act contains several provisions that affect employer-sponsored retirement
and health and welfare plans. The CARES Act reverses the Affordable Care Act (“ACA”)
restriction on reimbursement for over-the-counter (“OTC”) drugs and products and allows
HSAs, Archer MSAs, Health FSAs, and HRAs to reimburse for OTC drugs and products
after December 31, 2019. Interestingly, the CARES Act did not explicitly remove the
ACA’s reimbursement restrictions. Instead, it replaced the operative Code provisions with
a clarification that menstrual care products are to be treated as qualified medical expenses.
24 IRC §213(d)(10) 25 IRC §213(d)(10) 26 IRC §213
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TaxLaw
Medical care expenses27 include payments for the diagnosis, cure, mitigation, treatment, or
prevention of disease, or payments for treatments affecting any structure or function of the
body, and some over-the-counter drugs discussed above. Also included are insurance
premiums paid for the taxpayer, spouse and dependent for policies that cover medical care or
for a qualified long-term care insurance policy covering qualified long-term care services (see
deductible limitations below). If the taxpayer is an employee, medical expenses do not include
that portion of their premiums treated as paid by the employer under its sponsored group
accident or health policy or qualified long-term care insurance policy.
For the purposes of the Federal income tax deduction allowed for medical expenses, “medical
care” generally refers to the diagnosis, cure, mitigation, treatment, or prevention of illness or
disease, or for affecting any structure or function of the body. It includes:
• Transportation primarily for and essential to medical care;
• Medical insurance (including all Medicare premiums28);
• Prescribed drugs and insulin;
• Nursing services;
• Hospital care;
• Eye care;
• Fertility treatments;
• Legal expenses incurred to establish the right to proceed with a course of treatment;
• Weight reduction programs prescribed by a physician for treatment of medical
conditions related to obesity;
• Smoking cessation programs;
• Substance abuse counseling;
• Mental health counseling;
• Equipment and devices bought for medical reasons, such as eyeglasses, hearing aids
and crutches;
• Capital improvements to a residence for medical care to the extent they exceed the
increase in the property's value;
• Specially-equipped automobiles;
• Non-institutional food eaten solely for the alleviation or treatment of illness;
• Books and magazines in Braille;
• A special school for a mentally or physically handicapped person to alleviate a
handicap;
• Retirement home fees attributable to medical care;
• Qualified long-term care services as well as eligible premiums for insurance covering
qualified long-term care; and
• Expenses paid for the treatment of gender identity disorder
27 Pub. 502, Schedule A Instructions 28 CCA 201228037
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Who is a Dependent for Medical Purposes?
The definition of “dependent”29 is expanded for purposes of the medical expenses deduction.
For these purposes, an individual can qualify as a dependent even if he or she has income in
excess of the exemption amount or if he or she files a joint return with his or her spouse. To
include medical care expenses paid for a spouse or dependent, the person must have been the
taxpayers’ spouse or dependent either at the time, the medical services were provided or at the
time, the expenses were paid. Additionally, the minor child of divorced or separated parents is
treated as the dependent of both parents for purposes of the medical expenses deduction.
Example: Jan received medical treatment before she married Sam. Sam paid for the
treatment after they married. Sam can include these expenses in calculating his medical
expense deduction even if he and Jan file separate returns. If Jan had paid the expenses,
Sam could not include Jan's expenses in his separate return. Jan would include the
amounts she paid during the year in her separate return. If they filed a joint return, the
medical expenses both paid during the year would be used to figure their medical
expense deduction.
A person who otherwise qualifies as a dependent30 is considered a taxpayers’ dependent for
medical expense purposes even if: That person received gross income equal to or greater than the personal exemption
amount and/or filed a joint return for the year; or
The taxpayer, or the taxpayers’ spouse if filing jointly, could be claimed as a dependent
on someone else's return.
A child of divorced or separated parents can be treated as a dependent of both parents.31 Each
parent can include the medical expenses he or she pays for the child, even if the other parent
claims the child's dependency exemption, if:
The child is in the custody of one or both parents for more than half the year;
The child receives over half of his or her support during the year from his or her
parents; and
The child's parents are divorced or legally separated under a decree of divorce or
separate maintenance, are separated under a written separation agreement, or live apart
at all times during the last six months of the year.
This does not apply if the child's exemption is being claimed under a multiple support
agreement. A taxpayer who is considered to have provided more than half of a qualifying
relative's support under a multiple support agreement can include medical expenses the
taxpayer pays for that person. Any medical expenses paid by others who joined in the
agreement cannot be included as medical expenses by anyone.32
29 IRC §213(a) 30 IRC §151 31 IRC §213(d)(5) 32 Reg. Sec. 1.213-1(a)(3)
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Rowena and her three sisters each provides one-fourth of their mother's total support.
Under a multiple support agreement, Rowena treats her mother as her dependent.
Rowena paid all of her mother's medical expenses. Rowena's sisters repaid Rowena for
three-fourths of these expenses. In figuring her medical expense deduction, Rowena can
include only one-fourth of her mother's medical expenses. Rowena's sisters cannot
include any part of the expenses. However, if Rowena and her sisters share the
nonmedical support items and Rowena separately pays all of her mother's medical
expenses, Rowena can include the unreimbursed amount she paid for her mother's
medical expenses in her medical expenses.
The amount an adopting parent pays for medical services rendered directly to a child before its
placement in the adopting parents' home is deductible as a medical expense, provided that:
The child qualifies as a dependent of the adopting parent at the time the medical
services are rendered or at the time the expenses are paid; and
The medical expenses are paid by the adopting parent, or his agent, for the medical care
of the particular child and are not paid merely as reimbursement for expenses incurred
and paid by the adoption agency or other persons prior to adoption negotiations
between the agency and the adopting parent.33
If the medical expenses are paid by the adoption agency or other agent of the adopting
parent under an agency agreement made before the payment, reimbursement of those
expenses by the adopting parent is considered a payment of medical expenses by the
adopting parent. However, the adopting parent must clearly substantiate that any
deduction claimed is directly attributable to medical care of the child.
A taxpayer who receives benefit payments (such as social security benefits) as a guardian of a
dependent; and then pays the dependent's medical expenses, the expenses are not medical
expenses paid by the taxpayer. The dependent has paid his or her own medical expenses to the
extent of those benefits34 (Hodge v. Comm'r, 44 T.C. 186 (1965)).
33 Rev. Rul. 60-255 34 Hodge v. Comm'r, 44 T.C. 186 (1965)
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Tax Deduction for Long-Term Care Insurance35
The rates have steadily increased each year. The deductible limits are includable as a
medical deduction on Schedule A. For taxable years beginning in 2019, the limitations
regarding eligible long-term care premiums includible in the term "medical care," are as
follows:
Age before Close of Taxable
Year
2019 Deduction
Limits
2020 Deduction
Limits
40 or less $420 $430
More than 40 not more than 50 $790 $810
More than 50 not more than 60 $1,580 $1,630
More than 60 not more than 70 $4,220 $4,350
More than 70 $5,270 $5,430
The taxpayer may not deduct funeral or burial expenses, over-the-counter medicines,
toothpaste, toiletries, cosmetics, a trip or program for the general improvement of their health,
or most cosmetic surgery. No deduction is allowed for the amounts paid for nicotine gum and
nicotine patches, which do not require a prescription. No deduction is allowed for Medical
Marijuana.
The taxpayer can only include the medical expenses paid by the taxpayer during the year. The
total deductible medical expenses for the year must be reduced by any reimbursement of
deductible medical expenses. It makes no difference if the reimbursement is paid directly to the
taxpayer or if it is paid directly to the doctor, hospital, or other medical provider.
NOTE: Some expenses incurred by a physically handicapped individual to remove
structural barriers in their residence in order to accommodate their physical condition
such as constructing access ramps, widening doorways, and installing special support
bars are presumed not to increase value of the residence and are deductible in full.
IRA Withdrawals for Certain Medical Expenses The tax law creates an exception to the 10% penalty tax36 on early withdrawals from both an IRA
and a qualified plan for medical expenses in excess of 10% of adjusted gross income. In addition,
the taxpayer can withdraw money from an IRA (but not a qualified plan) for medical insurance
premiums37 (without regard to the 10% floor) if the individual has received unemployment
compensation under Federal or state law for at least 12 weeks.
35 IRC §213(d)(10) Notice 2019-41 36 IRC §72(t)(2)(B) 37 IRC §72(t)(2)(D)
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Capital Expenses Deductible as Medical Expenses
The cost of home improvements and special equipment is deductible as medical expenses if
their main purpose is medical care. The cost is deductible to the extent it does not increase the
value of the home or other capital asset. The costs must be reasonable to accommodate a home
for a person with a disability.
Example: John adds a ramp to the front of his home to allow access for his wife who is
confined to a wheelchair. The ramp cost $7,000 and according to an appraisal increased
the value of the house by $4,000. John can deduct the $3,000 of the home improvement
cost as a medical expense. Elevators, swimming pools, and other permanent improvements to taxpayers’ property
(including capital expenditures to accommodate a residence to a physically handicapped
individual) qualify as a medical expense only to the extent the total expense exceeds the
amount by which the improvement increases the value of the property.
Example: A taxpayer spends $5,000 to put in a central air conditioning system after
their daughter’s allergist recommends the installation to alleviate an asthmatic
condition. If the air conditioning unit boosts the value of the taxpayers’ home by
$4,500, the allowable deduction shrinks to only $500, the amount by which the cost
exceeds the increase in value. A renter could claim the entire cost because the
improvement adds nothing to the value of his or her property.
A written opinion from a competent real estate appraiser detailing how much the installation
raised the value of the property is recommended. The appraisal fee does not count under the
10% of AGI limit for medical expenses.
Whether the taxpayer is an owner or a renter, deductible items include the entire cost of
detachable equipment – such as a window air conditioner that relieves a medical problem. The
taxpayer may also include as part of the medical deduction amounts spent for such operating
and maintenance expenses as electricity, repairs, or a service contract.
A car specially equipped for medical reasons, the cost of special hand controls and other
special equipment installed in a car for use by a person with a disability is deductible as a
medical expense. The difference between the regular cost of the car and the specially equipped
vehicle can be deducted as a medical expense. The cost of operating the specially equipped
vehicle is not deductible.
Example: Fred Jackson had switched jobs in January 2019 and joined the electrical
union. The union does not pay for medical insurance for Fred and his family until
January 2020. Fred can deduct the medical insurance purchased with after tax dollars
through the union’s provider in 2019.
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What Do You Think?
Q1. Which of the following is a medical expense for 2020?
A. Weight reduction prescribed by a doctor.
B. Over the counter menstrual supplies
C. Long-term care insurance premiums
D. All of the above
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TaxLaw
What Do You Think - Answers
Answer Q1: D is the correct answer Q1: All of the items listed are deductible medical expenses. Medical
expenses can be medical or long-term insurance; capital improvements to the
home; the entire cost of detachable equipment that relieves a medical
problem and certain over the counter medications.
Under the CARES Act, the definition of a qualifying medical expense now includes certain
over-the-counter medications and products. Specifically, the act treats additional over-the-
counter medications, along with menstrual care products, as qualified medical expenses that
may be paid for using HSAs or other tax-advantaged accounts. As such, the CARES Act,
which took effect on March 27, 2020, permits reimbursement of over-the-counter products and
medications without the need of a prescription
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TaxLaw
Schedule A Taxes
Nondeductible Taxes Federal income and excise taxes
Social Security, Medicare, FUTA and RRTA taxes
State and local gasoline taxes
Car inspection fee
Special assessments for improvements to taxpayers’ property.
Tax paid for someone else
License fees, such as dog license, driver’s license or marriage license
California fire prevention fee
Foreign Real Property Tax
The following are the categories of taxes38 that are deductible regardless of the existence of a
trade or business or for-profit activity. Specifically, taxpayers may deduct the following:
• State and local real property taxes;
• State, local and foreign income taxes;
• State and local personal property taxes;
• The higher of state and local income tax or state and local sales tax.
• The generation-skipping transfer tax;
• State and local sales or excise taxes on certain motor vehicles.
SALT - State and Local Taxes
Among the biggest changes of TCJA are the state and local tax deduction amounts, also
referred to as the SALT deduction cap. Now that deduction limits are standard across the board
regardless of income, both middle and upper class taxpayers are feeling the financial
consequences of the new limits.
Previously, limits on how much single taxpayers could deduct were only implemented to
people with adjusted gross incomes over $150,000. However, after the introduction of the
TCJA, that has changed.
Now, all taxpayers, regardless of their income can deduct no more than $10,000 of total state
and local taxes, including property taxes. It is estimated by the White House Office of
Management and Budget that the cap on these deductions is saving the government over $57
billion; before the cap, SALT deductions cost the U.S. Treasury about $100 billion each year.
Up until the TCJA was passed, homeowners could deduct interest on home equity loans up to
$100,000; now, they only can if the funds are used for home improvement, nothing else.
The elimination of exemptions, SALT and limitations on home equity lines of credit, as well as
the increase in the standard deduction, have made many taxpayers take the standard deduction.
This has increased the taxable income of the taxpayers significantly in many cases.
38 IRC §164 (a),(b)
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Changes for tax years 2018-2025: (1) No deduction is allowed for foreign real property taxes; and
(2) The aggregate amount of taxes listed above that taken into account, including sales
taxes imposed in lieu of state income taxes is limited to $10,000 ($5,000 in the case of a
married individual filing a separate return).39
State and local taxes and property taxes paid while carrying on a trade or business, a rental
activity or an activity described in IRC §212 remain fully deductible.
Real Estate Taxes
State, local taxes paid on real estate owned by the taxpayer that was not used for business area
is deductible, but only if the taxes are based on the assessed value of the property. In addition,
the assessment must be made uniformly on property throughout the community, and the
proceeds must be used for general community or governmental purposes. If a mortgage
company pays taxes on behalf of the taxpayer, the deductible portion is the amount the
mortgage company pays, not the amount paid into the escrow account by the taxpayer. A
taxpayer can deduct all real estate taxes paid. Unlike mortgage interest, real estate taxes are not
limited to the first two personal residences. Charges for services, such as trash, water or sewer
are not deductible. Special assessments may be part of the tax bill.40
Improvement assessments, which improve the value of the property, increase the basis of the
property and are not deductible as real estate taxes. Maintenance assessments on existing
public facilities already in service are deductible as real estate taxes as well as interest charges
regardless of the assessment purpose.
Personal Property Tax
Enter the state and local personal property taxes paid by the taxpayer, but only if the taxes are
based on value alone and are imposed on a yearly basis.
Mortgage Payment Forbearance
The CARES Act allows taxpayers to suspend their mortgage payments by using forbearance.
A forbearance is a temporary postponement or reduction of mortgage payments. It is not
payment forgiveness. Under the CARES Act, borrowers are entitled to an initial forbearance
period of up to 180 days, upon a borrower’s request. In addition, upon a borrower’s request,
the forbearance must be extended for up to an additional 180 days. A borrower can, at any time
the borrower chooses, shorten the forbearance and resume repayment of the loan.
The taxpayer requests forbearance through their lender, no fees, penalties or interest is charged.
No documentation is required to prove the hardship beyond the assertion that the taxpayer is
suffering from such a hardship. However, if the taxpayer can still make their mortgage
payments, they should continue to do so.
39 IRC §164(a)(6) 40 Pub 530
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If the taxpayer has a Fannie Mae, Freddie Mac, FHA, VA, or USDA loan, they will not have
to pay back the amount that was suspended all at once—unless able to do so. Forbearance will
not affect the credit rating of the borrower. If their credit status when forbearance is granted
will remain through the time of forbearance.
At the end of the forbearance, the options can include paying all of the missed payments at one
time, spread out over a period of months, or added as additional payments or a lump sum at the
end of the mortgage. Information regarding this is handled by the lender.
If the mortgage is not through one of the lenders above, the borrower should contact their
lender, many private lenders are offering forbearance, but the terms may differ.
Home Mortgage Interest
TCJA provides that a taxpayer may treat no more than $750,000 as acquisition indebtedness
($375,000 in the case of married taxpayers filing separately) for purposes of the mortgage
interest deduction. In the case of acquisition indebtedness incurred before December 15, 2017,
the limitation are the same as before December 15, 2017: $1,000,000 ($500,000 in the case of
married taxpayers filing separately).
TCJA repeals the deduction for home equity indebtedness.
Under the Tax Cuts and Jobs Act, the acquisition indebtedness limits have been reduced, and
home equity indebtedness will no longer be deductible. Home equity indebtedness is any debt
(other than acquisition indebtedness) secured by a qualified residence, but only to the extent,
the total home equity indebtedness is not more than: (1) The qualified residence's fair market value, reduced by
(2) The amount of acquisition indebtedness on the qualified residence41
41 IRC §163(h)(3)(C)(i)
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The definition of acquisition indebtedness remains unchanged. In order to be considered
"acquisition debt" for deduction of mortgage interest on a qualified residence the debt must be
incurred in acquiring, constructing, or substantially improving any qualified residence of the
taxpayer, and the debt must be secured by the residence.42 TCJA reduces the debt principal
limit on acquisition indebtedness from the prior $1M threshold, down to just $750,000 instead.
The lower debt limitation only applies to new mortgages taken out after December 15, 2017;
any existing mortgages retain their deductibility of interest on the first $1M of debt principal.
In addition, a refinance of such “grandfathered” mortgages will retain their $1M debt limit (but
only to the extent of the then-remaining debt balance, and not any additional debt).
TCJA rules eliminate the ability to deduct interest on home equity indebtedness. There are no
grandfathering provisions for existing home equity debt. The determination is based not on
how the loan is structured and characterized, but on how the loan proceeds are used, and
specifically, whether they are used to acquire, build, or substantially improve the primary or
second residence. (Notably, the fact that acquisition indebtedness must be used to acquire,
build, or substantially improve a residence, and the loan must be secured by “such” residence,
means that borrowing against a primary home to acquire, build, or substantially improve a
second residence is not treated as acquisition indebtedness)
Further complicating the matter is the fact that IRS Form 1098, which reports the amount of
mortgage interest paid each year, makes no distinction between whether or how much of the
mortgage principal (and associated interest) is deductible acquisition indebtedness or not. This
is not entirely surprising, given that the mortgage lender (or the mortgage servicer) would not
necessarily know how the mortgage proceeds were subsequently spent. Nonetheless, the fact
that mortgage servicers will routinely report the full amount of mortgage interest on Form
1098, when not all of that interest is necessarily deductible, will almost certainly create
taxpayer confusion, and may even spur the IRS to update the form.
Guidance in IRS Publication 936 does provide mortgage interest calculator worksheets to
determine how to apply principal repayments with so-called “mixed-use mortgages” (where a
portion is acquisition indebtedness and a portion is not). Specifically, the rules stipulate that
principal payments will be applied towards home equity.
42 IRC §163(h)(3)(B)
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Whether property is a taxpayers’ principal residence depends on all the facts and
circumstances. If a taxpayer alternates between two properties, using each as a residence for
successive periods, the property that the taxpayer uses a majority of the time during the year
ordinarily will be considered the taxpayers’ principal residence43. Other relevant factors in
determining a taxpayers’ principal residence include:
(1) The taxpayers’ place of employment;
(2) The principal place of abode of the taxpayers’ family members;
(3) The address listed on the taxpayers’ Federal and state tax returns, driver's license,
automobile registration, and voter registration card;
(4) The taxpayers’ mailing address for bills and correspondence;
(5) The location of the taxpayers’ banks; and
(6) The location of religious organizations and recreational clubs with which the taxpayer
is affiliated.
A second home to be deductible must be identified as a qualified residence and used as a
residence. After December 31, 2017, the combined acquisition debt on the first and second
homes are limited to $750,000.
A taxpayer can treat a residence under construction as a qualified residence for a period of up
to 24 months, if the residence actually becomes a qualified residence as of the time it is ready
for occupancy.
Qualified Residence Interest is interest secured by the taxpayers’ debt on the principal
residence or second home subject to certain limitations. The home loan is normally recorded
under state and local law, with the home as collateral for the debt. Debt not secured by the
home is personal debt.
Example: Money borrowed from parents or others for a down payment is unsecured
debt, unless the loan is legally recorded with the home as collateral.
A taxpayer must be legally liable for a loan to deduct interest on a home mortgage.
Payment made on a loan where the taxpayer is not directly liable are deductible only if
the taxpayer is the legal or equitable owner of the real estate.
Mortgage Interest Statement
If a taxpayer paid $600 or more of mortgage interest (including certain points) during the year
on any one mortgage, they generally will receive a Form 1098, Mortgage Interest Statement, or
a similar statement from the mortgage holder. A taxpayer will receive the statement if they
paid interest to a person (including a financial institution or a cooperative housing corporation)
in the course of that person's trade or business.
43 IRC §163(h)(4)(A)(i)(I)
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Note: The statement should be received for each year by January 31 of the following
year. A copy of this form will also be sent to the IRS. This statement will show the total
interest paid during the year. If a home was purchased during the year, it will also show
the deductible points paid during the year, including seller paid points.
Form 1098 was Issued in Taxpayers’ SSN
Report deductible mortgage interest on Schedule A, Line 10.
Attach a statement of explanation if the deductible amount and the amount reported are
not the same.
If more than one person paid the deductible mortgage interest, include amounts paid by
each party on the statement.
Form 1098 was Not Issued in Taxpayers’ SSN
Report deductible mortgage interest on Schedule A, Line 11.
Include the name, identifying number and the address of the interest recipient in the
space provided on Line 11.
In general, if more than one individual is liable on a mortgage, he or she is each entitled to
deduct the mortgage interest that he or she personally paid, regardless of his or her ownership
interest in the property.44
Example: George and his wife file married filing separate and are jointly liable on a
mortgage, but George paid all of the mortgage interest from his separate funds, George
can deduct all of it, even if his wife owns 100% of the property.
If two people are jointly liable for the mortgage, and the interest is paid out of a joint checking
account, each individual generally can only deduct 50% of the interest.45 However, if one liable
person can prove that he or she supplied all of the funds in the joint checking account, that
person can deduct all of the mortgage interest.46
44 George A. Neracher, 32 BTA 236 45 Mark B. Higgins, 16 TC 140 46 Barbara S. Finney, TC Memo 1976-329
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Loan Origination Fees - Points
Points are deductible in full if all of the following requirements are met:
1. The loan is secured by the taxpayers’ main home.
2. Paying points is an established business practice in the area.
3. The points paid were not more than the amount generally charged in that area.
4. The taxpayer uses the cash method of accounting. This means they report income in the
year received and deduct expenses in the year paid.
5. The points were not paid for items that usually are separately stated on the settlement
sheet such as appraisal fees, inspection fees, title fees, attorney fees, or property taxes.
6. The funds the taxpayer provided at or before closing, and any points the seller paid,
were at least as much as the points charged. The taxpayer cannot have borrowed the
funds from the lender or mortgage broker in order to pay the points.
7. The loan is used to buy or build the taxpayers’ main or second home.
8. The points were computed as a percentage of the principal amount of the mortgage.
9. The amount is clearly shown as points on the settlement statement.
Points that are an additional interest charge constitute prepaid interest. They must be
capitalized by a cash-basis taxpayer and deducted ratably over the term of the loan if incurred
in a business transaction, the same as if the taxpayer were on the accrual basis.47
Points charged for specific services by the lender for the borrower’s account are not interest.
Examples of fees for services not considered interest are:
1) Lender’s appraisal fee,
2) Preparation costs for the mortgage note or deed of trust,
3) Settlement fees, and
4) Notary fees.
It is important for the taxpayer to understand how refinancing his or her mortgage works for
tax purposes. When he or she take out a mortgage to buy or build a home, it counts as home
acquisition debt and gets the $750,000 limit. A mortgage for other purposes is treated as a
home equity loan and gets no interest deduction. If the taxpayer refinances a mortgage that
counted as home acquisition debt, the points count as prepaid interest and are deductible. The
refinanced mortgage will also count as home acquisition debt as long as it is in the same
amount. If the taxpayer borrows more in the refinancing, then the original acquisition loan,
then the extra amount of cash pulled out will be treated as home equity debt unless it is used to
improve the home.
47 IRC §461(g)(1)
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The taxpayer can fully deduct (in the year paid) points paid on a loan to improve their main
home if the above tests one through six are met. Points that do not meet these requirements
may be deductible over the life of the loan. Points paid for refinancing generally can only be
deducted over the life of the new mortgage. However, if the taxpayer uses part of the
refinanced mortgage proceeds to improve the main home, and they meet the first six
requirements stated above, they can fully deduct the part of the points related to the
improvement in the year they paid with their own funds. The taxpayer can deduct the rest of
the points over the life of the loan.
Because of the principal residence requirement, a taxpayer cannot fully deduct in the year paid
points paid on loans secured by a second home; those points can be deducted only over the life
of the loan.
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TaxLaw
What Do You Think?
Q1. The CARES Act allows taxpayers to suspend their mortgage payments by
using forbearance. Which of the following is not correct regarding
forbearance?
A. A borrower can, at any time the borrower chooses, shorten the
forbearance and resume repayment of the loan.
B. The initial period of forbearance is 180 days.
C. Forbearance is a form of loan forgiveness.
D. A forbearance is a temporary postponement or reduction of mortgage payments.
Q2. Kelly, who is single, bought a principal residence for its fair market value of $850,000 in
May 2019. She paid $200,000 down payment and financed the remainder by borrowing
$650,000 through a loan secured by the house. Kelly also took out a loan for $50,000 for a new
kitchen, secured by the home. Which of the following is the correct.
A. Kelly may deduct, interest paid on acquisition debt of $650,000 and on the home equity
loan.
B. Kelly may deduct, interest paid on acquisition debt of $650,000 only.
C. Kelly may deduct interest on the $850,000 purchase price of the home.
D. Kelly may not deduct interest paid in the year she purchased the home.
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What Do You Think? – Answers
Answer Q1 – C is the correct answer
Q1. The CARES Act allows taxpayers to suspend their mortgage payments by
using forbearance. Which of the following is not correct regarding forbearance?
A. A borrower can, at any time the borrower chooses, shorten the forbearance and resume
repayment of the loan.
B. The initial period of forbearance is 180 days.
C. Forbearance is a form of loan forgiveness.
D. A forbearance is a temporary postponement or reduction of mortgage payments
The CARES Act allows taxpayers to suspend their mortgage payments by using forbearance.
A forbearance is a temporary postponement or reduction of mortgage payments. It is not
payment forgiveness. Under the CARES Act, borrowers are entitled to an initial forbearance
period of up to 180 days, upon a borrower’s request. In addition, upon a borrower’s request,
the forbearance must be extended for up to an additional 180 days. A borrower can, at any time
the borrower chooses, shorten the forbearance and resume repayment of the loan
Answer Q2. – A is the correct answer.
Q2. Kelly, who is single, bought a principal residence for its fair market value of $850,000 in
May 2019. She paid $200,000 down payment and financed the remainder by borrowing
$650,000 through a loan secured by the house. Kelly also took out a loan for $50,000 for a new
kitchen, secured by the home. Which of the following is the correct.
A. Kelly may deduct, interest paid on acquisition debt of $650,000 and on the home equity
loan.
B. Kelly may deduct, interest paid on acquisition debt of $650,000 only.
C. Kelly may deduct interest on the $850,000 purchase price of the home.
D. Kelly may not deduct interest paid in the year she purchased the home.
Kelly can deduct the interest on the acquisition debt of $650,000. The equity line for home
improvements is deductible in 2019/2020 since it is secured by the home and used for home
improvement (Total loans secured by the home is $700,000).
TCJA provides that a taxpayer may treat no more than $750,000 as acquisition indebtedness
($375,000 in the case of married taxpayers filing separately) for purposes of the mortgage,
interest deduction. TCJA repeals the deduction for home equity indebtedness not used for
home improvement.
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Charitable Contributions
CARES Act: The adjusted gross income limit for cash contributions was increased for
individual donors. For cash contributions (not donations of goods) made in 2020, the taxpayer
can elect to deduct up to 100 percent of their AGI (increased from 60 percent). The AGI limit
for cash contributions was also increased for corporate donors. Corporations can now deduct
up to 25 percent of taxable income (increased from 10 percent).
The CARES Act allows for an additional, “above-the-line” deduction for charitable gifts made
in cash of up to $300. This is for taxpayers who do not itemize on their 2020 taxes, It is an
above the line deduction.
Existing carry-over rules still apply, if the donations in 2020 exceed the AGI deduction limits,
the taxpayer may carry forward excess deductions for up to five subsequent tax years.
A Qualified Charitable Distribution (QCD) is a direct transfer of funds from an IRA trustee to
a qualified charity. The CARES Act did not change the rules around the QCD, which allows
individuals over 70½ years old to donate up to $100,000 in IRA assets directly to charity1
annually, without taking the distribution into taxable income.
However, remember that under the CARES Act an individual can elect to deduct 100 percent
of their AGI for cash charitable contributions. This effectively affords individuals over 59½
years old the benefits similar to a QCD; they can take a cash distribution from their IRA,
contribute the cash to charity, and may completely offset tax attributable to the distribution by
taking a charitable deduction in an amount up to 100 percent of their AGI for the tax year.
If the taxpayer is planning a large donation in 2020, this may be a smart strategy as long as he
or she is between the ages of 59½ and 70½ and are not dependent on existing retirement funds.
Partial Above-the-Line Charitable Contribution Deduction
A charitable contribution not in excess of $300 made in taxable years beginning in 2020 is
allowed to taxpayers who do not itemize. The contribution must be made in cash to a qualified
charitable organization or a new or existing donor advised fund.
Temporary Suspension of Contribution Limitations
The 50% limitation (60% in years 2018-2025) under §170(b) and (d) is suspended for cash
contributions made in 2020.
For corporations, the 10% limitation is increased to 25% of taxable income. This provision also
increases the limitation on deductions for contributions of food inventory from 15% percent to
25%.
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In general, a deduction is permitted for charitable contributions48, subject to certain limitations
that depend on the type of taxpayer, the property contributed, and the donee organization. The
amount of deduction generally equals the fair market value of the contributed property on the
date of the contribution. Charitable deductions are provided for income, estate, and gift tax
purposes.
To be deductible charitable contributions must meet the following requirements:
1. Contributions must be to or for the use of qualifying organizations, the IRS lists most
qualifying organizations in Publication 78,
2. Generally, they must be paid within the year, even if the taxpayer is on the accrual
basis,
3. They cannot exceed certain statutory limits, and
4. They must be itemized deductions for individuals.
Note: A contribution made to an individual is not deductible unless he or she is acting as an
agent for a qualified organization, even though he or she may be in need. Go,FundMe pages,
which are not 501(c) organizations, are not deductible.
For a contribution of cash, check, or other monetary gift (regardless of amount), the taxpayer
must maintain as a record of the contribution49 a bank record or a written communication from
the qualified organization containing the name of the organization, the date of the contribution,
and the amount of the contribution. In addition to deducting cash contributions, generally the
taxpayer can deduct the fair market value of any other property donated to qualified
organizations. For any contribution of $250 or more (including contributions of cash or
property), the taxpayer must obtain and keep a written acknowledgment from the qualified
organization indicating the amount of the cash and a description of any property contributed.
The acknowledgment must say whether the organization provided any goods or services in
exchange for the gift and, if so, must provide a description and a good faith estimate of the
value of those goods or services. The preparer should inquire whether these requirements were
met by the taxpayer and, if possible, view these documents.
Any contribution involving the payment of money to or on behalf of a charity is considered as
a cash contribution whether it is in the form of cash, check, credit card payroll deduction, out
of pocket expense, student living expense or foster parent expense.
48 IRC §170 49 IRC §170(f)(8)(A)
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Generally, a contribution is considered to be made at the time of its unconditional delivery. The
unconditional delivery or mailing of a check that subsequently clears in due course constitutes
a contribution on the delivery or mailing date. Contributions a taxpayer charges on a bank
credit card are deductible in the year the taxpayer makes the charge.50 For contributions a
taxpayer makes through a pay-by-phone account, the date the financial institution pays the
amount is the contribution date. This date should be shown on the statement the financial
institution sends the taxpayer.
The following is a tax law case involving proper statements and substantiation of charitable
donations. The case Durden v. Commissioner51, involved a Texas couple who claimed a
deduction of $25,171 for cash contributions to their church. The church sent a letter of
acknowledgement in January of 2008, but that receipt lacked a statement of whether any goods
or services were provided to the Durdens in exchange for their contributions. Obviously trying
to make up for the error, the church provided a second acknowledgement in June of 2009,
which did include the proper statements. Nevertheless, the IRS denied the deduction because
the Durdens failed to get a proper receipt from their church. In the IRS's view, the first
acknowledgement was lacking a statement of whether goods or services were provided by the
church, and the second acknowledgement was not a "contemporaneous" receipt, because it was
not received by the Durdens by the due date for filing their original return for the year. Because
the Durdens did not have proper receipts, the judge agreed with the IRS that the Durdens failed
to comply with the substantiation requirements of IRC 170(f) (8).
If an individual makes a gift to someone in the organization, the individual does not get a
charitable contribution deduction, and the individual receiving the gift does not report it as
income. Since the contribution did not occur through the organization, there is no reporting
responsibility for the organization.
Example: A church member gives the pastor a restaurant gift card in appreciation of
his kindness. This is a gift between two individuals; it is not a tax matter.
The key here is that the gift did not go through the church, nor was it related to services
provided.
Note: The pastor cannot receive gifts from the congregation in lieu of a salary. In this case, the
IRS would rule that the gifts were disguised compensation and would be taxable income to the
pastor. This situation applies only in cases where the pastor had rendered no special services
for the member.
Example: The pastor was compensated by a member for performing a wedding that
would be taxable income to the pastor, reported on Schedule C.
50 Rev. Rul. 8-38 51 T.C. Memo. 2012-140 (May 17, 2012)
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TCJA Increase of Cash contributions TCJA has increased the amount of cash contributions allowed to be contributed tax years 2018
through 2025. If contributions are all to 50% charities, the deduction for contributions is increased
from 50% of adjusted gross income before any net operating loss carryback, to 60% of adjusted
gross income. There is an exception for appreciated capital gain property.
Charities that are 50% organizations include:
Churches,
Tax-exempt educational organizations,
Tax-exempt hospitals and certain medical research organizations,
Certain organizations holding property for state and local colleges and universities,
A state, a possession of the U.S., or any political subdivision of any of the foregoing, or
the U.S. or the District of Columbia, if the contribution is for exclusively public
purposes,
An organization organized and operated exclusively for charitable, religious,
educational, scientific, or literary purposes or for the prevention of cruelty to children
or animals or to foster national or international amateur sports competition if it
normally gets a substantial part of its support from the government or the general
public,
Limited private foundations, and
Certain membership organizations more than one-third of whose support comes from
the public (§170(b)(1)).
A 30% limit applies to the following contributions:
Contributions to all qualified organizations other than 50% limit organizations. This
includes contributions to veterans' organizations, fraternal societies, nonprofit
cemeteries, and certain private nonoperating foundations.
Contributions for the use of any qualified organization.
However, if these contributions are of capital gain property, they are subject to the 20%
limit, described later, rather than the 30% limit.
Special 30% Limit for Capital Gain Property
A special 30% limit applies to contributions of capital gain property to 50% limit
organizations. However, the special 30% limit does not apply when the taxpayer chooses to
reduce the fair market value of the property by the amount that would have been long-term
capital gain if he or she had sold the property. Instead, only the 50% limit applies.
Two separate 30% limits. This special 30% limit for capital gain property is separate from the
other 30% limit. Therefore, the deduction of a contribution subject to one 30% limit does not
reduce the amount of the deduction for contributions subject to the other 30% limit. However,
the total deduction cannot be more than 50% of the adjusted gross income.
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Example: The adjusted gross income is $50,000. During 2020, Jane gave capital gain
property with a fair market value of $15,000 to a 50% limit organization. Jane did not
choose to reduce the property's fair market value by its appreciation in value. Jane also
gave $10,000 cash to a qualified organization that is not a 50% limit organization. The
$15,000 contribution of property is subject to the special 30% limit. The $10,000 cash
contribution is subject to the other 30% limit. Both contributions are fully deductible
because neither is more than the 30% limit that applies ($15,000 in each case) and
together they are not more than the 60% limit ($30,000).
20% Limit
The 20% limit applies to all contributions of capital gain property to or for the use of qualified
organizations (other than contributions of capital gain property to 50% limit organizations).
Noncash Contributions
A noncash contribution is a donation of property. The preparer must fill out Form 8283, and
attach it to the return, if the deduction for a noncash contribution is more than $500.
Another case of interest is Mohamed v. Commissioner. In this case, a California couple made
gifts of "extremely valuable" real property (more than $18.5 million total) to their charitable
trust in 2003 and 2004. The IRS denied the deduction for these contributions because the
Mohameds did not have the property independently appraised, as required by Treasury
regulations for noncash property contributions of more than $5,000. The taxpayer in this case
prepared and filed his own tax return, including the required Form 8283 for noncash charitable
contributions. The taxpayer admitted that he did not read the Form 8283 instructions, although
the form itself appeared simple enough, and perhaps was even a little misleading. (The IRS has
since revised Form 8283 (see below). The tax court agreed with the IRS that the Mohameds
had failed to satisfy the appraisal requirements of the Section 170 regulations, and therefore,
their charitable deductions were completely denied. The court agreed that this was a harsh
result, but found that "the problems of misvalued property are so great that Congress was quite
specific about what the charitably inclined have to do to defend their deductions, and we
cannot in a single sympathetic case undermine those rules”.
As is apparent from Durden v. Commissioner discussed earlier in this chapter and Mohamed v.
Commissioner. Above, it is essential that the taxpayer obtain the proper paperwork from the
charitable organization. Taxpayers’ should read the forms whether they prepare the return on
their own or go to a preparer. Being diligent regarding the information being filed is essential.
The example above Form 8283 is of a contribution of less than $5,000 and the example below
is of page three of Form 8283, which is a contribution if more.
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To substantiate a charitable cash contribution of less than $250, a taxpayer must be able to
provide:
• Bank record (canceled check; bank or credit card statement);
• Written communication from the donee showing:
• The donee's name;
• The date of the contribution; and
• The amount of the gift; or
• Other reliable written records showing the name of the donee, the date of the
contribution, and the amount of the contribution
The quality of the item when new, and its age must be considered, but it must be in good
condition to allow a deduction. Below is a guide regarding the value of used household goods..
Generally, for a charitable contribution of property with a claimed value of more than $5,00052,
a taxpayer must provide information about the donated property in Section B, Part I of Form
8283, the taxpayer must also obtain a qualified appraisal of the property prepared by a
qualified appraiser. The appraiser must sign Part III of Form 8283, and the donee must sign
and provide the information required in Part IV.
52 IRC §170(f)(11)(A) , (C) , (D
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Form 8283, Page 2
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Donated Goods Valuation Chart
Women’s Clothing
Blouse ($4 – $9)
Sweater ($4 – $13)
Pants ($4 – $23)
Dress ($6 – $28)
2pc Suit ($10 – $96)
Handbag ($2 – $10)
Hat ($1 – $9)
Shoes ($3 – $30)
Men’s Clothing
Shirt ($4 – $6)
Sweater ($4 – $6)
Pants ($4 – $23)
2pc Suit ($5 – $96)
Shoes ($3 – $30)
Jacket ($10 – $45)
Overcoat ($3 – $9)
Children’s Clothing
Shirt ($2 – $10)
Sweater ($2 – $10)
Pants/Jeans ($2 – $10)
Dress ($2 – $10)
Shoes ($3 – $10)
Boots ($6 – $10)
Snowsuit ($2 – $10)
Dry Goods
Pillow ($2 – $5)
Sheet ($2 – $9)
Blanket ($3 – $14)
Curtain ($2 – $7)
Drapes ($7 – $23)
Area Rug ($2 – $16)
Books ($0.59 – $2)
CD’s ($2 - $5)
Furniture
Floor Lamp ($8 – $34)
Sofa ($40 – $395)
Table Lamp ($3 – $20)
Stuffed Chair ($10 – $75)
Kitchen Set ($35 – $135)
End Tables ($10 – $75)
Coffee Table ($15 – $100)
Dresser ($20 – $80)
Appliances
Iron ($3 – $10)
Vacuum Cleaner ($5 – $70)
Coffee Maker ($5 – $10)
Radio ($1 – $10)
Working Television ($5 – $50)
DVD Player ($5 - $15)
Sewing Machine $5 -$75)
Bicycle ($5 - $80)
Miscellaneous
Battery Back-ups ($1.50 – $2)
Computers ($5 - $50)
Keyboards ($0.30 – $10)
Laptops ($5- $15)
Mice ($0.30 – $5.00)
Printers ($1 – $10)
Golf Clubs ($2 - $25)
Luggage ($5 - $15)
Remember: Noncash contributions must be receipted and itemized.
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Contribution Carryovers
Contributions are deductible in the year they are actually donated to a qualified charity
regardless of the taxpayers’ method of accounting.
Contributions is excess of 20%, 30% or 60% of the taxpayers’ AGI are carried over53 to the
next tax year. If the 20%, 30% or 60% ceilings limit the contributions, the amount not deductible
in the year contributed may be carried forward for up to five years and deducted on a future return.
See above for a definition of 20%, 30% and 60% of AGI contributions.
Taxpayers with a large charitable contribution carryover can take advantage of the CARES Act
change, which allows the taxpayer to donate up to 100% of their AGI. This includes the
carryover.
If the taxpayer takes the standard deduction while carrying forward a charitable contribution,
the contribution cannot be claimed in that year.54 However, the excess is carried over reduced
by the amount he or she would have been able to claim had he or she itemized their deductions
in the current year.
Recordkeeping Rules for Charitable Contributions
Required written acknowledgements from the charity must be received by the taxpayer by the
earlier of the date of filing or due date of the return, including extensions.
Part contribution, part goods or services. A written statement from a charity is required if a
donation is more than $75 and is partly a contribution and partly for goods and services. The
statement must contain an estimate of the value of goods or services received.
Exception: A written statement for goods or services is not required if one of the following is
true.
1. The charity is Federal, state, or local government or a religious organization where the
benefit is an intangible religious benefit, such as admission to a religious ceremony.
2. The goods or services are of token value.
3. The goods or services are membership benefits, as described under Membership fees or
dues as a donation.
Benefits Received
If a taxpayer contributes to a charitable organization and receives a benefit from it, he or she
may deduct only the amount that is more than the value of the benefit he or she received.
53 Pub 526, Charitable Contributions 54 Reg §1.170A-10(a)(2
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Examples of charitable contributions, which are not deductible because of benefits received
include:
(1) Tuition, even for children attending parochial school, and
(2) Payment in connection with an aged person’s admission to a home operated by a
charity, to the extent allocable to care to be given or the privilege of being admitted.
If a taxpayer pays more than the fair market value to qualified organizations for charity balls,
banquets, shows, etc., the amount that is more than the value of the privileges or other benefits
received is deductible as a contribution.
The presumption here is that the payment is not a gift. The taxpayer must show that a clearly
identifiable part of the payment is a gift. Only that part of the payment made with the intention
of making a gift and for which the taxpayer received no consideration qualifies as a
contribution.
NOTE: A receipt is not required where it is impractical to get one, such as leaving property at a
charity’s unattended drop site. The organization’s name, date of contribution, and description
of property are still required.
TCJA Casualties and Theft
Personal casualty losses, which include theft losses, are temporarily limited under the Tax Cuts
and Jobs Act of 2017. In the case of an individual, any personal casualty loss, which would
otherwise be deductible in tax years 2018-2025 is only allowed as a deduction in those years to
the extent it, is attributable to a federally declared disaster.55 There is an exception, however,
for personal casualty gains during those years. Such gains can be used to offset a personal
casualty loss not attributable to a federally declared disaster to the extent the loss does not
exceed the gain.
A Federally Declared Disaster
(A) In general. The term "Federally declared disaster" means any disaster subsequently
determined by the President of the United States to warrant assistance by the Federal
Government under the Robert T. Stafford Disaster Relief and Emergency Assistance
Act.
(B) Disaster area. The term "disaster area" means the area so determined to warrant
such assistance.
Any allowable casualty loss deductions are still deductible as an itemized deduction and
subject to $100 per casualty and 10% of AGI limitations.56
55 IRC §165(i)(5). 56 TCJA §11044
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Casualty Losses
A casualty is the loss of property (including damage and destruction) because of a sudden
event. The event must be federally declared, identifiable, unexpected, and unusual. Events that
meet these criteria include:
Car accidents,
Disaster-related demolition,
Earthquakes,
Fires,
Floods,
Hurricanes,
Shipwrecks,
Storms,
Terrorist attacks,
Tornadoes,
Vandalism, and Volcanic eruptions
Miscellaneous Itemized Deductions
Deductions Subject to 2% of Adjusted Gross Income Are Repealed under TCJA
This has been one of the most asked questions from taxpayer. Depending on the profession of the
taxpayer, these deductions were large and along with the loss of exemptions were a significant
difference.
The following items are not deductible after December 31, 2017 through December 31, 2025:
Unreimbursed employee business expenses
Tax preparation fees
Excess deductions of an estate
Fees to claim a tax refund
Hobby expenses
Indirect deductions of pass-through entities
Investment fees and expenses
Legal expenses
Loss on traditional IRA or Roth IRA
Repayments of Income if $3,000 or less.
Repayments of Social Security benefits
Trustee administrative fees for an IRA
Appraisal fees for a casualty loss on a contribution
Job seeking expense
Education expense
Union Dues
.
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Gambling Winnings and Losses
Taxpayers must report the full amount of their gambling winnings (with no reduction for
gambling losses) for the year as income on Form 1040, and then deduct their gambling losses
(up to the amount reported as gambling winnings) for the year separately on Schedule A (Form
1040) as a miscellaneous itemized deduction not subject to the 2 percent floor.57 When spouses
file a joint return for the tax year, their combined gambling losses are deductible to the extent
of their combined winnings. Gambling losses in excess of winnings are not deductible.58
For tax years after December 31, 2017 through December 31, 2025, different rules apply with
respect to professional gamblers. Whereas casual gamblers must claim their gambling losses
(up to the amount of their gambling winnings) as an itemized deduction, a professional
gambler can deduct his or her losses (up to the amount of his or her winnings) as an above-the-
line deduction in arriving at adjusted gross income. Additionally, the Tax Court held that the
limitation does not limit deductions for expenses incurred to engage in the trade or business of
gambling. A gambler's business expenses are not "losses from wagering transactions" subject
to the Code Sec. 165 deduction limitation.
Thus, such expenses are considered deductible business expenses.59 In Mayo, the Tax Court
also stated that it would no longer follow the contrary holding of Offutt v. Comm'r, and other
cases applying the Code Sec. 165(d) deduction limitation to Code Sec. 162 business expenses.
The deduction for gambling losses is temporarily modified under the Tax Cuts and Jobs Act of
2017 (TCJA) for tax years 2018-2025. For these years, the limitation on losses from gambling
transactions applies not only to the actual betting costs, but also not to other expenses incurred
in connection with gambling activity. For instance, an individual's otherwise deductible
expenses in traveling to or from a casino are permitted only to the extent of gambling winnings
for tax years 2018-2025. The TCJA Conference Report specifically notes that the TCJA
provision is meant to overturn the Tax Court's holding in Mayo.
A professional gambler is an individual engaged in the trade or business of gambling (engages
in gambling for profit). To determine whether an individual is a professional gambler, courts
have looked to the profit motive factors60. The Tax Court found the taxpayers’ gambling
activity was operated in a businesslike manner because he kept detailed accounts of his
gambling transactions and maintained numerous statistics for each horserace. The taxpayer
also spent a considerable amount of time handicapping races and studying racing programs,
frequently sought advice from other experienced gamblers, and enjoyed a modest profit from
his activities in the year at issue. Professional gamblers, like casual gamblers, can deduct their
gambling losses only up to the amount reported as gambling winnings.61
Example: Yosemite Sam was in the trade or business of gambling on horse races. During
57 IRC§67(b)(3) 58 IRC §165(d) 59 IRC §162 60 Reg. Sec. 1.183-2(b) 61 Alabsi v. Comm'r, T.C. Summary 2017-5
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2017, Yosemite incurred $10,000 of business expenses relating to gambling. He also had an
$11,000 loss from gambling (gambling gains of $120,000 less gambling losses of $131,000).
Yosemite cannot deduct the $11,000 of excess gambling losses over gambling gains. However,
he can deduct the $10,000 of gambling business expenses on his Schedule C. In 2018,
Yosemite had a $13,000 gambling loss (gambling gains of $120,000 less gambling losses of
$133,000) and also incurred $8,000 of business expenses relating to gambling. Yosemite
cannot deduct the $13,000 gambling losses and cannot deduct the $8,000 of business expenses.
Claim of Right - Recoveries
If a taxpayer receives earnings under a claim of right, and without restriction as to its
disposition, he must pay tax on it, even if there is some dispute as to whether he is entitled to
retain the money. If, in a later year, the dispute is resolved against the taxpayer and he is forced
to return the money, he may claim a deduction of the repayment in the year that it is made. The
deduction in the later year is not a miscellaneous itemized deduction subject to the 2% floor.
If the amount of the repayment is $3,000 or less, report the repayment on the form or schedule
that was originally reported. If reported as a capital gain, report the repayment as a capital loss
on Schedule D, if it was reported as income on a Sole Proprietorship, report the repayment as
an expense on the Schedule C, etc.
If reported as wages, unemployment or other income report the repayment as a miscellaneous
itemized deduction subject to 2% of AGI, on Schedule A. Under TCJA, this is repealed after
December 31, 2017 through December 31, 2025.
If the amount of the deduction exceeds $3,00062, a special computation is provided for the year
of the repayment.
The tax for that year is the lower of the following:
(1) The tax computed with the deduction for the repayment (reported on Schedule A
Other Miscellaneous Deductions), or
(2) The tax computed without the deduction, but reduced by the amount by which the
tax for the earlier year would have been reduced if the amount subsequently repaid had
never been included in income in the first place. This refigured tax is then subtracted
from the tax shown on the original return. Enter the result on Line 71 if Form 1040 and
enter “IRC 1341” next to Line 71.
The purpose is to protect the taxpayer when, due to a lower tax bracket, the deduction in the
later year does not save him as much tax as the inclusion in the earlier year cost him.
62 IRC §1341(a)
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What Do You Think?
Q1. Which of the following is allowed as a deduction in 2020?
A. Tax preparation expenses.
B. Employee business expenses
C. Gambling losses to the amount of gambling winnings.
D. Investment fees and expenses.
Q2. Which of the following statements are true regarding charitable contributions?
A. In the case of a noncash contribution the item donated must be in good condition in
order to claim the deduction.
B. In 2019, a charitable contribution may be deductible up to 60% of adjusted gross
income.
C. In order to deduct a charitable donation the taxpayer must itemize their deductions.
D. All of the above are true statements.
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What Do You Think? – Answer
Answer Q1 –C is the correct answer
Tax preparation expense, employee business expenses, and investment
fees and expenses are all 2% deductions that were repealed under TCJA.
Gambling losses to the amount of gambling winnings are allowed as an itemized deduction
(not subject to the 2% floor).
Answer Q2 – D all of the statements are correct.
Which of the following statements are true regarding charitable contributions?
A. In the case of a noncash contribution the item donated must be in good condition in
order to claim the deduction.
B. In 2019, a charitable contribution may be deductible up to 60% of adjusted gross
income.
C. In order to deduct a charitable donation the taxpayer must itemize their deductions.
D. All of the above are true statements
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Chapter 3 – Education and Related Issues
When figuring an education credit, use only the amounts
paid and those deemed to be paid during the tax year for
qualified education expenses.
Education credits are reported on Schedule 3, which is used for nonrefundable credit other than
the child tax credit or the credit for other dependents, such as the foreign tax credit, education
credits and general business credit.
Form 1098-T requirement. To be eligible to claim the American opportunity credit or the
lifetime learning credit, the law requires a taxpayer (or a dependent) to have received Form
1098-T, Tuition Statement, from an eligible educational institution. If a student’s educational
institution is not required to provide a Form 1098-T to the student, a taxpayer may claim a
credit without a Form 1098-T if the taxpayer otherwise qualifies, can demonstrate that the
taxpayer (or a dependent) was enrolled at an eligible educational institution, and can
substantiate the payment of qualified tuition and related expenses.
American Opportunity Credit
A taxpayer who pays qualified education expenses may elect to claim an American opportunity
tax credit of up to $2,500 per year for each eligible student.63 The amount of the credit for each
student is computed as 100 percent of the first $2,000 of qualified education expenses paid for
the student and 25 percent of the next $2,000 of such expenses paid.64
Generally, 40 percent of the American opportunity tax credit is refundable. Thus, a taxpayer
can get a refund for that portion of the credit to the extent it exceeds the taxpayers’ tax
liability.65
In 2019, refundable credits are reported on Form 1040, Page 2, Line 18, The taxpayer can
claim a refundable credit other than the earned income credit, American opportunity credit
(Form 8863), or additional child tax credit (Form 8812). Have other payments, such as an
amount paid with a request for an extension to file or excess social security tax withheld.
A taxpayer cannot treat any portion of the American opportunity tax credit as refundable if:
(1) At the end of the tax year, he was:
(a) under age 18,
(b) age 18 and his earned income was less than half his support, or
(c) a full-time student over age 18 but under age 24 and his earned income
was less than half his support;
63 IRC §25A(i) 64 IRC §25A(b)(1) 65 IRC §25A(i)(5)
Objectives:
Discuss and explain through relevant
examples the education credits and
adjustments.
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(2) At the end of the tax year, at least one of his parents was alive; and
(3) He or she is not filing a joint return for the tax year.
Taxpayers claiming the American opportunity tax credit must provide the employer
identification number of any institution to which qualified tuition and related expenses were
paid. The reporting of the education expenses is done by the Education Institution on Form
1098-T, Tuition Statement.
If there are qualified education expenses for a dependent during a tax year, the taxpayer may be
able to claim an American opportunity credit for their dependent expenses that year.
For the taxpayer to claim an American opportunity credit for the dependent’s expenses, the
dependent must be claimed as a dependent on the taxpayers’ tax return.
If the taxpayer claims on the tax return an eligible student who is their dependent, treat any
expenses paid (or deemed paid) by the dependent as if the taxpayer had paid them. Include
these expenses when figuring the amount of the American opportunity credit.
Qualified education expenses paid directly to an eligible educational institution for a dependent
under a court-approved divorce decree are treated as paid by the dependent.
If the taxpayer claims a dependent who is an eligible student, only the taxpayer can include any
expenses paid when figuring the amount of the American opportunity credit. If neither the
taxpayer nor anyone else claims the dependent, only the dependent can include any expenses
paid when figuring the American opportunity credit.
Form 1098-T Tuition Statement is issued by an eligible educational institution (a college,
university, vocational school, or other postsecondary educational institution that is described in
IRC §481 of the Higher Education Act of 1965), reporting amount of payments received during
the year. When figuring the education credit use only the amount actually paid during the
taxable year. Form 1098-T may also contain other information, such as adjustments from prior
years, the amount of scholarships or grants, reimbursements or refunds and whether the student
was enrolled at least half-time or as a graduate student.
Form 8863 is used to claim either the American Opportunity Credit or the Lifetime Learning
Credit. Part III of this form must be completed to determine which credit is claimed. The
definition of qualified education expenses is generally the same for both the American
Opportunity Tax Credit and the Lifetime Learning Credit.
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Example: In 2020, Ms. Allen makes a payment directly to an eligible educational
institution for her grandson Todd’s qualified education expenses. For purposes of
claiming an American opportunity credit, Todd is treated as receiving the money from
his grandmother and, in turn, paying his qualified education expenses himself.
Unless Todd is claimed as a dependent on someone else’s 2020 tax return, only Todd
can use the payment to claim an American opportunity credit.
If anyone, such as Todd’s parents, claims Todd on his or her 2020 tax return, whoever
claims him may be able to use the expenses to claim an American opportunity credit. If
anyone else claims Todd, Todd cannot claim an American opportunity credit.
American Opportunity Credit or Lifetime Learning Credit (2020) Caution. Both the American opportunity credit and the lifetime learning credit can be claimed on the same
return—but not for the same student.
American Opportunity Credit Lifetime Learning Credit
Maximum credit Up to $2,500 credit per eligible student Up to $2,000 credit per return
Qualified
expenses
Tuition, required enrollment fees, and
course materials that the student needs
for a course of study whether or not the
materials are bought at the educational
institution as a condition of enrollment or
attendance
Tuition and enrollment fee amounts required to be
paid to the institution for course-related books,
supplies, and equipment.
Modified adjusted
gross income
(MAGI) phase-
out
$160,000-180,000 if Married Filing
Jointly; $80,000-90,000 if Single, Head
of Household, or Qualifying Widow(er)
$116,000-$136,000 if Married Filing Jointly;
$58,000-$68,000 if Single, Head of Household, or
Qualifying Widow(er)
Eligibility
At least a half-time student in program
leading to a degree for the first 4 years of
postsecondary education
Taking one or more courses Undergraduate &
graduate or
Courses to acquire or improve job skills
Refundable/
nonrefundable
40% of credit may be refundable; the rest
is nonrefundable
Nonrefundable—credit limited to the amount of tax
on the taxable income
Form Used Form 8863 Form 8863
Felony drug
conviction
The student had not been convicted of a
felony for possessing or distributing a
controlled substance
Felony drug convictions are permitted
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Form 8863
Fees, Books Supplies and Equipment
American Opportunity Tax Credit: Generally, a fee is treated as a qualified education
expense only if the fee is a required payment to the eligible educational institution as a
condition of the student’s enrollment or attendance at the institution.66 Generally, qualified
education expenses are claimed as an education credit only if they are paid for an academic
period that begins in the same year. However, qualified education expenses paid for an
academic period that begins during the first three months of the following tax year can be
claimed as an education credit in the tax year they are paid. For a calendar year taxpayer,
qualified education expenses paid for an academic period that begins in January, February, or
March of the following tax year are treated as qualified education expenses in the year they are
paid.67
Fees that are unrelated to the student’s course of study (nonacademic fees) are not qualified
education expenses. For example, student activity fees and athletic fees are not qualified
education expenses. Expenses for books, supplies, and equipment are qualified education
expenses if they are required for a course of study.
Lifetime Learning Credit
For purposes of the lifetime learning credit, expenses for books, supplies, and equipment are
qualified education expenses only if the fee is a required payment to the eligible educational
institution as a condition of enrollment or attendance.
Form 1098-T Tuition Statement is issued by an eligible educational institution (a college,
university, vocational school, or other postsecondary educational institution that is described in
section 481 of the Higher Education Act of 1965), reporting either payments received during
the year or amounts billed during the year. When figuring the education credit use only the
amount actually paid during the taxable year. Form 1098-T may also contain other information,
such as adjustments from prior years, the amount of scholarships or grants, reimbursements or
refunds and whether the student was enrolled at least half-time or as a graduate student.
For taxable years beginning in 2019, a taxpayers’ modified adjusted gross income must be less
than $68,000 ($136,000 for a joint return) to qualify for the Lifetime Learning Credit (LLC).
The credit will phase-out between $58,000 and $68,000 ($116,000 and $136,000). The credit is
20% of the first $10,000 of qualified education expenses paid for all eligible students.
66 Reg. Sec.1.25A-2(d)(2)(i) 67 IRC § 25A(g)(4)
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An eligible student for LLC includes a student who is the taxpayer, the taxpayers’ spouse, or
the taxpayers’ dependent. The following rules apply:
The lifetime learning credit is allowed if the student is enrolled in one or more courses
at an eligible educational institution and the course or courses are part of a
postsecondary degree program or are taken to acquire or improve job skills.68
o The American opportunity tax credit is allowed only for courses taken as part of
a postsecondary degree program in which the student is carrying at least half the
normal full-time workload. In contrast, for purposes of the LLC, a student need
not be carrying a specific workload. The credit may be allowed for the qualified
education expenses related to a single course. Moreover, for purposes of the
lifetime learning credit, the course or courses the student is taking need not be
part of a postsecondary degree program. The credit may be allowed if the course
or courses are taken by the student to acquire or improve job skills.
The lifetime learning credit is available for all years of postsecondary education of a
student and for all courses taken by a student to acquire or improve job skills.
There is no limit to the number of tax years that a taxpayer may claim a lifetime
learning credit for any particular student.69
The lifetime learning credit may be claimed for a student even if the student has a
felony drug conviction.
68 Code §25A(c)(2)(B) 69 Reg. Sec. 1.25A-4(b)
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What Do You Think?
An eligible student for LLC includes a student who is the taxpayer, the
taxpayers’ spouse, or the taxpayers’ dependent. Which of the following is not a
true statements regarding the Lifetime Learning Credit?
A. For taxable years beginning in 2019, a taxpayers’ modified adjusted gross income must
be less than $68,000 ($136,000 for a joint return) to qualify for the Lifetime Learning
Credit (LLC).
B. The credit is 20% of the first $10,000 of qualified education expenses paid for all
eligible students.
C. The lifetime learning credit is available for all years of postsecondary education of a
student and for all courses taken by a student to acquire or improve job skills.
D. The LLC can be claimed for only 4 years of post-secondary degree program.
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What Do You Think?-Answers
A1. An eligible student for LLC includes a student who is the taxpayer, the
taxpayers’ spouse, or the taxpayers’ dependent. Which of the following is
not a true statements regarding the Lifetime Learning Credit?
A. For taxable years beginning in 2019, a taxpayers’ modified adjusted
gross income must be less than $68,000 ($136,000 for a joint return) to qualify for the
Lifetime Learning Credit (LLC).
B. The credit is 20% of the first $10,000 of qualified education expenses paid for all
eligible students.
C. The lifetime learning credit is available for all years of postsecondary education of a
student and for all courses taken by a student to acquire or improve job skills.
D. The LLC can be claimed for only 4 years of post-secondary degree program.
Answer Q1 – D is the correct answer.
The statement is incorrect because, there is no limit to the number of tax years that a taxpayer
may claim a lifetime learning credit for any particular student
A – C are all correct statements
For taxable years beginning in 2019, a taxpayers’ modified adjusted gross income must be less
than $68,000 ($136,000 for a joint return) to qualify for the Lifetime Learning Credit (LLC).
The credit is 20% of the first $10,000 of qualified education expenses paid for all eligible
students.
The lifetime learning credit is available for all years of postsecondary education of a
student and for all courses taken by a student to acquire or improve job skills.
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Qualified Tuition Plan or §529 Plan
A qualified tuition program (commonly referred to as a “qualified tuition plan” or “529 plan”)
is a program established and maintained by either a state; or an eligible educational institution
under which a taxpayer can prepay, or contribute to an account that will be used to pay a
designated beneficiary’s qualified higher education expenses.
Observation: Prior to 2018, the term “higher education expenses”, as used in IRC §529, had
roughly the same meaning as it does in everyday use: expenses incurred for college and other
forms of postsecondary education. Beginning in 2018, however, the term was expanded to
include tuition for elementary and secondary schools, making the definition more taxpayer-
friendly, but also more confusing.
Contributions to QTPs are not deductible. QTP distributions used for postsecondary education
expenses are generally nontaxable. Distributions used for tuition paid in connection with
enrollment or attendance at a public, private, or religious elementary or secondary school are
also nontaxable, but are subject to a $10,000 annual limit. In certain instances, taxes may apply
to QTP distributions. While it is possible to lose money on an investment in a QTP, it is not
common. However, should this occur, a limited deduction may be available.
Allowing 529 plans to be used for K-12 tuition 529 plans are tax-advantaged investment accounts originally designed to help families pay for
college. The earlier the taxpayer starts saving, the greater he or she will benefit from tax-free
compounding. Currently, 529 withdrawals are tax-free as long as the funds are spent toward
qualified higher education expenses, which include tuition, room and board, and computer
software and equipment at any eligible post-secondary institution.
Under TCJA, parents who send their children to private elementary and high school will have
more options when it comes to saving for tuition. Up until now, the only vehicles that offered
tax-free savings for K-12 were Coverdell Education Savings Accounts (ESAs). With tax-free
earnings growth and tax-free withdrawals for qualified purchases, Coverdell ESAs operate
very similar to a 529 savings plan. There are, however, a few key differences:
TCJA allows 529 plans to be used for up to $10,000 per year in K-12 tuition expenses, giving
more families an opportunity to save tax-free for private and religious schools. Families who
are currently saving with a Coverdell ESA and want to switch to a 529 plan can do a rollover
with no tax consequences.
Qualified education expenses must be reduced by any expenses paid directly or indirectly using
tax-free educational assistance.
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In general, for the purposes of the education tax credits, “qualified tuition and related
expenses70” are defined as tuition and fees (such as fees for books, supplies, and equipment
used in a course of study) that are required for the enrollment or attendance of an eligible
student at an eligible educational institution
Generally, qualified education expenses paid on behalf of the student by someone other than
the student (such as a relative) are treated as paid by the student. However, qualified education
expenses paid (or treated as paid) by a student who is claimed as a dependent on another tax
return are treated as paid by that taxpayer.
For more information and additional examples, see Who Can Claim a Dependent’s Expenses in
Pub. 970, Chapter 2 or 3.
Most students receive his or her Form 1098-T71 through his or her online accounts at the
college or university. It is a common item, which is not presented by the taxpayer at the tax
interview, it is essential that the preparer review this form to complete the allowable Education
Credits.
Recapture of Education Credit
With respect to any student, the amount of qualified tuition and related expenses for a tax year
is calculated by adding all qualified tuition and related expenses paid for the tax year, and
subtracting any refund of such expenses received from the eligible educational institution
during the same taxable year (including refunds of loan proceeds).72
If a taxpayer or someone other than the taxpayer receives a refund (including refunds of
loan proceeds) of qualified tuition and related expenses paid on behalf of a student in a
prior tax year and the refund is received before the taxpayer files a Federal income tax
return for the prior tax year, the amount of the qualified tuition and related expenses for
the prior tax year is reduced by the amount of the refund.
If a taxpayer receives a refund or someone other than the taxpayer receives a refund
(including refunds of loan proceeds) of qualified tuition and related expenses, paid on
behalf of a student for which the taxpayer claimed an education tax credit in a prior tax
year, the income tax for the refund year is increased by the recapture amount.
The recapture amount is the difference in tax liability for the prior tax year; and the
results the prior year is credit calculated with the refund included.
70 IRC§25A(f)(1)(A) 71 Form 1098T Instructions 72 Reg. Sec. 1.25A-5(f)
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If loan proceeds used to pay qualified tuition and related expenses during a tax year are
refunded by an eligible educational institution to a lender on behalf of the borrower, the
refund is treated as a refund of qualified tuition and related expenses.
If, a taxpayer or someone other than the taxpayer receives any excludable educational
assistance for the qualified tuition and related expenses paid on behalf of a student
during a prior tax year (or attributable to enrollment at an eligible educational
institution during a prior tax year), the educational assistance is treated as a refund of
qualified tuition and related expenses. If the excludable educational assistance is
received before the taxpayer files, a Federal income tax return for the prior tax year, the
amount of the qualified tuition and related expenses for the prior tax year is reduced by
the amount of the excludable educational assistance. If the excludable educational
assistance is received after the taxpayer has filed a Federal income tax return for the
prior tax year, any education tax credit claimed for the prior tax year is subject to
recapture
Example: Jack paid $7,000 of qualified education expenses in August 2017 and his son began
college in September 2017. Jack filed his 2017 tax return on February 15, 2018, and claimed an
American opportunity tax credit of $2,500 on his return. In March 2018, he received a refund
of $4,000 of the qualified education expenses. Jack must recalculate the credit using $3,000
($7,000 - $4,000) of qualified education expenses. The recalculated credit is $2,250. Jack must
include $250 ($2,500 - $2,250) of additional tax liability on his 2018 return.
There is a special rule for the treatment of refunds where qualified tuition and related expenses
are paid in two tax years for the same academic period. Under this rule, the taxpayer may
allocate the refund in any proportion to qualified tuition and related expenses paid in the prior
tax year or the subsequent taxable year if the taxpayer or someone other than the taxpayer:
Pays qualified tuition and related expenses in one tax year for a student’s enrollment or
attendance at an eligible educational institution during an academic period beginning in
the first three months of the taxpayers’ next tax year;
Pays qualified tuition and related expenses in the subsequent tax year for the academic
period beginning in the first three months of the subsequent tax year; and
Receives a refund of qualified tuition and related expenses during the subsequent tax
year for the academic period beginning in the first three months of the subsequent tax
year.
However, the amount of the refund allocated to a tax year may not exceed the qualified tuition
and related expenses paid during the tax year with respect to the academic period beginning in
the subsequent tax year. The sum of the amounts allocated to each tax year cannot exceed the
amount of the refund.
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Qualified Tuition Program and Coverdell Education Savings Comparison
Qualified Tuition Program 73(QTP)
Coverdell Education Savings
Account74 (Coverdell ESA)
Description A program that allows the taxpayer
to either prepay or contribute to an
account for a student’s higher
education. Up to $10,000 can be
used for K-12. May be state or
private plan.
Accounts used to pay qualified
education expenses of a
designated beneficiary.
Ownership U.S. Citizen with a valid SSN,
including beneficiary. Beneficiary
and owner do not need to be
related.
Beneficiary or parent.
Age limit None No contribution once beneficiary
is over 18 and balance must be
distributed by age 30. Age limits
do not apply to beneficiaries with
special needs.
Contributors Any individual including
beneficiary.
No income limits.
$2,000 per beneficiary, no matter
how many Coverdell ESA’s are
set up for that beneficiary.
Contribution Limits No annual limits.
Account balance limits may be set
by plan. Most state plans are over
$200,000
Contributor subject to annual
phase-out range of $95,000 to
$110,000 ($190,000 to $220,000
for MFJ)
Who is Taxed? Owner, unless the distribution is
paid directly to beneficiary or for
the benefit of beneficiary.
Designated Beneficiary
Deadline None April 15 of the year following the
close of the tax year.
QTP and Coverdell ESA
When dealing with QTPs and ESAs it is important to understand all terminology:
A half-time student is a student who is enrolled for at least half the full-time academic
workload for the course of study the student is pursuing. The school determines what is
considered a fulltime workload for a particular course of study. Form1098-T Box 8 will
be checked.
73 IRC §529 74 IRC §530
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Tax-free education assistance includes:
o The tax-free portion of a scholarship or fellowship – Form 1098-T, Box 5
o Veterans’ educational assistance
o Pell grants – Form 1098-T, Box 5
o Employer-provided educational assistance
o Any other tax-free payments received as educational assistance (except gifts or
inheritances)
Tax-free Distributions
o Distributions are not taxable if less than the beneficiary’s adjusted qualified
expenses for the year.
o Nontaxable distributions are not reported on the tax return.
Taxable Distributions
o If distributions are more that the adjusted expenses, portion of the earnings are
taxable
Keep in Mind: A student or the student’s parent may claim the American Opportunity and
Lifetime Learning Credits in the same year as a Coverdell ESA or a QTP distribution is
taken as long as the same qualified expenses are not used for both.
NOTE: Covid-19 has disrupted many plans in 2020. A taxpayer withdrew money from a QTP
or 529 plan to pay for qualified higher education expenses, including room and board for his
son; Covid-19 force the dorms to close and his son had to return home. The son completes the
semester online and the father got a refund for the room and board. The refund for qualified
education expenses including room and board can be recontributed to the QTP within 60 days
of receiving it. The recontributed amount cannot exceed the refunded amount. 75
ABLE Accounts TCJA increases the contribution limitation to Achieving a Better Life Experience (ABLE)76
accounts under certain circumstances. While the general overall limitation on contributions
(the per-donee annual gift tax exclusion ($15,000 for 2020) remains the same, the limitation is
increased with respect to contributions made by the designated beneficiary of the ABLE
account. Under the provision, after the overall limitation on contributions is reached, an ABLE
account's designated beneficiary can contribute an additional amount, up to the lesser of (1) the
federal poverty line for a one-person household; or (2) the individual's compensation for the
tax year. Additionally, the provision allows a designated beneficiary of an ABLE account to
claim the saver's credit for contributions made to his or her ABLE account.
The provision is effective for tax years beginning after December 22, 2017 and will sunset
after December 31, 2025.
75 IRC §529(c)(3)(D) 76 IRC §529A
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Rollovers: TCJA allows existing 529 savings plans to be rolled into 529 ABLE accounts.
ABLE accounts were first introduced in 2014, to help Americans living with disabilities save
for education and other living expenses. Prior to the ABLE Act, if a person with a disability
earned more than $700 per month, or had $2,000 or more in savings, they risked having to
forfeit eligibility for public benefits like Medicaid. Like traditional 529 plans, ABLE accounts
offer tax-free investment growth and tax-free withdrawals when the funds are used to pay for
qualified expenses. For ABLE accounts, this includes things like college, job training, and
healthcare and financial management.
In some cases, parents start saving for their child’s college education in a traditional 529 plan,
and later learn that the child has a disability. Before now, these parents had limited options,
since taking a distribution from the 529 plan to fund an ABLE account would have been
considered a non-qualified withdrawal – triggering income tax and a 10% penalty on the
earnings portion. Twenty-seven states currently offer ABLE plans, each with their own fee
structure and investment options. Some plans also offer a debit or purchasing card for everyday
expenses.
U.S. Savings Bonds Interest Exclusion
When purchasing a Series EE bond, or I bond the taxpayer pays the face value of the bond. It
accrues interest until the bond matures.
The difference between the purchase price and the redemption value is taxable interest income.
The taxpayer can report interest income77 from Series EE, and I bonds in one of these ways:
Report the interest in the year it is earned.
Report the entire amount of interest earned when the bond matures or when it is
redeemed whichever comes first.
Example: The taxpayer purchased a $1,000 Series I bond that earns 4% interest, and keeps
it for 5 years. The taxpayer can either report $40 each year in interest, or wait to report
$200 in interest when he redeems the bond.
Upon redemption, the taxpayer will receive a Form 1099-INT that reports the full amount of
interest the bond earned. If the interest was reported when earned every year, the taxpayer
subtracts the interest paid in prior years from his or her taxable income.
By reporting interest annually, the taxpayer can even out income over the years. This is useful
if the U.S. Savings Bond interest is substantial. If this method is chosen, it must be continued.
This:
Includes the interest for bonds owned or later acquired
Applies to all Series EE, Series E, and Series I bonds
For most investors, it probably works out better to report the interest when the bond is
redeemed.
77 Regs. § 1.61-7(b)(3) (The election is set forth in § 454 ).
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Income from United States Savings Bonds for Taxpayers Who Pay Qualified Higher
Education Expenses 78 The taxpayer can help cover college expenses by investing in bonds or by cashing in bonds
previously purchased. The bond interest can be excluded from taxable income if both of these
apply:
The taxpayer redeems Series EE bonds purchased after 1989 or Series I bonds.
The money is used to pay qualified education expenses.
To qualify for this tax break:
The bonds must be Series EE bonds purchased after 1989 or Series I bonds.
The student cannot own the bonds. The bonds must be in one of these names:
o Taxpayers’ name
o Taxpayers’ spouse’s name
o Both the taxpayer and the spouse’s names as co-owners
The taxpayer must be at least age 24 in the month before the bond was issued.
If the redemption amount of the bond is more than the total qualified education expenses, the
taxpayer can only exclude a portion of the interest. Use Form 8815 to figure the interest that
can be excluded from income. The interest exclusion is phased out at higher income levels
based on modified adjusted gross income (MAGI). Use Form 8815 to figure the modified AGI.
For taxable years beginning in 2020, the exclusion, regarding income from United States
savings bonds for taxpayers who pay qualified higher education expenses, begins to phase-out
for modified adjusted gross income above $123,550 for joint returns and $82,350 for all other
returns. The exclusion is completely phased out for modified adjusted gross income of
$153,550 or more for joint returns and $97,350 or more for all other returns.
Qualified educational expenses include:
Tuition and fees (such as lab fees and other required course expenses).
Expenses that benefit the taxpayer, spouse, or a dependent for which the taxpayer can
claim an exemption.
Expenses paid for any course required as part of a degree or certificate-granting
program.
Expenses paid for sports, games, or hobbies qualify only if part of a degree or
certificate program.
Keep in Mind: The costs of books or room and board are not qualified expenses.
The amount of qualified expenses is reduced by the amount of any scholarships, fellowships,
employer-provided educational assistance, and other forms of tuition reduction (such as
education credits).
78 IRC §135
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The taxpayer must apply both the principal and interest from the bonds to pay qualified
expenses in order to exclude the interest from his or her gross income. If the amount of eligible
bonds cashed during the year exceeds the amount of qualified educational expenses paid during
the year, the amount of excludable interest is reduced pro rata.
Example: John and Maria Sample cashed his or her Series EE Bonds to pay for his or
her daughter Jasmine’s college education. Their modified adjusted gross income is
$111,000.The qualified education expenses is $9,000, the amount of interest income is
$3,240 the total principal and interest of the bond is $6,240.
The entire amount of interest would be excluded, since the qualified expenses are more
than the distribution and the Sample’s adjusted gross income is less than the phase-out
of the exclusion. The interest is reported as income on Schedule B, Line 1; the
exclusion is reported on Line 3 of Schedule B, Form 8815 must be included in the
return.
Student Loan Interest79
The student loan interest paid in 2019 limited to $2,500 is an above the line deduction
depending on the AGI and filing status of the taxpayer. For 2019, the deduction phase-out for
Single, Head of Household or Qualifying Widow is more than $70,000 but less than $85,000.
The MFJ phase-out is more than $140,000 but less than $170,000.
The deduction is claimed as an adjustment to income so John does not need to itemize his
deductions on Schedule A. He can claim the deduction if all of the following apply:
He paid $3,200 in interest on a qualified student loan in tax year 2019.
He is legally obligated to pay interest on a qualified student loan
His filing status is not Married Filing Separately
His modified adjusted gross income is less than a specified amount which is set
annually, and
o John and his wife, if filing jointly, cannot be claimed as dependents on someone
else's return
o A qualified student loan is a loan taken out solely to pay qualified higher
education expenses.
Since John paid $700 over the maximum in student loan interest, he received Form 1098-E.
John can deduct the full $2,500 in 2019.
79 IRC §221
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Student Loans Discharged on Account of Death or Disability
TCJA modifies the exclusion of student loan discharges from gross income, by including
within the exclusion certain discharges at death or total and permanent disability of the student.
Loans eligible for the exclusion under the provision are loans made by
(1) The United States (or an instrumentality or agency thereof),
(2) A state (or any political subdivision thereof),
(3) Certain tax-exempt public benefit corporations that control a state, county, or
municipal hospital and whose employees have been deemed to be public employees
under state law,
(4) An educational organization that originally received the funds from which the loan
was made from the United States, a State, or a tax-exempt public benefit corporation, or
(5) Private education loans.80
Under previous legislation, loans discharged due to death or totally and permanently, disabled
were viewed as income tax by the IRS. This means that individuals had to pay taxes on this
money just as they would with their yearly wages. The higher income status actually
disqualified many from receiving means-based government benefits like Medicaid and SSI–
benefits designed in part to help individuals with disabilities who cannot work.
Example: If someone with the current average student loan debt of $37k had their
student loans discharged, they would end up with a tax bill of anywhere between
$3,700 to $14,800 depending on their tax bracket.
The provision applies to discharges of loans after December 31, 2017, and before January 1,
2026.
MAGI when using Form 1040.
If the taxpayer files Form 1040, the MAGI is the AGI on line 8b of that form figured without
taking into account any amount on Schedule 1 (Form 1040), line 20 (student loan interest
deduction), line 21 (tuition and fees deduction) and modified by adding back any:
Foreign earned income exclusion,
Foreign housing exclusion,
Foreign housing deduction,
Exclusion of income by bona fide residents of American Samoa, and
Exclusion of income by bona fide residents of Puerto Rico.
80 Section 1407 of Consumer Protection Act
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What Do You Think?
Q1. A graduate student took one class at Harvard in 2020 and received a Form
1098T. He wants to take an education credit (assume he meets all
requirements). Which of the following is not correct?
A. The Lifetime Learning Credit applies to undergraduate, graduate, and
professional degree courses, and even to post-graduate courses that
help improve job skills
B. For purposes of the Lifetime Learning Credit, qualified education
expenses are tuition and certain related expenses required for enrollment in a course at
an eligible educational institution.
C. The graduate student would qualify for either the American Opportunity Credit or the
Lifetime Learning Credit.
D. The Lifetime Learning Credit is not refundable, so it will not be paid to the taxpayer in
a refund, it will decrease the tax liability.
Q2. All of the following are a true statement, except?
A. The maximum credit available to a taxpayer who has three children in college, for each
of which the taxpayer claims a dependent exemption, is $7,500 if claiming the
American Opportunity Credit.
B. A taxpayer whose parents claim his or her dependent exemption is allowed American
Opportunity Credit.
C. A taxpayer receives an education credit for tuition expense paid in 2018. He or she
receives a refund of those expenses paid the following year after his or her 2018 return
was filed. The taxpayer must repay the difference in tax liability on his 2019 tax return.
D. The American Opportunity Credit is usually the more favorable education credit if the
student qualifies.
Q3. Which of the following is not a correct statement regarding Form 1098-T?
A. Student Loans are reported on Form 1098-T.
B. Grants or Scholarships are reported on Form 1098-T.
C. Tuition paid to the educational institution is reported on Form 1098-T.
D. The Federal ID Number of the educational institution is reported on Form 1098-T.
Q4. Which of the following was created as a savings account to assist parents in paying for
educational expense for K-12?
A. Coverdell ESA
B. Student Loan Interest Deduction
C. American Opportunity Credit
D. Lifetime Learning Credit
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What Do You Think? - Answers
A1: C – Is the correct answer - IRC §25A – Hope and Lifetime Learning
Credits
The American Opportunity Credit applies only to the first four year of post-
secondary school education. Therefore, the graduate student is not eligible
for the American Opportunity Credit.
The Lifetime Learning Credit applies to undergraduate, graduate, professional degree courses,
and post-graduate courses to improve job skills. There is no limit as to the number of years the
taxpayer can claim the credit and no minimum enrollment requirements. Qualified expenses
include tuition and certain related expenses required for enrollment in a course at an eligible
educational institution. Unlike the American Opportunity Credit, the Lifetime Learning Credit
is not refundable and can be used only to reduce tax liability.
A2: B – Is the correct answer
The taxpayer cannot claim the American Opportunity Credit if the parents chose not to claim
the dependent exemption even though they are allowed to do so. The taxpayer is not allowed to
claim the personal exemption for him or herself.
The maximum American Opportunity Credit available is $2,500 per eligible student compared
to the Lifetime Learning Credit, which allows a maximum credit of $2,000 per tax return.
What does a taxpayer do who uses education expenses to calculate an education credit and
after the return is filed, receives a refund of education expenses that were used in this
calculation? He or she must refigure the education credit using the amount of education
expenses originally used less the refund. The taxpayer must then pay any difference in tax
liability cause by the decrease in education credit on the taxpayers’ next tax return.
A3: A is the correct answer Form 1098T, Tuition Statement does not report student loan interest, that is reported on Form
1098-E, Student Loan Interest Statement. A 1098T is a vehicle to report information to the
taxpayer regarding the payments made or billed through the year, as well as pertinent
information needed to complete Form 8863.
A4: A - Is the correct answer.
This account was created as an incentive to help parents and students save for education
expenses. A Coverdell ESA can be used to pay a student’s eligible K-12 expenses, as well as
post-secondary expenses. On the other hand, income limits apply to contributors, and the total
contributions for the beneficiary of this account cannot be more than $2,000 in any year, no
matter how many accounts may have been established.
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A beneficiary is someone who is under age 18 or is a “special needs” individual.
Contributions to a Coverdell ESA are not deductible, but amounts deposited in the account
grow tax free until distributed. The beneficiary will not owe tax on the distributions if less than
a beneficiary’s qualified education expenses at an eligible institution. This benefit applies to
qualified higher education expenses as well as to qualified elementary and secondary education
expenses.
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Objective: Explanations and examples of :
Relevant Pass-through Entities
Rental Activities
QBI
Form 1040 and Schedules
Forms 8995 and 8995A
Chapter 4 –Relevant Pass-through Entities (RPE), Rental Activities and
Qualified Business Income (QBI)
On January 18, 2019, the IRS and the Treasury Department issued final regulations and three
related pieces of guidance, implementing the new qualified business income (QBI) deduction
under §199A. Tax Cuts and Jobs Act (TCJA) added Code Sec. 199A, which provides the
deduction for qualified business income (QBI) for tax years beginning after December 31,
2017, and before January 1, 2026. The QBI deduction was enacted to provide tax relief to
small businesses that do not operate as C corporations, because C corporation tax rates were
significantly reduced under the TCJA, from graduated rates with a top rate of 35% to a flat rate
of 21%. Unlike the qualified business income (QBI) deduction, the corporate rate change is
permanent, and the TCJA eliminated the alternative minimum tax (AMT) for corporations.81
In general, if the total taxable income in 2019 was under $160,700 for single filers or $321,400
for joint filers, the taxpayer may qualify for the deduction. In 2020, the limits are $163,300 for
single filers or $326,600 for joint filers. If the taxpayer is over that limit, complicated IRS rules
determine whether the business income qualifies for a full or partial deduction
Qualified Business income comes from a relevant pass-through entity (RPE) such as a
partnership (other than a Publicly Traded Partnership (PTP)) or an S corporation that is owned,
directly or indirectly, by at least one individual, estate, or trust or a sole proprietorship.
The final regulations are similar to the proposed regulations in defining a trade or business.
The IRS has declined to adopt a definition other than deferring to §162 and saying it is an
activity (other than as an employee) carried on regularly and continuously for profit. The
regulations provide one exception to the trade or business requirement for rentals.
A rental activity will be treated as trade or business if it is rented as a commonly controlled
trade or business owned by the taxpayer making a self-rental a trade or business even if the
activity might not have otherwise satisfied that standard. Commonly control means the
property must be rented as an individual or pass-through. The individual or pass-through must
own 50 percent or more of both the property and business.82 This differs from the proposed
regulations.
The final regulations note that taxpayers should report items consistently in all cases where the
Code uses the trade or business standard. For example, if the taxpayer is treating a rental
activity as a trade or business for purposes of §199A, the taxpayer should comply with the
information reporting requirements and issue Form 1099 when appropriate.
81 TCJA §§13001 and 12001 82 IRC §§707(b), 267(b)
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A qualified trade or business is any Section 162 trade or business, with three exceptions:
1. A trade or business conducted by a C corporation.
2. For taxpayers with taxable income that exceeds the threshold amount, specified service
trades or businesses (SSTBs). An SSTB is a trade or business involving the
performance of services in the fields of health, law, accounting, actuarial science,
performing arts, consulting, athletics, financial services, investing and investment
management, trading, dealing in certain assets or any trade or business where the
principal asset is the reputation or skill of one or more of its employees or owners.
NOTE: The SSTB exception does not apply for taxpayers with taxable income below
the threshold amount and is phased in for taxpayers with taxable income above the
threshold amount. For 2019, the threshold amount is $321,400 for a married couple
filing a joint return, or $160,700 for all other taxpayers. The threshold amounts will be
adjusted for inflation in subsequent years.
3. The trade or business of performing services as an employee
NOTE: Wages or salaries, reasonable compensations to S-Corporation owners
(Form W-2) or guaranteed payments from a partnership (Form 1065 K-I Part III,
Line 4) are not included in QBI.
Regulations Regarding Section 199A
The QBI of an RPE is determined at the shareholder/partner level, and the deduction has no
effect on the adjusted basis of a partner's interest in the partnership or a shareholder's basis in S
corporation stock.
Relevant Pass-through Entities (RPE)
S Corporation Partnership LLC
Pertinent Part
of Internal
Revenue Code
Subchapter S; Code
Sections 1361 through
1379.
Subchapter K; Code
Sections 701 through
777.
Subchapter K; Code
Sections 701 through
777.
IRS Resource Form 2553, Election
by a Small Business
Corporation.
Publication 541,
Partnerships.
Form 8832, Entity
Classification Election.
Ownership and
Capital
Structure
No more than 100
shareholders and
limitations on who can
own stock. Can only
have one class of stock
(but voting differences
allowed).
Need at least two
partners; otherwise no
limitation on "who and
how many." Limited
partnerships have one
or more limited
partners.
Default for single
member LLCs is
disregarded for federal
tax purposes while
multi-member LLCs
are treated as
partnerships.
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S-Corporation Partnership LLC
Limited
Liability for
Owners
Shareholders are not
liable for debts
incurred by the
corporation. Their
liability is generally
limited to amount
invested.
General partners are
personally liable for all
partnership debts.
Limited partner's
liability is generally
limited to amount
invested.
Like shareholders,
members are not liable
for debts incurred by
the LLC, whether a
single member LLC or
a multi-member LLC.
Continuity of
Life
Usually unlimited life,
unless otherwise
limited in Articles of
Incorporation.
However, a number of
eligibility rules must
be monitored and met
to retain S status.
Depends on state law
or entity agreement.
Terminates for federal
tax purposes if 50% or
more of capital and
profits interests are
transferred within a 12-
month period.
Depends on state law or
articles/agreement.
Multi-member LLC
termination governed
by partnership rules,
while single member
LLC ends/dissolves
when owner dies.
Management
of Entity
Managed by board of
directors who appoint
the corporate officers.
In a general
partnership, the
partners specify each
person's role. In a
limited partnership, the
general partners
manage the business.
LLC can be member-
managed, in which case
all members share
responsibility for the
day-to-day operations,
or manager-managed.
Transferability
of Ownership
Interests
Transferable, but may
be limited by buy/sell
agreement. In addition,
transfer must not
terminate S status.
Transfer rights are
governed by state law
and the partnership
agreement, if one
exists.
Transfer rights are
governed by state law
and the operating
agreement.
Income
Taxation of
Entity
Income taxed once to
the shareholders,
although some S
corporations are
subject to built-in gains
tax.
Income taxed once to
the partners.
In single member LLC,
owner is taxed. In
multi-member LLC,
income taxed once to
members.
Income
Taxation of
Owners (Who
are Assumed to
be Individuals)
Pass-through and
distributions taxed at
maximum rate of 20%
or 39.6%.
Partnership items and
distributions taxed at
maximum rate of 20%
or 39.6%.
LLC items and
distributions taxed at
maximum rate of 20%
or 39.6%.
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S-Corporation Partnership LLC
Self-
employment
(SE) and
Payroll
Taxation of
Owners
No SE tax. Wages
subject to payroll taxes,
while dividend
distributions subject
only to income tax.
However, risk that
distributions will be
classified as wages
subject to payroll taxes
if reasonable wages are
not paid.
General partners treat
their share of business
income and guaranteed
payments for services
or use of capital as SE
income. Limited
partners only report
guaranteed payments
for services as SE
income.
Members generally
treat their share of
business income and
guaranteed payments
for services or use of
capital as SE income.
Members treated as
limited partners only
report guaranteed
payments for services
as SE income.
Capital Gains
and Losses
Passed through to
shareholders who may
be eligible for reduced
tax rate.
Passed through to
partners who may be
eligible for reduced tax
rate.
Passed through to
members who may be
eligible for reduced tax
rate.
Alternative
Minimum Tax
(AMT)
Owed by shareholders;
entity must provide
AMT information to
them.
Owed by partners;
entity must provide
AMT information to
them.
Owed by members;
entity must provide
AMT information to
them.
Entity-level
Penalty Taxes
Built-in gains tax, tax
on excess net passive
investment income,
and LIFO recapture
tax.
No income taxes of any
kind can be assessed
against partnership.
No income taxes of any
kind can be assessed
against LLC taxed as
partnership.
Deductibility of
Losses
Losses passed through
to shareholders, and
are deductible under
the basis, at-risk, and
passive activity loss
rules, in that order.
Losses passed through
to partners, and are
deductible under the
basis, at-risk, and
passive activity loss
rules, in that order.
Losses passed through
to members, and are
deductible under the
basis, at-risk, and
passive activity loss
rules, in that order.
Passive Activity
Loss (PAL)
Rules
Apply at the
shareholder level; do
not apply to the S
corporation.
Apply at the partner
level; do not apply to
the partnership.
Apply at the member
level; do not apply to
the LLC.
At-risk Rules Apply at the
shareholder level.
Apply at the partner
level.
Apply at the member
level.
Unreasonable
Compensation
Unreasonably, low
compensation can be
paid to shift income to
family members or
avoid employment
taxes.
Not an issue, although
IRS may question
partner's status as
employee.
Not an issue, although
IRS may question
member's status as
employee.
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S-Corporation Partnership LLC
Section 179
Dollar
Limitation
Applies at the S
corporation level and
the shareholder level.
Applies at the
partnership level and
the partner level.
Applies at the LLC
level and the member
level.
Fringe Benefits
for Owners
Health and some other
benefits for
shareholders owning
more than 2% of stock
treated as
compensation or a
distribution.
Health and some other
benefits for partners
treated as guaranteed
payment or a
distribution.
Health and some other
benefits for members
treated as guaranteed
payment or a
distribution.
As for carryovers of unused deductions, the regulations clarify that QBI cannot be less than
zero, and the carryforward of QBI does not affect the current-year deduction for purposes of
other sections of the code. They also clarify that if an individual has an overall loss after
adding qualified REIT dividends and PTP income, then the portion of the Sec. 199A deduction
related to the REIT and PTP income is zero for the tax year, and it does not affect QBI for the
year. Instead, the loss from the REIT or PTP is carried forward and used to offset REIT/PTP
income in the succeeding year or years for Sec. 199A purposes.
For taxpayers who have multiple trades or businesses, the regulations provide that losses are
netted with income before the application of limitations for individuals over the threshold
amount, based on W-2 wages and unadjusted basis immediately before acquisition (UBIA) of
qualified property and determining QBI. The regulations also clarify that QBI deduction does
not reduce net earnings from self-employment or net investment income and it does not result
in AMT.
If an individual's taxable income exceeds the threshold amount, QBI imposes a limit on the
deduction based on the greater of either W-2 wages paid or the wages paid and UBIA.
Simultaneously with its release of the regulations, the IRS also issued Rev. Proc. 2019-11,
which provides three methods of calculating W-2 wages. The three methods for determining
W-2 wages are substantially similar to the methods provided in Rev. Proc. 2006-47.
The regulations clarify that QBI applies to income that is effectively connected with a U.S.
trade or business83. The QBI is computed on the trade or business (IRC §162) not on the
individual receiving the deduction.
83 IRC §864(c)
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Any item of short-term capital gain, short-term capital loss, long-term capital gain, or long-
term capital loss, including any item treated as one of these items, that are treated as capital
gains or losses, is not taken into account as a qualified item of income, gain, deduction, or loss.
If they are not capital gains or losses, they are included in QBI.
Interest income on accounts or notes receivable for services or goods of the trade or business is
included in QBI, while interest income on working capital and reserves is not QBI, since it is
held for investment.
Reasonable compensation84 is excluded from the computation of QBI. Similarly, guaranteed
payments from a partnership85 for services are excluded. The regulations clarify that the term
"reasonable compensation" is limited to the compensation paid by an S corporation but does
not extend this rule to partnerships for purposes of this section. Rather, the regulations state
that this rule is intended to clarify that even if an S corporation fails to pay a reasonable salary
to its shareholder-employees, it is nonetheless precluded from including an amount equal to
reasonable compensation in QBI.
In the case of expenditures that are allocable to more than one of the taxpayers’ trades or
businesses, the regulations do not specify any allocation methods, but they allow the use of any
reasonable method as long as it is consistently applied.
84 IRC §199A (c)(4)(A) 85 IRC§707(c)
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Form 1040
Form 1040 (Page 1 and 2 on the next pages) were redesigned for 2019 tax year. The number of
schedule were reduced and combined into three new schedules. These schedules will be used
as needed to complete complex tax returns. Also included with Form 1040 are schedules and
forms that were used in prior years. These schedules and forms were revised in 2019.
Form 1040 example is of John Sample who is a photographer; he lives with his son Michael
and files Head of Household. Michael has lived with John full time since 2015; he qualifies for
the Child Tax Credit. John files Head of Household.
John is the only shareholder of ABC Photography, an S-Corporation. The S-Corporation pays
John wages of $70,000 and pays his family health insurance of $9,500.
S corporations must pay himself a reasonable compensation as a shareholder-employee
in return for services that the employee provides to the corporation before non-wage
distributions may be made to the shareholder-employee. The amount of reasonable
compensation will never exceed the amount received by the shareholder either directly
or indirectly.
Health insurance premiums paid on behalf of a greater than 2-percent S corporation
shareholder-employee are deductible by the S corporation and reportable as wages on
the shareholder-employee’s Form W-2, subject to income tax withholding.
In the example, John is a 100% shareholder and $9,500 of health insurance premiums
are included in Box 1 of his W-2, wages, tips and other compensation. The $9,500
premium is not included in Box 3, Social Security wages and tips or in Box 5, Medicare
wage. These additional wages are not subject to Social Security, Medicare (FICA), or
Unemployment (FUTA) taxes if the payments of premiums are made to or on behalf of
an employee under a plan or system, that makes provision for all or a class of
employees (or employees and their dependents).
John is the sole proprietor of a design business (See Schedule C below). John
contributed $15,000 to his IRA account.
John Sample reported his wages on Line 1 of Form 1040. John received a 1099DIV from
Morgan Stanley which reported ordinary dividends of $4,500 of which $1,650 were qualified
dividends (see Form 1040, Line 3). Form 1099DIV from Morgan Stanley also reported Section
199A dividends in Box 5 of $800 which is a portion of the ordinary dividends reported in Box
1 of Form 1099DIV. (See the Form 8995, line 6 later in this text). John contributed $5,000 to
his IRA account. John is also the sole proprietor of his design business.
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Schedule 1, Part 1 is used for additional income and adjustments to income. Schedules 1, 2 and
3 all flow to Form 1040. In this example the additional income is from Schedule C and the S-
Corp which flow to Schedule E, page 2 and then to Schedule 1 and Form 1040. The
adjustments are John’s deductible portion of SE Tax, self-employed health insurance and his
IRA contribution. (See the example below).
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A 2-percent shareholder-employee is eligible for an above-the-line deduction in arriving at
AGI for amounts paid during the year for medical care premiums (Self-employed health
insurance, Line 16, Schedule 1) if the medical care coverage was established by the S
corporation and the shareholder met the other self-employed medical insurance deduction
requirements. If, however, the shareholder or the shareholder’s spouse was eligible to
participate in any subsidized health care plan, then the shareholder is not entitled to the above-
the-line deduction.86 Since the SE health insurance amount is not included in the gain or loss in
Box 1 of Schedule K-1 it is not a deduction on determining the QBI.
86 IRC § 162(l).
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Schedule C and QBI Worksheet
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In the example below the unadjusted basis immediately after acquisition (UBIA) of qualified
property generally equals the cost of tangible property subject to depreciation that satisfies all
of the following criteria:
The property is both held by and available for use in the trade or business at the close of
the tax year;
The property is used at any point during the tax year in the production of the trade or
business's QBI; and
The property's depreciable period for UBIA of qualified property purposes has not
ended before the close of the taxpayer's tax year.
For purposes of the third criterion, the property's depreciable period is either 10 years after the
property is placed in service, or the last day of the last full year of the property's normal Sec.
168(c) depreciable period, whichever is later.
An asset with a five- or seven-year depreciable life under the modified accelerated cost
recovery system (MACRS) has a depreciable life of 10 years for UBIA of qualified property
purposes, while a building has a depreciable life of 39 years for both MACRS and UBIA
purposes. In 2018, John had purchased a computer used 100% for his design business for
$3,860 with a five year life. John took bonus depreciation on the computer in 2018. He must
continue to include the UBIA for 10 years or until the day he removes the computer from
service. (See Line 14 Below
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S-Corporation and QBI Worksheet
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The income from S-Corporation - ABC Photography is reported on Schedule E, page 2 (see
above). The Section 179 deduction is netted with the income before reporting it on Schedule 1
and before the computation of QBI. TCJA and the related regulations state that losses or
deductions that were disallowed, suspended limited or carried over from taxable years ending
before January 1, 201887 and in a later taxable year for purposes of computing QBI. QBI does
not affect the taxpayers’ basis in the S-Corporation or a partnership, the basis computation is
done on the entity level.
The income from each entity is computed separately and then combined on 2019 Form 8995.
The Schedule C is John’s second business and qualifies for QBI. The net profit from Schedule
C, which includes the Section 179 and the business use of home deductions, is entered on line
1 below. The gain from Schedule C is reduced by the deductible portion of self-employment
tax, which is directly related to this business.
For individuals with taxable income that does not exceed the threshold amount the QBI
deduction is determined by adding:
(1) 20 percent of the total QBI amount (including QBI attributable to a
Specified Service Trades or Business); plus
(2) 20 percent of the combined amount of qualified REIT dividends and
qualified publicly traded partnership (PTP) income (including the individual's
share of qualified REIT dividends, and qualified PTP income from RPEs).
REIT Dividends
Qualified REIT dividends include any dividend received from a real estate investment trust
held for more than 45 days and for which the payment is not obligated to someone else and that
is not a capital gain dividend or qualified dividend plus qualified REIT dividends received
from a regulated investment company.
Ordinary REIT dividends are taxed at ordinary rates as opposed to the lower qualified dividend
rates. The new Sec 199A rules allow a taxpayer to deduct 20 percent of the REIT dividend
amount reported as income. Qualified Dividends are also part of ordinary dividends and are
shown in box 1b of the Form 1099-DIV.
The maximum rate of tax on qualified dividends is the same as long term capital gains:
• 0% on any amount that otherwise would be taxed at a 10% or 15% rate.
• 15% on any amount that otherwise would be taxed at rates greater than 15% but
less than 39.6%.
• 20% on any amount that otherwise would be taxed at a 39.6% rate.
87 IRC §§465,469,704(d) & 1366(d)
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To qualify for the maximum rate, all of the following requirements must be met.
The dividends must have been paid by a U.S. corporation or a qualified foreign
corporation.
The dividends are not of the type specifically excluded from qualified dividends.
The holding period must be met
To be qualified dividends the stock must be held for more than 60 days during the 121-day
period that begins 60 days before the ex-dividend date. The ex-dividend date is the first date
following the declaration of a dividend on which the buyer of a stock is not entitled to receive
the next dividend payment. When counting the number of days a stock is held include the day
the stock is disposed of but not the day it is acquired.
Along with IRC §199A dividends John has two other sources of QBI. John does computer
designs and layouts; this is a separate business from his S Corporation and is reported on
Schedule C as a sole-proprietorship.
The sum of these two items is then compared to 20 percent of the amount by which the
individual's taxable income exceeds net capital gain. The lesser of these two amounts is the
individual's deduction.88 The term "net capital gain" for purposes of Code Sec. 199A is defined
as net capital gain plus any qualified dividend income for the tax year.
If the total QBI amount is less than zero, the portion of the individual's Code Sec. 199A
deduction related to QBI is zero for the tax year. The negative total QBI amount is treated as
negative QBI from a separate trade or business in the succeeding tax year89.
If the combined amount of REIT dividends and qualified PTP income is less than zero, the
portion of the individual's QBI deduction related to qualified REIT dividends and qualified
PTP income is zero for the tax year. The negative combined amount must be carried forward
and used to offset the combined amount of REIT dividends and qualified PTP income in the
succeeding tax year of the individual for purposes of Code Sec. 199A. This carryover rule does
not affect the deductibility of the loss for purposes of other provisions.90
88 Reg. §1.199A-1(b)(3) 89 Reg. §1.199A-1(c)(2)(i) 90 Reg. § 1.199A-2(c)(2)(ii)
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Form 8995
2019 Form 8995 is used for this example (2020 Form 8995 has not been released as of the
printing of this document), the thresholds are based on 2019.
Form 8995 is used when the taxpayer
Has QBI, qualified REIT dividends, or qualified PTP income or loss,
The 2019 taxable income before the QBI deduction is less than or equal to $160,700
($160,725 if married filing separately or a married nonresident alien; $321,400 if
married filing jointly), and
The taxpayer is not a patron in a specified agricultural or horticultural cooperative.
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What Do You Think?
Q1. Which of the following is an exception to a qualified trade or business as
describe in Section 162?
A. Taxpayers with taxable income that exceeds the threshold amount,
specified service trades or businesses (SSTBs).
B. A trade or business conducted by a C corporation
C. The trade or business of performing services as an employee
D. All of the above.
Q2. Maria reports her income from her accounting business on Schedule C. Her profit for the
year is $60,000, her adjustments on Schedule 1 of Form 1040 directly related to her business
are $4,300 deductible portion of self-employment tax, $23,000 contribution to her SEP, and
$5,000 self-employed health insurance. What is the amount carried to Line 1 of Form 8995
(Qualified Business Income or Loss)?
A. $25,700
B. $12,000
C. $35,000.
D. None of the above
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What Do You Think? _Answers
A1. Answer D Which of the following is an exception to a qualified trade or
business as describe in Section 162?
A. Taxpayers with taxable income that exceeds the threshold amount, specified
service trades or businesses (SSTBs).
B. A trade or business conducted by a C corporation
C. The trade or business of performing services as an employee
D. All of the above.
A qualified trade or business is any Section 162 trade or business, with three exceptions:
1. A trade or business conducted by a C corporation.
2. For taxpayers with taxable income that exceeds the threshold amount, specified service
trades or businesses (SSTBs). An SSTB is a trade or business involving the
performance of services in the fields of health, law, accounting, actuarial science,
performing arts, consulting, athletics, financial services, investing and investment
management, trading, dealing in certain assets or any trade or business where the
principal asset is the reputation or skill of one or more of its employees or owners. For
2019, the threshold amount is $321,400 for taxpayers filing MFJ, $160,700 for
taxpayers filing Single or HoH and $160,725 for MFS. The threshold amounts will be
adjusted for inflation in subsequent years.
3. The trade or business of performing services as an employee
A2. Answer – A Maria reports her income from her accounting business on Schedule C. Her
profit for the year is $60,000, her adjustments on Schedule 1 of Form 1040 directly related to
her business are $4,300 deductible portion of self-employment tax, $23,000 contribution to her
SEP, and $5,000 self-employed health insurance. What is the amount carried to Line 1 of Form
8995 (Qualified Business Income or Loss)?
A. $25,700- This is correct. $60,000- ($4,300+$23,000+$5000)=$25,700
B. $12,000 - This is incorrect, no deductions were taken, This is 20% of the
profit.
C. $35,000 - This is incorrect because only the SEP was deducted in
determining QBI.
D. None of the above
QBI Explanation Worksheet.
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Calculating the Qualified Business Income Deduction below the Threshold
Speedy and Jumpy are married and earn $220,000/year, which includes $90,000 in
wages from Speedy’s job managing a theater, and $130,000 of net income from
Jumpy’s clothing store (a sole proprietorship business reported on her Schedule C). In
addition, the couple has $5,000 of ordinary dividends income. The couple’s taxable
income is $225,000, of which $130,000 is “Qualified Business Income”. Speedy and
Jumpy have no capital gains.
In 2019, the couple is eligible for a $24,400 standard deduction, making their taxable
income $200,600 (before calculating QBI). They will report a $26,000 QBI deduction,
further reducing their taxable income to $169,600. The calculation is as follows:
The lesser of
20% of taxable income - $200,600 x 20% =$40,120, or
20% of QBI - $130,000 x 20% = $26,000
Hewie, Dewie and Lewie all have $110,000 of net qualifying business income in 2019, but
each has different amounts of other income, itemized deductions and capital gains.
Example Hewie Dewie Lewie
(A) Net qualifying business income $110,000 $110,000 $110,000
Taxable Income before IRC §199A 140,000 80,000 130,000
Capital Gains 0 0 40,000
(B) Taxable Income less capital gains 140,000 80,000 90,000
Lesser of (A) or (B) 110,000 80,000 90,000
IRC §199A deduction (20% of above) $ 22,000 $ 16,000 $ 18,000
Trade or Business Requirement for QBI; Rental Real Estate Activities
Like any activity, to rise to the level of being a trade or business,91 a rental real estate activity
must be considerable, regular, and continuous in scope. In determining whether a rental real
estate activity meets those criteria, the IRS has stated that relevant factors might include, but
are not limited to, the following:
(1) The type of rented property (commercial real property versus residential property);
(2) The number of properties rented;
(3) The owner's or the owner's agents day-to-day involvement;
(4) The types and significance of any ancillary services provided under the lease; and
(5) The terms of the lease (for example, a net lease versus a traditional lease and a
short-term lease versus a long-term lease)
91 IRC§162
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Recognizing the difficulties taxpayers and practitioners may have in determining whether a
taxpayers’ rental real estate activity is sufficiently regular, continuous, and considerable for the
activity to constitute a trade or business, the IRS has provided a safe harbor under Code Sec.
199A for rental real estate activities.92.
Safe Harbor for Rental Real Estate Enterprise to Be Treated as a Trade or Business
The safe harbor for a rental real estate enterprise will be treated as a trade or business solely for
purposes of Code Sec. 199A and the calculation of the QBI deduction. For this purpose, a
rental real estate enterprise is defined as an interest in real property held for the production of
rents and may consist of an interest in multiple properties.
According to Notice 2019-7, the individual or relevant pass-through entity (RPE) relying on
the safe harbor must hold the interest directly or through an entity disregarded as an entity
separate from its owner. Taxpayers must either treat each property held for the production of
rents as a separate enterprise or treat all similar properties held for the production of rents (with
the exception of certain rental real estate arrangements that are excluded from the safe harbor
provisions, as discussed below) as a single enterprise. Commercial and residential real estate
may not be part of the same enterprise. Taxpayers may not vary this treatment from year-to-
year unless there has been a significant change in facts and circumstances.
Under the safe harbor and solely for the purposes of the QBI deduction, a rental real estate
enterprise will be treated as a trade or business if the following requirements are satisfied
during the tax year with respect to the rental real estate enterprise:
(1) Separate books and records are maintained to reflect the income and expenses for
each rental real estate enterprise.
(2) For tax years, beginning prior to January 1, 2023, 250 or more hours of rental
services are performed per year with respect to the rental enterprise.
For tax years, beginning after December 31, 2022, in any three of the five consecutive tax
years that end with the tax year (or in each year for an enterprise held for less than five years),
250 or more hours of rental services are performed (as described in the safe harbor) per year
with respect to the rental real estate enterprise.
(3) The taxpayer maintains contemporaneous records, including time reports, logs, or
similar documents, regarding the following:
(i) Hours of all services performed;
(ii) Description of all services performed;
(iii) Dates on which such services were performed; and
(iv) Who performed the services. Such records are to be made available for
inspection at the request of the IRS.
The contemporaneous records requirement will not apply to tax years beginning before January
1, 2019.
92 Notice 2019-7
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For purposes of the safe harbor, rental services include:
(1) Advertising to rent or lease the real estate;
(2) Negotiating and executing leases;
(3) Verifying information contained in prospective tenant applications;
(4) Collection of rent;
(5) Daily operation, maintenance, and repair of the property;
(6) Management of the real estate;
(7) Purchase of materials; and
(8) Supervision of employees and independent contractors.
Rental services may be performed by owners or by employees, agents, and/or independent
contractors of the owners. The term "rental services" does not include financial or investment
management activities, such as arranging financing; procuring property; studying and
reviewing financial statements or reports on operations; planning, managing, or constructing
long-term capital improvements; or hours spent traveling to and from the real estate.
Form 8995, Qualified Business Income Deduction Simplified Computation is a one-page form
and does not contain any lines for a taxpayers’ allocable share of W-2 wages from a trade,
business, or aggregation; nor does it include a line for the taxpayers’ allocable share of the
unadjusted basis immediately after acquisition (UBIA) of all qualified property. It is to be used
by taxpayers that do not have W-2 wages or UBIA. Examples are on the following pages.
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QBI Rental Example – Form 8995
Garfield and Lizzy are a married couple. Lizzie works in a pet shop; she received a W-2 for
$48,000. Garfield has three single-family rentals and one duplex. None of his property is
commercial. Garfield manages all of his rentals and keeps a separate bank account for rental
incomes and expenses. He does all the collection of rents, advertising, repairs, gardening and
upkeep. Garfield kept a log of his hours and averages 14 hours a week working on the rental
properties. Garfield received $2,200 in qualified dividends from Purina.
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The taxable income prior to QBI is $119,800 ($48,000 (wages) + $94,000 (rental income) +
$2,200 (dividends) - $24,400 (standard deduction)). Form 8995 is new for 2019; the IRS also
issued Form 8995A for more complex QBI calculations.
For 2019, all of the rentals were rented throughout the year.
Rental 1: $20,000 Triplex: $66,000
Rental 2: $16,000 Rental 3: ($8,000)
No QBI Worksheet is needed in this example since there are no adjustments to income which
go in this QBI calculation.
Notice 2019-07 includes procedures for a safe harbor for treating a rental activity as a trade or
business for purposes of §199A. If the activity meets the harbor requirements, the activity will
be treated as a trade or business as defined under §199A(d) and the regulations. If the safe
harbor requirements are not met, the activity may still be treated as a
trade or business if the activity otherwise meets the definition of a trade or business under §162
[Reg. §1.199A-1(b)(14)]. Taxpayers who already qualify as a real estate professional easily
qualify as a trade or business under this test assuming they keep the required records.
Rental Activity Defined
An interest in real property, or multiple properties, held to produce rents.
The individual or relevant pass through entity (RPE) must hold the activity directly
or, through a disregarded entity separate from its owner under Reg. §301.7701-3.
Each rental activity must be treated as a separate activity OR all similar properties
treated as a single activity. This treatment cannot vary from year to year unless
there is a significant change in the facts and circumstances.
Commercial and residential real estate activities cannot be treated as the same
activity.
Safe Harbor Test
Separate books and records are maintained that reflect income and expenses for each rental
activity.
For taxable years beginning prior to Jan. 1, 2023, taxpayers must perform 250 or more
hours of rental services per year for each rental activity. For taxable years beginning after
Dec. 31, 2022, taxpayers must perform 250 or more hours of rental services per year for
each rental activity in any 3 of the 5 consecutive years that end with the taxable year (every
year if the activity was held for less than five years).
The taxpayer must maintain contemporaneous records, including time reports, logs or
similar documents all the following:
o Hours of all services performed.
o Description of all services performed.
o Dates the services were performed.
o Who performed the services?
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Rental Services Rental services may be performed by owners or by employees, agents, and/or independent contractors
of the owners. They include:
Advertising to rent or lease the property.
Negotiating and executing leases.
Verifying information in prospective tenant applications.
Collection of rent.
Daily operation, maintenance and repair of the property.
Management of the real estate.
Purchase of materials.
Supervision of employees and independent contractors.
Rental services do not include financial or investment management activities such as:
Arranging financing.
Procuring property.
Studying and reviewing financial statements on operations.
Planning, managing or constructing long-term capital improvements.
Hours spend traveling to and from the rental property.
Other Rules
Certain rental activities are excluded from using the safe harbor method. They include:
Real estate used by the taxpayer (including an owner or beneficiary of an RPE
relying on this safe harbor) as a residence for any part of the year under §280A.
Real estate rented or leased under a triple net lease. For purposes of this revenue
procedure, a triple net lease includes a lease agreement that requires the tenant or
lessee to pay taxes, fees, and insurance, and to be responsible for maintenance
activities for a property in addition to rent and utilities or a portion of such allocable
to the part of the property the tenant rents or leases.
Procedural Requirements
The taxpayer or RPE must include a statement attached to the return claiming or
passing through the §199A deduction information that the requirements in Section
3.03 of this revenue procedure have been satisfied.
The statement must be signed by the taxpayer, or an authorized representative of an
eligible taxpayer or RPE, which states:
“Under penalties of perjury, I (we) declare that I (we) have examined the
statement, and, to the best of my (our) knowledge and belief, the statement
contains all the relevant facts relating to the revenue procedure, and such facts
are true, correct, and complete.”
The individual or individuals who sign must have personal knowledge of the facts
and circumstances related to the statement.
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Different Rules Apply at Different Levels of Taxable Income
The rule disqualifying specified service trades or businesses from being considered a qualified
trade or business does not apply to individuals with taxable income of less than $160,700
($321,400 for joint filers) for 2019 and $163,300 for single filers or $326,600 for joint filers for
2020. Other rules, such as one preventing individuals from claiming the QBI deduction for
employment income, and disallowing of corporate income apply to all taxpayers, regardless of
their level of taxable income.
Reasonable Compensation and Guaranteed Payments Are Not QBI
What is a Reasonable Salary? – The instructions for Form 1120S (“U.S. Income Tax Return
for an S Corporation”) state: “Distributions and other payments by an S corporation to a
corporate officer must be treated as wages to the extent the amounts are reasonable
compensation for services rendered to the corporation.” There are no specific guidelines in the
tax code regarding the definition of reasonable compensation. The various courts that have
ruled on this issue have based their determinations on the facts and circumstances of the
individual cases.
NOTE: Wages or salaries, reasonable compensations to S-Corporation owners
(Form W-2) or guaranteed payments from a partnership (Form 1065 K-I Part III,
Line 4) are not included in QBI.
These are some factors that courts have considered, when determining reasonable
compensation.
The officer’s training and experience
The officer’s duties and responsibilities
The time and effort that the officer devotes to the business
The corporation’s dividend history
The corporation’s payments to non-shareholder employees
The timing and manner of the bonuses paid to key people at the corporation
The payments that comparable businesses have made for similar services
The corporation’s compensation agreements
The formulas that similar corporations have used to determine compensation
The IRS has provided lists of contributing factors that courts have used when determining
reasonable compensation, but has not provided additional guidance in this area. The IRS leaves
it to each corporation to quantify these factors and determine a reasonable salary; this allows
the IRS the ability to challenge the amount of reasonable compensation The IRS has a long
history of examining S-Corporations’ tax returns to ensure that reasonable compensation is
being paid, particularly when a corporation pays no compensation to employee-stockholders.
TCJA added the QBI deduction. This deduction applies to S corporations (among many other
business entities) and adds another level of complexity to the determination of reasonable
compensation.
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The wages of an S corporation’s employee-stockholder are NOT treated as qualified business
income (QBI) that is eligible for the individual’s 199A deduction. However, the corporation
deducts these wages as a business expense when it calculates the profit that passes through to
the shareholder as QBI on Schedule K-1. Larger wages mean less K-1 flow-through income
(QBI) and a smaller QBI deduction. In this case, S corporations tend to minimize stockholders’
salaries in order to maximize flow-through income; this strategy increases the employee-
stockholder’s QBI deduction and lowers the payroll taxes for both the corporation and the
employee-stockholder.
The IRS, however, can recharacterize "dividends" that are paid lieu of reasonable
compensation for services performed for the S corporation.93 Therefore, “reasonable
compensation” of an S corporation shareholder refers to any amounts paid by the S corporation
to the shareholder, up to the amount that would constitute reasonable compensation.
Astro is the sole shareholder and CEO of MARS, Inc., an S corporation that is a
qualified trade or business. MARS has net income in 2019 of $250,000 after deducting
Astro’s $100,000 salary. MARS makes payments of $350,000 to Astro in 2019, of
which it classifies $100,000 as wages and $250,000 as ordinary income. Assume that
reasonable compensation for someone with Astro’s experience and responsibilities is
$200,000. Astro’s qualified business income from MARS in 2019 is $150,000, which is
its net income of $250,000, minus the $100,000 of “ordinary income” that are actually
reasonable compensation ($200,000 reasonable compensation - $100,000 of payments
classified as wages by MARS). The $200,000 treated as reasonable compensation is not
QBI.
If married taxpayers who are filing a joint return in 2019 have 1040 taxable income that
exceeds $321,400 and is a SSTB, the QBI deduction begins to be subject to a wage
limitation. Once the 1040 taxable income for married taxpayers filing jointly exceeds
$421,400, the wage limitation is fully phased in. In that event, the QBI deduction becomes
the lesser of the wage limitation or 20% of the QBI; if the wage limitation is zero, there is no
QBI deduction.
The wage limitation comprises the wages that the S-Corporation paid, including those paid to
stockholders, plus the unadjusted cost of the qualified property that the S-Corporation owned
and used during the year. To be more specific, the wage limitation is the larger of
50% of the wages that the S-corporation paid or
25% of the S-Corporations’ paid wages plus 2.5% of the unadjusted cost of its
qualified property.
93 Rev. Rul 74-44
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For those high-income shareholders for whom the wage limitation applies, if the corporation
pays no wages and has no qualified property, the shareholder will not have a QBI deduction.
If shareholder of an S-Corporation which is a specified service trade or business, that has
wages or qualified property, the shareholder is subject to the phase out on their individual
return.
The IRS describes specified service trades or businesses are those in the fields of health, law,
accounting, actuarial science, performing arts, athletics, consulting, financial services, and
brokerage services, as well as those for which reputation and/or skill are contributing factors.
QBI does not include reasonable compensation paid to the taxpayer by any qualified trade or
business of the taxpayer for services rendered with respect to the trade or business.
Guaranteed Payments. Guaranteed payments include payments made by a partnership,
without regard to its income, to a partner, for services provided to the partnership. Partnerships
are not required by federal tax law to make guaranteed payments to partners who provide
services to the partnership, and are not constrained by a reasonableness standard if they choose
to do so. To the extent a partnership makes such payments to a partner, the partnership’s
ordinary income (and qualified business income) is reduced by the amount of the payment
because guaranteed payments are deductible to the partnership. To the partner receiving the
guaranteed payment, the payment is ordinary income but is not qualified business income.
Antoinettte and JoanArc are the equal owners of French, a partnership that is a
qualifying trade or business. In 2019, French had $1,250,000 of ordinary income before
deducting $700,000 in guaranteed payments made to Antoinettte and JoanArc for their
services to French ($350,000 each), and $550,000 of ordinary income after deducting
the guaranteed payments ($1,250,000 - $700,000). Antoinettte and JoanArc’s qualified
business income for 2019 is $550,000, or $275,000 each.
TCJA provides that if the net amount of qualified business income from all qualified trades or
businesses during the tax year is a loss, it be carried forward as a loss from a qualified trade or
business in the next tax year for QBI purposes only. Any deduction allowed in a subsequent
year is reduced (but not below zero) by 20 percent of any carryover qualified business
loss.Wages or salaries, reasonable compensations to S-Corporation owners (Form W-2) or
guaranteed payments from a partnership (Form 1065 K-I Part III, Line 4) are not included in
QBI.
In 2018, Popeye has qualified business income of $20,000 from Spinach Design a sole
proprietorship, and a qualified business loss of $50,000 from Olive Oil. Popeye is not
permitted a QBI deduction for 2018 and has a QBI carryover loss of $30,000 to 2019. In 2019,
Popeye has qualified business income of $40,000 from Spinach Design and income of $70,000
from Olive Oil. Refer to the QBI Explanation Worksheets, for a breakdown of the income.
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Popeye’s wife Quacky earned $12,000 in feather gathering from the Down Co. Popeye and
Quacky had no other income for the 2019. The 2019 taxable income for Popeye and Quacky
before the QBI deduction is $97,600. ($12,000 (wages) + $110,000 (business income)-$24,400
(standard deduction)).
See Form 8995, Line 3 for the carryover from 2018. Keep in mind that carryovers of
QBI only affect QBI not ordinary income.
The amounts on line 12 of these worksheets go to Line 1 of Form 8995. (See next page)
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Determining the Final Amount of the QBI Deduction These additional calculations will only change the QBI deduction in two situations:
(1) The taxpayer has qualified REIT dividends, qualified cooperative dividends, or
qualified publicly traded partnership income, or
(2) The taxpayers’ taxable income (reduced by any net capital gain) is less than his or
her qualified business income.
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Example: Peter Popple a single taxpayer sells pots and pans. He reports his net income of
$70,000 on Schedule C. During the year, he sold stock in Pickled Pepper Corp for a long-term
gain of $9,000. The long term capital gain is not included in the QBI see Line 12 of Form
8895 in the following example.
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Qualified Property Defined
For purposes of the QBI deduction, TCJA defines “qualified property” as tangible property of a
character subject to depreciation that is held by, and available for use in, the qualified trade or
business at the close of the tax year. The property is used in the production of qualified
business income, and for which the depreciable period has not ended before the close of the tax
year. The depreciable period with respect to qualified property of a taxpayer means the period
beginning on the date the property is first placed in service by the taxpayer and ending on the
later of
(1) The date 10 years after that date, or
(2) The last day of the last full year in the applicable recovery period that would apply
to the property under Code Sec. 168 (without regard to Code Sec. 168(g)).
Calculating W-2 Wage Limitation
Rev. Proc. 2019-11 provides the following three methods for calculating W-2 wages:
(1) The unmodified Box method, which allows for a simplified calculation;
(2) The modified Box 1 method; and
(3) The tracking wages method.
The discussions of "wages" in Rev. Proc. 2019-11 and in the Code Sec. 199A regulations are
for purposes of Code Sec. 199A only and have no application in determining whether amounts
are wages for purposes of the Federal Insurance Contributions Act (FICA), Federal
Unemployment Tax Act (FUTA), or for purposes of federal income tax withholding, or any
other wage-related determination.
NOTE: The final regulations prevent employees from qualifying for the 20 percent
QBI deduction by becoming an independent contractor. The final regulations create the
presumption that if a person was an employee of an employer, but suddenly becomes an
independent contractor while providing substantially the same services directly or
indirectly to the former employer, it is presumed for the next three years that they are
still an employee for purposes of §199A, thus no §199A deduction. This
recharacterization is only for the purposes of §199A and does not convert the taxpayer
to an employee for payroll tax purposes
While the unmodified Box method allows for a simplified calculation, the other two methods
provide greater accuracy.
The W-2 wages calculated are not necessarily the W-2 wages that are properly allocable to
QBI and eligible for use in computing the Code Sec. 199A limitations. Only W-2 wages that
are properly allocable to QBI may be taken into account in computing the Code Sec.
199A(b)(2) W-2 wage limitations. Therefore, when computing W-2 wages taxpayers must
determine the extent to which the W-2 wages are properly allocable to QBI. Then, the properly
allocable W-2 wages amount is used in determining the W-2 wages limitation under for that
trade or business.
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As previously mentioned, W-2 wages for purposes of Code Sec. 199A include:
(1) The total amount of wages;
(2) The total amount of elective deferrals;
(3) Compensation deferred under Code Sec. 457; and
(4) The amount of designated Roth contributions.94.
Form W-2, the elective deferrals95 and the amounts deferred under Code Sec. 457 directly
correlate to code items reported in Box 12 on Form W-2.
Box 12, Code D is for elective deferrals to a Code Sec. 401(k) cash or deferred
arrangement plan (including a SIMPLE 401(k) arrangement);
Box 12, Code E is for elective deferrals under a Code Sec. 403(b) salary reduction
agreement;
Box 12, Code F is for elective deferrals under a Code Sec. 408(k)(6) salary reduction
Simplified Employee Pension (SEP);
Box 12, Code G is for elective deferrals and employer contributions (including
nonelective deferrals) to any governmental or nongovernmental Code Sec. 457(b)
deferred compensation plan;
Box 12, Code S is for employee salary reduction contributions under a Code Sec.
408(p) SIMPLE (simple retirement account);
Box 12, Code AA is for designated Roth contributions (as defined in Code Sec. 402A)
under a Code Sec. 401(k) plan; and
Box 12, Code BB is for designated Roth contributions (as defined in Code Sec. 402A)
under a Code Sec. 403(b) salary reduction agreement. However, designated Roth
contributions are also reported in Box 1, Wages, tips, other compensation and are
subject to income tax withholding.
For any tax year, a taxpayer must calculate W-2 wages for purposes of QBI using one of the
three methods96 described below. Special rules are provided for a taxpayer with a short tax
year. In calculating W-2 wages for a tax year under the methods below, the taxpayer includes
only those Forms W-2 that are for the calendar year ending with or within the taxable year of
the taxpayer and that meet the rules of application.
94 Rev. Proc 2019-11 (Section 4) 95 IRC §402(q)(3) 96 Rev Proc. 2019-11
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Unmodified Box Method
Under the unmodified box method, W-2 wages are calculated by taking, without modification,
the lesser of: (1) The total entries in Box 1 of all Forms W-2 filed with SSA by the taxpayer with
respect to employees of the taxpayer for employment by the taxpayer; or
(2) The total entries in Box 5 of all Forms W-2 filed with SSA by the taxpayer with
respect to employees of the taxpayer for employment by the taxpayer.
Modified Box 1 Method
Under the Modified Box 1 method, the taxpayer makes modifications to the total entries in Box
1 of Forms W-2 filed with respect to employees of the taxpayer. W-2 wages under this method
are calculated as follows: (1) Total the amounts in Box 1 of all Forms W-2 filed with SSA by the taxpayer with
respect to employees of the taxpayer for employment by the taxpayer,
(2) Subtract from the total obtained in (1) amounts included in Box 1 of Forms W-2
that are not wages for federal income tax withholding purposes, including amounts that
are treated as wages for purposes of income tax withholding under section 3402(o); and
(3) Add to the amount obtained in (2) the total of the amounts that are reported in Box
12 of Forms W-2 with respect to employees of the taxpayer for employment by the
taxpayer and that are properly coded D, E, F, G, and S.
Tracking Wages Method
Under the tracking wages method, the taxpayer actually tracks total wages subject to federal
income tax withholding and makes appropriate modifications. W-2 wages under this method
are calculated as follows: (1) Total the amounts of wages subject to federal income tax withholding that are paid
to employees of the taxpayer for employment by the taxpayer and that are reported on
Forms W-2 filed with SSA by the taxpayer for the calendar year; plus
(2) The total of the amounts that are reported in Box 12 of Forms W-2 with respect to
employees of the taxpayer for employment by the taxpayer and that are properly coded
D, E, F, G, and S.
Calculating the phase-in of QBI with W-2 wage limitation phases in for a taxpayer with taxable
income in excess of the threshold amounts. Therefore, for a taxpayer with taxable income
below these thresholds, the W-2 limitation does not apply. For purposes of phasing in the wage
limit, taxable income is computed without regard to the 20 percent deduction.
Taxpayers between the taxable income thresholds, who are not in a specified service trade or
business are subject to only a partial wage and capital limitation. The deductible QBI amount
for a business of a taxpayer with taxable income between the thresholds is 20% of QBI, less an
amount equal to a “reduction ratio” multiplied by an “excess amount.”
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The “reduction ratio” is calculated as the amount of taxable income in excess of the lower
threshold amount of $321,400 for Married Filing Jointly ($160,700 for Single and Head of
Household), divided by $100,000 for joint filers ($50,000 for other taxpayers)97. The more the
taxable income, the higher the reduction ratio and the more the wage and capital limitations
apply until they are fully phased in at $415,000 (or $207,500 Single, Head of Household).
The “excess amount98” is the amount of the difference between:
(1) The deductible QBI amount of the qualified business with no wage and capital
limitation (20% of QBI); and
(2) The deductible QBI amount of the qualified business with a fully phased-in wage
and capital limitation. The reduction ratio is applied to this amount to determine the
reduction of the wage and capital limitation.
Form 8995-A, Qualified Business Income Deduction
This form is six pages and is composed of four parts and four schedules:
Part I, Trade, Business, or Aggregation Information;
Part II, Determine The Adjusted Qualified Business Income;
Part III, Phased-in Reduction; and
Part IV, Determine The Qualified Business Income Deduction.
Schedule A, Specified Service Trades or Businesses, is composed of two parts, one for
non-publicly traded partnership information, and one for publicly traded partnership
information.
Schedule B, Aggregation of Business Operations, has space for three aggregations of
trades or businesses and asks taxpayers to explain the factors that allow aggregation of
the taxpayers’ businesses.99 Additionally, if a taxpayer holds a direct or indirect interest
in a relevant pass-through entity (RPE) that aggregates multiple trades or businesses,
the taxpayer is required to attach a copy of the RPE’s aggregations. Schedule B also
asks taxpayers if there were any changes in aggregations from the prior year and to
explain such changes.
Schedule C, Loss Netting and Carryforward, is the same as in the 2018 Schedule C
worksheet used for 2018 tax returns. The 2019 Schedule C calculates the qualified
business net loss and the carryforward amount for each of the taxpayers’ trades or
businesses or the aggregation of trades or businesses.
Schedule D, Special Rules for Patrons of Agricultural or Horticultural Cooperatives
(COOP), is also the same as the 2018 Schedule D worksheet used for 2018 tax returns.
The 2019 Schedule D is to be completed only by a patron of an agricultural or
horticultural cooperative and is used to compute the patron reduction used in
calculating the qualified business income component.
97 IRC§ 199A(b)(3)(B)(ii) 98 IRC§ 199A(b)(3)(A)(ii) 99 Reg Sec. 1.19A-4
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Overall limitation applied after combined QBI is calculated
After the deductible QBI amount is calculated for each of taxpayers’ qualified businesses under
the various taxpayer scenarios above, the deductible QBI amounts are combined to determine
the taxpayers’ combined qualified business income. Therefore, if the taxpayer has only one
qualified business, the combined QBI amount is the same as the deductible QBI amount for
that business. After determining the taxpayers’ combined QBI amount, the overall limitation is
applied. Under the overall limitation, the Sec. 199A deduction is the lesser of the combined
QBI or 20% of the taxpayers’ taxable income in excess of net capital gain.
To calculate UBIA, the regulations state that the existing rules used to determine “unadjusted
basis” in Regs. Secs. 1.263(a)—(h)(5) provide a reasonable basis to determine UBIA under
Sec. 199A. Similarly, the rules for determining UBIA for qualified property subject to a Sec.
1031 like-kind exchange or a Sec. 1033 involuntary conversion are described in Regs. Sec.
1.199A-2.
According to the regulations “immediately after acquisition” means the date the property was
placed in service. For qualified property contributed to a partnership or an S corporation in a
Sec. 721 or 351 transaction, respectively, and immediately placed in service, the basis will be
the same basis determined under Secs. 723 and 362, respectively. However, to avoid abuse of
these property basis rules, property acquired within 60 days of the end of the tax year and
disposed of within 120 days without having been used for at least 45 days before disposition
will generally not be qualified property included in the UBIA computation.
Calculating QBI over the Threshold
Bob and Carol are married and file a joint tax return. Bob is a shareholder in ABC, an entity
taxed as an S corporation for tax purposes that conducts a single trade or business. ABC holds
no qualified property. Bob’s share of ABC’s QBI is $300,000 in 2019. Bob’s share of the W-2
wages from ABC in 2019 is $40,000. Carol earns wage income from employment by an
unrelated company. After allowable deductions unrelated to ABC, Bob and Carol’s taxable
income for 2019 is $325,600. Bob and Carol are within the phase-in range because their
taxable income exceeds the applicable threshold amount, $321,400, but does not exceed the
threshold amount plus $100,000, or $421,400. Consequently, the QBI component of Bob and
Carol’s Code QBI deduction may be limited by the W-2 wage and UBIA of qualified property
limitations but the limitations will be phased in. The UBIA of qualified property limitation
amount is zero because ABC does not hold qualified property
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*A “Patron reduction” (Line 14) is a refund issued to those who purchase goods or services
from a cooperative, and is calculated based upon the amount that each patron spends at the
cooperative in a given taxable year.
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W-2 wages are the total wages subject to wage withholding100 under elective deferrals, and
deferred compensation paid by the qualified trade or business with respect to employment of
its employees during the calendar year ending during the tax year of the taxpayer.
Van owns and operates Rubber Soles, a shoe store, as a single owner S Corporation of
which he has one employee. Assume that Rubber Soles is qualified trade or business,
and that it has no qualified property. Van pays himself a reasonable salary of $150,000,
he has one employee who he pays $65,000, the S corporation has $128,000 of taxable
income, which is Van’s ordinary business income. Van’s taxable income before QBI is
$198,500 ($150,000 (W-2 Income) $128,000 (1120S K-1) – $52,000 (Section 179
deduction from 1120S K-1) - $27,500 (Itemized deductions))
100 IRC §3401(a)
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Guaranteed payments to a partner in a partnership and the profit from a sole-proprietorship, do
not meet the definition of W-2 wages. Such payments are not subject to withholding (partners
and sole proprietors pay estimated taxes), and are reported to the IRS, not the SSA. Thus, and
profits from a Schedule C fail two of the tests for W-2 wages.
Assume the same facts as Rubber Soles, except that Chip is a sole-proprietor of Chip
and Dale Soles. Chip receives compensation in the form of a profit of $278,000. The
profit is the qualified business income. Chip’s taxable income is $193,310. Chip’s
employee wages are $65,000.
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See the QBI Explanation Worksheet below, note the $65,000 of wages on line 18.
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To calculate the QBI deduction, Chip uses the lower of QBI or taxable income before
Qualified Business Income Deduction. The QBI is on Line 2 of Form 8995-A ($266,037). The
taxable income before the Qualified Business Income Deduction is on line 34 of Form 8995-A
($241,637). The example has the QBI Deduction of $48,327 ($241,637 x 20%).
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QBI Deduction – Specified Service Trade or Business
Certain types of businesses defined as “specified service trades or business” (SSTBs) are not
considered qualified businesses for individuals whose taxable income exceeds certain
thresholds (discussed below). A specified service trade or business means any trade or business
involving the performance of services in the fields of health, law, accounting, consulting,
financial services, brokerage services, actuarial science, athletics, or performing arts.
Specified service trades or businesses also include any trade or business where the principal
asset of such trade or business is the reputation or skill of one or more of its employees or
owners.
Specified service trades or businesses also include trades or businesses, which involve the
performance of services that consist of investing and investment management, trading, or
dealing in securities, partnership interests, or commodities. For this purpose, the terms
“security” and “commodity” have the same meanings as those provided in the rules for the
mark-to-market accounting method for dealers in securities.101
Specified Service Trades or Businesses (SSTB)102 include the following:
• Health
• Law
• Accounting
• Actuarial science • Performing arts
• Consulting
• Athletics
• Financial services
• Brokerage services
• Investing and investment management
• Services in trading
• Services in dealing securities, commodities, and partnership interests
• Any trade or business where the principal asset of such trade or business is the reputation or
skill of one or more of its employees or owners
Code Section 199A specifically excludes Engineering and Architecture from SSTB
classification. For clarification, the final regulation for Code Section 199A state that
Engineering and Architecture are not included in “consulting”.
Health
The provision of medical services by physicians, pharmacists, nurses, dentists, veterinarians,
physical therapists, psychologists, and other similar healthcare professionals performing
services.
101 IRC §§475(c)(2), 475(e) (2) 102 §1.199A-5
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Regulations point out that, a radiologist might be never come into direct contact with the
patient, but it remains health. The skilled nursing and assisted living facilities are also difficult
and will be decided by the general facts and circumstances.
An outpatient surgical center is not included in SSTB; the IRS does not believe it is a trade or
business providing services in the field of health. The medical professionals were separately
billed and not provided by the surgery center.
Sales of pharmaceuticals and medical devices by a retail pharmacy is not by itself a trade or
business performing services in the field of health, A pharmacist and a physical therapist will
be included in the health field.
Law
The services by lawyers, paralegals, legal arbitrators, mediators, and similar professionals are
part of SSTB.
Accounting
Final Section 1.199A-5 defines the “Accounting” SSTB
The provision of services by accountants, enrolled agents, return preparers, financial auditors,
and similar professionals. Tax return advice, preparation, and bookkeeping services are
included.
Accounting does not include payment processing and billing analysis.
Consulting
Consulting is defined as professional advice and counsel to clients to assist the client in
achieving goals and solving problem. It includes providing advice and counsel regarding
advocacy with the intention of influencing decisions made by a government or governmental
agency and all attempts to influence legislators and other government officials on behalf of a
client by lobbyists and other similar professionals.
If a trade or business provides consulting services that are not separately purchased or billed,
then such trades or businesses are not in a trade or business in the field of consulting.
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Financial services
The field of financial services includes the provision of financial services to clients including
managing wealth, advising clients with respect to finances, developing retirement plans,
developing wealth transition plans, the provision of advisory and other similar services
regarding valuations, mergers, acquisitions, dispositions, restructurings and raising financial
capital by underwriting, or acting as the client’s agent in the issuance of securities, and similar
services.
Financial advisors, investment bankers, wealth planners, and retirement advisors and other
similar professionals are also included in SSTB, but insurance is not.
Services provided by stockbrokers and other similar professionals is an SSTB but does not
include services provided by real estate agents and brokers, or insurance agents and brokers.
Investing and investment management
The regulations define “Investing and investment management” as a trade or business
involving the receipt of fees for providing investing, asset management, or investment
management services, including providing advice with respect to buying and selling
investments. Directly managing real property is not included in SSTB.
Reputation or skill is defined as:
A. A trade or business in which a person receives fees, compensation, or other income
for endorsing products or services.
B. A trade or business in which a person licenses or receives fees, compensation, or
other income for the use of an individual’s image, likeness, name, signature, voice,
trademark, or any other symbols associated with the individual’s identity.
C. Receiving fees, compensation, or other income for appearing at an event or on radio,
television, or another media format.
Special Rules for Partnerships and S Corporations
TCJA provides that, in the case of a partnership or S corporation, the business income
deduction apply at the partner or shareholder level. Each shareholder of an S corporation takes
into account the shareholder’s pro rata share of each qualified item of income, gain, deduction,
and loss. Each shareholder is treated as having W-2 wages for the tax year equal to the
shareholder’s pro rata share of W-2 wages of the S corporation, and a pro rata share of
qualified property equal to the shareholder’s allocable share of pro rata share depreciation.
Similar rules apply to a partner in a partnership, who takes into account his or her allocable
share of all of same items mentioned in the preceding paragraph. The partner’s allocable share
of W-2 wages is required to be determined in the same manner as the partner’s allocable share
of wage expense (which is typically the same as the partner’s allocable share of ordinary
income). The partner’s allocable share of qualified property is equal to the shareholder’s
allocable share of depreciation. If the partnership agreement does not provide for special
allocations of depreciation, the partner’s allocable share of qualified property will be the same
as the partner’s allocable share of ordinary income.
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Estates and Trusts
Estates and trusts are separate legal entities for federal income tax purposes. Therefore, the
fiduciary of an estate or trust generally must file a separate federal income tax return for the
estate or trust.
In general, trusts are taxed in the same manner in which an individual is taxed. Thus, the for
example, gross income of an estate or trust consists of all items of gross income received
during the tax year, including:
(1) Income accumulated in trust for the benefit of unborn or unascertained persons or
persons with contingent interests;
(2) Income accumulated or held for future distribution under the terms of the will or
trust;
(3) Income that is to be distributed currently by the fiduciary to the beneficiaries, and
income collected by a guardian of an infant that is to be held or distributed as the court
may direct;
(4) Income received by estates of deceased persons during the period of administration
or settlement of the estate; and
(5) Income that, in the discretion of the fiduciary, may be either distributed to the
beneficiaries or accumulated.
However, one important difference between the taxation of an individual and the taxation of a
trust is that a trust can take a deduction for distributions made to beneficiaries, and the
beneficiary is generally required to include in their income the amount of the distribution. IRC
§642 also provides specific rules relating to deductions that do not apply to individual
taxpayers. Taking certain tax attributes from the system governing the taxation of individuals,
corporations and partnerships, Subchapter J creates a unique set of rules for a trust and its
beneficiaries.
Whether or not, a beneficiary will be required to include in his or her income amounts received
as a distribution from a trust is determined by computing the trust’s taxable income, and its
distribution deduction. If a beneficiary receives, a distribution that the trust took a distribution
deduction for, the beneficiary includes that amount in his or her taxable income. However, if
the trust made a distribution for which it did not receive a distribution deduction, that amount is
generally not included in a beneficiary’s gross income.
The taxable income of an estate or trust must be distinguished from its fiduciary accounting
income (FAI) and its distributable net income (DNI). In determining the taxable income of an
estate or trust, the income and deductions of the estate or trust are generally determined in the
same manner as they are for individual taxpayers. In addition, estates and trusts are allowed a
special deduction for income distributed to beneficiaries
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Special Rules for Trusts and Estates
TCJA provides that trusts and estates are eligible for the 20-percent deduction. The section
further provides that rules similar to the ones under now-repealed Code Sec. 199 (as in effect
on December 1, 2017) apply for apportioning between fiduciaries and beneficiaries any W-2
wages and unadjusted basis of qualified property under the limitation based on W-2 wages and
capital.
Real Estate Investment Trust (REIT) Dividends, Cooperative Dividends, and Publicly Traded
Partnership Income.
A deduction is allowed under the provision for 20 percent of the taxpayers’ aggregate amount
of qualified REIT dividends, qualified cooperative dividends, and qualified publicly traded
partnership income for the tax year.
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What Do You Think?
Q1. Which one of the following is not a factor when determining if rental
real estate rises to the level of being a trade or business for QBI?
A. Determining that the property is residential rental property
B. The owner’s or the owner’s agents day-to-day involvement
C. The types of services provided under the lease
D. The amount of income generated by the rental property.
Q2. Sponge Bob owns and operates Yellow Bubbles, a sole proprietorship that is a qualified
trade or business. Sponge Bob has $100,000 in qualified business income from Yellow
Bubbles, and no other items of income or loss. He has a total of $25,000 in itemized
deductions. His taxable income, prior to applying any QBI deduction, is $75,000 ($100,000
income from Yellow Bubbles - $25,000 in individual deductions).
How much is Sponge Bob’s QBI deduction?
A. $15,000,
B. -0-
C. $25,000
D. $75,000
Q3. What is the total QBI deduction allowed on the Toe’s tax return?
Bunion Toe is working as a Podiatrist for Footies, an S Corporation. Bunion’s share of the S
Corporation wages is $50,000 and he receives qualifying business income of $36,000.
Bunion’s wife Helen is a sole proprietor designing websites, her qualifying business income is
$90,000, Helen has no depreciable assets; she has no employees. The Toe’s taxable income is
$150,000, which includes capital gains of $7,600.
A. $126,000
B. $25,200
C. $142,400
D. $150,000
Q4. Which of the following is not a correct method for calculating W-2 wages for the
computation of qualified business income deduction?
A. The Unmodified Box Method is a simplified method used to calculate the wages
for the QBI calculation by comparing Box 1 and Box 5 of Form W-2.
B. The Modified Box 1 method, the taxpayer makes modifications to the total
entries in Box 1 of Forms W-2.
C. The Tracking Wages Method is more accurate than the unmodified method
when used to determine the wages for the QBI calculation.
D. The Reduction Ratio Method applies a phase-in method.
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What Do You Think? – Answers
A1. D is the correct Answer. Which one of the following is not a factor when
determining if rental real estate rises to the level of being a trade or business for
QBI?
A. Determining that the property is residential rental property
B. The owner’s or the owner’s agents day-to-day involvement
C. The types of services provided under the lease
D. The amount of income generated by the rental property.
Like any activity, to rise to the level of being a trade or business, a rental real estate activity
must be considerable, regular, and continuous in scope. In determining whether a rental real
estate activity meets those criteria, the IRS has stated that relevant factors might include, but
are not limited to, the following:
(1) The type of rented property (commercial real property versus residential property);
(2) The number of properties rented;
(3) The owner’s or the owner’s agents day-to-day involvement;
(4) The types and significance of any ancillary services provided under the lease; and
(5) The terms of the lease (for example, a net lease versus a traditional lease and a short-term
lease versus a long-term lease)
Recognizing the difficulties taxpayers and practitioners may have in determining whether a
taxpayers’ rental real estate activity is sufficiently regular, continuous, and considerable for the
activity to constitute a trade or business, the IRS has provided a safe harbor under Code Sec.
199A for rental real estate activities.
A2.. A is the correct answer. $15,000 Sponge Bob owns and operates Yellow Bubbles, a sole
proprietorship that is a qualified trade or business. Sponge Bob has $100,000 in qualified
business income from Yellow Bubbles, and no other items of income or loss. He has a total of
$25,000 in itemized deductions. His taxable income, prior to applying any QBI deduction, is
$75,000 ($100,000 income from Yellow Bubbles – minus $25,000 in individual deductions).
For a taxpayer eligible for the QBI deduction who does not have any qualified REIT
dividends, qualified cooperative dividends, or qualified publicly traded partnership
income, calculation of the final amount of the QBI deduction is straightforward. For
such taxpayers, the QBI deduction amount is the lesser of –
(1) The sum of the taxpayers’ QBI deduction for all qualified trades or
businesses (reduced, but not below zero, by 20 percent of any carryover
qualified business loss); or
(2) An amount equal to 20 percent of the taxpayers’ taxable income (reduced by
any net capital gain).
The effect of reducing taxable income by any net capital gain is to ensure that the QBI
deduction does not exceed 20 percent of income taxed at regular rates. The amount in
(2), above (“taxable income limitation”), will only apply in situations where taxable
income is less than the taxpayers’ total QBI from all qualified trades or businesses
(reduced by any QBI loss carryover).
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A3. B is the correct answer. $25,200. What is the total QBI deduction allowed on the Toe’s
tax return? Bunion Toe is working as a Podiatrist for Footies, an S Corporation. Bunion’s share
of the S Corporation wages is $50,000 and he receives qualifying business income of $15,000.
Bunion’s wife Helen is a sole proprietor designing websites, her qualifying business income is
$90,000, Helen has no depreciable assets; she has no employees. The Toe’s taxable income is
$150,000, which includes capital gains of $7,600.
Example Footies Rentals Sole Proprietor
Net qualifying business income $36,000 $90,000
(A) Total qualified business income $126,000
(B) Taxable Income less capital gains $150,000 - $7,600 = $142,400
Lesser of (A) or (B) $126,000
IRC §199A deduction (20% of above) $25,200
After the deductible QBI amount is calculated for each of taxpayers’ qualified businesses under
the various taxpayer scenarios above, the deductible QBI amounts are combined to determine
the taxpayers’ combined qualified business income. Therefore, if the taxpayer has only one
qualified business, the combined QBI amount is the same as the deductible QBI amount for
that business. After determining the taxpayers’ combined QBI amount, the overall limitation is
applied. Under the overall limitation, the Sec. 199A deduction is the lesser of the combined
QBI or 20% of the taxpayers’ taxable income in excess of net capital gain.
A4. D is the correct answer. Which of the following is not a correct method for calculating
W-2 wages for the computation of qualified business income deduction?
A. The Unmodified Box Method is a simplified method used to calculate the wages
for the QBI calculation by comparing Box 1 and Box 5 of Form W-2.
B. The Modified Box 1 method, the taxpayer makes modifications to the total
entries in Box 1 of Forms W-2.
C. The Tracking Wages Method is more accurate than the unmodified method
when used to determine the wages for the QBI calculation.
D. The Reduction Ratio Method applies a phase-in method.
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.
Unmodified Box Method
Under the unmodified box method, W-2 wages are calculated by taking, without modification,
the lesser of: (1) The total entries in Box 1 of all Forms W-2 filed with SSA by the taxpayer with
respect to employees of the taxpayer for employment by the taxpayer; or
(2) The total entries in Box 5 of all Forms W-2 filed with SSA by the taxpayer with
respect to employees of the taxpayer for employment by the taxpayer.
Modified Box 1 Method
Under the Modified Box 1 method, the taxpayer makes modifications to the total entries in Box
1 of Forms W-2 filed with respect to employees of the taxpayer. W-2 wages under this method
are calculated as follows: (1) Total the amounts in Box 1 of all Forms W-2 filed with SSA by the taxpayer with
respect to employees of the taxpayer for employment by the taxpayer,
(2) Subtract from the total obtained in (1) amounts included in Box 1 of Forms W-2
that are not wages for federal income tax withholding purposes, including amounts that
are treated as wages for purposes of income tax withholding under section 3402(o); and
(3) Add to the amount obtained in (2) the total of the amounts that are reported in Box
12 of Forms W-2 with respect to employees of the taxpayer for employment by the
taxpayer and that are properly coded D, E, F, G, and S.
Tracking Wages Method
Under the tracking wages method, the taxpayer actually tracks total wages subject to federal
income tax withholding and makes appropriate modifications. W-2 wages under this method
are calculated as follows: (1) Total the amounts of wages subject to federal income tax withholding that are paid
to employees of the taxpayer for employment by the taxpayer and that are reported on
Forms W-2 filed with SSA by the taxpayer for the calendar year; plus
(2) The total of the amounts that are reported in Box 12 of Forms W-2 with respect to
employees of the taxpayer for employment by the taxpayer and that are properly coded
D, E, F, G, and S.
The “reduction ratio” is not a method of calculating W-2 wages for QBI.
The “reduction ratio” is calculated as the amount of taxable income in excess of the lower
threshold amount divided by $100,000 for joint filers ($50,000 for other taxpayers). The more
the taxable income, the higher the reduction ratio, and the more the wage and capital
limitations apply until they are fully phased out.
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Rental Income
Rental income is any payment the taxpayer receives for the use or occupation of property or a
dwelling unit over a specific time. The gross income from the rental is principally for customer
use.
A dwelling unit includes apartments, condominiums, mobile home, boat, vacation home, or
similar property. A dwelling unit has basic living accommodations such as sleeping space, a
toilet and cooking facilities. Income from room rentals at a hotel or motel is not considered
rental income and is reported on a Schedule C.
The following items are included as part of Rental Income:
Security deposits - that are kept by the property owner or used as the last months’
rent are included in rent. Security deposits that are returned to the tenant are not
income, if any portion of the security deposit is kept for damages, etc. it is included
in income. Some states require the property owner to pay interest on the security
deposit.
Tax Court has held that a deposit is not taxable income to its recipient unless the
recipient has some guarantee that it will be allowed to keep the funds. Deposits were
taxable if the facts and circumstances indicated that they were advance payments of
rent or prepayments for services rendered, whereas, deposits were nontaxable if
their primary purpose was to serve as security for the depositor's
performance.103Later Tax Court cases have decided the issue based upon whether
the taxpayer or the customer had control over the disposition of the payment.104
Advance rent is any amount received before the period that it covers. Include
advance rent in rental income in the year it is received, regardless of the period it
covers or the method of accounting used.
Payment for canceling a lease is included in income in the year received with no
effect on the remaining lease.
An expense that is paid by the tenant is rental income and can be deducted as any
other rental expense by the property owner105.
Example: The tenant’s dishwasher broke while the property owner was out of
town. The tenant contacted the property owner who gave permission for the tenant
to have it repaired. The tenant got the dishwasher repaired and deducted the amount
from the rent. The property owner would report the amount of the repair as rental
income and report the amount as a rental expense.
103 Kansas City S. Indus., Inc. v. Comr., 98 T.C. 242 (1992 104 Herbel v. Comr., 106 T.C. 392 105 IRC §109
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If property or services are received instead of money as part of the rent, include the
fair market value in income. If services are agreed upon at a specified price, that
price is the fair market value.
Example: Sam owns three houses, John lives in one of the houses that he rents for
$1,400 per month, John is a gardener and he does the gardening for all three houses.
John and Sam agreed on $300 per month, which he subtracts from his rent. Since
they agreed upon the price that is considered the FMV of the gardening, the $300 is
included as rental income and the $300 for gardening is included as an expense.
If the tenant has a lease with an option to buy, the payments received under the
agreement are usually rental income. If the tenant exercises the option, the
payments received after the date of sale are considered part of the selling price.
Rental Expenses
Ordinary and necessary expenses are deductible for managing, conserving or maintaining
rental property from the time it is first available for rent. Accurate record keeping is mandatory
for expenses to be deductible.
Repairs are considered an expense and deductible in the year they are paid. Repairs are
costs that keep the property in good condition, do not add material value to property
and do not substantially prolong the life of the property.
Improvements add to the basis of the property must be depreciated. An improvement
adds to the value of property, prolongs its useful life or adapts it to new uses. The cost
of an improvement must be capitalized and can generally be depreciated as if the
improvement was separate property. Repairs made within extensive remodeling or
restoration of property are included as part of the improvement and capitalized. The
cost of an improvement is depreciated according to the MACRS class and recovery
period of the underlying property.
Work done on the rental property that does not add much value to the house or the life
of the property, but rather keeps the property in good condition is considered a repair,
not an improvement. Repainting, fixing gutters, repairing floors, or replacing broken
windows are examples of repairs.
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The following is a list of common rental expenses:
Advertising
Cleaning and maintenance
Utilities
Insurance
Taxes
Interest
Points
Commissions
Tax return preparation fees
Local transportation costs
Rental payments or leases on equipment
Example: John and Mary Sampler own two single-family rentals. They purchased one of the
rentals in 2015 and the other in 2016. John and Mary had a loss on one of their rentals and a
small gain on the other rental. The full amount of the rental income is in the total.
Certain expenses are more difficult to determine whether they are deductible. Vacant property
expenses are deductible beginning at the time the property is available for rent regardless of
when rental income is actually received. Mortgage interest reported to the owner of the
property on Form 1098 (if over $600) is a deductible expense. Points or “loan origination
fees”, if any, are charges solely for the use of the money and are considered interest. Insurance
premiums paid in advance cannot be deducted in full in the year paid. The premium must be
allocated to the period covered and deducted in that year. Local benefit taxes that increase the
value of the property, such as charges for putting in sewers, streets or sidewalks are non-
depreciable capital expenditures and are added to the basis only.
Depreciation is deductible on the house from the time it is available for rent, but not on the
land. Land value can normally be determined from the tax bill or the closing statements.
Appliances, fixtures and improvements are depreciable items and can be deducted.
Travel expenses that are ordinary and necessary expenses of traveling are deductible if the
primary purpose of the trip was to collect rents, or to manage, conserve, or maintain the rental
property. The travel expenses must be properly allocated between rental and non-rental
activities. The business relationship of the travel expense to the property should be clear. The
ordinary local transportation expenses to collect rents, or to manage, conserve, or maintain the
rental property is deductible. Commuting for investment or rental real estate purposes is
nondeductible.106
106 Reg. §1.212-1
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Condominiums and Cooperatives
Special rules apply to the rental of a condominium or cooperative. If a taxpayer is a tenant-
stockholder 107in a cooperative housing corporation or a member of a condominium
management association for a condominium that he/she owns, then the taxpayer is treated as
having made his/her proportionate share of the cooperative corporation's or condominium
association's qualifying expenditures.
A condominium is a dwelling in a multi-unit building. Along with owning the unit, the owner
also owns some of the common elements of the structure such as land, lobbies, elevators, and
service areas. The owners of the units may pay dues or assessments for the care of these
common areas. If the condominium is a rental, expenses such as depreciation, repairs, upkeep,
dues, interest, taxes and assessments for the care of the common parts of the structure are
deductible. Any special assessments for improvements to the rental must be capitalized and
depreciated.
All of the maintenance fees paid to cooperative housing authority for a cooperative apartment
rented to others are deductible. Any payment for improvements or a capital asset cannot be
deducted. The payment is added to the basis of the stock in the cooperative. In addition to the
maintenance fees, direct payments for repairs, upkeep and other rental expenses can be
deducted. The cooperative will give the owner a breakdown of the expenses.
Classification of Activities
1. Passive activities - investment in a trade or business with no material participation which
includes most rental activities, limited partnerships.
There are limits on passive activity deductions and credits. Generally, income
cannot be offset by passive losses (other than passive income). Nor can taxes be
offset by income (other than passive income) with the credits resulting from passive
activities. Any excess loss or credit is suspended to the next year
Rental real estate activities are generally considered a passive activity and the
amount of deduction allowed is limited. Active participation in rental real estate
activity allows a taxpayer with an adjusted gross income of under $100,000 to
deduct up to $25,000 ($12,500 if Married Filing Separately) in passive losses
against non-passive income. Taxpayers are considered actively participating if they
own 10% of the rental activity and make management decisions in a significant and
bona fide sense. Use Form 8582 to compute and track passive activities and
suspended amounts from year to year
2. Non-passive activities - trade or business activities with material participation. Include
wages and SE income. A person engaged in a trade or business is not subject to passive
loss rules if material participation rules are met.
3. Portfolio Income - interest, dividends, and royalties from investments such as stocks, bonds
and interest bearing accounts.
107 IRC 25D(e)(5)
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Material Participation
A taxpayer “materially participates” in an activity if the individual is involved in the operations
of the activity on a regular, continuous or substantial basis. The individual must meet one of
the seven tests used by the IRS in determining material participation. Specifically, the
individual must be able to demonstrate:
• More than 500 hours of participation in an activity
• More than 100 hours of participation in an activity and no one else participates as
much
• That his or her participation includes “substantially all” of active participation of all
individuals in participation activity
• That the activity is a significant participation activity (SPA) and individual's aggregate
participation in all SPAs exceeds 500 hours
• That he or she materially participated in activity in any 5 years out of the last 10 years
• That, for a personal service activity, he or she materially participated in any 3 prior
taxable years; or
• That, based on all the facts and circumstances, the individual's participation in the
activity was material because it was regular, continuous and substantial.
Keep in Mind: When determining material participation in an activity review the “regular,
continuous and substantial” participation.
Passive Activity Rules
Passive activity loss rules apply to this example. A passive loss108 is a loss that arises from:
• An activity which involves the conduct of a trade or business in which the taxpayer
does not “materially participate”; or
• Any rental activity
If the taxpayer “actively participates” 109in the residential rental activity, he or she may be able
to deduct a loss of up to $25,000 against ordinary (nonpassive) income such as wages or
investment income.
The taxpayer actively participates in the rental activity if:
He or she make key management decisions such as the people who the taxpayer
rents to, the rental terms, approving capital expenditures, etc.
He or she arrange for others to provide services.
Active participation does not require regular, continuous, substantial involvement with the
property. However, in order to satisfy the active participation test, the taxpayer and spouse
must own at least 10% of the rental property. Ownership as a limited partner does not count as
active participation in rental real estate.
108 IRC§469(c) 109Reg. § 1.469-9(j)
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If the taxpayer meets the above tests, he or she can claim a loss against nonpassive income up
to $25,000. If the taxpayer is filings Married Filing Separately and lives apart from the spouse
for the entire year, he or she may claim $12,500. If the taxpayer is Married Filing Separately
and did not live apart from the spouse for the entire year, he or she is not eligible for the special
allowance.
Modified AGI Limitation (MAGI is explained below)110
If the MAGI is above $100,000, the $25,000 allowance amount is reduced by
one-half the excess over $100,000.
If Married, Filing Separately, the $12,500 allowance amount is reduced by one-
half the excess over $50,000.
If MAGI is $150,000 ($75,000 Married File Separate), the allowance is reduced
to zero.
Losses, which are not allowed because of the amount limitations, are suspended losses.
Suspended losses are allowed as a deduction in the year the activity is fully disposed of in a
taxable transaction. If the sale of the passive activity results in a gain that exceeds that
activity’s current and suspended losses, the excess gain is passive income, which will allow the
deduction of losses from other passive activities. The activity must be passive in the year of
sale.
Even if a taxpayer qualifies for the $25,000 special allowance, the rental real estate remains a
passive activity. Meeting the active participation standard simply means that the taxpayer may
use some or all of the $25,000 offset if modified adjusted gross income is less than $150,000.
The difference between active participation and material participation is that active
participation can be satisfied without regular, continuous, and substantial involvement in
operations, so long as the taxpayer participates, in the making of management decisions or
arranging for others to provide services (such as repairs), in a significant and bona fide sense.
Management decisions must be relevant include approving new tenants, deciding on rental
terms, approving capital or repair expenditures, and other similar decisions. The active
participation standard is a lower standard than the material participation standard. Unlike the
material participation requirements, there are no specific hourly requirements. It is possible
that the taxpayer can meet the active participation standard for a rental property even when
there is an on-site manager or a real estate agent handling the property. However, the taxpayer
must be exercising his independent judgment and not simply ratifying the decisions made by
the manager.111
110 IRC § 469(i)(6)(A) 111 Madler v. Comm'r, T.C. Memo. 1998-112
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Since John and Mary collect the rents and do all the work around the rental, they meet the
requirement for active participation in rental real estate. Since the taxpayer and spouse actively
participated in a passive rental real estate activity, they can deduct up to $25,000 ($12,500
MFS) of loss from the activity, depending on their adjusted gross income.
Modified adjusted gross income for this purpose is the adjusted gross income figured without
the following.
Taxable social security and tier 1 railroad retirement benefits.
Deductible contributions to individual retirement accounts (IRAs) and Section
501(c)(18) pension plans.
The exclusion from income of interest from qualified U.S. savings bonds used to pay
qualified higher education expenses.
The exclusion from income of amounts received from an employer's adoption
assistance program.
Passive activity income or loss included on Form 8582.
Modified adjusted gross income is simply adjusted gross income computed without any
passive activity loss (or passive income). In this case, MAGI is adjusted gross income
computed without any of the following:
Taxable social security and tier one railroad retirement benefits;
Deductible contributions to IRA’s and pension plans;
The amounts excludible from income relating to income from savings bonds used to
pay higher education tuition and fees112 and relating to income for certain adoption
assistance payments from employers113;
Amounts allowed as a deduction relating to the domestic production activities
deduction, relating to the deduction for certain retirement savings amounts, relating to
the deduction allowed for education loan interest, relating to the deduction for qualified
tuition and related expenses114; and
Any passive activity loss or any rental real estate loss allowed because the taxpayer is a
real estate professional who materially participated in the rental activity.115
Generally, the taxpayer may deduct suspended passive losses in the year that they dispose of
their entire interest in the activity.
112 IRC §135 113 IRC §137 114 IRC §§199; 219; 221; 222. 115 IRC §469 (i)(3)(F)
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Passive Losses
The passive loss limitation rules, were enacted to limit the extent taxpayers could offset
ordinary income with losses arising from activities in which they did not have "substantial and
bona fide involvement." It was meant to address the concern that some taxpayers were
engaging in certain activities in order to generate losses that could be used to shelter income
from other activities.
The underlying concepts of Form 8582 is relatively simple. Form 8582 merely computes the
allowable loss for the given year. Passive activity losses are allowed to the extent of passive
income - and rental real estate losses with active participation are permitted to the extent of the
$25,000 special allowance. The Form 8582 worksheets simply allocate passive income
amongst the various passive activities on a pro rata basis, and the worksheets allocate the
$25,000 offset amongst the rental real estate activities.
Part II of Form 8582 computes the special allowance for rental real estate, based on the
taxpayers’ modified adjusted gross income. Rental real estate losses with active participation
are allowed up to $25,000, but that amount is reduced when the taxpayers’ modified adjusted
gross income exceeds $100,000. Refer to the modified adjusted gross income limitation
discussion earlier in this chapter.
Personal Use
A personal use dwelling does not qualify for QBI. The personal use of a dwelling unit comes
into play if a personal residence or any other property was changed to a rental at any time
during the year other than the beginning of the tax year. The yearly expenses such as taxes and
insurance must be divided between rental and personal use. For depreciation purposes, treat the
property as being placed in service on the conversion date.
If only part of a property is rented, the expenses and depreciation must be divided between the
rental and personal use. Direct expenses of the rental do not have to be divided. The cost of the
first phone line cannot be deducted, but a portion of other utilities can be deducted. The most
common ways to divide the expenses are by either square footage or number of rooms.
For each property listed on line 1 of Schedule E, report the number of days in the year each
property was rented at fair rental value and the number of days of personal use.
A day of personal use is any day, or part of a day, that the unit was used:
The owner for personal purposes,
Any other person for personal purposes, if that person owns part of the unit (unless
rented to that person),
Anyone in the owners family (or in the family of someone else who owns part of the
unit), unless the unit is rented at a fair rental price to that person as his or her main
home,
Anyone who pays less than a fair rental price for the unit, or
Anyone under an agreement that lets the owner use some other unit.
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Do not count as personal use:
Any day spent working substantially full time repairing and maintaining the unit, even
if family members used it for recreational purposes on that day, or
Any days the unit is used as the main home before or after renting it or offering it for
rent, if the owner rented or tried to rent it for at least 12 consecutive months (or for a
period of less than 12 consecutive months at the end of which it was sold or
exchanged).
The tax treatment of rental income and expenses for a dwelling unit that is also used for
personal purposes depends on whether it is used as a home. The dwelling unit is considered a
home for tax purposes if during the year116 it is used for personal purposes more than the
greater of:
1. 14 days …or
2. 10% of the total days, it is rented to others at a fair rental price.
If a home is rented fewer than 15 days during the year, none of the rental income or expenses is
to be included. If the home is rented more than 15 days, all the income and expense must be
reported, including depreciation. All expenses and depreciation must be allocated between
personal and rental use.
Rental Activity Treated as a Business
There are six major exceptions to an activity being treated as a rental activity under the passive
activity loss (PAL) rules. Each of the six exceptions is briefly discussed below with some
examples. These exceptions apply to rental real estate as well as any equipment leasing
activity.
An activity is not considered a rental activity for purposes of the PAL rules where the
average customer use is seven days or less117. For example, this rule might apply to
many vacation condos, vacation homes, beach cottages, bed and breakfasts, charter
boats, aircraft leases, and businesses that lease out automobiles, short-term rentals of
DVDs/videos, tools, or tuxedos. Not qualified for QBI.
An activity is not considered a rental activity where the average customer use is thirty
days or less and significant personal services118 are provided. For example, providing a
hotel or motel room with daily house cleaner service would fall within this definition.
Not qualified for QBI.
116 IRC §§280A(e)(1) , 280A(c)(5 117 Reg. Sec. 1.469-1T(e)(3)(ii)(A) 118 Reg. Sec. 1.469-1T(e)(3)(iv)
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An activity is not considered a rental activity where extraordinary personal services are
provided by or on behalf of the owner of the property in connection with making the
property available for use by customers. Services are extraordinary only if the services
provided in connection with the use of the property are performed by individuals, and
the use by customers of the property is incidental to their receipt of such services. For
example, the use by patients of a hospital's boarding facilities generally is incidental to
their receipt of the personal services provided by the hospital's medical and nursing
staff. Not qualified for QBI.
An activity is not considered a rental activity where the rental is incidental to a non-
rental activity. The rental of property during a tax year is treated as incidental to a
nonrental activity of the taxpayer if the principal purpose for holding the property
during the tax year is to realize gain from appreciation of the property. Not qualified for
QBI.
An activity is not considered a rental activity where the taxpayer customarily makes the
property available during defined business hours for nonexclusive use by customers.
For example, this rule might apply to activities involving the operation of health clubs,
spas, and golf courses. Not qualified for QBI.
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What Do You Think?
Q1 – Which of the following is not a true statement?
A. Improvements are considered an expense and deductible in the year
they are paid.
B. Improvements add to the basis of the property and are depreciated.
C. The cost of an improvement must be capitalized and can generally
be depreciated as if the improvement was separate property.
D. Repairs made within extensive remodeling or restoration of
property are included as part of the improvement and capitalized.
Q2 –Which of the following is a component of active participation in rental real estate?
A. Active participation requires regular, continuous, substantial involvement with the
property.
B. The taxpayer makes key management decisions such as the people to whom the
taxpayer rents, the rental terms, approving capital expenditures, etc.
C. An individual can show active participation if he or she arranges for others to provide
services.
D. B and C above
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What Do You Think? - Answers
A1: A - Is the correct answer Repairs are considered an expense and deductible in the year they are paid,
not improvements. Repairs are costs that keep the property in good condition,
do not add material value to property and do not substantially prolong the life
of the property.
Improvements add to the basis of the property and are depreciable. An improvement adds to
the value of property, prolongs its useful life or adapts it to new uses. The cost of an
improvement must be capitalized and can generally be depreciated as if the improvement was
separate property. Repairs made within extensive remodeling or restoration of property are
included as part of the improvement and capitalized. The cost of an improvement is
depreciated according to the MACRS class and recovery period of the underlying property
A2: D – Is the correct answer
The taxpayer actively participates in the rental activity if they make key management decisions
such as the people. To whom the taxpayer rents, the rental terms, approving capital
expenditures, etc. They also can show active participation if they arrange for others to provide
services. Active participation does not require regular, continuous, substantial involvement
with the property. However, in order to satisfy the active participation test, the taxpayer and
spouse must own at least 10% of the rental property. Ownership as a limited partner does not
count.
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Chapter 5 –Depreciation and Cost Basis
Bonus Depreciation for Qualified Improvement
Property The special depreciation allowance (bonus depreciation119) allows taxpayers to write-off 100%
of the cost of qualified property acquired and placed in service during the year, rather than
write-off the cost through depreciation over the MACRS recovery period of the property.
Qualified property includes both new and used property. Bonus deprecation is the default
method in the year placed in service. An election is required to opt out of bonus depreciation.
TCJA. Prior to the Tax Cuts and Jobs Act (TCJA), qualified improvement property was
classified as a specified type of property eligible for bonus depreciation. Qualified
improvement property is defined as any improvement to an interior portion of a building that is
non-residential real property if such improvement is placed in service after the date such
building is first placed in service. Qualified improvement property does not include any
improvement for which the expenditure is attributable to the enlargement of the building, an
elevator or escalator, or the internal structural framework of the building. One of the
requirements to claim bonus depreciation is that qualified property must be tangible property
depreciated under MACRS with a recovery period of 20 years or less.
Although Congress intended to treat qualified improvement property as eligible for bonus
depreciation. TCJA eliminated qualified improvement property120 placed in service after
December 31, 2017 as a specified category of qualified property, and amended IRC section
168(e) to eliminate the 15-year MACRS property classification for qualified leasehold
improvement property, qualified restaurant property, and qualified retail improvement
property. Although the Conference Report for TCJA indicated that Congress intended qualified
improvement property to have a 15-year recovery period, the amended version of IRC section
168(e) made by TCJA does not classify it as having a recovery period of 20 years or less.
Thus, a legislative change had to be enacted to provide for a recovery period of 20 years or less
for qualified improvement property placed in service after 2017. Regulations issued by the IRS
after TCJA clarified that qualified leasehold improvement property, qualified restaurant
property that is qualified improvement property, and qualified retail improvement property
acquired by the taxpayer before January 1, 2018 is classified as 15- year MACRS property,
eligible for bonus depreciation. Such property placed in service after 2017 is 39-year MACRS
property, not eligible for bonus depreciation.
119 IRC §168 120§13204 of TCJA
Objective: TCJA and CARES Act Depreciation
Changes
1. Explain qualifying property
2. New rules for Bonus Depreciation
3. §179 TCJA changes
4. Explanation of Original Use requirement
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CARES Act. The Coronavirus Aid, Relief, and Economic Security Act amended the code121to
provide that qualified improvement property is classified as 15-year property under MACRS.
The CARES Act also amended the definition of qualified improvement property by providing
that the improvement must be made by the taxpayer. The CARES Act also states qualified
improvement property has a class life of 20 years for purposes of the alternative depreciation
system. These amendments are effective as if included in TCJA. As a result, qualified
improvement property placed in service by the taxpayer after December 31, 2017 is 15-year
property and thus eligible for bonus depreciation.
Revenue Procedure 2020-25. The IRS has issued guidance allowing a taxpayer to change its
depreciation method for qualified improvement property placed in service after December 31,
2017 for tax years ending in 2018, 2019, or 2020. The revenue procedure also allows a
taxpayer to make a late election, or to revoke or withdraw one or more of the following
elections for 2018, 2019, or 2020:
• The election to use the alternative depreciation system [IRC §168(g)(7)],
• The special election to use bonus depreciation for certain plants bearing fruits and nuts [IRC
§168(k)(5)],
• The election not to use bonus depreciation for qualified property [IRC §168(k)(7)], or
• The election to use 50% bonus depreciation instead of 100% bonus depreciation for the first
tax year ending after September 27, 2017122.
Election not to use bonus depreciation. IRC section 168(k)(7) allows a taxpayer to make an
election not to deduct bonus depreciation for any class of property that is qualified property
placed in service during the tax year. The election must be made by the due date, including
extensions, of the tax return for the tax year in which the qualified property is placed in service.
The election is made by attaching a statement to the return indicating the class of property for
which the taxpayer is not claiming any bonus depreciation. If the election is not made on the
original return, an election can be made on an amended return if filed within six months of the
due date of the original return, excluding extensions. Once made, the election cannot be
revoked without IRS consent.
Qualified improvement property is included in the 15-year property class and is not a separate
class of property. However, qualified improvement property acquired after September 27, 2017
and placed in service before January 1, 2018 is a separate class of property. In light of the
CARES Act retroactively treating qualified improvement property as 15- year property,
Revenue Procedure 2020-25 provides the following special rules:
121 IRC§168(e) 122 IRC §168(k)(10)
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If a taxpayer
(a) Placed in service depreciable property during its 2018, 2019, or 2020 tax year,
(b)Timely filed its federal income tax return or partnership return for the year the
property was placed in service, and such return was filed on or before April 17, 2020,
(c)Wants to make the election to not claim bonus depreciation for qualified
improvement property, and
(d) Did not previously revoke or withdraw the election, then the taxpayer may make the
election:
1) By following the normal procedure for making the election on a timely filed
tax return for the year the property is placed in service as described above, or
2) By filing an amended income tax return or partnership return by October 15,
2021 for the year the property is placed in service, but no later than the
applicable statute of limitations for the tax year for which the amended return is
being filed (See Revenue Procedure 2020-23 regarding filing an amended return
for partnerships subject to the centralized partnership audit regime), or
3) By filing Form 3115 with the taxpayer’s timely filed original federal income
tax return or partnership return:
a) For the taxpayer’s first or second tax year succeeding the tax year in
which the taxpayer placed in service the property, or
b) That is filed on or after April 17, 2020 and on or before October 15,
2021.
The option to file Form 3115 is considered a change from an impermissible method of
depreciation to a permissible method of depreciation and thus is treated as a change in method
of accounting with an IRC section 481(a) adjustment required for the year of change. Amended
return or Form 3115. If a taxpayer placed in service qualified improvement property after
December 31, 2017 and began depreciating the property as 39-year property under MACRS,
the CARES Act now makes that depreciation method an improper method of depreciation.
To correct this situation, Revenue Procedure 2020-25 permits the taxpayer to:
• File an amended return for the year(s) the qualified improvement property was placed
in service to correct the method of depreciation (even if the improper method has been
used on two or more consecutive returns),
• File an administrative adjustment request (AAR) under IRC section 6227 (for certain
partnerships subject to the centralized partnership audit regime), or
• File Form 3115, Application for Change in Accounting Method, to change to a
permissible depreciation method. If the taxpayer chooses to file an amended return or
AAR, it must include the adjustment to taxable income for the change in determining
depreciation of the qualified improvement property and any collateral adjustments to
taxable income or to tax liability.
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This revenue procedure also provides rules for taxpayers who want to:
• Elect to use the alternative depreciation system under IRC section 168(g)(7) for
qualified improvement property,
• Elect to use bonus depreciation for certain plants bearing fruits and nuts under IRC
section 168(k)(5), or revoke a previously made election to use bonus depreciation for
such plants,
• Elect to use 50% bonus depreciation instead of 100% bonus depreciation for the first
tax year ending after September 27, 2017 under IRC section 168(k)(10), or revoke a
previously made election to use 50% bonus depreciation instead of 100% bonus
depreciation for such property, or
• Revoke a previously made election to not use bonus depreciation for a class of
property.
Adjustments also must be made on original or amended returns or AARs for any affected
succeeding tax year. If the taxpayer chooses to file Form 3115, the taxpayer corrects the prior
year improper method of depreciation on the next tax return that is filed. Since 15-year
depreciation or bonus depreciation produces a greater deduction than 39-year depreciation,
prior year depreciation claimed is less than the correct amount. This is referred to as a
“negative IRC section 481 adjustment,” and results in a decrease in taxable income for the tax
year of change.
Report the entire negative IRC Section 481 adjustment as “Other Expenses” on the business
return for the year of change. One-year qualified improvement property. Under normal
procedures, if the improper depreciation method was claimed for only one year, the taxpayer
has not yet adopted a method of accounting and, therefore, corrects the error on an amended
return.
Revenue Procedure 2020-25 provides a special rule for one-year qualified improvement
property that was placed in service by the taxpayer in the tax year immediately preceding the
year of change. Under this special rule, the taxpayer has the option to either file an amended
return, or make the change following the Form 3115 procedures.
TCJA Expansion of Bonus Depreciation
The TCJA significantly expands bonus depreciation: For qualified property placed in service
between September 28, 2017, and December 31, 2022 (or by December 31, 2023, for certain
property with longer production periods), the first-year bonus depreciation percentage
increases to 100%.
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Expands the definition of qualified property to include qualified film, television, and live
theatrical productions for which a deduction otherwise would have been allowable.123
The provision extends and modifies the additional first-year depreciation deduction through 2026
(through 2027 for longer production period property and certain aircraft). The 50-percent
allowance is increased to 100 percent for property placed in service after September 27, 2017, and
before January 1, 2023, (January 1, 2024, for longer production period property and certain
aircraft), as well as for specified plants planted or grafted after September 27, 2017, and before
January 1, 2023. Thus, the provision repeals the phase-down of the 50-percent allowance for
property placed in service after December 31, 2017, and for specified plants planted or grafted after
such date. The 100-percent allowance is phased down by 20 percent per calendar year for property
placed in service, and specified plants planted or grafted, in taxable years beginning after 2022
(after 2023 for longer production period property and certain aircraft). Under the provision, the
bonus depreciation percentage rates are as follows:
The 100-percent allowance is phased down by 20 percent per calendar
year for property placed in service, and specified plants planted or
grafted, in taxable years beginning after 2022. Under the provision, the
bonus depreciation percentage rates are as follows:
Bonus Depreciation
Percentage
Placed in Service Year Qualified Property in General Certain Aircraft
2023 80 percent 100 percent
2024 60 percent 80 percent
2025 40 percent 60 percent
2026 20 percent 40 percent
2027 None 20 percent
For purposes of the bonus depreciation allowance that applies to qualified property acquired
and placed in service after September 27, 2017, the term “qualified property,” means property
that:
a. Is MACRS property that has a recovery period124, regardless of any election
made by the taxpayer under the alternative depreciation system, of 20 years or
less;
b. Is computer software for which a deduction is allowable under 125without regard
to the bonus depreciation rules;
c. Is water utility property;
d. Is a qualified film or television production for which a deduction would have
been allowable or is qualified live theatrical production for which a deduction
would have been allowable under IRC §181;
e. Meets either an original use requirement or acquisition requirement (see below);
and was placed in service by the taxpayer before January 1, 2027 (January 1,
2028, for certain longer life property).
123 IRC §181 124 IRC §168 (c) 125 IRC §167 (a)
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Listed Property
Special rules apply to the depreciation of listed property, which includes cars and other
property used for transportation, property used for entertainment, and certain computers and
cellular phones.
If a taxpayer owns listed property that is not used more than 50 percent in a qualified business
for the tax year, the taxpayer must determine the MACRS depreciation deduction for the
business use of that listed property by using the alternative depreciation system (ADS) rather
than the normal MACRS accelerated depreciation rules.126
Original Use Requirement for Bonus Depreciation and IRC §179
Under the original use requirement, the original use of the property has to begin with the
taxpayer. Under the acquisition requirement, property qualifies for bonus depreciation if the
property was not used by the taxpayer at any time before the acquisition, and the acquisition of
the property meets the requirements of IRC §§ 179(d)(2)(A), 179(d)(2)(B), 179(d)(2)(C), and
179(d)(3). Therefore, for property placed in service after September 27, 2017, bonus
depreciation is allowed for new and used property.
To prevent abuses, the additional first-year depreciation deduction applies only to property
purchased in an arm’s-length transaction. It does not apply to property received as a gift or from
inheritance. In the case of trade-ins, like-kind exchanges, or involuntary conversions, it applies only
to any money paid in addition to the traded-in property or in excess of the adjusted basis of the
replaced property.
IRC §179
Eligible Property
Expands the definition of
Section 179 property to include certain depreciable tangible personal property used
predominantly to furnish lodging or in connection with furnishing lodging; and
Qualified real property to include any of the following improvements to nonresidential
real property placed in service after the date the property was first placed in service:
o Roofs;
o Heating,
o Ventilation and air-conditioning property;
o Fire protection and alarm systems; and
o Security systems.
126 IRC §280F(b)
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To qualify for the IRC §179 deduction, property must be one of the following types of
depreciable property:
(1) Tangible personal property to which the modified accelerated cost recovery system
(MACRS) rules under IRC §168 apply;
(2) Other tangible property described in IRC §1245(a) (3) (except buildings and their
structural components) used as:
(a) An integral part of manufacturing, production, or extraction or of furnishing
transportation, communications, electricity, gas, water, or sewage disposal
services;
(b) A research facility used in connection with any of the activities; or
(c) A facility used in connection with any of the activities in (a) for the bulk
storage of fungible commodities;
(3) A single-purpose agricultural (livestock) or horticultural structure;
(4) A storage facility (except buildings and their structural components) used in
connection with distributing petroleum or any primary product of petroleum;
(5) Off-the-shelf computer software placed in service in a tax year beginning after
2002, and meet the following criteria
o The software must be subject to a non-exclusive license
o The software must not have been substantially modified.
(6) Qualified real property placed in service in any tax year beginning after 2009.
In order to be eligible for the IRC §179 deduction, the property must have been acquired by
purchase127 for use in the active conduct of a trade or business. IRC §179 property can be
either new or used.
Taxpayers would be able to fully and immediately expense 100 percent of the cost of qualified
property acquired and placed in service after September 27, 2017 and before January 1, 2023
(with an additional year for certain qualified property with a longer production period). Under
the provision, qualified property would not include any property used by a regulated public
utility company or any property used in a real property trade or business
Tangible Personal Property Tangible personal property is any tangible property that is not real property, including
machinery and equipment; property contained in or attached to a building (other than structural
components). Refrigerators, grocery store counters, office equipment, printing presses, testing
equipment, and signs; gasoline storage tanks and pumps at retail service stations; and livestock,
including horses, cattle, hogs, sheep, goats, and mink and other furbearing animals are
examples of tangible personal property.
127 IRC §179(d)(1)(C)
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The treatment of property as tangible personal property for IRC §179 deduction is not
controlled by its treatment under local law. For example, property may not be tangible personal
property for the deduction even if treated so under local law, and some property (such as
fixtures) may be tangible personal property for the deduction even if treated as real property
under local law.
IRC §179 was amended in 1981 and the definition of qualifying property was substantially
changed. The definition now includes (in part) any property of a character subject to the
allowance for depreciation that is used as an integral part of manufacturing, production, or
extraction.
TCJA also requires a real property trade or business electing out of the limitation on the
deduction for interest to use ADS to depreciate any of its nonresidential real property,
residential rental property, and qualified improvement property.
Section 179 at a Glance for 2020
2020 Deduction Limit = $1,040,000. This deduction is good on new and used equipment, as
well as off-the-shelf software. To take the deduction for tax year 2020, the equipment must be
financed or purchased and put into service between January 1, 2020 and the end of the day on
December 31, 2020.
2020 Spending Cap on equipment purchases = $2,590,000. This is the maximum amount that
can be spent on equipment before the Section 179. Deduction available to his or her company
begins to be reduced on a dollar for dollar basis. This spending cap makes Section 179 a true
“small business tax incentive” (because larger businesses that spend more than $3,630,000 on
equipment will not get the deduction.)
Bonus Depreciation: 100% for 2020. Bonus Depreciation is generally taken after the Section
179 Spending Cap is reached. The Bonus Depreciation is available for both new and used
equipment. In 2019 maximum amount a taxpayer may expense under IRC §179 for 2019 to
$1,020,000, and or increases the phase-out threshold amount to $2,550,000.
Note: Bonus depreciation has no limit and is allowed in the first year, only.
Property that is predominantly used to furnish lodging or in connection with furnishing lodging
now qualifies for §179 expensing. This means that if a taxpayer purchases §1245 property
(furniture for an apartment complex, hotel, motel or dormitory) he or she can now expense
these items instead of depreciating.
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Luxury Autos
A taxpayer who uses his personal car (or other vehicle) for business purposes, can deduct his or
her actual car expenses or use the business standard mileage rate to figure the amount of his
deduction as long as the deduction is not being taken as an itemized unreimbursed employee
business expense deduction in 2018 – 2025128(TCJA eliminated employee business expenses).
If a taxpayer wants to use the business standard mileage rate, he or she must use that method in
the first year the car is available for business use and, after that, he or she can choose to use
either the standard mileage rate or actual expenses on a year-by-year basis. A taxpayer who
uses the business standard mileage rate method must figure his deduction by multiplying the
business standard mileage rate by the number of business miles the car was driven during the
year.
Beginning on Jan. 1, 2019 the standard mileage rates for the use of a car, van, pickup or panel
truck will be:
58 cents per mile for business miles driven, up from 54.5 cents in 2018.
14 cents per mile driven for in service for charitable organizations
20 cents per mile driven for medical and moving expenses, up from 18 cents in 2018
(Moving expenses as an adjustment to income are repealed by TCJA, moving expenses
related to a trade or business is allowed as a deduction.)
Beginning on Jan. 1, 2020 the standard mileage rates for the use of a car, van, pickup or panel
truck will be:
57.5 cents per mile for business miles driven, down from 58 cents in 2019.
14 cents per mile driven for in service for charitable organizations
17 cents per mile driven for medical and moving expenses, down from 20 cents in 2018
(Moving expenses as an adjustment to income are repealed by TCJA, moving expenses
related to a trade or business is allowed as a deduction.)
The standard mileage rate for business is based on an annual study of the fixed and variable
costs of operating an automobile, including depreciation, insurance, repairs, tires, maintenance,
gas and oil.
128 IRC §162(a)(2), 67(g)
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There is also a special rule that applies to luxury automobiles. The depreciation deductions
allowable for such automobiles are limited to a maximum dollar amount each tax year.129 This
is known as the luxury automobile limitation. The bonus depreciation deduction available for
automobiles is limited by the luxury automobile limitations. The Tax Cuts and Jobs Act of
2017 (TCJA) increased the depreciation limitations that apply to listed property. For passenger
automobiles placed in service after December 31, 2017, for which the additional first-year
depreciation deduction130is not claimed, the maximum amount of allowable depreciation is
$10,000 for the year in which the vehicle is placed in service, The allowable depreciation is
$16,000 for the second year, $9,600 for the third year, and $5,760 for the fourth and later years
in the recovery period. The limitations are indexed for inflation for passenger automobiles
placed in service after 2018.
The limitation for SUVs has also increased as part of TCJA. It will be adjusted for inflation
after 2018. For vehicles purchased in 2018, the limitation is still $25,000.
The Tax Cuts and Jobs Act changed depreciation limits for passenger vehicles placed in
service after Dec. 31, 2017. If the taxpayer does not claim bonus depreciation, the greatest
allowable depreciation deduction is:
$10,000 for the first year
$16,000 for the second year
$9,600 for the third year
$5,760 for each later taxable year in the recovery period
If a taxpayer claims 100 percent bonus depreciation, the greatest allowable depreciation
deduction is:
$18,000 for the first year
$16,000 for the second year
$9,600 for the third year
$5,760 for each later taxable year in the recovery period
Strict substantiation rules also apply for listed property. No deduction is allowed for any listed
property unless the taxpayer substantiates each element of the expenditure or use as
specifically provided in the regulations.131
These caps are adjusted annually for inflation effective for vehicles placed in service after
2018.132 The $8,000 bump-up to the first-year cap if bonus depreciation is claimed is not
adjusted for inflation.
129 IRC §280F(a) 130 IRC §168(k) 131 IRC §274(d)(4) 132 IRC §280F(d)
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In the case of a vehicle, a mileage log is essential. The mileage log should be kept; there are
many types of mileage logs including paper logbooks, phone applications, printouts from map
programs etc. Whichever type of log that is used should include the time, and business
purpose. Many apps can be used to track and store the mileage.
Larger Vehicles
As noted above, the TCJA increased bonus depreciation to 100 percent for qualifying property
acquired and placed into service after September 27, 2017, and before January 1, 2023. It also
extended bonus depreciation to used property acquired and placed into service after September
27, 2017.
SUVs with a gross vehicle weight rating above 6,000 lbs. are not subject to depreciation limits.
They are, however, limited to a $25,000133 IRC §179 deduction. No depreciation or §179 limits
apply to SUVs with a GVW more than 14,000 lbs. Trucks and vans with a GVW rating above
6,000 lbs. but not more than 14,000 lbs. generally have the same limits: no depreciation
limitation, but a $25,000 IRC §179 deduction. These vehicles, however, are not subject to the
§179 $25,000 limit if any of the following exceptions apply:
The vehicle is designed to have a seating capacity of more than nine persons behind the
driver’s seat;
The vehicle is equipped with a cargo area at least 6 feet in interior length that is an open
area or is designed for use as an open area but is enclosed by a cap and is not readily
accessible directly from the passenger compartment; or
The vehicle has an integral enclosure, fully enclosing the driver compartment and load-
carrying device, does not have seating behind the driver’s seat, and has no body section
protruding more than 30 inches ahead of the leading edge of the windshield.
Although SUVs purchased after September 27, 2017, remain subject to the $25,000 IRC § 179
limit, they are eligible for 100% bonus depreciation if they are above 6,000 lbs. This is true for
both new and used vehicles. For a taxpayers’ first taxable year ending after Sept. 27, 2017,
taxpayers may elect to apply a 50 percent allowance instead of the 100 percent allowance. To
make the election, they must attach a statement to a timely filed return (including extensions)
indicating they are electing to claim a 50% special depreciation allowance for all qualified
property. Once made, the election cannot be revoked without IRS consent. As noted above,
taxpayers may also elect out of bonus entirely for any class of property by filing an election on
a timely filed return. Once filed, that election can also not be revoked without IRS consent
Taxpayers can only take these deductions to the extent of qualified business use. If the business
use is 50 percent or less, the taxpayer is not eligible for IRC §179 or additional first-year
depreciation. Straight line depreciation over a 5-year life must be used for the portion allocable
to business use. All calculations in this article assume 100 percent business use.
133 IRC §179(b)(5)(A
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What Do You Think?
Q1. Jack purchased a small pickup on July 1, 2017. He started using the pickup for
his business in January 2019. He uses this pickup only for business, he purchase
another vehicle for personal use. What is the maximum amount of depreciation
allowed for tax year 2019?
A. $18,000
B. $16,000
C. $16,400
D. $10,000
Q2. Betty purchased a duplex as a rental in 2015. On Oct 1, 2019 she purchased a new heating
and air conditioning unit for Apt 1 for $6,500 she installed the units on January 15, 2020. She
purchased and installed new flooring in Apt. 2 for $4,500 on Feb 10, 2019. On Jan 20, 2019,
Betty purchased a computer for $1,250, she kept track of her use of the computer and uses it
70% for business. How much is Betty allowed to deduct under IRC §179 on her 2019 tax
return.
A. $11,000
B. $12,250
C. $11,875
D. $ 5,375
Q3. James acquired and placed into service an SUV in February of 2018 (bought for $45,000)
as his primary farming vehicle. He is able to document 100 percent business use through travel
logs. The SUV has a GVW of 8,000 lbs.
Which of the following is not correct?
A. James could expense $25,000 under IRC § 179 and then apply 50 percent bonus
depreciation ($20,000).
B. James is able to depreciate the entire amount in 2018 using 100 percent bonus
depreciation.
C. James is able to expense the entire amount using IRC §179.
D. None of the above
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What Do You Think? – Answers
A1: D – Is the correct answer
Jack purchased a small pickup on July 1, 2017. He started using the pickup for his business in
January 2019. He uses this pickup only for business, he purchase another vehicle for personal
use. What is the maximum amount of depreciation allowed for tax year 2019?
A. $18,000 – is the correct answer (See below)
B. $16,000
C. $16,400
D. $10,000
Depreciation Limits for Passenger Automobiles, Trucks, and Vans Acquired after September
28, 2017, and Placed in Service during Calendar Year 2018 for which the §168(k) Additional
First Year Depreciation Deduction Applies:
Tax Year Amount
1st Tax Year $18,000
2nd Tax Year 16,000
3rd Tax Year 9,600
Each Succeeding Year 5,760
A2. Betty purchased a duplex in 2015. On Oct 1, 2019 she purchased a new heating and air
conditioning unit for Apt 1 for $6,500 she installed the units on January 15, 2020. She
purchased and installed new flooring in Apt. 2 for $4,500 on Feb 10, 2018. On Jan 20, 2019,
Betty purchased a computer for $1,250, she kept track of her use of the computer and uses it
70% for business. How much is Betty allowed to deduct under IRC §179 on her 2019 tax
return. C is the correct answer.
A. $11,000
B. $12,250
C. $11,875 is the correct answer. $6500+$4500+875 100% of the heating unit + 100%
of the flooring +70% of the computer.
D. $ 5,375
A3. James acquired and placed into service an SUV in February of 2018 (bought for $45,000)
as his primary farming vehicle. He is able to document 100 percent business use through travel
logs. The SUV has a GVW of 8,000 lbs.
Which of the following is not correct? A is the correct answer
A. James could expense $25,000 under IRC § 179 and then apply 50 percent bonus
depreciation ($20,000). This answer is incorrect; if the SUV had been placed in service
in 2017 this would be correct.
B. James is able to depreciate the entire amount in 2018 using 100 percent bonus
depreciation.
C. James is able to expense the entire amount using IRC §179.
D. None of the above
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Cost Basis
Cost basis is the amount invested in the property for tax purposes. Basis is generally the cost of
the property if acquired by purchase. Cost includes cash and debt obligations paid for the
property as well as the FMV of other property or services the taxpayer provides in obtaining
property.
The cost basis of an asset includes amounts paid for the following items:
• Sales tax charged on the purchase.
• Freight charges to obtain the property.
• Installation and testing charges.
• Excise taxes.
• Legal fees incurred to obtain the property.
• Recording fees and revenue stamps.
• Commissions.
Real Property Real property is land and generally anything built on, growing on, or attached to the land. If
acquiring property for a lump sum and the property consists of land and buildings, allocate the
cost basis according to the respective FMVs of the land and buildings at the time of purchase.
Fair market value is the price at which the property would change hands between a willing
buyer and a willing seller, neither under compulsion to buy or to sell, and both having
reasonable knowledge of all the necessary facts.
Certain settlement expenses paid on the purchase of real property are included in basis.
Allocate these fees between land and buildings.
• Settlement costs added to basis include:
• Abstract fees.
• Charges for installing utility service.
• Legal fees.
• Recording fees.
• Surveys.
• Transfer taxes.
• Owner’s title insurance.
• Any amount the seller owes that the buyer assumes, such as real estate taxes.
Settlement costs do not include amounts placed in escrow for the future payment of expenses,
nor do they include fees and costs of getting a loan, casualty insurance premiums, rent for
occupancy of property before closing, or charges for utilities and other services related to
occupancy of the property before closing.
If a buyer assumes an existing mortgage, basis includes the amount paid for the purchase plus
the amount of the mortgage assumed.
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Points paid to get a mortgage do not add to the basis of the property. Deduct points over the
term of the loan unless the taxpayer meets the criteria to claim the points in full.
Constructed Property
The basis of constructed assets includes expenses of construction, such as:
• The cost of land.
• The cost of labor and materials.
• Architect’s fees.
• Building permit charges.
• Payments to contractors.
• Payments for rental equipment.
• Inspection fees.
Add demolition costs and other losses incurred for the demolition of any building to the cost of
the land on which the building was located. This includes the adjusted basis of the building
demolished. Allocate the cost of a tract of land purchased and subdivided to each of the lots in
the subdivision.
Intangible Asset
Intangible assets include goodwill, patents, copyrights, trademarks, trade names, and franchises.
The basis of an intangible asset is usually the cost to buy or create the asset. If created, the basis
does not include the time invested by the creator, author, or inventor.
Purchase of a Trade or Business
Purchasing a group of assets that constitutes a trade or business requires an allocation of the
separate assets purchased. If the buyer and seller enter into a written agreement that has an
allocation of the purchase price, this agreement is binding on both parties unless the IRS
determines the allocation is inappropriate. Both the buyer and the seller must complete Form
8594, Asset Acquisition Statement.
If no allocation was made in the written agreement, or the IRS determines the allocation is
inappropriate, the residual method allocates the purchase price to the various assets in
proportion to, but not more than, their FMV in the following order:
• Class I: Cash and general deposit accounts, other than certificates of deposit held in
banks, savings and loan associations and other depository institutions.
• Class II: Actively traded personal property, including certificates of deposit, foreign
currency, U.S. government securities and publicly traded stock.
• Class III: Assets the taxpayer marks-to-market, including accounts receivable.
• Class IV: Stock in trade, or other property of a kind that would properly be included in
the inventory of the taxpayer if on hand at the close of the taxable year, or property held
primarily for sale to customers in the ordinary course of a trade or business.
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• Class V: All assets other than Classes I, II, III, IV, VI, and VII. Furniture, fixtures,
buildings, land, vehicles, and equipment, which constitute all or part of a trade or
business, are generally in this class.
• Class VI: All §197 intangibles except goodwill and going concern value.
• Class VII: Goodwill and going concern value.
Adjusted Basis Before determining gain or loss, adjust the basis for certain items.
Increase the basis of property by:
• Capital improvements (having a useful life of more than one year).
• Assessments for local improvements.
• Rehabilitation expenses reduced by any rehabilitation credit taken.
• Expenditures to restore property that suffered a casualty loss.
• Certain legal fees, such as the cost of defending or perfecting title.
• Zoning costs.
Decrease the basis of property by various deductions, credits, or tax benefits allowed against
the property. Some examples include:
• Energy conservation subsidies.
• Casualty and theft losses.
• Certain credits allowed on the property, such as credits for employer provided childcare
and qualified electric vehicles.
• Deferred gain.
• Section 179 expense.
• Certain canceled debt excluded from income.
• Rebates received from the manufacturer or seller.
• Depreciation, amortization, and depletion.
• Various nontaxable distributions, such as nontaxable corporate distributions or amounts
received for granting an easement (sale of an interest in real property).
• •
• •
•
• •
• •
•
• •
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Basis Other Than Cost
Property Received for Services
The FMV of property received for services is included in income and then becomes the basis in
that property.
Restricted Property
If the property is restricted property, the basis is the property’s FMV when vesting occurs. The
taxpayer can make an election to include the FMV as income at the time of the transfer as
opposed to the time of vesting.
Property is substantially vested when it is transferable or when it is not subject to a substantial
risk of forfeiture.
Bargain Purchases
A bargain purchase is a purchase of an item for less than FMV. If the bargain purchase was
compensation for services, the difference between the purchase price and the FMV is included
in income. The FMV becomes the basis because that bargain element is included in income,
unless an exception applies (incentive stock options and qualified employee discounts).
Involuntary Conversions
Property received in an involuntary conversion, if similar or related in service or use to the
property involuntarily converted, generally has a basis equal to the old property’s basis on the
date of conversion, with the following adjustments:
Decreased by any loss recognized on the exchange or any money received that was
not spent on similar property.
Increased by any gain recognized on the exchange or any cost of acquiring
replacement property.
Like-kind Exchange Property received in a taxable exchange has a basis equal to the FMV of the property at the time
of the exchange.
Property received in a nontaxable like-kind exchange generally has the same basis as the
old property given up. If the taxpayer paid additional money to get the new property,
increase the basis by the additional money paid.
The basis of unlike property received is its FMV on the date of the exchange because the
receipt of unlike property is taxable.
Property received in a partially nontaxable exchange generally has the same basis as the
old property exchanged with the following adjustments:
o Decreased by any money received or any loss recognized on the exchange.
o Increased by any additional costs incurred or any gain recognized on the
exchange.
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Property Settlement A property settlement between divorcing or divorced couples is not a taxable event. The basis
of property in a spousal transfer is the transferor spouse’s adjusted basis. This also applies to a
transfer by a former spouse, incident to a divorce.
Gift The basis of property received as a gift depends on the donor’s adjusted basis, the FMV at the
time of the gift, and any gift tax paid.
If the FMV is less than the donor’s adjusted basis, the basis differs for figuring gain or loss.
Use the donor’s adjusted basis, increased or decreased by appropriate adjustments
during ownership, as the basis for determining depreciation or gain on disposition.
Use the FMV on the date of the gift, increased or decreased by appropriate adjustments
during ownership, as the basis for determining loss on a disposition.
A disposition could result in no gain or loss if sold for an amount between FMV and the
adjusted basis.
If the FMV is equal to or more than the donor’s adjusted basis, the recipient basis is the
donor’s adjusted basis increased by the part of the gift tax due to the net increase in the
value of the gift.
If received before 1977, increase the basis by all the gift tax paid; however, the increase
cannot exceed the FMV at the time of the gift.
If received after 1976, increase the basis by the part of the gift tax paid that is due to the
net increase in value of the gift. Determine the gift tax for a net increase in value by
multiplying the gift tax by a fraction. The numerator is the net increase in value of the
gift and the denominator is the amount of the gift. The amount of the gift is the value of
the gift reduced by any annual exclusion, or any marital or charitable deduction that is
applicable.
Inheritance
The basis of inherited property is one of the following amounts:
The FMV of the property at the date of the individual’s death.
The FMV on the alternate valuation date if the personal representative for the estate
chooses to use alternate valuation.
The value under the special-use valuation method for real property used in farming,
qualified woodlands, or closely held businesses, if chosen for estate tax purposes.
The decedent’s adjusted basis in land to the extent of the value excluded from the
decedent’s taxable estate as a qualified conservation easement.
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Converted Property For property converted from personal to business or rental use, the basis for depreciation is the
lesser of the FMV or the adjusted basis on the date of conversion. If the taxpayer later sells or
disposes of the property, the basis to use depends on whether figuring gain or loss.
The basis for gain is the adjusted basis in the property when sold.
The basis for loss is the smaller of the adjusted basis or the FMV at the time of the
conversion plus or minus required adjustments.
Example: A taxpayer sells his house, which he had changed to rental property after using it as
his home. When converted to rental use, it had a FMV of $33,000 and an adjusted basis of
$35,000. His basis for depreciation is $33,000, the lesser of FMV or adjusted basis. He claimed
$3,000 depreciation, figured under the straight-line method, while renting.
For figuring gain, his adjusted basis at the time of the sale is $32,000 ($35,000 adjusted basis
on conversion – $3,000 depreciation). For figuring loss, his adjusted basis at the time of the
sale is $30,000 ($33,000 FMV on conversion – $3,000 depreciation). In this example, use
FMV because it was smaller than the adjusted basis at the time of changing the house to
rental use. If the sales price is between $30,000 and $32,000, the taxpayer has neither a gain
nor loss on the sale.
Basis of Stocks The basis in stocks and bonds depends on the method of acquisition (purchase, gift,
inheritance, etc.). Certain events then adjust that basis.
A nondividend distribution is a distribution not paid out of earnings and profits of a
corporation. It is nontaxable to the recipient to the extent there is stock basis and it reduces that
shareholder’s stock basis. If the taxpayer cannot identify the specific shares subject to the
nondividend distribution, reduce the basis of the earliest shares purchased first.
Delivering certificates to a broker and identifying a specific purchase date or a specific purchase
price can accomplish identification. If a broker or agent holds the stock, inform the broker
which stock to sell, and receive written confirmation.
Dividend Reinvestment
Dividend reinvestment plans invest the dividends in additional shares or fractional shares of
stock. The basis is the actual cost of the shares.
For taxable stock dividends, the basis of the new stock is the FMV on the date of distribution.
For a per-share basis of stock received as nontaxable stock dividends, divide the taxpayers’
adjusted basis of the old stock between the shares of old stock and the new stock.
If the old and new shares are identical, divide the adjusted basis by the total number of old and
new shares.
A stock right is a right to acquire a corporation’s stock.
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Stock rights that have been exercised, sold, or expire have the following treatment:
If the rights are taxable, the basis of the right is the FMV at the time of the distribution.
If the rights are nontaxable when received, the basis is zero if allowed to expire. For the
exercise or sale of a right, the basis depends on the FMV at the time of the distribution.
If the rights had a FMV of 15% or more of the FMV of the old stock, the taxpayer must
divide the adjusted basis of the stock between the stock and the rights based on the
FMV of each.
If the FMV of the rights are less than 15%, the basis is zero unless the taxpayer chooses
to divide the basis of the old stock between the old stock and the stock rights. If the
taxpayer makes this choice, attach a statement to his or her return for the year the
taxpayer received the stock rights indicating he or she chooses to divide the basis in the
stock.
If exercised, the basis of the new stock is the sum of its cost and the basis of the stock
rights exercised.
Jackie owns 100 shares of ABC Company stock, which cost $22 per share. The ABC Company
gives Jackie 10 nontaxable stock rights that would allow her to buy 10 more shares at $26 per
share. At the time the stock rights were distributed, the stock had a FMV of $30, not including
the stock rights. Each stock right has a FMV of $3. Even though the FMV of the stock rights
were less than 15% of the FMV of the stock, the taxpayer chose to divide the basis of the old
stock between the old stock and the stock rights. Figure the basis of the stock rights and the
basis of the old stock as follows.
Basis of old stock: 100 shares x $22 $2,200 .00
FMV of old stock: 100 shares x $30 $3,000 .00
FMV of rights: 10 rights x $3 $30 .00
New basis of old stock: ($3,000 ÷ $3,030) x
$2,200
$2,178 .22
Basis of rights: $2,200 .00 – $2,178 .22 $21 .78
If Jackie sold the rights, the basis for figuring gain or loss is $2.18 per right ($21 .78 ÷ 10). If
Jackie exercised the rights, the basis of the stock acquired is the price paid ($26) plus the basis
of each right exercised for a total basis of $28 .18 ($26 .00 + $2 .18). The remaining basis of
the old stock is $21 .78 per share.
Basis of Mutual Funds To determine gain or loss on the disposition of mutual fund shares, basis is determined using
cost basis or an average basis.
Cost basis is either a specific share identification method or a first-in first-out (FIFO) method.
If average basis does not apply to other shares in the same mutual fund, use cost basis.
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Use the average basis method if acquiring shares at various times and for various amounts and
the custodian or agent holds the shares. Determine average basis using the single category
method. Add the basis of all shares regardless of long-term or short-term, and then the number
of shares for an average basis divides that total.
The FIFO method is required unless electing the average method or the specific share
identification requirements are satisfied.
Basis of Bonds The premium paid to acquire a taxable bond becomes part of the basis in the bond. The
taxpayer can elect to amortize the premium and then reduce the basis by the amount of
amortized premium deducted each year.
Amortization of the premium paid for tax-exempt bonds is required even though not deducted.
Reduce the basis of the tax-exempt bond by the amortization for the year.
Bond premium is the amount by which the taxpayers’ basis in the bond right after acquisition
is more than the total of all amounts payable on the bond.
Original issue discount (OID) is a form of interest included in income as it accrues over the
term of the debt instrument. Increase basis in the debt instrument by the amount of OID
included in income.
S Corporation Stock Various transactions within an S corporation adjust the shareholder’s basis annually. A
shareholder’s basis has two components: stock basis and loan basis.
The amount of money or adjusted basis of property transferred to the corporation in exchange
for stock determines the shareholder’s beginning basis in the corporate stock:
Increase the shareholder’s basis in S corporation stock by additional contributions, the
shareholder’s share of all income items of the S corporation, including tax-exempt
income, and both separately and not separately stated income passed through to the
shareholder.
Decrease the shareholder’s basis in S corporation stock by property distributions
(including cash), nondeductible expenses, depletion, and deductible losses and
deductions reported on Schedule K-1.
If total stock basis reductions exceed the amount needed to reduce stock basis to zero, the
excess (excluding a decrease due to distributions) reduces the basis of any loans the
shareholder made to the corporation.
Increases restore a shareholder’s reduced loan basis before increasing stock basis.
Distributions that exceed stock basis are taxed as capital gains and do not reduce loan
basis.
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Basis Reference
Chart
How Acquired Basis for Gain, Loss, and Depreciation
Purchase Usually cost. Includes cash, FMV of other property and services,
sales tax, freight, testing and installation, closing costs, and
indebtedness assumed.
Nontaxable and partially
taxable exchanges
Basis of property acquired is the same as the basis of the property
given up increased by additional costs and any gain recognized,
and decreased by money or unlike property received and any loss
recognized.
Gifts If the FMV is less than the donor’s adjusted basis:
Basis for gain or depreciation is the donor’s adjusted basis
increased or decreased by adjustments to basis while the
taxpayer held the property. The basis for loss is the FMV at the
time of the gift, increased or decreased by adjustments to basis.
If the FMV is equal to or greater than the donor’s adjusted basis:
The basis for gain, loss, and depreciation is the donor’s adjusted
basis increased by all or a portion of the gift tax paid.
Conversion from
personal use to business
use
Depreciation: Lesser of adjusted basis or FMV at the date of
conversion .
Gain: Adjusted basis .
Loss or depreciation: Lesser of adjusted basis or FMV at the
date of conversion adjusted for improvements, disposals, or
depreciation allowed or allowable .
Inherited FMV at date of death or alternate valuation date if elected .
Transfer between
spouses
Carryover of basis prior to transfer . No gain or loss recognized .
Stocks and bonds Usually cost. Either first acquired, first sold (FIFO), or specific
identification.
Stock split: Divide the original basis between the old and new
stock.
Dividend reinvestment: FMV on the dividend payment date .
Reduced by nontaxable distributions .
Mutual fund shares Cost . May use average basis if bought at different times and prices, or specific identification.
Original issue discount Cost, increased by OID included in income .
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Sales and Other Dispositions
A sale is the transfer of property for money, a mortgage, note, or other promise to pay money.
A trade is the transfer of property for other property or services.
A gain is the excess of the amount realized over the adjusted basis of the property. A loss is the
excess of the adjusted basis over the amount realized.
The amount realized is the total of all money received plus the FMV of all property and
services received and minus expenses of the sale. The amount realized also includes any
liabilities assumed by the buyer and liabilities to which the property traded is subject (mortgage,
real estate taxes, etc.). The amount realized is not necessarily the same amount that is included
in income and subject to tax.
Realized gain or loss is the amount realized less the adjusted basis of the property.
The amount recognized is the amount that is included or deducted in determining gross income
for tax purposes. The amount recognized could differ from the amount realized. This may
occur in a like-kind exchange when the recognized gain is limited to the amount of boot
received.
Recognized gain or loss is the gain or loss included in determining gross income.
If the taxpayer sells or exchanges property used partly for business or rental and partly for
personal, figure the gain or loss as if selling two separate properties.
Allocate the selling price, expenses of the sale, and the basis of the property to each
portion.
Adjust the basis of the business portion by depreciation allowed or allowable.
Report the following in the same manner as a sale:
A redemption of stock generally receives sale treatment and is subject to the capital gain or loss
provisions unless the redemption is a dividend or other distribution on stock. Treat a
redemption as a sale or trade of stock if any of the following apply:
The redemption is not essentially equivalent to a dividend.
There is a substantially disproportionate redemption of stock.
There is a complete redemption of all the stock owned by a taxpayer.
The redemption is a distribution in partial liquidation of a corporation.
A redemption or retirement of bonds or notes at maturity is a reportable sale or trade.
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Treat a surrender of stock by a majority shareholder who retains control of a corporation as a
contribution to capital rather than an immediate loss deductible from taxable income. The
shareholder must reallocate the basis in the surrendered shares to the retained shares.
Treat stocks, stock rights, and bonds that become worthless during the tax year as if sold on the
last day of the year.
Treat payments received by a tenant for the cancellation of a lease as an amount realized from
the sale of property.
Treat payments received for granting the exclusive use of a copyright throughout its life in a
particular medium as received from the sale of property.
Subtract the amount received for granting an easement from the basis of the property. Any
amount received that is more than the basis attributable to that part of the property is a taxable
gain. If the taxpayer transfers a perpetual easement for consideration and does not keep any
beneficial interest in the part of the property affected by the easement, treat the transaction as a
sale of property.
The amount realized from the disposition of a life interest in property, an interest in property for
a set number of years, or an income interest in a trust is a recognized gain under certain
circumstances:
If the taxpayer received the interest as a gift, inheritance, or a transfer incident to
divorce, disregard the basis and the amount realized is a recognized gain.
This rule does not apply if all the interests in the property are disposed of at the same
time.
For property converted from personal use to rental or business use, and used for business or
rental at the time of the sale, a loss on the sale is deductible.
If the adjusted basis of the property was more than the FMV at the time of the conversion to
business use, the loss is limited. The deductible loss is determined as follows:
Lesser of the property’s adjusted basis or FMV at the time of
conversion.
+ Cost of improvements and other increases to basis since the change.
– Depreciation and other decreases to basis.
– Amount realized on the sale.
= The result is the deductible loss. If the amount realized is more, treat
the result as zero.
Gain is determined by subtracting the adjusted basis from the amount realized. If the property
was the taxpayers’ main home prior to the conversion and still within the two-out-of-five-year
use period, exclude part of the gain.
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The abandonment of property is a disposition of property. Deduct a loss on abandonment of
business or investment property as an ordinary loss. The adjusted basis at the time of
abandonment is the loss in the year of abandonment. Gain or loss can result from a foreclosure
or repossession on a later date.
Treat a foreclosure or repossession as a sale or exchange from which the borrower realizes a
gain or loss. Report the transaction the same as other sales with the gain or loss being the
difference between the adjusted basis in the property and the amount realized. This reportable
event is separate from the cancellation of debt that may result if there is any loan balance
remaining after the foreclosure or repossession.
Involuntary Conversion
An involuntary conversion occurs when the individual’s property is destroyed, stolen,
condemned, or disposed of under a threat of condemnation and the taxpayer receives other
property or money in payment, such as insurance or a condemnation award. Report gain or
loss from an involuntary conversion on the tax return for the year realized. Depending on the
type of involuntary conversion and the replacement property, gain is eligible for deferral.
Condemnation is the legal taking, without the owner’s consent, of private property for public
use by a federal, state, or local government or political subdivision for a reasonable amount of
money or property.
A condemnation award is money the taxpayer is paid or the value of other property received
for the condemned property. This includes the amount paid for the sale of property under threat
of condemnation.
Severance damages are not part of a condemnation award. Severance damages result if there is
a decrease in the value of the portion of the property retained when the other part of the
property was condemned. Severance damages reduce the basis of the remaining property.
Taxable gain results if the severance damages are more than the basis of the remaining part.
The taxpayer can choose to postpone gain on an involuntary conversion.
Gain results if the award, less expenses of obtaining it, is more than the adjusted basis in the
property. If not replaced within a specific period or the taxpayer receives dissimilar property or
cash, the gain is taxable. To postpone the entire gain, the cost of the replacement property must
be equal to or more than the reimbursement for the property. A taxpayer may choose to
postpone recognizing the gain if either of the following provisions apply:
The taxpayer purchases property similar or related in service or use to the condemned
property.
The taxpayer purchases a controlling interest (at least 80%) in a corporation that owns
similar property.
A loss results when money or other property received is less than the adjusted basis in the
property.
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The replacement period for a condemnation or threat of condemnation begins on the earlier of
the date the condemned property was disposed of or the date on which threat of condemnation
began. For property damaged, destroyed, or stolen in a casualty or theft, the replacement period
begins on the date of the casualty or theft.
The replacement period ends two years after the close of the first tax year of realizing any part
of the gain from the condemnation, casualty, or theft. The replacement period ends three years
after the end of the first tax year of realizing any part of the gain from a condemnation of real
property held for business or investment. For a main home located in a federally designated
disaster area, the replacement period is four years.
Like-Kind Exchange
The IRS has provided relief to taxpayers having difficulty completing like-kind exchanges due
to the COVID-19 pandemic. Under IRS Notice 2020-23, like-kind exchange deadlines that
would otherwise fall between April 1 and July 14 are extended to July 15
TCJA retains Section 1031 for real estate exchanges. However, Section 1031 may no longer be
utilized to defer taxes for transactions involving personal property. Real estate exchanges are
subject to the same rules and regulations as under previous law. The 45-day identification and
180-day exchange periods remain unchanged, as does the role of the Qualified Intermediary.
All real estate in the United States, improved or unimproved, also remains like-kind to all other
domestic real estate. Foreign real estate continues to be not like-kind to real estate in the U.S.
Personal property assets that can no longer be exchanged include intangibles, such as
broadband spectrums, fast-food restaurant franchise licenses and patents; aircraft, vehicles,
machinery and equipment, railcars, boats, livestock, artwork and collectibles.
The exchange of property for the same kind of property is the most common type of
nontaxable exchange.
To be a like-kind exchange134, the property traded and the property received must be qualifying
property and like-kind property.
Qualifying property is property the taxpayer holds for investment or for productive use
in a trade or business. The like-kind exchange rules do not apply to the following:
Property used for personal purposes.
Stock in trade or other property held primarily for sale.
Stock, bonds, notes, or other securities or evidence of indebtedness, such
as accounts receivable.
Partnership interests.
Certificates of trust or beneficial interest.
Choses in action.
134 IRC §1031(a)
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Like-kind property is property of the same nature or character, even if it differs in grade or
quality. Depreciable tangible personal property can be either like-kind or like-class.
Like-class properties are depreciable tangible personal properties within the same
General Asset Class or Product Class. The same product class includes property listed
in a 6-digit product class in sections 31 through 33 of the North America Industry
Classification System (NAICS).
Real property is more flexible in that unimproved real property and improved real
property are like-kind.
Intangible personal property and not depreciable personal property may qualify
depending on the nature and the character of the rights involved. It also depends on the
nature or character of the underlying property to which those rights relate.
The exchange of goodwill or going concern value of one business for the goodwill or
going concern value of another business is not a like-kind exchange.
A deferred exchange135 is an exchange where the taxpayer transfers property used in a business or
held for investment and later receives like-kind property to use in a business or held for
investment.
Treat the transaction as a sale instead of deferred exchange if the taxpayer actually or
constructively receives money or unlike property before receiving the replacement property.
The taxpayer must identify replacement property within 45 days of transferring the relinquished
property.
The taxpayer must receive replacement property by the earlier of the following dates:
The 180th day after the date of transfer of the relinquished property.
The due date, including extensions, for the tax return for the tax year in which the
transfer of the relinquished property occurs.
If meeting all the requirements for a nontaxable exchange, but the taxpayer receives unlike
property or cash (called boot) in addition to like property, the exchange is partially nontaxable.
Gain to the extent of boot received is included in income.
135 Reg. Sec. 1.1031(k)-1(a
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What Do You Think?
Q1. Which of the following is true regarding the purchase of a business?
A. Purchasing a group of assets that constitutes a trade or business
requires an allocation of the separate assets purchased.
B. Form 8594, Asset Acquisition Statement must be completed by both
parties.
C. The written agreement is binding by both the buyer and the seller, if
the allocation was part of the purchase price.
D. All of the above
Q2. Compensation given to a property owner for the loss in value of a portion of land and for
the decrease in value to the remaining property which the government takes for public use by
condemnation under its eminent domain rights, is known as which of the following?
A. Like-Kind Exchange
B. Severance Damage
C. Inheritance
D. Disposition
Q3. Which of the following is not a decrease in adjusted basis?
A. Energy conservation subsidies.
B. Assessments for local improvements.
C. Section 179 expense.
D. Certain canceled debt excluded from income.
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What Do You Think? – Answer
A1. – Answer
The correct answer is D, they are all correct
Purchasing a group of assets that constitutes a trade or business requires an
allocation of the separate assets purchased. If the buyer and seller enter into a written
agreement that has an allocation of the purchase price, this agreement is binding on both
parties unless the IRS determines the allocation is inappropriate. Both the buyer and the seller
must complete Form 8594, Asset Acquisition Statement.
A2. The correct answer is B
Compensation given to a property owner for the loss in value of a portion of land and for the
decrease in value to the remaining property which the government takes for public use by
condemnation under its eminent domain rights, is known as which of the following?
A. Like-Kind Exchange
B. Severance Damage
C. Inheritance
D. Disposition
A3. The correct answer is B
Which of the following is not a decrease in adjusted basis?
A. Energy conservation subsidies.
B. Assessments for local improvements.
C. Section 179 expense.
D. Certain canceled debt excluded from income.
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Chapter 6 – Clergy Tax
Changes in society have prompted significant
changes in the way religious and charitable organizations carry out their missions. As a result,
ministers now work in a variety of organizations, and their duties extend beyond those
associated with traditional church pastors. These changes have made determining who meets
the definition of a “minister of the gospel” a complex decision.136 A minister for tax purposes
is determined based on who employs the individual and the duties the individual performs. An
individual does not have to work for a church or denomination to be considered a minister but
must perform the duties of a minister as specified in the regulations to be treated as a minister.
Those who qualify as ministers are subject to a unique set of tax rules. These rules include the
benefit of a tax-free housing allowance and the detriment of being self-employed for Social
Security tax purposes. Thus, clarity on the definition of minister is an important issue for these
taxpayers. In addition to a salary, ministers are also often compensated with a housing
allowance. The U.S. 7th Circuit Court of Appeals upheld the constitutionality of the housing
allowance benefit in 2019 in Gaylor, et al v. Mnuchin, et al. The Seventh Circuit held that the
exclusion from gross income for housing allowances provided to ministers does not violate the
Establishment Clause of the First Amendment.137 The court found that the statute has a secular
legislative purpose, does not either advance or inhibit religion, and does not foster excessive
government entanglement with religion. This ruling provides a substantial income tax benefit
for ministers. The housing allowance excluded from gross income remains subject to self-
employment (SE) tax.
Definition of Minister under the Regulations
The regulations under Secs. 107 and 1402 provide guidelines for determining who qualifies as
a minister. Both sections state that a minister is distinguished by the duties he or she performs.
The regulations state that the duties of a minister include the ministration of sacerdotal
functions and the conduct of religious worship, and the control, conduct, and maintenance of
religious organizations (including the religious boards, societies, and other integral agencies of
such organizations), under the authority of a religious body constituting a church or church
denomination.2
136 IRC§107 137 Gaylor, et al. v. Mnuchin, 2019 PTC 86 (7th Cir. 2019)
Objective:
Identify and review the major points of
the Affordable Care Act
Understand important items in the ACA.
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The duties of a minister138 include the performance of sacerdotal functions, the conduct of
religious worship, the administration and maintenance of religious organizations and their
integral agencies, and the performance of teaching and administrative duties at theological
seminaries.
The definitions above identify the following categories of people who qualify as ministers:
Those in traditional clergy roles (e.g., priests, pastors, rabbis) who typically perform
sacerdotal functions and conduct worship;
Those who work for secular organizations to the extent they perform sacerdotal
functions and conduct worship;
Those who control and maintain religious organizations at the local church or
denomination level; and
Teachers and administrators at seminaries.
Two key issues arise in defining those who qualify as ministers: whether their service is
conducted under the authority of a church or denomination and whether their duties are
encompassed by the regulations above. Those under the control of a church or denomination
whose predominant duties are specified in the regulations have the strongest positions.
The more crucial of the two issues is the duties performed by the minister. Individuals
performing minister duties outside the auspices of a church or denomination can qualify as
ministers based on duties performed. For example, chaplains employed by secular
organizations have successfully qualified as ministers because they conducted worship and
administered sacraments.3
The following examples139 help identify those outside traditional minister roles who qualify as
ministers. In these examples, either the specific duties of the minister or the assignment of
duties by the religious organization, determines whether the person qualifies as a minister.
An ordained chaplain at a university, who teaches a religion class, provides spiritual
counseling, and conducts worship services is considered a minister. 4 In this example, the
duties of the chaplain qualify him or her as a minister even though he or she is not working
at a religious organization.
A person performs the duties of a minister while conducting religious worship and
performing sacerdotal functions even if other employment is not ministry related. In effect,
a person can have two careers simultaneously, one as a minister and another in a secular
position.
An ordained minister directing an agency of the denomination qualifies as a minister.
An ordained minister assigned by his or her denomination to advise a company in the
publication of a book about the denomination is considered a minister.
138 Regs. Sec. 1.107-1(a) 139 Regs. Sec. 1.1402(c)-5
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In the last two examples, the taxpayers are ministers based mainly on their conduct and
maintenance of a denomination, not because their daily tasks are those of a typical minister.
IRS and Judicial Determinations
The above examples from the regulations notwithstanding, those performing tasks outside
traditional ministry roles have a more time that is difficult qualifying as ministers. This issue
has come up in court cases and IRS rulings involving employees in religious and secular
organizations. This section summarizes how the Tax Court has interpreted the definition of a
minister.
Employees of Churches
The Tax Court provided what is probably the most widely cited and useful analysis of the law
in Knight.8 Knight was not ordained and could not administer the sacraments. However, he
conducted worship, was licensed, and was considered a spiritual leader in his church. The court
held that Knight qualified as a minister, applying a five-factor test initially established in
Wingo.9 140In that case, the Tax Court set forth the following attributes and duties of a minister:
Is ordained, commissioned, or licensed;
Is recognized by the religious body as a spiritual leader;
Conducts religious worship;
Administers sacraments; and
Is involved in the control, conduct, or maintenance of a religious organization.
In Knight, the court stated that the first factor must be met and the other factors should be
weighed against the facts and circumstances of each taxpayer to make a determination. The
Knight decision is particularly influential because it is the most recent case on this issue
decided by the full Tax Court. In addition, IRS audit guidelines cite this decision, referring
those auditing ministers back to these five factors.
The guidance provided in Knight is even more important given two recent moves by the IRS.
First, the IRS no longer provides a definition of minister in the latest edition of its Tax Guide
for Churches and Religious Organizations. Second, the IRS has stated that it will no longer
issue private letter rulings addressing the issue of whether a taxpayer meets the definition of a
minister.141 Lacking IRS guidance, ministers and their employers must rely on judicial
interpretations to determine those who qualify as ministers.
140 Wingo 89 TC 911 (1987) 141 Rev. Proc 2006-3,2006-1 IRB 122
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Subsequent Tax Court decisions measured the facts of each case against the five factors from
Wingo. For example, in Haimowitz, the taxpayer did not meet the definition of a minister
because he was not ordained, commissioned, or licensed in the Jewish faith, and his duties
were mainly administrative. Haimowitz failed to meet any of the five factors. In Brannon, he
Tax Court ruled that the taxpayer satisfied the definition of a minister because he met four of
the five factors specified in Wingo. He was licensed, conducted worship, presided over the
sacerdotal functions of baptism, communion, and marriage, and was assigned to control and
maintain the Trinity-Weoka Church.
Most ministers work for local churches, and many court decisions address whether church
employees qualify as ministers. There are fewer decisions providing guidance on whether those
employed by church-affiliated organizations qualify as ministers. The next section draws
heavily on IRS guidance to provide parameters that determine how those employed by these
organizations can qualify as ministers.
Employees of Church-Affiliated Organizations
Ordained administrators and teachers at seminaries qualify as ministers142. The IRS has taken a
narrow interpretation of this regulation. The educational institution must be an integral part of a
church or denomination. Thus, faculty and administrators at interdenominational seminaries
are not ministers because the seminaries are not controlled by a specific church or
denomination.
Control by a church or denomination must be evident. In Colbert, 143a religion professor at a
church-affiliated college was denied a housing allowance because there was no evidence that a
church exercised control over the school. Church control was also a key issue in this ruling,
four ordained religion professors at a Christian college qualified as ministers and were eligible
for a housing allowance. The IRS ruled that the church controlled the college because it was
founded and partially funded by the church and controlled by a board of trustees, the majority
of whom the church selected.
Teachers and administrators at elementary and secondary schools have also attempted to
qualify as ministers. Lack of control by a church or denomination prevents these individuals
from qualifying even if the school has a religious purpose. Even those employed by church-
controlled schools cannot qualify as ministers if they are not ordained or commissioned and
their duties are indistinguishable from those of employees at secular schools.
Given the IRS interpretation, seminaries and religious colleges should carefully examine their
circumstances to ensure that employees meet IRS parameters before treating them as ministers.
Teachers in elementary and secondary schools would qualify as ministers only in unusual
circumstances. For example, an ordained rabbi at a school controlled by a local synagogue who
teaches religion classes, conducts worship services, and prepares students for adult Jewish life
could qualify as a minister.
142 Under Regs. Sec. 1.107-1(a), 143 Colbert 6 TC 449 (1974)
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Employees of Nonchurch Organizations
Those employed outside churches have a time that is more difficult qualifying as ministers.
Nevertheless, the regulations provide leeway for some individuals to qualify. The
determination depends on duties performed and affiliation with a religious organization, with
duties performed being the most important factor. Individuals in this category include
chaplains in prisons and hospitals and those employed by parachurch organizations.
Chaplains working for nonchurch organizations who conduct worship and perform sacerdotal
functions have successfully qualified as ministers. Performance of these two functions is the
key factor in the following cases and rulings.
In Boyd,144the taxpayer was a chaplain employed by the Indianapolis Police Department. The
IRS conceded that he performed the duties of a minister. However, it took issue with his
employment outside a religious organization. The court ruled in favor of Boyd because he
performed the duties of a minister under the close supervision of a federation of churches,
providing a connection to a religious organization.
IRS rulings that address whether chaplains qualify as ministers are relatively old. This limits
their value, since it is likely that IRS perspective has changed. Chaplains in government-owned
hospitals and private nonprofit hospitals were ministers because they conducted worship and
performed sacraments (baptisms, marriages, funerals, and prayers for the sick).
Three IRS letter rulings also held that chaplains were ministers. Only the taxpayers who
requested these rulings can rely on them, but they reveal IRS reasoning. A negative aspect of
these rulings is that they were issued more than 20 years ago.
A chaplain for a state Department of Human Services was held to be a minister based on duties
performed. A chaplain for a nonprofit, nonchurch-related hospital was a minister because he
conducted worship, performed sacraments, and provided counseling to patients, their relatives,
and hospital staff.
Those employed by parachurch organizations face the challenge of qualifying as ministers
under the same rules as those employed by churches. Ministers receiving favorable rulings
have succeeded by producing evidence of their connection to local churches.
A 1994 Tax Court decision considered the situation of two Baptist ministers who established
an organization to promote world missions. The organization carried out its mission by
producing videotapes for local churches, and the taxpayers were the key people in the
production process. The court held that this production and distribution of videos supported the
cause of foreign missions, a sacerdotal function within the Baptist faith. Although the
taxpayers were not affiliated with any local church, the tapes they produced were used by over
30,000 churches. This was evidence of a connection to local churches.
144 Boyd TC Memo 181-528
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In a more recent decision, an ordained minister working for an evangelical organization
qualified as a minister. The organization produced religious literature and television programs
and conducted crusades. The IRS disallowed the minister’s housing allowance because he did
not work for a church or denomination. In siding with the taxpayer, the Tax Court saw the
followers of the organization as a “body of believers” similar to a church. They were loyal to
the organization and consistently attended its worship services and crusades. 145
Regardless of their place of employment, taxpayers seeking to qualify as ministers must
establish that they perform the duties of a minister as described in the regulations. They have a
stronger position if they can show that they perform their duties in association with a
denomination or a local church. Employees of churches, church-affiliated organizations, and
secular organizations who qualify as ministers are subject to the benefits and requirements
described in the next section.
Tax Rules Unique to Ministers
Those meeting the definition of minister face a unique set of tax rules in three areas. Ministers
are:
Eligible for the housing allowance and parsonage exclusion;
Considered self-employed for Social Security tax purposes; and
Exempt from federal income tax withholding.
Those advising ministers should be familiar with the application of tax law in these areas.
Housing Allowance/Parsonage
Sec. 107 provides an exclusion from gross income to the extent that a minister’s employer pays
his or her housing costs. The employer can provide housing by paying housing costs
(parsonage) or providing cash that the minister uses to pay these costs (housing allowance).
Housing costs include rent, mortgage payments (principal and interest), utilities, maintenance,
insurance, and furnishings.
This exclusion is the most attractive benefit available to ministers because housing costs
represent a high percentage of income. Most state income tax laws also permit an exclusion,
increasing the tax savings. Most rulings and case law related to ministers concern the claiming
of this exclusion.
The employer must designate the amount of the housing allowance in advance. It is limited to
the lesser of:
The amount designated by the employer;
The fair rental value of the residence (FRV); or
The actual expenses incurred.
145 Whittington TC Memo 2000-296
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In 2002, Congress amended Sec. 107 to state explicitly that the amount excluded as housing
allowance cannot exceed the fair rental value of the residence plus the cost of utilities.146 This
upper limit on the amount of the housing allowance can be estimated using internet or print
sources that document local rental values.
To compute the allowable housing allowance, the tax preparer needs to obtain several pieces of
information from the minister regarding their home:
• Officially written document designating the allowance amount
• Reasonable pay for the minister’s services
• Fair rental value (FRV) of the home, including furnishings and a garage, if applicable
• Documentation of amounts used and paid for qualified housing allowance expenses
Common Qualified Housing Allowance Expenditures
• Rent or home purchase costs (down payment and mortgage principal payments)
• Interest payments for mortgage and financing furniture and/or appliances
• Home-owner’s insurance premiums
• Real estate property taxes
• Fixtures, appliances, and furnishings
• Repairs, maintenance, improvements, landscaping, and upkeep of home and contents
• Cleaning supplies, yard, and gardening tools
• Utilities
When FRV, actual costs, or reasonable pay are less than the official designated allowance, the
excess is subject to federal income tax withholding (FITW) and reported on Form 1040 as
wages with the designation “excess allowance.”
Example 1: Rev. Pete, an ordained minister, receives an employment contract from his church.
Annual Salary: $42,000
Fair Rental Value (FRV) $1,000 a month including utilities
Allowance -0-
Tax Purposes
Excludable Allowance $ 12,000
Subject to Federal Taxable Income (FTI) $ 42,000
Subject to SE Tax $ 54,000
146 Clergy Housing Allowance Clarification Act of 2002 PL 107-181
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The minister can either rent a home or own a home. The following items can be included when
the minister owns a home:
• Home purchase costs (down payment and mortgage principal payments)
• Interest payments for mortgage and financing furniture and/or appliances
• Home-owner’s insurance premiums
• Real estate property taxes
• Fixtures, appliances, and furnishings
• Repairs, maintenance, improvements, landscaping, and upkeep of home and contents
• Cleaning supplies, yard, and gardening tools
• Utilities
Example 2: This example is of a Rabbi who owns his home. His employment contract
guaranteed him a salary of $52,000 and a housing allowance of $30,000. In this example, the
FRV is less than designated allowance. The excess allowance ($30,000 - $19,500) $10,500 is
added to wages (FTI) on Form 1040.
Annual Salary: $52,000
Fair Rental Value (FRV) including furnishing and utilities $19,500
Allowance paid per agreement $30,000
Actual home costs listed above expended $22,000
Tax Purposes
Excludable Allowance $ 19,500
Subject to Federal Taxable Income (FTI) ($52,000 + ($30,000-$19,500)) = $62,500
Subject to SE Tax $ 82,000
If the FRV $30,000 and the allowance per agreement $19,500, the amount expended $22,000,
and the Rabbi’s salary $52,000 the taxable amounts would be:
Tax Purposes
Excludable Allowance $19,500
Subject to Federal Taxable Income (FTI) $52,000
Subject to SE Tax $71,500
Self-Employed Status
Ministers are self-employed for Social Security tax purposes with respect to their ministerial
services, even though most are treated as employees for federal income tax purposes. Self-
employment tax is assessed on taxable compensation and nontaxable housing
allowance/parsonage. The 15.3% self-employment tax rate presents a challenge to new
ministers who are used to paying half this rate in secular jobs. Quarterly estimated tax
payments are typically necessary to ensure that the minister has paid an adequate amount of tax
throughout the year. The minister can also increase his or her withholding on taxable
compensation to meet estimated tax payment requirements.
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Classification as Employees or Independent Contractors
Most ministers are classified as employees for federal income tax reporting based on tests
established by the IRS and the courts. The extent of control by the employer determines the
minister’s classification. Because most employers have the right to designate how the minister
performs his or her job, including when and where the work is performed, ministers are most
likely to be classified as employees.
These ministers receive Form W-2 and report their taxable gross income as employees.
However, the minister’s status as self-employed for Social Security tax purposes comes into
play here. Since they are considered self-employed, ministers are exempt from federal income
tax withholding.32 However, ministers can request that their employers withhold taxes.
Conclusion
The tax rules applicable to ministers provide a challenge to employers and tax preparers trying
to comply with the tax law in this area. The first challenge is determining those who meets the
definition of a minister under Sec. 107. The second is applying a unique set of rules to those
who qualify as ministers.
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What Do You Think?
Q1. The minister can either rent a home or own a home. The following items can be
included when the minister owns a home. Which of the expenses below are
allowed?
A. Home purchase costs (down payment and mortgage principal
payments)
B. Real estate property taxes
C. Cleaning supplies, yard, and gardening tools
D. All of the above
Q2. Changes in society have prompted significant changes in the way religious and charitable
organizations carry out their missions. Which of the following is correct?
A. A minister for tax purposes is determined based on who employs the individual and the
duties the individual performs.
B. An individual does not have to work for a church or denomination to be considered a
minister but must perform the duties of a minister as specified in the regulations to be
treated as a minister.
C. An individual who follows the guideline of IRC Sections. 107 and 1402 as a minister.
D. All of the above
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What Do Your Think – Answers
A1. D is the correct answer. The minister can either rent a home or own a home.
Which of the expenses below are allowed?
A. Home purchase costs (down payment and mortgage principal payments)
B. Real estate property taxes
C. Appliances, and furnishings
D. All of the above
Common Qualified Housing Allowance Expenditures
• Rent or home purchase costs (down payment and mortgage principal payments)
• Interest payments for mortgage and financing furniture and/or appliances
• Home-owner’s insurance premiums
• Real estate property taxes
• Fixtures, appliances, and furnishings
• Repairs, maintenance, improvements, landscaping, and upkeep of home and contents
• Cleaning supplies, yard, and gardening tools
• Utilities
A2. D is the correct answer. Changes in society have prompted significant changes in the way
religious and charitable organizations carry out their missions. Which of the following is
correct?
A. A minister for tax purposes is determined based on who employs the individual and
the duties the individual performs.
B. An individual does not have to work for a church or denomination to be considered a
minister but must perform the duties of a minister as specified in the regulations to
be treated as a minister.
C. An individual who follows the guideline of IRC Sections. 107 and 1402 as a
minister.
D. All of the above
Changes in society have prompted significant changes in the way religious and
charitable organizations carry out their missions. As a result, ministers now work in
a variety of organizations, and their duties extend beyond those associated with
traditional church pastors. These changes have made determining who meets the
definition of a “minister of the gospel” a complex decision.147 A minister for tax
purposes is determined based on who employs the individual and the duties the
individual performs. An individual does not have to work for a church or
denomination to be considered a minister but must perform the duties of a minister
as specified in the regulations to be treated as a minister.
147 IRC§107
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The regulations under Secs. 107 and 1402 provide guidelines for determining who qualifies as
a minister. Both sections state that a minister is distinguished by the duties he or she performs.
The regulations state that the duties of a minister include the ministration of sacerdotal
functions and the conduct of religious worship, and the control, conduct, and maintenance of
religious organizations (including the religious boards, societies, and other integral agencies of
such organizations), under the authority of a religious body constituting a church or church
denomination.
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Chapter 7– Miscellaneous Items
Digital Signatures
Effective immediately, the IRS will accept images
of signatures (scanned or photographed) and
digital signatures on documents related to the
determination or collection of tax liability. In
addition, the IRS is allowing its employees to accept documents via email and to transmit
documents to taxpayers using SecureZip or other established secured messaging systems.
The taxpayer or representative must include a statement, either in the form of an attached cover
letter or within the body of the email, stating: “The attached [name of document] includes
[name of taxpayer] valid signature and the taxpayer intends to transmit the attached document
to the IRS.” The choice to transmit documents electronically is solely that of the taxpayer.
These guidelines apply to the following documents only:
Extensions of statute of limitations on assessment or collection
Waivers of statutory notices of deficiency and consents to assessment
Agreements to specific tax matters or tax liabilities (closing agreements)
Any other statement or form that needs the signature of a taxpayer or representative and
is traditionally collected by IRS personnel outside standard filing procedures (such as a
case-specific powers of attorney)
Virtual Currency
Investments in virtual currency are currently happening and the number of investors is ever
increasing. Numbers are showing that upwards of 15% of Americans are investing in virtual
currency.
As tax preparers, we must practice due diligence by asking clients, “Is the taxpayer investing in
virtual currency?” This is necessary because the small investor may not think of virtual
currency as a taxable event. They may view it more like collecting coins as a hobby.
Virtual currency is a digital representation of value, other than a representation of the U.S.
dollar or a foreign currency (“real currency”), that functions as a unit of account, a store of
value, and a medium of exchange. Some virtual currencies are convertible, which means that
they have an equivalent value in real currency or act as a substitute for real currency. The IRS
uses the term “virtual currency” to describe the various types of convertible virtual currency
that are used as a medium of exchange, such as digital currency and cryptocurrency.
Regardless of the label applied, if a particular asset has the characteristics of virtual currency, it
will be treated as virtual currency for Federal income tax purposes.
Objective:
Review Estate & Gift Tax Exclusions
Effects of TCJA on AMT & NOL
TCJA changes to Kiddie Tax
TCJA repealed items effect on 2019
tax
Review Foreign Account & Asset
Reporting (FinCen)
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The IRS says virtual currency is not currency but is “other property.” How it is held makes the
difference in how the virtual currency is accounted for and reported, whether it be a capital
gain, ordinary income or subject to SE tax.
Schedule 1 has a question “At any time during 2019, did the taxpayer receive, sell, send,
exchange, or otherwise acquire any financial interest in any virtual currency?” Answering this
question can be difficult. If a taxpayer has virtual currency but made no transactions during the
year, there is no guidance from the IRS how the question should be answered.
The Internal Revenue Service has begun sending letters to taxpayers with virtual currency
transactions that potentially failed to report income and pay the resulting tax from virtual
currency transactions or did not report their transactions properly.
"Taxpayers should take these letters very seriously by reviewing their tax filings and when
appropriate, amend past returns and pay back taxes, interest and penalties," said the IRS
Commissioner. "The IRS is expanding our efforts involving virtual currency, including
increased use of data analytics. We are focused on enforcing the law and helping taxpayers
fully understand and meet their obligations."
The IRS started sending the educational letters to taxpayers. By the end of August 2019, more
than 10,000 taxpayers were sent to taxpayers. The names of these taxpayers were obtained
through various ongoing IRS compliance efforts.
For taxpayers receiving an educational letter, there are three variations: Letter 6173, Letter
6174 or Letter 6174-A, all 3 versions strive to help taxpayers understand their tax and filing
obligations and how to correct past errors.
Last year the IRS announced a Virtual Currency Compliance campaign to address tax
noncompliance related to the use of virtual currency through outreach and examinations of
taxpayers. The IRS will remain actively engaged in addressing non-compliance related to
virtual currency transactions through a variety of efforts, ranging from taxpayer education to
audits to criminal investigations.
Virtual currency is an ongoing focus area for IRS Criminal Investigation. IRS Notice 2014-21
states that virtual currency is property for federal tax purposes and provides guidance on how
general federal tax principles apply to virtual currency transactions.
Compliance efforts follow these general tax principles. The IRS will continue to consider and
solicit taxpayer and practitioner feedback in education efforts and future guidance. The IRS
anticipates issuing additional legal guidance in this area in the near future.
Gamers
Gamers who transact in virtual currencies as part of a video game do not have to report the
transactions on a tax return if the currencies do not leave the game environment, the IRS made
clear in a statement released on its website.
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The clarification relates to whether, or when, a currency used in a video game should be
considered "convertible," meaning it can be converted into real currency. The Service's current
guidance on virtual currencies applies only to currencies that are convertible, a typical example
being bitcoin.
The clarification came two days after the IRS made an unannounced deletion of language from
its website about video game currencies.
On Feb 14 2020, the IRS the IRS stated on their website, that the language about virtual
currencies potentially caused concern for some taxpayers. We have changed the language in
order to lessen any confusion. Transacting in virtual currencies as part of a game that do not
leave the game environment (virtual currencies that are not convertible) would not require a
taxpayer to indicate this on their tax return.
Before the Feb. 12 website edit, the IRS "Virtual Currencies" webpage said that examples of a
convertible virtual currency include "Bitcoin, Ether, Roblox, and V-bucks." Roblox is an
online video game platform, and V-bucks is an in-game currency used in the game Fortnite.
The same webpage now lists bitcoin as the sole example of a convertible virtual currency.
The IRS treats virtual currencies such as bitcoin as property, rather than as currency, and says
that general tax principles applicable to property transactions apply to transactions using virtual
currency. In a set of frequently asked questions, the IRS notes that its current guidance about
the taxation of virtual currency transactions relates only to virtual currencies that are
convertible.
Some virtual currencies are convertible, which means that they have an equivalent value in real
currency or act as a substitute for real currency. The IRS uses the term "virtual currency" in
these FAQs to describe the various types of convertible virtual currency that are used as a
medium of exchange, such as digital currency and cryptocurrency.
The IRS recently revised Form 1040, Schedule 1 that now asks taxpayers, "Did the taxpayer
receive, sell, send, exchange, or otherwise acquire any financial interest in any virtual
currency?" As noted above, the IRS's Feb. 14 statement clarifies that transacting in virtual
currencies as part of a game that do not leave the game environment "would not require a
taxpayer to indicate this on their tax return."
Insolvency
In 2020, Covid-19 brought about business closures and increased sustained unemployment.
Although some government programs have assisted in payment of mortgages, several
taxpayers have been faced with losing their homes and cancellation of debt on their credit
cards. It is time to pull out Form 982 again and do a quick review.
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Many clients can be insolvent without being bankrupt, but if they are in bankruptcy, they are
insolvent. Many clients think of the two as the same thing, but they are very different.
Bankruptcy is a court proceeding in which a judge and court trustee examine the assets and
liabilities of individuals and businesses who cannot pay their bills and decide whether to
discharge those debts so they are no longer legally required to pay them.
Insolvency is a problem that bankruptcy is designed to solve. Insolvency is the inability to pay
debts when they are due. Fortunately, there are solutions for resolving insolvency, including
borrowing money or increasing income so that you can pay off debt. You also could negotiate
a debt payment or settlement plan with creditors. Bankruptcy is usually a final alternative when
other attempts to clear debt fail. This segment is a quick review of insolvency.
A taxpayer is insolvent when his or her total liabilities exceed his or her total assets. The
forgiven debt may be excluded as income under the "insolvency" exclusion.148 Normally, a
taxpayer is not required to include forgiven debts in income to the extent that the taxpayer is
insolvent. The forgiven debt may also qualify for exclusion if the debt was discharged in a
Title 11 bankruptcy proceeding or if the debt is qualified farm indebtedness or qualified real
property business indebtedness. If the taxpayer believe he or she qualifies for any of these
exceptions, see the instructions for Form 982.
The discharge of indebtedness income from a debt discharged when a taxpayer is insolvent is
excludable from the taxpayer's gross income. The amount of the exclusion is limited to the
amount by which the taxpayer is insolvent.149 For example, in Newman v. Comm'r, a taxpayer
had cancellation of debt income because of overdrawing his bank account by $7,900 and not
correcting the negative balance. However, the court found that because the taxpayer had debts
totaling $50,000 and assets of only $35,500, he was insolvent to the extent of $14,500. Since
that amount was more than the $7,900 COD income, the COD income was excluded from his
gross income under the insolvency provision.
148 IRC §108(a)(1)(b) 149 IRC §108(a)(3)
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A taxpayer is insolvent to the extent liabilities exceed the fair market value of assets
immediately before the debt is discharged.150 For purposes of determining insolvency, assets
include the value of everything the taxpayer owns. This includes assets that serve as collateral
for debt and exempt assets that are beyond the reach of the taxpayer's creditors under the law,
such as the taxpayer's interest in a pension plan and the value of his or her retirement account.
In valuing property such as a principal residence or vacation home, courts will not accept a
value placed upon property for local property tax purposes where there is no evidence of the
method used in arriving at that valuation. Similarly, a letter from a finance or mortgage
company showing the value of a home does not establish the home's fair market value where
the letter does not describe the property nor explain the methodology used to determine its
value. The court is usually looking for an appraisal, showing comparable values of homes and
a reasonable determination of FMV at the time of insolvency.
For purposes of determining insolvency, liabilities include:
(1) The entire amount of recourse debts;
(2) The amount of nonrecourse debt that is not in excess of the fair market value of the
property that is security for the debt; and
(3) The amount of nonrecourse debt in excess of the fair market value of the property
subject to the nonrecourse debt (excess nonrecourse debt), to the extent nonrecourse
debt in excess of the fair market value of the property subject to the debt is
discharged.
Example: The Shepherds were a married couple residing in New Jersey. They faced some
financial troubles and outstanding credit card debt of $9,962. The credit card company referred
the couple to an outside collection agency, which in turn agreed to settle the balance in
exchange for making payments of $5,550. The Shepherds made the required payments in 2008
and the remaining debt of $4,412 was cancelled. In January 2009, the credit card company
issued a 2008 Form 1099-C, Cancellation of Debt.
With the exception of three major items, the Shepherds and the IRS agreed on the value of all
assets and liabilities before reaching court.
The three items in dispute were a principal residence, a beach house and Mr. Shepherd’s
pension. The taxpayers included a loan against Mr. Shepherd’s pension as a liability, but did
not include the value of his pension as an asset. Mr. Shepherd had the ability to withdraw some
portion of his pension on the date of the debt discharge. The IRS stated that the value of the
pension should be included as an asset in the insolvency calculation.
150 IRC §108(d)(3)
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The other disagreement between the two parties was the value to be used in the insolvency
calculation of the couple’s principal residence and beach house. The Shepherds submitted
evidence from a 2018 property tax valuation appeal signed May 6, 2019, for the value of their
beach house. This appeal was based on comparable sales compiled by Mr. Shepherd, but no
evidence was provided for the court to determine their accuracy. The Court ruled that the
taxpayers failed to substantiate the FMV of the two homes and failed to include the value of
the pension. Because of this, they were deemed solvent and the full amount of cancellation of
debt income was taxable.
This case is an example of:
• If the taxpayer cannot substantiate the FMV of all assets and liabilities for an
insolvency calculation, the IRS and courts will most likely disallow the insolvency
exclusion.
• FMV must be determined immediately before the debt was cancelled.
• Property tax assessments are not an indication of true FMV.
• Comparable sales can be persuasive evidence of FMV, but evidence and
methodology to determine value are required.
• FMV determined at a date substantially before or after the cancellation, two years in
this case, does not prove FMV at the time of cancellation.151
Excess nonrecourse debt is not treated, as a liability to the extent the nonrecourse debt is not
discharged. In Jackson v. Comm'r,152 the court held that a taxpayer could not claim insolvency
because of retirement buyback payments. According to the court, the payments did not
constitute a liability for purposes of determining whether the taxpayer was insolvent because
the payments did not carry legal consequences for nonpayment.
Richard Jackson began working for the State of New York. At that time, he was enrolled as
participant in the New York State and Local Retirement System. Jackson was required to make
biweekly contributions equal to 3 percent of his salary until he accrued 10 years of service
credit. Jackson left his job and received a distribution of approximately $11,500 from the
retirement plan.
Jackson returned to employment with the State of New York. Jackson took advantage of an a
buyback agreement, Jackson agreed to repay the $11,500 distribution he received previously
plus interest. The payments were to be withheld from his pay for 228 payroll periods. Jackson
made the buyback payments for about two years, until his job was eliminated and he retired.
Jackson's monthly retirement benefit was reduced because he had not fully repaid the plan in
accordance with the buyback agreement.
151 TC Memo 2012-212 152 TC Summary 2018-43
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Jackson realized income from discharged indebtedness of $11,552 as the result of debts that
were discharged by two banks. On his 2013 tax return, Jackson did not report the discharged
indebtedness as income. The IRS audited his return and determined that the $11,552 was
required to be included in taxable income. Jackson petitioned the Tax Court to challenge the
IRS's determination.
The Tax Court held that Jackson was not insolvent in 2013 because the buyback payments
were not a liability. Evaluating the nature of the obligation, the court determined that the
payments served as a substitute for regular retirement plan contributions and that each payment
was credited to Jackson's retirement account. The court concluded that because the buyback
payments were deposited into Jackson's retirement account and did not carry legal
consequences for repayment, they were not a liability for purposes of insolvency.153 The court
concluded Jackson was not insolvent when he realized income from the discharge of
indebtedness, and was not entitled to an exclusion.
A taxpayer reports that he or she is excluding canceled debt from income under the insolvency
exclusion by attaching Form 982, Reduction of Tax Attributes Due to Discharge of
Indebtedness (and Section 1082 Basis Adjustment), to his or her federal income tax return and
checking the appropriate box on line 1. On line 2, the taxpayer includes the smaller of the
amount of the debt canceled or the amount by which the taxpayer was insolvent immediately
before the cancellation.
Below is an example of the Insolvency worksheet from IRS Publication 4681. I have the
taxpayer complete this form and sign and date the bottom for my files. This is not an IRS
requirement. Remind clients of the IRS requirement that the amounts on the worksheet are
immediately before the cancellation of debt. Form 982 is included in the tax return and
electronically filed.
Example: In the prior year, Jerry was released from his obligation to pay his personal credit
card debt for $5,000. In February of the current year, Jerry received a Form 1099-C from his
credit card lender showing canceled debt of $5,000 in Box 2. None of the exceptions to the
general rule that canceled debt is included in income applies. Jerry determines that his total
liabilities immediately before the cancellation were $15,000 and the fair market value of his
total assets immediately before the cancellation was $7,000. Thus, immediately before the
cancellation, Jerry was insolvent to the extent of $8,000 ($15,000 total liabilities minus $7,000
fair market value of his total assets). Because the amount by which Jerry was insolvent
immediately before the cancellation was more than the amount of his debt canceled, Jerry can
exclude the entire $5,000 canceled debt from income.
153 IRC§108(d)(3)
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Example: Assume the same facts as in the preceding example, except that Jerry's total
liabilities immediately before the cancellation were $10,000 and the fair market value of his
total assets immediately before the cancellation was $7,000. In this case, Jerry is insolvent to
the extent of $3,000 ($10,000 total liabilities minus $7,000 fair market value of his total assets)
immediately before the cancellation. Because the amount of the canceled debt was more than
the amount, by which Jerry was insolvent immediately before the cancellation, Jerry can
exclude only $3,000 of the $5,000 canceled debt from income under the insolvency exclusion.
Estate and Trust Tax Rates and Brackets
For 2018 through 2025, under TCJA, the tax rate for estates and trusts are 10% of taxable
income up to $2,550, 24% of the excess over $2,550 but not over $9,150; 35% of the excess
over $9,150 but not over $12,500; and 37% of the excess over $12,500.
If Taxable Income Is:
Over But Not Over The Tax Is:
$0 $2,600 10% of the taxable income
$2,600 $9,300 $260.00 plus 24% of the excess over $2,600
$9,300 $12,750 $1,868.00 plus 35% of the excess over $9,300
$12,750 --- $3,075.50 plus 37% of the excess over $12,750
Increase in Estate and Gift Tax Exclusion
TCJA doubled the exclusion and adjusted if for inflation. The exclusion for 2019 is
$11,400,000 (and $22,800,000 for a married couple). The exclusion for 2020 is $11,580,000
(and $23,160,000 for a married couple).
Under the new tax law, individuals are now able to transfer approximately $11,580,000 free of
estate, gift and GST tax during their lives or at death. A married couple will be able to transfer
approximately $23,160,000 during their lives or at death. Due to the portability provisions, any
unused Federal estate tax exclusion for the first spouse may be used by the surviving spouse
for lifetime gifting or at death.
For purposes of the Federal estate and gift taxes, a portability election allows a decedent’s
unused exclusion amount (deceased spousal unused exclusion amount, or DSUE amount) to
become available for application to the surviving spouse’s subsequent transfers during life or at
death.
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What Do You Think?
Q1. Which of the following is not correct?
A. A taxpayer can be insolvent without being bankrupt.
B. Individuals and businesses who cannot pay their bills are bankrupt.
C. Insolvency is the inability to pay debts when they are due.
D. Bankruptcy is a court proceeding to resolve insolvency.
Q2. Virtual currency is a digital representation of value, other than a representation of the U.S.
dollar or a foreign currency (“real currency”), that functions as a unit of account, a store of
value, and a medium of exchange.
Which of the following is correct?
A. Some virtual currencies act as a substitute for real currency.
B. Virtual currency can be accounted for and reported as a capital gain.
C. Virtual currency can be accounted for and reported as ordinary income.
D. All of the above are correct.
Q3. Which of the following is a correct statement regarding Estate Tax in 2020?
A. Individuals are able to transfer approximately $5.6 million, free of estate, gift and GST
tax during their lives or at death.
B. A married couple will be able to transfer approximately $22,800,000 during their lives
or at death.
C. Portability provisions are no longer allowed in 2020.
D. None of the above are correct
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What Do You Think? – Answers
B is the correct answer.
A1. Which of the following is not correct?
A. A taxpayer can be insolvent without being bankrupt.
B. Individuals and businesses who cannot pay their bills are bankrupt. C. Insolvency is the inability to pay debts when they are due.
D. Bankruptcy is a court proceeding to resolve insolvency.
Many clients can be insolvent without being bankrupt, but if they are in bankruptcy, they are
insolvent. Many clients think of the two as the same thing, but they are very different.
Bankruptcy is a court proceeding in which a judge and court trustee examine the assets and
liabilities of individuals and businesses who cannot pay their bills and decide whether to
discharge those debts so they are no longer legally required to pay them.
Insolvency is a problem that bankruptcy is designed to solve. Insolvency is the inability to pay
debts when they are due. Fortunately, there are solutions for resolving insolvency, including
borrowing money or increasing income so that you can pay off debt. You also could negotiate
a debt payment or settlement plan with creditors. Bankruptcy is usually a final alternative when
other attempts to clear debt fail. This segment is a quick review of insolvency.
A2. Virtual currency is a digital representation of value, other than a representation of the U.S.
dollar or a foreign currency (“real currency”), that functions as a unit of account, a store of
value, and a medium of exchange.
Which of the following is correct?
Answer D is the correct answer A. Some virtual currencies act as a substitute for real currency.
B. Virtual currency can be accounted for and reported as a capital gain.
C. Virtual currency can be accounted for and reported as ordinary income
D. All of the above are correct
The IRS uses the term “virtual currency” to describe the various types of convertible virtual
currency that are used as a medium of exchange, such as digital currency and cryptocurrency.
Regardless of the label applied, if a particular asset has the characteristics of virtual currency, it
will be treated as virtual currency for Federal income tax purposes. .
The IRS says virtual currency is not currency but is “other property.” How it is held makes the
difference in how the virtual currency is accounted for and reported, whether it be a capital
gain, ordinary income or subject to SE tax.
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A3. Which of the following is a correct statement regarding Estate Tax in 2020?
Answer - B -Is the correct answer.
B is the correct answer a married couple will be able to transfer approximately $23,160,000
during their lives or at death in 2020.
A is incorrect because, under TCJA, individuals are now able to transfer approximately
$11,580,000 free of estate, gift and GST tax during their lives or at death. A married couple
will be able to transfer approximately $23,160,000 during their lives or at death.
C is incorrect because portability provisions are still allowed. Any unused Federal estate tax
exclusion for the first spouse may be used by the surviving spouse for lifetime gifting or at
death.
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Alternative Minimum Tax
Taxpayers use Form 1040, Schedule 2 to report amounts they owe for the Alternative Minimum
Tax (AMT) or when they need to make an excess advance premium tax credit repayment.
The tax law gives special treatment to some kinds of income and allows special deductions and
credits for some kinds of expenses. Taxpayers who benefit from the law in these ways may have
to pay at least a minimum amount of tax through an additional tax. This additional tax is called
the alternative minimum tax (AMT). A taxpayer may have to pay the AMT if taxable income for
regular tax purposes, combined with certain adjustments and tax preference items, is more than
the AMT exemption amount.
The tentative minimum tax is a percentage of the amount by which alternative minimum taxable
income exceeds the applicable exemption amount for the taxpayers’ filing status. AMT is owed
when the tentative minimum tax is higher than the regular tax.
The AMT system taxes certain types of income that are tax-free under the regular tax system and
disallows some regular tax breaks. The maximum AMT rate is 28% versus the 37% regular tax
maximum rate that applies for 2018-2025 under the TCJA. For 2018, the 28% AMT rate starts
when AMT income exceeds $191,500 for married joint-filing couples and $95,750 for others.
The taxpayer is allowed an AMT exemption154, which is deducted in calculating AMT income.
The TCJA significantly increases the exemption amounts for 2018-2025. The exemption is
phased out when AMT income surpasses the applicable threshold, but the TCJA greatly
increases those thresholds for 2018-2025.
AMT risk factors
Various interacting factors make it difficult to pinpoint exactly who will be hit by the AMT and
who will not. High income (from whatever source) can cause his or her AMT exemption to be
partially or completely phased out, which increases the odds of owing the AMT.
The AMT exemption amounts for individuals for tax years beginning in 2019 are: (1) $111,700 in the case of a joint return or a surviving spouse; and
(2) $71,700 in the case of an individual who is unmarried and not a surviving spouse;
(3) $55,850 in the case of a married individual filing a separate return; and
(4) $25,000 in the case of an estate or trust
The AMT exemption amounts for individuals for tax years beginning in 2020 are: (1) $113,400 in the case of a joint return or a surviving spouse; and
(2) $72,900 in the case of an individual who is unmarried and not a surviving spouse;
(3) $56,700 in the case of a married individual filing a separate return; and
(4) $25,400 in the case of an estate or trust
The exemption amount is reduced by 25% of the excess of the AMT taxable income over the
applicable phase-out threshold. Under the TCJA, only those taxpayers with income exceeding to
154 IRC §55(d)(4)(A)
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$1 million and $500,000, respectively will hit the threshold.
The fact that the TCJA lowered five out of the seven regular tax rates while leaving AMT rates at
26% and 28% increases the odds of owing the AMT. The offsetting factor is the TCJA’s
liberalized AMT exemption rules. The interplay of these two factors may result in some upper-
middle income taxpayers still owing the AMT, but they will probably owe less than under prior
law.
Changes that effect AMT
Large itemized deductions for state and local taxes: Under the prior-law regular
federal income tax rules taxpayers who itemize could benefit from all state and local
taxes, but they are completely disallowed under the AMT rules. TCJA reduces the state
and local taxes to $10,000 ($5,000 for those who use married filing separate status). State
and local taxes being limited to $10,000, will lower the amount of AMT.
Personal and dependent exemptions: These deductions are completely disallowed
under the AMT rules. TCJA has repealed personal and dependent exemption. This
change will also lower AMT.
Significant miscellaneous itemized deductions: For 2018-2025, the new law eliminates
the miscellaneous itemized deductions and home equity interest that were disallowed
under the prior year AMT rules.
AMT will still be effected by the following items, which may cause AMT
The difference between the market value of the shares on the exercise date and the
ISO exercise price. The way to avoid this is to sell the incentive stock option on the
date it is exercised.
Interest income from private activity bonds
Standard deductions allowed under the regular tax rules are completely disallowed
under the AMT rules
An alternative tax net operating loss deduction and an alternative minimum tax foreign tax credit
(AMTFTC) are available in computing AMT. In addition, a taxpayer may be entitled to a
minimum tax credit (MTC) for AMT incurred in prior tax years. A taxpayers’ personal credits
may offset the taxpayers’ AMT liability in full. The AMT tax is the excess of the taxpayers’
tentative minimum tax over the taxpayers’ regular tax. TCJA also repealed the corporate AMT,
effective for tax years beginning after December 31, 2017.
Kiddie Tax.
The so-called kiddie tax has been around since 1986. The kiddie tax was an effort to close a tax
loophole for the wealthy; the idea was that taxing a child’s passive income at the same rate as
that of their parents would mean there would be little to no reason to shift income. Since the
creation of the tax, parents have scrambled to figure it out. The rules depend on many factors,
including the age of the children, as well as the amount and source of the income.
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TCJA simplifies the “kiddie tax” by effectively applying ordinary and capital gains rates
applicable to trusts and estates to the net unearned income of a child. Thus, taxable income
attributable to earned income is taxed according to an unmarried (single) taxpayers’ brackets and
rates. The child’s tax is no longer affected by the tax situation of the child’s parent or the
unearned income of any siblings.
The Kiddie Tax only applies to:
Children under 19 years of age, and
Children aged 19 through 23 who are full-time students and whose earned income does
not exceed half of the annual expenses for their support.
A child who turns 19 or 24 (if a full-time student) by the end of the tax year is not subject to the
kiddie tax. To be considered a student, a child must attend school full time during at least five
months of the year. It does not matter whether the child is claimed as a dependent on the parent’s
return. However, the tax does not apply to a child under 24 who is married and files a joint tax
return.
The kiddie tax applies only to unearned income a child receives from income-producing property
(or investment property), such as cash, stocks, bonds, mutual funds, and real estate. Any salary
or wages that a child earns through full-or part-time employment are not subject to the kiddie tax
rules – that income is taxed at the child’s regular income tax rate.
The Kiddie Tax Before 2018 and After 2025
Under the old law in effect before 2018, children could pay tax at their own income tax rate on
unearned income they received up to a threshold amount. All unearned income that kids received
above the threshold amount was taxed at their parent’s highest income tax rate, if higher than the
child’s rate. That rate could be as high as 39.6%, compared to the 10% rate that most children
would be paying. Figuring the kiddie tax could be complex. For example, if a parent had more
than one child subject to the kiddie tax, the net unearned income of all the children had to be
combined, and a single kiddie tax calculated. The TCJA eliminated these rules starting in 2018,
but they are to return for 2026 and later.
The Kiddie Tax 2018 through 2025
For 2018 through 2025 children’s unearned income is not taxed at their parents income tax rates.
Instead, all net unearned income over a threshold amount $2,200 for 2019 is taxed using the
brackets and rates for trusts and estates. The 2019 rates are shown in the following chart:
Kiddie Taxable Unearned Income Tax Rate
up to $2,600 10%
$2,601 to $9,300 24%
$9,301 to $12,750 35%
all over $12,750 37%
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This greatly simplified the kiddie tax by applying a single set of tax rates to all of a child’s
unearned income. Moreover, a child’s tax rate is no longer affected by his or her parents’ tax
situation or the unearned income of any siblings.
However, these rates can be higher than the parents’ rates, which would have applied under prior
law. For example, the kiddie tax rate is 37% on income over $12,750. A married couple would
have to have over $612,350 in income in 2019 to pay tax at this rate. It is not advantageous to
arrange for the dependent children to have substantial amounts of unearned income.
On the other hand, children with smaller unearned incomes can pay less under these tax rates.
For example, a child can have up to $4,800 in unearned income and pay only a 10% tax on
$2,600 of it, for a $260 total tax ($4,800 unearned income - $2,200 kiddie tax floor = $2,600
income subject to kiddie tax; 10% x $2,600 = $260). Most parents pay income tax at a higher
rate than 10% (married taxpayers would have to have a taxable income of $19,400 or less to pay
tax at this rate).
If the child has unearned income subject to the kiddie tax, he or she should file his or her own tax
return with IRS Form 8615, Tax for Certain Children Who Have Unearned Income.
Final Regulations Expand Use of Health Reimbursement Arrangements
The U.S. Departments of Health and Human Services, Labor, and Treasury issued final
regulations, which expand the use of a new type of health reimbursement arrangement (HRA)
and allow those HRAs to be integrated with individual health insurance coverage.
When employers have fully adjusted to the regulations, the Departments estimate that the
expansion of HRAs will benefit approximately 800,000 employers and more than 11 million
employees and family members, including an estimated 800,000 Americans who were
previously uninsured.
Background
Health reimbursement accounts or health reimbursement arrangements (HRAs) are employer-
funded group health plans from which employees are reimbursed tax-free for qualified medical
expenses up to a fixed dollar amount per year. Unused amounts may be rolled over to be used in
subsequent years. The employer funds and owns the account.On June 13, the Departments of
Labor, Health and Human Services, and Treasury issued final regulations, which permit
employers to offer a new "Individual Coverage HRA" as an alternative to traditional group
health plan coverage, subject to certain conditions. The final regulations, which are effective
beginning in January of 2020, also introduce another new HRA, the Excepted Benefit HRA.
Individual Coverage HRA and Excepted Benefit HRA
Among other medical care expenses, the new Individual Coverage HRAs can be used to
reimburse premiums for individual health insurance chosen by an employee as well as
subsidizing an employee's premiums in the individual Exchange (Obamacare) market. These
HRAs promote employee and employer flexibility, while also maintaining the same tax-favored
status for employer contributions towards a traditional group health plan.
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The final regulations also increase flexibility in employer-sponsored insurance by creating a
second limited kind of HRA, the "Excepted Benefit HRA" that can be offered to employees in
addition to a traditional group health plan. These "Excepted Benefit HRAs," the benefits of
which are capped at $1,800, permit employers to finance out-of-pocket medical care costs (for
example, the cost of copays, deductibles, or other expenses not covered by the primary plan)
even if the employee declines enrollment in the traditional group health plan.
Mechanics of an Individual Coverage HRA
An Individual Coverage HRA reimburses employees for their medical care expenses (and
sometimes their family members' medical care expenses), up to a maximum dollar amount that
the employer makes available each year. The employer can allow unused amounts in any year to
roll over from year to year. Employees must enroll in individual health insurance (or Medicare)
for each month the employee (or the employee's family member) is covered by the Individual
Coverage HRA. This can be individual health insurance offered on or off an Exchange.
However, it cannot be short-term, limited-duration insurance (STLDI) or coverage consisting
solely of dental, vision, or similar "excepted benefits." There are many other important
requirements as well.
The following are some of the features and/or requirements of Individual Coverage HRAs:
(4) An employer must offer the same terms to all participants within a class, with the
exception that an employer can (i) offer higher HRA contributions based on an
employee's age (limited to up to three times as much as the contribution to the HRA's
youngest participant), and (ii) offer higher HRA contributions based on an employee's
family size;
(5) Employers that offer traditional group health insurance coverage to current employees
can offer Individual Coverage HRAs to new employees in the same class;
(6) Individual Coverage HRAs allow for the combination of classes of employees but, in
certain circumstances, apply a minimum class size requirement;
(7) A minimum class size requirement, which varies based on employer size, applies to
certain classes of employees in certain circumstances in which the potential for health
factor discrimination is greatest;
(8) A minimum class size requirement applies for Individual Coverage HRAs only if the
plan sponsor offers a traditional group health plan to at least one other class of
employees and offers an Individual Coverage HRA to at least one class of employees;
(9) If the minimum class size requirement applies, it applies only to certain classes that are
offered an Individual Coverage HRA and does not apply to a class of employees
offered a traditional group health plan or to a class of employees that is not offered any
group health plan;
(10) Where the minimum class size rules apply, the minimum class size is equal to 10
employees for an employer with fewer than 100 employees; equal to 10 percent of the
total number of employees (rounded down to a whole number), for an employer with
100 to 200 employees; and equal to 20 employees for an employer that has more than
200 employees;
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(11) Individual Coverage HRAs are not the property of the employee and employers
may limit the amount that can be carried over from year-to-year or accessed by the
employee after separation, subject to applicable COBRA or other continuation of
coverage requirements;
(12) Individual Coverage HRAs do not require that a minimum number of individual
health insurance plans be available to employees in order for the employer to offer an
Individual Coverage HRA; and
(13) Individual Coverage HRA may include full-time employees and part-time
employees as separate permitted classes.
Individual Coverage HRA and Premium Tax Credit
The premium tax credit (PTC) provided in Code Sec. 36B was enacted as part of the Affordable
Care Act. It is a refundable tax credit for eligible individuals and families who purchase health
insurance through an insurance Exchange. The PTC, which is payable in advance directly to the
insurer, subsidizes the purchase of certain health insurance plans through an Exchange and is
available for lower income taxpayers.
A taxpayer cannot claim the PTC for Exchange health insurance coverage for any month the
taxpayer is covered by the Individual Coverage HRA. Nor can a taxpayer claim the PTC for the
Exchange coverage of any family members for any month those members are covered by the
Individual Coverage HRA. If a taxpayer opts out of the Individual Coverage HRA and the HRA
is considered unaffordable, the taxpayer may claim the PTC for him or herself and any family
members enrolled in Exchange coverage if such taxpayers are otherwise eligible. If a taxpayer
opts out of the HRA and the HRA is considered affordable, the taxpayer may not claim the PTC
for him or herself or any family members.
Advantages and Disadvantage of the Final Regulations
Many healthcare professionals have weighed in on whether these new rules will favorably or
unfavorably impact employees and the health insurance market in general. On the plus side,
Individual Coverage HRAs provide tax advantages because the reimbursements provided to
employees under the HRA are not includible in employees' taxable wages and the expenses are
deductible by employers. Individual Coverage HRAs extend the tax advantage for traditional
group health plans to HRA reimbursements of individual health insurance premiums. Employers
may also allow employees to pay for off-Exchange health insurance on a tax-favored basis, using
a salary reduction arrangement under a cafeteria plan, to make up any portion of the individual
health insurance premium not covered by the employee's Individual Coverage HRA. The term
"off-Exchange health insurance" refers to a health insurance policy that is purchased directly
from a health insurance carrier or through an agent or broker, outside of the official Affordable
Care Act-created health insurance exchange.
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According to HHS, in most cases, the Individual Coverage HRA rule is advantageous because it
will increase worker options for health insurance coverage by allowing workers to shop for plans
in the individual market and select coverage that best meets their needs. It will also result in
coverage being more portable for many workers. Citing a 2018 Kaiser Family Foundation
Employer Health Benefits Survey, HHS said that 81% of small to midsized employers (i.e., those
with fewer than 200 employees) and 42% of larger employers (i.e., those with at least 200
employees) offering health benefits in 2018 provided only one type of health plan to their
employees.
The HRA rule should also help small employers, who face larger administrative costs from
offering a traditional group health plan, compete for talent. HHS noted that a significant number
of small employers have stopped offering coverage since 2010. According to the 2018 Kaiser
survey, between 2010 and 2018, the percentage of firms offering coverage declined from 59% to
47% at firms with 3-9 workers, from 76% to 64% at firms with 10-24 workers, from 92% to 71%
at firms with 25-49 workers, and from 95% to 91% at firms with 50-199 workers. Expanding the
number of employers providing healthcare coverage means a broader market over which the
healthcare risks are distributed and this could lead to a lowering of premiums for that market.
Other healthcare professionals are taking a wait-and-see approach, noting that the new rules will
shake up the insurance market with respect to employer-provided health insurance, but it is
unclear how that will play out. Some commented on the fact that many opponents of the
Medicare-for-All insurance plan have used the fact that such a plan would disrupt employer-
provided health insurance as a reason to oppose the plan.
According to the Brookings Institute, a nonprofit public policy organization based in
Washington, D.C., changes in employer coverage arrangements under the new rules will create
winners and losers within firms to the extent that firms do not make offsetting changes to their
compensation structures, with younger and higher-income workers generally benefiting at the
expense of older and lower-income workers. The final rule's limitation on how much
contributions to Individual Coverage HRAs can vary by age makes such effects more likely.
Foreign Earned Income and Housing Exclusion
Covid-19 Qualified individuals may exclude a portion of their foreign earned income and
housing costs under IRC section 911.
The exclusion applies if the qualified individual:
A) Is a U.S. citizen whose tax home is in a foreign country and establishes that he or she
is a bona fide resident of a foreign country for an uninterrupted period that includes the
entire tax year, or
B) Is a U.S. citizen or resident who, during any period of 12 consecutive months, is
present in a foreign country during at least 330 full days.
A qualified individual will qualify as a bona fide resident or under the physical presence test if
the individual left the country because of war, civil unrest, or similar adverse conditions that
precluded the normal conduct of business.
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For 2019 and 2020, the IRS has ruled that the COVID-19 Emergency is an adverse condition that
precluded the normal conduct of business as follows:
• In the People’s Republic of China, excluding the Special Administrative Regions of
Hong Kong and Macau (China), as of December 1, 2019, and
• Globally as of February 1, 2020.
The period covered by the COVID-19 Emergency period ends on July 15, 2020, unless an
extension is announced by the IRS. Individuals who left China on or after December 1, 2019, or
another foreign country on or after February 1, 2020, but on or before July 15, 2020, will be
treated as a qualified individual; if such individual establishes a reasonable expectation that he or
she would have met the requirements under IRC section 911, but for the COVID-19 Emergency.
Example 1: An individual arrived in China on September 1, 2019, and established that he
reasonably expected to work in China until September 1, 2020, but departed China on
January 10, 2020, due to the COVID-19 Emergency. Assuming the individual meets all
the other requirements under IRC section 911, the individual is considered a qualified
individual.
Example 2: An individual was present in the United Kingdom on January 1 through
March 1, 2020, established that he reasonably expected to work in the United Kingdom
for the entire calendar year, but left the United Kingdom on March 2, 2020, due to the
COVID-19 Emergency. He returns to the United Kingdom on August 25, 2020, for the
remainder of the year. Assuming the individual meets all the other requirements under
IRC section 911, the individual is considered a qualified individual.
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FinCen
Foreign Account and Asset Reporting
A resident alien or U.S. citizen files Form 8938, Statement of Foreign Financial Assets, and/or
Financial Crimes Enforcement Network (FinCEN) Form 114, Report of Foreign Bank and Financial
Accounts, to report foreign bank accounts, securities, retirement plans, and other certain specified
assets.
Form 8938
The Form 8938 is an informational reporting form for reporting specified foreign financial assets
owned by a resident alien or U.S. citizen. A specified individual must file Form 8938 if the
individual has an interest in one or more specified foreign financial assets and the aggregate value of
those assets exceed a threshold.
Filing Status Living In U.S. Presence Abroad
Last Day Anytime Last Day Anytime
Unmarried (S,HH) $50,000 $75,000 $200,000 $300,000
MFJ $100,000 $150,000 $400,000 $600,000
MFS $50,000 $75,000 $200,000 $300,000
A specified individual is:
A U.S. citizen.
A U.S. resident alien for any part of the year.
A nonresident alien who elects treatment as a resident alien for purposes of filing a joint
income tax return.
A nonresident alien who is a bona fide resident of American Samoa or Puerto Rico.
The definition of a specified foreign financial asset for purposes of Form 8938 is:
Depository or custodial financial accounts maintained by a foreign financial institution.
To the extent not held in an account at a financial institution:
Stocks or securities issued by foreign corporations.
Any financial instrument or contract that has an issuer or counterparty that is not a U.S.
person.
Any interest in a foreign entity155
A taxpayer files Form 8938 with his or her Form 1040.
155 §6038D(b); Reg. §1.6038D-3
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Failure to File Form 8938
A taxpayer who is required to file Form 8938 but does not file a complete and correct form
by the due date is subject to a penalty up to $10,000.
For a failure to file within 90 days after the IRS sends a notice of the failure to file, an
additional penalty of $10,000 applies for each 30-day period the failure continues.
The maximum additional penalty is $50,000.
FinCEN Form 114
The FinCEN Form 114 is an informational reporting document reporting the ownership interest
or signature authority over a foreign bank or financial account. A taxpayer with at least $10,000 in
foreign financial or bank accounts at any time during the calendar year must file a FinCEN Form
114. A United States person has a financial interest if the U.S. person is the owner of record or
holder of legal title, regardless of whether maintaining the account for the benefit of the U.S.
person or for the benefit of another person.
In Ott. v. U.S156 a district court held that a taxpayer who owned several Canadian
brokerage accounts was liable for almost $1 million in penalties for failing to Report of
Foreign Bank and Financial Accounts (FBAR) for calendar years 2007, 2008, and 2009.
The court concluded that the taxpayer's failure to review his tax returns; his decision not
to ask his tax preparer about foreign account reporting obligations; his decision to send
his mail to a Canadian address; and his knowledge of almost a million dollars in account
balances for the years in question, all indicated that he acted with reckless disregard to his
reporting requirements
The filing threshold for married taxpayers filing a joint tax return starts when the combined total
account balance exceeds $10,000 at any time during the tax year. U.S. persons, U.S. citizens,
resident aliens, trusts, estates, and domestic entities are all subject to this filing requirement and
threshold amount. Taxpayers are required to report the ownership in the foreign account
electronically on a Financial Crimes Enforcement Network (FinCEN) Report 114, Report of
Foreign Bank and Financial Accounts (FBAR). Electronic filing is done by using FinCEN’s
BSA online e-filing system at http://bsaefiling.fincen.treas.gov/main.html.
Do not confuse the FinCEN Report 114 FBAR reporting and Form 8938, Statement of Specified
Foreign Financial Assets. These forms are used to report similar and sometimes the same
information, but the information reported can be different information. To understand the
difference, Form 8938 reports foreign financial assets. The FBAR reports foreign financial
accounts. The term “asset” incorporates more than just financial accounts. The filing threshold
for Form 8938, if living in the U.S., is $50,000 ($100,000 for MFJ) on the last day of the tax year
or $75,000 ($150,000 for MFJ) at any time during the tax year. Higher threshold amounts apply
to individuals living abroad. Form 8938 is filed with the tax return; FBAR reporting is a separate
filing requirement.
In August 2016, the IRS assessed penalties on Mr. and Mrs. Ott totaling $60,000 [10,000 x 2
156 2020 PTC 77 (E.D. Mich. 2020),
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accounts (3 years)] along with late payment penalties and interest for an addition of
approximately $13,000. The taxpayers appeared in court to request reasonable cause on their
failure to comply with the filing requirements. Mrs. Ott admitted they did not disclose the
accounts, but she was unable to present evidence in support of reasonable cause for failure to
disclose the foreign accounts.
The Otts suggested they took reasonable steps by hiring a tax professional who prepared their
income tax returns. Reliance on the tax professional would suggest reasonable cause, in which
penalties should be abated according to Tracey. For reasonable cause, the taxpayer must
ultimately rely upon the advice in good faith and prove the professional was competent by
having expertise in the subject matter, to justify the reliance. The taxpayer must also prove that
they provided all necessary and accurate information to that professional. Tracey was unable to
support reasonable cause due to the fact they never disclosed the accounts to their tax
professional.
The court moved to grant judgement summary against the Otts, stating the time to present
evidence in support of their defense was in court. Disputes of material fact must be submitted
timely. Reasonable cause circumstances include an honest misunderstanding of the law and good
faith in the reliance of a tax professional to the extent of the taxpayers’ effort to assess their
proper tax liability. The Otts failed to provide their foreign financial information to their tax
professional.
When preparing income tax returns, tax professionals should at least be asking their clients the
right questions, multiple times if applicable, to help determine whether the clients may have
other filing obligations.
A United States person also has a financial interest in a foreign financial account in which the
owner of record or holder of legal title is one of the following:
An agent, nominee, attorney, or a person acting in some other capacity on behalf of the
U.S. person with respect to the account.
A corporation in which the U.S. person owns directly or indirectly either:
o More than 50% of the voting power of shares of stock.
o More than 50% of the voting power of all shares of stock.
A partnership in which the U.S. person owns directly or indirectly either:
o An interest in more than 50% of the partnership’s profits.
o An interest in more than 50% of the partnership’s capital.
A trust of which the U.S. person:
o Is the grantor of the trust.
o Has an ownership percentage in the trust for U.S. federal tax purposes.
A trust in which the U.S. person has greater than 50% present beneficial interest in the
assets or income of the trust for the calendar year.
Any other entity in which the U.S. person owns directly or indirectly more than 50% of
the voting power, total value of equity interest or assets, or interest in profits.
In regards to Form 114, a person means a taxpayer (including a minor child) and legal entities
including but not limited to, a limited liability company, corporation, partnership, trust, and
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estate. Signature authority is the authority of a taxpayer (alone or in conjunction with another
individual) to control the disposition of assets held in a foreign financial account by direct
communication (whether in writing or otherwise) to the bank or other financial institution that
maintains the financial account. A foreign bank or financial account is any financial account
located outside the United States.
A reportable account includes:
Securities.
Brokerage.
Savings.
Demand.
Checking.
Deposit.
Time deposit.
Other accounts maintained by a financial institution or (other person performing the
services of a financial institution).
Commodity futures or options account.
Insurance policy with a cash value.
Annuity policy with a cash value.
Shares in a mutual fund or similar pooled fund (a fund that is available to the general
public with a regular net asset value determination and regular redemptions).
Due Date for FinCEN
The due date of the FinCEN Form 114 is on or before April 15 of the succeeding year and has an
automatic six-month extension (that means no request is needed to obtain an extension). In
addition, U.S. persons filing FinCEN Form 114 must file electronically through FinCEN’s BSA E-
Filing System. This is not part of the taxpayers’ federal income tax return.
FinCEN Form 114 Penalties
A taxpayer who is required to file FinCEN Form 114 and fails to do so is subject to a civil
penalty not to exceed $10,000 per violation.
For a taxpayer who reported all taxable income and paid the tax on that income in a prior
year, but just failed to file FinCEN Form 114, the IRS can waive the penalty.
A taxpayer who willfully fails to report an account or account identifying information
may be subject to a civil monetary penalty equal to the greater of
o $100,000 or
o 50% of the balance in the account at the time of the violation.
The criminal penalty for willful failure to file is a fine of not more than $250,000 or
imprisonment for not more than five years, or both. If the violation is part of a pattern of
illegal activity, the maximum fine is $500,000 and the maximum length of sentence is 10
years.
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What Do You Think?
Q1. Which of the following is not correct regarding Health Reimbursement Accounts
(HRAs)?
A. An HRA is an employer-funded group health plan.
B. Unused amounts may be rolled over to be used in subsequent years.
C. The employer arranges for outside funds who manages and owns the account.
D. Employees are reimbursed tax-free for qualified medical expenses up to a fixed
dollar amount per year.
Q2. Which of the following would be a qualified individual for the COVID-19
Emergency in an adverse condition for the foreign income exclusion and housing
allowance?
A. An individual arrived in China on August 1, 2019, and established that he reasonably
expected to work in China until August 1, 2020, but departed China on February 2,
2020, due to the COVID-19 Emergency. Assuming the individual meets all the other
requirements.
B. An individual was present in France on January 1 through March 1, 2020, established
that he reasonably expected to work in France for the entire calendar year, but left the
France on April 5, 2020, due to the COVID-19 Emergency. He returns to France on
September 1, 2020, for the remainder of the year. Assuming the individual meets all
the other requirements.
C. An individual was present in Denmark on November 12, 2019 through January 15,
2020, established that he reasonably expected to work in Denmark for the entire
calendar year, but left on January 5, 2020, due to the COVID-19 Emergency. He
returns to Denmark on July 1, 2020, for the remainder of the year. Assuming the
individual meets all the other requirements.
D. All of the above meet the requirements.
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What Do You Think? -Answers
A1.Which of the following is not correct regarding Health Reimbursement Accounts (HRAs)?
Answer C is not correct
A. An HRA is an employer-funded group health plan.
B. Unused amounts may be rolled over to be used in subsequent years.
C. The employer arranges for outside funds who manages and owns the account.
D. Employees are reimbursed tax-free for qualified medical expenses up to a fixed dollar
amount per year.
Health reimbursement accounts or health reimbursement arrangements (HRAs) are
employer-funded group health plans from which employees are reimbursed tax-free for
qualified medical expenses up to a fixed dollar amount per year. Unused amounts, may be
rolled over to be used in subsequent years. The employer funds and owns the account it is
not funded or owned by anyone other than the business.
A2 Answer C does not meet requirements
Which of the following would be a qualified individual for the COVID-19 Emergency in an
adverse condition for the foreign income exclusion and housing allowance?
A. An individual arrived in China on August 1, 2019, and established that he reasonably
expected to work in China until August 1, 2020, but departed China on February 2, 2020,
due to the COVID-19 Emergency. Assuming the individual meets all the other
requirements.
B. An individual was present in France on January 1 through March 1, 2020, established that
he reasonably expected to work in France for the entire calendar year, but left the France
on April 5, 2020, due to the COVID-19 Emergency. He returns to France on September
1, 2020, for the remainder of the year. Assuming the individual meets all the other
requirements.
C. An individual was present in Denmark on November 12, 2019 through January 15,
2020, established that he reasonably expected to work in Denmark for the entire
calendar year, but left on January 5, 2020, due to the COVID-19 Emergency. He
returns to Denmark on July 1, 2020, for the remainder of the year. Assuming the
individual meets all the other requirements.
D. All of the above meet the requirements.
C does not meet the requirements because he or she left Denmark prior to February 1, 2020.
For 2019 and 2020, the IRS has ruled that the COVID-19 Emergency is an adverse condition that
precluded the normal conduct of business as follows:
• In the People’s Republic of China, excluding the Special Administrative Regions of
Hong Kong and Macau (China), as of December 1, 2019, and
• Globally as of February 1, 2020
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Chapter 8 - Business Related Changes
Paycheck Protection Program
The Paycheck Protection Program is part of the CARES Act.
Information regarding this loan is discussed in the Update Section
of this Syllabus. This loan is designed to provide a direct
incentive for small businesses to keep their workers on the payroll.
SBA will forgive loans if all employees are kept on the payroll for eight weeks and the money is
used for payroll, rent, mortgage interest, or utilities.
The taxpayer can apply through any existing SBA 7(a) lender or through any federally insured
depository institution, federally insured credit union, and Farm Credit System institution that is
participating. Other regulated lenders will be available to make these loans once they are
approved and enrolled in the program. The taxpayer should consult with your local lender as to
whether it is participating in the program.
The ability for businesses to apply for and obtain a Paycheck Protection Program (PPP) loan was
established by CARES Act. Under the PPP, a recipient of a covered loan may use the proceeds to
pay:
Payroll costs including certain employee benefits relating to healthcare
Interest on mortgage and other debt obligations
Rent
Utilities
There has been many questions regarding this program and as a result changes have been
implemented and explanations released by the IRS. The following paragraphs are a few of those.
Paycheck Protection Loan Forgiveness Application - EZ
The U.S. Small Business Administration (SBA) posted a revised, Paycheck Protection Program
(PPP) loan forgiveness application implementing the PPP Flexibility Act of 2020. In addition
to revising the full forgiveness application, SBA also published a new EZ VERSION of the
forgiveness application that applies to borrowers who:
Are self-employed and have no employees; or
Did not reduce the salaries or wages of their employees by more than 25%, and did not
reduce the number or hours of their employees; or
Experienced reductions in business activity as a result of health directives related to
COVID-19 and did not reduce the salaries or wages of their employees by more than
25%.
The EZ application requires fewer calculations and less documentation for eligible borrowers.
Details regarding the applicability of these provisions are available in the instructions to the new
form.
Objectives:
Explain with examples the
miscellaneous business changes.
TCJA changes and CARES act are
discussed with examples.
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Both applications give borrowers the option of using the original 8-week covered period (if their
loan was made before June 5, 2020) or an extended 24-week covered period. These changes will
result in a more efficient process and make it easier for businesses to realize full forgiveness of
their PPP loan.
PPP Flexibility
The Congress has passed several bills modifying the PPP and other items contained in the
CARES Act. The following are a few changes and explanations of interest.
Extending the minimum maturity of PPP loans that still have a remaining balance after
the government forgives part of them to five years. The government would continue to
guarantee the remainder of the loan.
Extending the PPP lifespan from June 30, 2020, to Dec. 31, 2020, for using loan
proceeds.
Extending the period during which businesses may spend PPP loan funds from eight
weeks after issuance to the earlier of 24 weeks after issuance or Dec. 31, 2020 (though
eligible employers may elect to retain the eight-week covered period instead).
Specifying that PPP loans can be forgiven even if the number of full-time employees
decreases, as long as the employer can prove:
o it attempted to rehire the same number of employees, but its former employees
were unavailable;
o similarly qualified employees were unavailable; or its business is unable to return
to the same level of activity it had before Feb. 15, 2020.
Lowers the amount that must be spent on payroll to be eligible for forgiveness from 75%
to 60%.
Allowing all employers to take advantage of the CARES Act deferral of the 6.2%
employer portion of Social Security payroll taxes, regardless of whether they have had a
PPP loan forgiven.
All the changes would be effective retroactively, as if included in the CARES Act originally.
The SBA has reported that 4.5 million businesses have received approval for loans totaling
$510.6 billion. About $130 billion remain available for loans.
Clarification of Deductions
According to Notice 2020-32, businesses that qualify for PPP loan forgiveness, will not be able
to deduct certain business expenses, including wages, paid for by the loan, and the income
associated with the forgiveness is excluded from gross income.
"The money coming in the PPP is not taxable. So, if the money that is coming is not taxable, you
cannot double dip," Mnuchin said in a televised interview. "You cannot say that you are going to
get deductions for workers that you did not pay for."
Most tax professionals are used to this situation; however, some believe Congress intended for
these expenses to still be deductible. In fact, a bipartisan group of Senators introduced a bill this
week that would make this change. It is pending.
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The SBA issued updated PPP FAQ, https://www.sba.gov/document/support--faq-lenders-
borrowers that includes guidance on loan forgiveness if an employee declines to return to work.
The answer to question 40 states that the loan forgiveness amount will not be reduced if an
employee declines to return to work. Keep check the FAQ’s they are a good source of
information.
Excess Business Losses -TCJA
Under TCJA, for tax years beginning after December 31, 2017, excess business losses157 of a
taxpayer other than a corporation are not allowed for the tax year.
Such losses are carried forward and treated as part of the taxpayers’ net operating loss (NOL)
carryforward in subsequent tax years. Another significant change in the TCJA is the limitation of
excess losses for taxpayers other than corporations. For purposes of the excess business loss
limitation, a nonpassive activity is a trade or business activity in which the taxpayer owns an
interest and materially participates in the activity. Internal Revenue Code (IRC) Section 469
defines “material participation” as an activity in which the taxpayer is involved in the operation
on a regular, continuous and substantial basis.
Prior to the TCJA’s passage, there were no limitations on the amount of excess business losses
an individual taxpayer could deduct in a tax year. This allowed individual taxpayers to directly
offset other sources of income, including wages, interest, dividends and capital gains with losses
generated from nonpassive business activities, regardless of the size of the loss generated.
Effective for tax years beginning after December 31, 2017, the TCJA disallows excess business
losses for taxpayers other than corporations. This “deduction reduction” is calculated as the
excess of the taxpayers’ aggregate deductions attributable to trades or businesses, over the sum
of the aggregate gross income or gain attributable to trades or businesses plus a threshold amount
($500,000 for Married Filing Jointly and $250,000 for all other taxpayers). The excess loss
becomes an NOL carried forward indefinitely.158 This limitation applies at the partner or S
corporation shareholder level and expires December 31, 2025, absent future legislation.
The CARES Act, amended section 461(l) to restrict the limitation on excess business losses of
noncorporate taxpayers to tax years beginning after 2020 and before 2026. The CARES Act
repealed the limitation for tax years 2018, 2019, and 2020. Form 461, Limitation of Business
Losses, has been eliminated for those years. If the taxpayer filed a 2018 and/or 2019 return(s)
with the limitation, they can file an amended return.
157 IRC§§ 461(5)(l) & 199(A) 158 IRC§172
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Excess Business Losses – The CARES Act Overview -Section 2304 of the Act amended IRC Section 461 such that:
The $250,000 (or $500,000 for married taxpayers filing jointly) limitation on excess
business losses for non-corporate taxpayers does not apply until January 1, 2021. As a
result, affected taxpayers may be able to fully deduct business losses arising in 2018, 2019
and 2020.
An excess business loss for a taxable year is determined without regard to any:
1. NOL deduction;
2. Qualified Business Income deduction;
3. Capital loss deduction; and
4. Deductions, gross income or gains attributable to any trade or business of
performing services as an employee.
The amount of net capital gain included in the excess business loss calculation may not
exceed the lesser of the taxpayer’s:
1. Net capital gain attributable to trades or businesses; or
2. Total net capital gain
The CARES Act lifts the disallowance of “excess business losses” for individuals and flow-
through entities for taxable years beginning before December 31, 2020159. Under the TCJA,
noncorporate taxpayers were permitted deductions attributable to a trade or business only up to
the amount of the income or gain attributable to that trade or business for the tax year plus
$250,000 ($500,000 for joint filers). This TCJA limitation applied to tax years beginning after
December 31, 2017 and before December 31, 2026. The CARES Act lifts this limitation for tax
years beginning in 2018, 2019, and 2020, permitting deduction of business losses in excess of the
above threshold. For tax years beginning in 2021 through 2026, taxpayers may treat excess
business losses as NOLs for purposes of determining a net operating loss carryover in the
following year. As a result, individual taxpayers that incurred an excess business loss limitation
in 2018 and/or 2019 should consider amending their 2018 and/or 2019 income tax return(s) to
remove the limitation.
The CARES Act also makes certain technical corrections to the TCJA with respect to the
calculation of excess business losses.
The determination of excess business losses takes into account the lesser of
(i) Capital gain attributable to a trade or business or
(ii) Net capital gain income.
Excess business losses are determined without regard to any capital losses or any deductions,
gross income, or gains attributable to any trade or business of performing services as an
employee. Deductions allowable under Sections 172 and 199A are not taken into account in
determining excess business losses.
159 CARES Act §304, IRC §461(1)
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Modifications of Limitation on Deductibility of Business Interest160
Increase in Business Interest Expense Limitation. The CARES Act increases the business interest
expense limitation (as amended by the TCJA) from 30% to 50% of adjusted taxable income for
tax years beginning in 2019 and 2020. For these tax years, taxpayers subject to the limitation
(generally, taxpayers with average annual gross receipts for the prior three tax years below $26
million) may now deduct business interest expense up to 50% of their adjustable taxable income.
However, taxpayers may still elect to apply the 30% limitation. In the case of a partnership, the
election must be made by the partnership.
Special Rules for Partnerships. The increased limitation does not apply to partnerships for tax
years beginning in 2019. However, partners allocated excess business interest in a tax year
beginning in 2019 will be treated as having fully deductible business interest in the following tax
year equal to 50% of that allocated excess business interest amount. The remaining 50% of such
allocated excess business interest will be subject to the customary limitations for excess business
interest, such that it can only be applied against subsequent tax years’ excess taxable income
from the partnership.
Election to Use 2019 Taxable Income to Compute Limitation. For tax years beginning in 2020,
taxpayers may elect to use their 2019 adjusted taxable income to determine the limitation amount
(prorated if the taxpayer’s 2020 tax year is a short tax year). This election must also be made at
the partnership level.
Accelerated AMT Credit Recovery161
The CARES Act allows for accelerated recovery of corporate alternative minimum tax
refundable credits. TCJA repealed the AMT and allowed corporations to recover AMT credits,
including via refund, in years 2018 through 2021.
The CARES Act accelerates the recovery and refund of such credits to the taxable years
beginning in 2018 and 2019. Further, corporations may elect to recover the full amount of
refundable AMT credits in the first tax year beginning in 2018. The application must be filed
prior to December 31, 2020 and must state the amount of the refund claimed.
Technical Amendments Regarding Qualified Improvement Property162
The CARES Act makes qualified improvement property eligible for bonus depreciation.
Qualified improvement property is any improvement to an interior portion of a building, which is
nonresidential real property. This provision corrects a drafting error in TCJA that caused
qualified improvement property to be depreciated over 39 years as opposed to the intended 20
years, rendering qualified improvement property ineligible for bonus depreciation. The CARES
Act sets the depreciable life of qualified improvement property at 20 years, allowing taxpayers to
take advantage of bonus depreciation
160 CARES Act §2306, IRC §163(j) 161 CARES Act §2305, IRC §59 162 CARES Act §2307, IRC §168
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Net Operating Loss -TCJA
For tax years ending after December 31, 2017, the NOL is limited to 80% of taxable income. The
option to carryback an NOL is disallowed. The remaining NOL is carried forward to the
following year; it continues to be carried forward until it is used up.
To have an NOL, the loss must generally be caused by deductions from:
Trade or business,
Work as an employee (although not deductible for most taxpayers in 2018),
Casualty and theft losses resulting from a federally declared disaster,
Moving expenses (although not deductible for most taxpayers in 2018), or
Rental property.
A loss from operating a business is the most common reason for an NOL. Partners or
shareholders can use their separate shares of the partnership's or S-Corporation's business income
and business deductions to figure their individual NOLs.
For tax years beginning before January 1, 2018, NOLs were able to offset 100% of taxable
income. They were carried back two years and carried forward for twenty years. Under TCJA an
NOL can offset only 80% of taxable income in any given tax year. Furthermore, NOLs can no
longer be carried back, they must be carried forward. The 20-year carryforward period has been
replaced with an indefinite carryforward period.
NOLs created in tax years beginning before January 1, 2018 are subject to the old rules. Only
NOLs generated in tax years beginning after December 31, 2017 are subject to the new rules.
For tax years beginning before January 1, 2018, losses from a non-passive business were allowed
to offset other sources of income without restriction.
For tax years beginning January 1, 2018 through December 31, 2025, excess business losses of a
taxpayer other than a corporation are not deductible in the current year and the NOL.
Example: Bob the Builder is a single taxpayer owns a construction company. The company was
formed as an S Corp with the individual taxpayer as the sole owner. His business had always
shown a profit, but in 2018, the taxpayer suffers a $500,000 loss on operations. Bob has the
following income from other sources for the 2019 tax year:
In this scenario under prior tax law, disregarding adjustments for other deductions, the taxpayer
would report adjusted gross income (AGI) equal to the sum of these income and loss items for a
net loss of $40,000. This loss would be reported on the taxpayers’ 2018 federal income tax
return, creating an NOL that—under prior tax law—would be eligible for a two-year carryback
or 20-year carryforward.
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Under TCJA, the taxpayers’ loss generated from the business would be limited to a total of
$250,000, with any excess loss treated as part of the taxpayers’ NOL carryforward to subsequent
years. Therefore, in this scenario, the taxpayer would report AGI of $210,000 ($300,000 +
$10,000 + $150,000 - $250,000 (excess business threshold)) on the 2018 federal income tax
return and may be required to pay income tax, depending on other personal deduction items.
The $250,000 excess business loss is treated as an NOL under the new tax law and carried
forward indefinitely, subject to the 80 percent of taxable income limitation mentioned above.
The CARES Act includes corporate and other business tax relief, including permitting
carrybacks of (and the lifting of the taxable income limitation on the use of) net operating losses
(“NOLs”), increased business interest deductibility, and accelerated recovery of alternative
minimum tax credits, among other forms of relief.
Net Operating Loss – CARES Act
Overview - Section 2303 of the Act amended IRC Section 172 such that:
The 80 percent of taxable income limitation does not apply to NOLs arising in 2018,
2019 or 2020.
Any NOL arising in a taxable year beginning after December 31, 2017, and before
January 1, 2021, generally must be carried back to each of the five taxable years
preceding the taxable year in which the loss arises. As a result, taxpayers must generally
take into account such NOLs in the earliest taxable year in the five-year carryback
period, and carry forward the unused amount to each succeeding taxable year. However,
taxpayers are permitted to make an irrevocable election to relinquish the NOL carryback
period for any taxable year.
The CARES Act expands taxpayers’ ability to deduct NOLs arising before the 2021 taxable year,
by temporarily lifting the 80% limitation on NOLs. The Tax Cuts and Jobs Act of 2017 limited
NOL deductions for taxable years beginning after December 31, 2017 to 80% of taxable income
in the year of the deduction. The CARES Act lifts the 80% taxable income limitation on the use
of NOLs for taxable years beginning before January 1, 2021. However, NOLs carried forward
from 2018, 2019 or 2020 to taxable years beginning after December 31, 2020 will be subject to
the 80% limitation163.
163 CARES Act §2303,IRC §172
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The TCJA generally disallowed the use of NOLs against the income of prior tax years. The
CARES Act allows an NOL incurred by a corporation in tax years beginning after December 31,
2017 and before January 1, 2021 to be carried back to each of the five tax years preceding the tax
year of the NOL. An NOL arising during this period that a taxpayer elects to carry back must be
carried back to the earliest year within the five-year period in which the taxpayer has taxable
income. As under pre-CARES law, a taxpayer may elect to waive the carryback period.
A taxpayer that is a real estate investment trust for a given tax year may not carry back NOLs
incurred during that tax year to any preceding tax year. Similarly, any NOL incurred in a taxable
year in which a taxpayer is not a REIT may not be carried back to a preceding tax year in which
the taxpayer was a REIT.
For life insurance companies, any NOL carryback to a tax year beginning before January 1, 2018
will be treated in the same manner as an operations loss carryback under the rules existing before
TCJA.
TCJA required certain U.S. shareholders of a foreign corporation to include in gross income their
share of the foreign corporation’s earnings that were not previously subject to U.S. tax.164 Under
the CARES Act, income may not be taken into account in determining the amount of an NOL or
the amount of taxable income that may be reduced by any NOL carryback. Further, the taxpayer
may elect to exclude from the five-year carryback period all years in which the taxpayer included
income under Section 965. Such an election must be made by the filing return deadline for the
first taxable year ending after March 27, 2020.
Taxpayers considering whether to make the election to relinquish the carryback period or to
exclude taxable year in which the taxpayer had Section 965 income from the carryback period
for their 2018 or 2019 taxable years have until the due date (including extensions) for filing their
tax returns for the first taxable year ending after the date of enactment (March 27, 2020).
164 CARES Act §965
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Extended Time Limit for IRS Levy
The IRS reminds individuals and businesses that they have additional time to file an
administrative claim or bring a civil action for wrongful levy or seizure165. Tax reform legislation
enacted in December, 2018 extended the time limit from nine months to two years.
Here are some facts about levies and the extension of time to file a claim or civil action:
An IRS levy permits the legal seizure and sale of property to satisfy a tax debt. For
purposes of a levy, the term “property” includes wages, money in bank or other financial
accounts, vehicles and real estate.
The time-frames apply when the IRS has already sold the property it levied. Taxpayers
can make an administrative claim for return of their property within two years of the date
of the levy.
If an administrative claim is made within the extended two-year period, the two-year
period for bringing suit is extended for one of two periods, whichever is shorter:
o Twelve months from the date, the person filed the claim.
o Six months from the date, the IRS disallowed the claim.
The change in law applies to levies made before, on or after December 22, 2017, as long as the
previous nine-month period had not yet expired.
Anyone who receives an IRS bill titled, Final Notice of Intent to Levy and Notice of Your Right
to A Hearing, should immediately contact the IRS. By doing so, a taxpayer may be able to
arrange to pay the liability, instead of having the IRS proceed with the levy.
Applying for an EIN
As part of its ongoing security review, the Internal Revenue Service announced that starting May
13 only individuals with tax identification numbers may request an Employer Identification
Number (EIN) as the “responsible party” on the application.
An EIN is a nine-digit tax identification number assigned to sole proprietors, corporations,
partnerships, estates, trusts, employee retirement plans and other entities for tax filing and
reporting purposes.
165
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The change will prohibit entities from using their own EINs to obtain additional EINs. The
requirement will apply to both the paper Form SS-4, Application for Employer Identification
Number (PDF), and online EIN application.
Either individuals named, as responsible party must have a Social Security number (SSN) or an
individual taxpayer identification number (ITIN). The IRS made the announcement weeks in
advance, entities and their representatives will have time to identify the proper responsible
official and comply with the new policy.
The Form SS-4 Instructions (PDF) provide a detailed explanation of who should be the
responsible party for various types of entities. Generally, the responsible party is the person who
ultimately owns or controls the entity or who exercises ultimate effective control over the entity.
In cases where more than one person meets that definition, the entity may decide which
individual should be the responsible party.
Only governmental entities (federal, state, local and tribal) are exempt from the responsible party
requirement as well as the military, including state national guards.
There is no change for tax professionals who may act as third-party designees for entities and
complete the paper or online applications on behalf of clients.
The new requirement will provide greater security to the EIN process by requiring an individual
to be the responsible party and improve transparency. If there are changes to the responsible
party, the entity can change the responsible official designation by completing Form 8822-B,
Change of Address or Responsible Party. A Form 8822-B must be filed within 60 days of a
change.
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What Do You Think?
Q1. The Congress has passed several bills modifying the PPP and other items contained
in the CARES Act. Which of the following is a provision that has been modified?
A. The PPP lifespan from June 30, 2020, to Dec. 31, 2020, for using loan proceeds.
B. The amount that must be spent on payroll to be eligible for forgiveness from
75% to 60%.
C. Allowing all employers to take advantage of the CARES Act deferral of the 6.2%
employer portion of Social Security payroll taxes, regardless of whether they have had a
PPP loan forgiven.
D. All of the above statements is correct.
Q2. Which of the following is not a correct statement regarding how the CARES Act affected
excess business losses?
A. The CARES Act lifted the disallowance of excess business losses starting before
December 31, 2020.
B. QBI is not included in the computation of excess business loss for a taxable year.
C. Capital loss are considered in the computation of an excess business loss for a taxable
year.
D. All of the above statements are correct.
Q3. Tax reform legislation changed the time allowed to file an administrative claim for property
seized due to wrongful levy or seizure. How long has the time been extended?
A. Nine months.
B. Twelve months.
C. Two years.
D. Six months.
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What Do You Think? – Answers
D is the correct answer, all of the statements are correct.
A1. The Congress has passed several bills modifying the PPP and other items
contained in the CARES Act. Which of the following is a provision that has
been modified?
A. The PPP lifespan from June 30, 2020, to Dec. 31, 2020, for using loan proceeds.
B. The amount that must be spent on payroll to be eligible for forgiveness from 75% to
60%.
C. Allowing all employers to take advantage of the CARES Act deferral of the 6.2%
employer portion of Social Security payroll taxes, regardless of whether they have had a
PPP loan forgiven.
D. All of the above statements are correct.
C is the correct answer
A2. Which of the following is not a correct statement regarding how the CARES Act affected
excess business losses?
A. The CARES Act lifted the disallowance of excess business losses starting before
December 31, 2020.
B. QBI is not included in the computation of excess business loss for a taxable year.
C. Capital loss are considered in the computation of an excess business loss for a taxable
year.
D. All of the above statements are correct.
C is the correct answer because it is false. An excess business loss for a taxable year is
determined without regard to a capital loss deduction. A is correct taxpayers may be able to fully
deduct business losses arising in 2018, 2019 and 2020. B is also correct, QBI is not considered
when calculating excess business loss for the taxable year.
C is the correct answer. Taxpayers can make an administrative claim for return of their
property within two years of the date of the levy.
A3. Tax reform legislation changed the time allowed to file an administrative claim for property
seized due to wrongful levy or seizure. How long has the time been extended?
A. Nine months.
B. Twelve months.
C. Two years.
D. Six months.
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Chapter 9– Affordable Care Act
After December 31, 2018, the shared responsibility
provision has been repealed. This is not a repeal of
the Affordable Care Act. Taxpayers are still
obligated to carry health insurance, either through
their employers, through the ACA Exchange, or by
independently selecting and paying for their own ACA-compliant plans. They will no longer pay
a penalty if they do not. This is part of the Tax Cuts and Jobs Act of 2017. This change went into
effect on after Jan. 1, 2019.
The requirement that the employer, or the exchange or the insurance company provide proof of
insurance for tax purposes is still part of the law. The exemptions have not been repealed but
without any penalty, they are somewhat meaningless.
Under the Affordable Care Act (ACA), the Federal government, state governments, insurers,
employers, and individuals share responsibility for improving the quality and availability of
health insurance coverage in the United States. The ACA reforms the existing health insurance
market by prohibiting insurers from denying coverage or charging higher premiums because of
an individual’s preexisting conditions. The ACA also creates the Health Insurance Marketplace
(Marketplace, also known as the Exchange).
The Marketplace is where taxpayers find information about health insurance options, purchase
health insurance, and, if eligible, obtain help paying premiums and out-of-pocket costs. A new
tax credit, the premium tax credit, is available through the Marketplace and helps eligible
taxpayers pay for coverage.
NOTE: See the CA section of this syllabus for information on how CA will be using the
exchange known as Covered CA in the CA health mandate starting Jan 1, 2020.
Requirement to Have Health Insurance166
The ACA also includes the individual shared responsibility provision, which requires individuals
to have qualifying health care coverage (called minimum essential coverage) for each month of
the year, qualify for a coverage exemption, or make a shared responsibility payment (SRP) when
filing their Federal income tax returns.
Beginning January 1, 2014, all non-exempt U.S. citizens and legal residents without an
exemption are required to maintain minimum essential health insurance coverage or pay a
penalty tax on their individual tax return. The provision applies to individuals of all ages,
including children. The taxpayer or married couple who can claim a child or another individual
as a dependent for Federal income tax purposes is responsible for making the payment if the
dependent does not have coverage or an exemption.
166 IRC§ 5000A(d)
Objective:
Identify and review the major points of
the Affordable Care Act
Understand important items in the ACA.
Explain the value and pitfalls of the
Premium Tax Credit.
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Health care penalty eliminated
The penalty for failure to obtain health insurance coverage (the “individual mandate”) has been
eliminated as of the beginning in 2019. Taxpayer’s are no longer required to pay a penalty for
not having minimum essential coverage.
Premium Tax Credit The Premium Tax Credit167 (PTC) is a Federal tax credit to help eligible taxpayers pay for health
insurance. When enrolling in health coverage through the Marketplace, eligible taxpayers choose
to have some or all of the benefit of the credit paid in advance to their insurance company
(advance credit payments) or to get all of the benefit of the credit on their Federal tax return.
Those who choose to have advance credit payments made must file a Federal tax return even if
they have gross income that is below the income tax filing threshold.
Individuals and families can receive the PTC to help them afford health insurance coverage
purchased through an exchange or marketplace. Exchanges may operate in every state and the
District of Columbia. The premium tax credit is refundable so taxpayers who have little or no
income tax liability can still benefit. The credit also can be paid in advance to a taxpayers’
insurance company to help cover the cost of premiums. If taxpayers’ advance credit payments
for a taxable year exceed the PTC allowed for the year, the taxpayer owes the excess as an
additional tax168. The limitation amounts on the increase of tax for excess advance credit
payments are adjusted for inflation.
In general, taxpayers are allowed a premium tax credit if they meet all of the following:
• The taxpayer, spouse (if filing a joint return), or dependents were enrolled at some time during
the year in one or more qualified health plans offered through the Marketplace.
• One or more of the individuals listed above were not eligible for other MEC during the months
they were enrolled in the qualified plan through the Marketplace.
• The taxpayer is an applicable taxpayer. A taxpayer is an applicable taxpayer if he or she meets
the following three requirements:
o The taxpayers’ income is at least 100% but not more than 400% of the Federal
poverty line for the taxpayers’ family size.
o If married, the taxpayer files a joint return with his or her spouse (unless the
taxpayer is considered unmarried for Head of Household filing status, or meets
the criteria169, which allows certain victims of domestic abuse or spousal
abandonment to claim the premium tax credit using the MFS filing status). See
the instructions for Form 8962, Premium Tax Credit, for more details about these
exceptions.
o The taxpayer cannot be claimed as a dependent by another person
167 Federal Register /Vol. 77, No. 100 168 IRC §36B(f)(2)(B) 169 Notice 2014-23 or T.D. 9683
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A taxpayer with household income below 100% of the Federal poverty line can be an applicable
taxpayer as long as the taxpayer, the taxpayers’ spouse, or a dependent who enrolled in a
qualified health plan is not a U.S. citizen, but is lawfully present in the U.S. and not eligible for
Medicaid because of immigration status.
Premium Tax Credit Eligibility
• Household income must be between 100% and 400% of the Federal poverty level.
• Covered individuals must be enrolled in a “qualified health plan” through an Affordable
Insurance Exchange.
• Covered individuals must be legally present in the United States and not incarcerated.
• Covered individuals must not be eligible for other qualifying coverage, such as Medicare,
Medicaid, or affordable employer-sponsored coverage.
• The taxpayer cannot file a Married Filing Separately170 tax return (unless the taxpayer
meets the criteria, which allows certain victims of domestic abuse to claim the premium
tax credit using the Married Filing Separately filing status for the calendar year); and
• Cannot be claimed as a dependent by another person,171
NOTE: Individuals who purchase their own coverage, however, are entitled only to the
deduction allowed for unreimbursed medical expenses, including any health insurance premium
amounts, to the extent that the expenses exceed 25 percent of their adjusted gross income (AGI).
Credit Amount
• The credit amount is generally equal to the difference between the premium for the
“benchmark plan” and the taxpayers’ “expected contribution.”
• The expected contribution is a specified percentage of the taxpayers’ household income.
The percentage increases as income increases, from 2.04% of income for families at
100% of the Federal Poverty Level (FPL)172 to 9.69% of household income for families
at 400% of FPL. (The actual amount a family pays for coverage will be less than the
expected contribution if the family chooses a plan that is less expensive than the
benchmark plan.)
• The benchmark plan is the second-lowest-cost plan173 that would cover the family at the
“silver” level of coverage.
• The credit is capped at the premium for the plan the family chooses (so no one receives a
credit that is larger than the amount he or she actually pays for their plan).
170 Notice 2014-23 171 IRC §151 172 §2110(c) 5 of the Social Security Act (42 U.S.C. 1397jj(c)(5) 173 IRC §36B(3)B, Second Lowest Cost Silver Plan
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Special Rules
The credit has advance payments made directly to the insurance company on the family’s behalf.
The advance payments are then reconciled against the amount of the family’s actual premium tax
credit, as calculated on the family’s Federal income tax return. Any repayment due from the
taxpayer is subject to a cap for taxpayers with incomes under 400% of FPL.
Poverty Thresholds
The poverty thresholds are the original version of the Federal poverty measure. They are updated
each year by the Census Bureau. The thresholds are used mainly for statistical purposes, for
instance, preparing estimates of the number of Americans in poverty each year. (In other words,
all official poverty population statistics are calculated using the poverty thresholds, not the
guidelines.)
The individual will use the Federal Poverty Level Guidelines174 to calculate the cost assistance
on the health insurance marketplace.
NOTE: The Federal Poverty Guidelines are issued in January of each year in the Federal
Register by the Department of Health and Human Services (HHS). Only use the chart from Form
8962 Instructions, other FPL charts used for other purposes may not be the same.
The taxpayer is not required to repay any portion of the advance payment if a family ends the
year with household income below 100% of FPL after having received advance payments based
on an initial Exchange determination of ineligibility for Medicaid.
It is very important that the taxpayer report change in income to the marketplace. The effects of
Covid-19 may change the amount a taxpayer may receive in assistance. If his or her salary is cut
or they have lost a source of income, they may be able to receive more assistance. It is equally
important if the taxpayer income increases they report this change to the exchange to avoid a
large tax bill. Be sure to remind the taxpayer that the premium assistance is limited according to
income.
Household Income
In general, the household income includes the adjusted gross income plus any tax-exempt Social
Security benefits, tax-exempt interest and tax-exempt foreign income. Supplemental Security
Income (SSI) does not count.
The income should include wages, salaries and tips; taxable interest; taxable amounts of pension,
annuity or IRA distributions and Social Security benefits. Other categories, such as business
income, farm income, capital gains, unemployment compensation; alimony received, royalties or
foreign earned income, also should be considered.
174 IRC §5000A (4) (d)
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Items not included are child support, worker’s compensation, veteran disability payments or
proceeds from student loans or home equity and bank loans.
For purposes of the Premium Tax Credit, the household income is the modified adjusted gross
income plus that of every other individual in the family for whom the taxpayer can properly
claim a deduction and who is required to file a Federal income tax return.
Modified adjusted gross income is the adjusted gross income the Federal income tax return plus:
Any excluded foreign income175
Nontaxable Social Security benefits (including tier 1 railroad retirement benefits), and
Tax-exempt interest received or accrued during the taxable year.
Example: David and Melinda are Married Filing Jointly taxpayers. They have one child,
Phil, age 17, whom they claim as a dependent. Phil works part time and has a filing
requirement. David and Melinda’s household income calculation would include their MAGI,
as well as Phil’s MAGI.
A taxpayer is allowed a premium tax credit only for months that a member of the taxpayers’ tax
family is (1) enrolled in a policy offered through the Marketplace and (2) not eligible for
minimum essential health coverage (other than individual market coverage). The taxpayers’ tax
family consists of the taxpayer, the taxpayers’ spouse if filing jointly, and all other individuals
for whom the taxpayer claims a personal exemption deduction. The family members who meet
the above two requirements are the taxpayers’ “coverage family.”
For any tax year, the taxpayer received advance credit payments in any amount or if the taxpayer
plans to claim the premium tax credit, he or she must file a Federal income tax return for that
year. This filing requirement applies whether or not the taxpayer would otherwise be required to
file a return.
If the taxpayer receives any advance credit payments, he or she will use their tax return to
reconcile the difference between the advance credit payments made on their behalf and the actual
amount of the credit that they may claim. Form 1095-A is issued by the Marketplace as an
information statement showing the amount of the premiums and advance credit payments by
January 31 of the year following the year of coverage. The taxpayer should receive the
information statement by Jan. 31, each year and can use this information to compute the
premium tax credit on the tax return and to reconcile the advance credit payments made with the
amount of the actual premium tax credit. The Marketplace also reports this information to the
IRS.
175 IRS §911
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Shared Policy Allocations
In cases where the taxpayer divorced or are legally separated during the tax year and are enrolled
in the same qualified health plan, the taxpayer and the former spouse must allocate the policy
amounts on their separate tax returns to figure their premium tax credit and reconcile any
advance payments made on their behalf.
The allocation can be between zero and 100% as agreed upon be each taxpayer. This is done by
dividing the number of enrollees claimed as a personal exemption by the total number
individuals enrolled in the health plan. If the taxpayers does not agree on an allocation then the
allocation percentage is equal (50%).
Example: Judy and her husband were divorced July 1. Their family of herself, her
husband and three children were enrolled in health care from an exchange. One of her
children is properly claimed by her ex-husband and the allocation percentage agreed upon
was 60% for Judy and 40% for her ex-husband of the premiums paid from Jan 1 through
June 30.
If Judy and her ex-husband had not agreed on an allocation Judy and her ex-husband
would have to split the cost of the health care so 50% of the Premium Tax Credit is
allocated to Judy and 50% to her ex-husband.
Coverage Reporting Requirements
The Affordable Care Act (ACA) imposes some new annual reporting requirements, the specific
objective of which is to inform the IRS and individuals about who has access to minimum
essential coverage (MEC), and when an employer shared responsibility assessment might be
owed. In addition, these requirements are intended to facilitate the determination about who is
eligible for premium assistance.
Under the ACA, both health insurance providers and large employers (50 or more full-time
employees) have new reporting requirements to ensure they are meeting health care coverage
obligations. The information reporting obligations are meant to provide policy details for each
person who is provided with coverage to the IRS. At the end of the year, taxpayers and their
dependents must be able to prove that they were participating in a qualified health plan, thereby
producing a need for third party tax information reporting.
Health insurance providers will have significantly increased responsibilities, requiring them to
organize and report information about each member and their corresponding coverage, to both
the insured individual and the IRS, or face penalties matching those of other non-wage forms.
Taxpayers in turn will receive two forms to include in their filing at the end of each year. They
will receive a 1095-B from their insurance provider as well as a 1095-C from their employer if
they work for a large company. They will continue to receive Form 1095-A if they purchase
coverage through the State exchange (Marketplace).
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Under Section 6055 of the ACA, health insurers, self-insuring employers and other health
coverage providers are required to provide information to the IRS about the entity providing
coverage and each enrolled individual. They must also provide individual coverage information
to each of their members.
Under Section 6056 of the ACA, large employers (50 or more full-time employees) are required
to provide information on health insurance offered and provided in the previous year to the IRS
as well as to each of their employees. This information reports on the employers’ compliance
with the employer mandate and play or pay rules. Failure to comply with these mandates results
in a penalty fee if required coverage is not offered to full-time employees and their dependents.
If employees are not offered health coverage under an employer-sponsored plan, they are eligible
to claim a premium tax credit to purchase health coverage through a qualified Health Care
Exchange.
Form 1095-B
Form 1095-B will be provided by the health insurance provider to the individual member in
order to report on the type of coverage provided, period of coverage, and for whom coverage was
provided– including each dependent.
1095-C
Form 1095-C will be provided by large employers to their employees in order to report on the
type of coverage provided as well as identification information for each employee and their
dependents.
Form 1095-A
This form is issued by Health Care Exchanges (web-based health insurance marketplaces). Form
1095-A provides information on each individual enrolled in the ‘qualified health plans’ (QHPs).
Every year the Health Care Exchanges will be required to provide Form 1095-A to the individual
by the end of January. This form will include information such as the level of coverage,
identifying information for the primary insured, monthly health insurance premiums paid to the
insurance company selected through the Marketplace. It will also list the amount of premium
assistance received in the form of advance payments of the premium tax credit that were paid
directly to the insurance company. Every month, marketplaces will be required to report this
information to the Department of Health and Human Services, he or she will in turn report to the
IRS.
If the taxpayer chose to have advance payments of the premium tax credit paid directly to their
insurance company in 2020 they must file a 2020 Federal income tax return. Even if the taxpayer
did not choose to receive advance payments, he or she must file a 2020 Federal income tax return
to claim the Premium Tax Credit.
If the taxpayer has questions regarding Form 1095-A, the IRS will not be able to answer
questions about the information on his or her Form 1095-A or about missing or lost forms. These
questions must be resolved by the taxpayer through their exchange or marketplace.
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The PTC will vary based on family income and the cost of health insurance in the exchange
available to the taxpayer. The credit will equal the difference between the premium for the
second-lowest-price silver plan (also known as the benchmark plan) and a specified percentage
of income. In 2019, the percentage ranges from 2.08 percent for those with incomes below 133
percent of poverty and scales up to 9.8 percent for those with incomes up to 400 percent of
poverty. The percentage will be adjusted in subsequent years to account for any excess in the rate
of premium growth over the rate of income growth176.
The PTC is only available to taxpayers who purchased health coverage through the Marketplace.
On Form 8962, a taxpayer must subtract the advance credit payments for the year from the
amount of the taxpayers’ premium tax credit calculated on the tax return. If the premium tax
credit computed on the return is more than the advance credit payments made on the taxpayers’
behalf during the year, the difference will increase the refund or lower the amount of tax owed.
This will be reported in the Payments section of Form 1040. If the advance credit payments are
more than the premium tax credit (an excess advance credit payment), the difference will
increase the amount owed and result in either a smaller refund or a balance due. This will be
entered in the Tax and Credits section of the return. There may be a limitation on the amount of
tax liability a taxpayer owes because of an excess advance credit payment. The limitation is
based on the taxpayers’ household income.
The Covered California income limits require consumers to have a household income that ranges
from 0% to 400% of the Federal Poverty Level (FPL) in order to qualify for assistance on a
government health insurance plan. According to Covered California income guidelines and
salary restrictions, if an individual makes less than $47,520 per year or if a family of four earns
wages less than $97,200 per year, then they qualify for government assistance based on their
income
Penalties
Personal information submitted for verification may be used to the extent necessary for the
verification purposes and may not be disclosed to anyone not identified in the law. Any person,
who submits false information due to negligence or disregard for any rule, and without
reasonable cause, is subject to civil penalty of not more than $25,000. Any person who
intentionally provides false information will be fined not more than $250,000. Any person who
knowingly and willfully uses or discloses confidential information will be fined not more than
$25,000. A fine imposed may not be collected through a lien or levy against property.
176 IRC§5000 (d)(2)
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Self-Employed Health Insurance Deduction
Generally, a self-employed177 individual—is allowed an above the line deduction for all or a
portion of the taxpayers’ premiums paid during the taxable year for health insurance for the
taxpayer, the taxpayers’ spouse, the taxpayers’ dependents, and any child of the taxpayer under
the age of 27. No deduction is allowed for the portion of premiums for a qualified health plan
equal to the amount of the Premium Tax Credit,178
For the premiums to be deductible, the insurance plan must be established with respect to the
taxpayers’ business. A sole proprietor who purchases health insurance in his or her individual
name has established a plan providing medical care coverage with respect to his or her trade or
business. Therefore, the sole proprietor may deduct the medical care insurance costs for himself,
his spouse and dependents, but only to the extent that the cost of the insurance does not exceed
the earned income from the business where the insurance was purchased.
SEHI can come from a partnership. The partnership pays the insurance premiums, and the
partnership reports the premium amounts on Schedule K-1 as guaranteed payments to be
included in the partner’s gross income if the premiums are paid for services rendered in the
capacity of a partner and to the extent, the premiums are determined without regard to
partnership income.
A 2-percent S shareholder can qualify for self-employed health insurance. The policy can be
either in the name of the S corporation or in the name of the shareholder. Either the 2-percent
shareholder can pay the premiums him or herself or the S corporation can pay them and report
the premium amounts on Form W-2 as wages to be included in the shareholder’s gross income.
A taxpayer cannot add the net profits from all his or her trades and businesses for purposes of
determining the deduction limitation. However, if a self-employed individual has more than one
trade or business, the medical care insurance costs of the self-employed individual and his or her
spouse and dependents are deductible under each specific health insurance plan established under
each specific business up to the net earnings of that specific trade or business. The SEHI
deduction cannot exceed the earned income from the business where the insurance was
purchased.
Medicare is considered health insurance, no matter what Part the taxpayer is paying.
177 IRC §162 (l) 178 IRC §280C(g)
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TaxLaw
The self-employed person is allowed a deduction for specified premiums not to exceed the
amount to the lesser of
The specified premiums less the premium tax credit attributable to the specified
premiums, and
The sum of the specified premiums not paid through advance credit payments and the
additional tax imposed (if any) that is due the taxpayer receiving Advance Premium Tax
Credit in excess of the Premium Tax Credit allowed (if any) after applying the limitation
on the amount of the APTC that must be repaid.
Because the SEHI deduction179 is allowed in computing adjusted gross income and because
adjusted gross income is necessary for computing the PTC, the taxpayer must know the
allowable deduction to compute the premium tax credit. Thus, the amount of the deduction is
based on the amount of the PTC, and the amount of the credit is based on the amount of the
deduction – a circular relationship. Rev. Proc. 2014-41 provides calculation methods that resolve
the circular relationship between the deduction and the PTC. Using the calculations in Rev. Proc.
2014-41 is optional. A taxpayer may determine amounts of the deduction and the PTC using any
method, if the amounts claimed satisfy the requirements of applicable tax law.
When taxpayers determine their allowable self-employed health insurance deduction, they have
two options for the calculation:
(1) The calculation method, or
(2) The simplified method. The taxpayers’ self-employed health insurance deduction
cannot exceed the lessor of:180
• The taxpayer earned income derived by the taxpayer from the trade or business
with respect to which the health insurance is established.
• The sum of the Marketplace premiums not paid through advance credit
payments and the limitation on additional tax.
Rev. Proc. 2014-41 provides taxpayers with calculation methods that resolve this circular
relationship.
179 IRC §162 (l) 180 Rev. Proc 2014-41 §5.03
247
TaxLaw
What Do You Think?
Q1. Which of the following will qualify for a Premium Tax Credit?
A. The Smith’s have household income between 100% and 400% of the
Federal poverty level and maintain minimum essential coverage through
their workplace.
B. John Jones has household income of 103% of the Federal poverty level
and is eligible for Medicaid.
C. Peter King purchased his qualifying coverage from the Marketplace, he is a welder and
expected to earn $75,000; his business did not do well and his total income for the year fell
below 300% of the FPL, he paid all the premiums without assistance.
D. None of the above
Q2. Which of the following is not a true statement regarding household income for the
computation of the Premium Tax Credit?
A. Modified adjusted gross income includes excludable foreign earned income when
computing household income for the Premium Tax Credit
B. Child support is included in household income.
C. Nontaxable Social Security Benefits are included in household income.
D. Household income includes income earned at McDonald’s by the taxpayers’ 16-year-old
son.
248
TaxLaw
What Do You Think? – Answers
Answer Q1. – C – Peter’s total income for the year was below 400% of the
FPL and he purchased his coverage through the marketplace. He is eligible for
the Premium Tax Credit.
A. The Smith’s do not qualify for the Premium Tax Credit because they had coverage through
their workplace.
B. John Jones did not qualify for the Premium Tax Credit because he is eligible for Medicaid.
Premium Tax Credit Eligibility
• Household income must be between 100% and 400% of the Federal poverty level.
• Covered individuals must be enrolled in a “qualified health plan” through an Affordable
Insurance Exchange.
• Covered individuals must be legally present in the United States and not incarcerated.
• Covered individuals must not be eligible for other qualifying coverage, such as Medicare,
Medicaid, or affordable employer-sponsored coverage.
• The taxpayer cannot file a Married Filing Separately tax return (unless the taxpayer meets
the criteria, which allows certain victims of domestic abuse to claim the premium tax
credit using the Married Filing Separately filing status for the calendar year); and
• Cannot be claimed as a dependent by another person,
Individuals who purchase their own coverage, however, are entitled only to the deduction
allowed for unreimbursed medical expenses, including any health insurance premium amounts,
to the extent that the expenses exceed 10 percent of their adjusted gross income (AGI)
Answer Q2. –B – Child support is not included in household income when figuring the Premium
Tax Credit.
For purposes of the Premium Tax Credit, the household income is the modified adjusted gross
income plus that of every other individual in the family for whom the taxpayer can properly
claim a deduction and who is required to file a Federal income tax return.
Modified adjusted gross income is the adjusted gross income the Federal income tax return plus:
Any excluded foreign income
Nontaxable Social Security benefits (including tier 1 railroad retirement benefits), and
Tax-exempt interest received or accrued during the taxable year.
In general, the household income includes the adjusted gross income plus any tax-exempt Social
Security benefits, tax-exempt interest and tax-exempt foreign income. Supplemental Security
Income (SSI) does not count.
The income should include wages, salaries and tips; taxable interest; taxable amounts of pension,
249
TaxLaw
annuity or IRA distributions and Social Security benefits. Other categories, such as business
income, farm income, capital gains, unemployment compensation; alimony received, royalties or
foreign earned income, also should be considered.
Items not included are child support, worker’s compensation, veteran disability payments or
proceeds from student loans or home equity and bank loans.
2020
TaxEase, LLC
EXAM QUESTIONS
2020
TaxEase, LLC
10-HOUR TAX LAW
EXAM QUESTIONS
Final Exam – Tax Law
1. Which of the following qualifies for an Economic Impact Payment?
A. A dependent on another return.
B. An individual with no taxable income.
C. A Single taxpayer with $102,000 AGI.
D. A nonresident alien.
2. Which of the following is true regarding inflation increases to tax brackets in 2019?
A. The chained consumer price index results in lower inflation adjustments, which
means smaller annual increases than with the current tax.
B. Unlike tax brackets prior to TCJA (which uses a measure of the consumer price index
(CPI) for all-urban consumers), the inflation adjustment uses the chained consumer
price index for all-urban consumers (C-CPI-U).
C. The income tax bracket thresholds are all adjusted for inflation after December 31,
2018, and then rounded to the next lowest multiple of $100 in future years.
D. All of the above.
3. Which of the following is not correct regarding student loans under the CARES Act?
A. This includes automatic suspension of principal and interest payments on federally
held student loans from March 13, 2020 through September 30, 2020.
B. All payments of student loans to a private lender from March 13 through September
30 will apply directly to principal.
C. The CARES Act amends the existing code section to provide an exclusion from
income for payments of interest or principal made by an employer on any qualified
education loan incurred by an employee for the education of the employee.
D. Payments of student loan principal and/or interest by the employer is allowed up to
$5,250 in employer-paid educational assistance.
4. Which of the following is not correct regarding an IRA in 2020?
A. The taxpayer can convert the entire balance of a traditional IRA account to a Roth
account tax-free.
B. Tax Cuts and Jobs Act of 2017 banned recharacterization of a Roth back to a
traditional IRA.
C. To recharacterize a regular IRA contribution, the taxpayer must tell the trustee of the
financial institution holding the IRA to transfer the amount of the contribution plus
earnings to a different type of IRA (either a Roth or traditional) in a trustee-to-trustee
transfer or to a different type of IRA with the same trustee.
D. All of the items above are correct regarding IRS accounts in 2020.
5. Howard installs an elevator in his home because of his wife’s physical handicap. The
elevator costs $16,000 to install. The increase in the basis of the house is $10,000. How
much can Howard deduct as a medical deduction in the year of installation?
A. $5,000.
B. $6,000
C. $7,000
D. $25,000
6. In 2020, Peter paid real estate taxes on his personal residence of $5,950; $11,050 CA
income tax was withheld. How much is he allowed to deduct on Schedule A?
A. $5,950
B. $11,050
C. $10,000
D. $17,000
7. Which of the following is not a true statement regarding a Qualified Charitable
Deduction of an IRA?
A. A charitable deduction is allowed on a QCD that is excluded from income.
B. The taxpayer must be 70 ½ or older at the time of the QCD.
C. QCD’s are limited to $100,000 per taxpayer.
D. All or part of the taxpayers RMD may be included in the QCD.
8. Which of the following is correct when describing the temporary postponement or
reduction of mortgage payments?
A. Forbearance of mortgage payments.
B. Mortgage payment forgiveness. C. Borrower loan repayment. D. None of the above.
9. Many changes were made to charitable contributions for 2020. Which of the following is
not a change due to the CARES Act?
A. The adjusted gross income limit for cash contributions was increased for individual
donors. For cash contributions made in 2020, the taxpayer can elect to deduct up to
100 percent of their AGI.
B. The CARES Act changed the AGI limit for cash contributions for corporate donors.
Corporations can now deduct up to 75 percent of taxable income.
C. The CARES Act allows for an additional, “above-the-line” deduction for charitable
gifts made in cash of up to $300.
D. A Qualified Charitable Distribution (QCD) is a direct transfer of funds from an IRA
trustee to a qualified charity.
10. The Economic Impact Payment is considered an advanced refund for tax year 2020, which of
the following is considered a true statement? A. The taxpayer received more money based on his or her 2019 return than he or she
should have; if the payment was based on tax year 2020. The taxpayer must increase
his or her tax liability on the 2020 tax return by the excess amount of EIP received.
B. The EIP is included in gross income on the taxpayer’s 2020 return.
C. The EIP is excludable from income in 2020.
D. Taxpayers whose only income is Social Security are not required to file a tax return
and are not eligible for the EIP.
11. In 2020, which of the following is deductible subject to 2% of adjusted gross income?
A. Tax Preparer fees.
B. Union Dues.
C. Job search expenses for a new job in the same field.
D. None of the above.
12. In 2020, which of the following is correct regarding gambling income under TCJA?
A. Taxpayers must report the full amount of their gambling winnings (with no reduction
for gambling losses) for the year as income on Form 1040.
B. The taxpayer can deduct gambling losses (up to the amount reported as gambling
winnings) for the year separately on Schedule A (Form 1040) as a miscellaneous
itemized deduction not subject to the 2 percent floor.
C. When spouses file a joint return for the tax year, their combined gambling losses are
deductible to the extent of their combined winnings.
D. All of the above.
13. Which of the following is correct regarding a casualty loss in 2020?
A. Personal casualty losses, which include theft losses, are temporarily limited under the
Tax Cuts and Jobs Act of 2017.
B. The casualty loss must be federally declared, identifiable, unexpected, and unusual.
C. Any allowable casualty loss deductions are deductible as an itemized deduction and
subject to $100 per casualty and 10% of AGI limitations.
D. All of the above.
14. Which of the following will substantiate a charitable donation of less than $250?
A. Canceled check, bank or credit card statement.
B. Written communication from the donee showing the donations and the amount
contributed.
C. A written record of the date of the contribution, where it was contributed and the
amount of the gift.
D. All of the above
15. Which of the following does not apply to a professional gambler?
A. Professional gamblers can deduct business expenses as an itemized deduction.
B. A professional gambler can deduct his or her gambling business expenses on
Schedule C.
C. Professional gamblers’ losses are limited to winnings.
D. A written record of income and expenses are required as any other business.
16. Which items below are not found on Form 1098T?
A. The number of years the student has attended college.
B. Whether the student is a graduate student.
C. Scholarships or grants received
D. The employer identification number of college where the tuition was paid.
17. TCJA increases the contribution limitation to Achieving a Better Life Experience
(ABLE) accounts under certain circumstances. Which of the following is correct?
A. Contributions per-donee is the annual gift tax exclusion ($15,000 for 2020).
B. An ABLE account’s designated beneficiary can contribute an additional amount,
up to the lesser of (1) the federal poverty line for a one-person household; or (2)
the individual’s compensation for the tax year.
C. The beneficiary can claim the saver’s credit for contributions made to his or her
ABLE account.
D. All of the above are correct.
18. Which of the qualified higher education expenses is not allowed for the Exclusion of US
Savings Bonds?
A. The costs of books or room and board.
B. Qualified expenses reduced by scholarships received.
C. Expenses paid for sports, games, or hobbies qualify only if part of a certificate
program are qualified expenses.
D. Expenses paid for a niece who is a dependent of the taxpayer are qualified
expenses.
19. Student Loans Discharged because of death or disability have been modified by TCJA.
Which of the following are qualifying loans?
A. The United States (or an instrumentality or agency thereof).
B. A state (or any political subdivision).
C. An educational organization that originally received the funds from which the
loan was made from the United States, a State, or a tax-exempt public benefit
corporation.
D. All of the above.
20. In reference to safe harbor being treated as a trade or business, rental services include all
of the items below, except?
A. Collection of rent.
B. Financial Services
C. Maintenance
D. Supervision of Employees
21. Which of the items listed pertaining to a Schedule E rental is true?
A. The taxpayer can depreciate the property from the time it is available to rent.
B. The taxpayer can deduct traveling expense to collect rent.
C. Repairs are considered an expense and deductible in the year they are paid.
D. All of the above.
22. Of the statements below, which is false regarding qualified business income related to
relevant pass-through entities (RPE)?
A. The entity must meet Code Sec. 162(a) “trade or business” requirements.
B. The QBI of an RPE is determined at the shareholder/partner level.
C. The QBI deduction will reduce or increase the adjusted basis of a partner’s
interest in the partnership or a shareholder’s basis in S corporation stock.
D. All of the above are correct.
23. Which of the following is a correct qualification for Qualified Business Income?
A. Qualified business income does not include any amount paid by an S corporation
that is treated as reasonable compensation of the taxpayer.
B. The IRS can recharacterize “dividends” that are paid in lieu of reasonable
compensation to a S-Corp shareholder.
C. Guaranteed payments paid to a partner is not qualified business income.
D. All of the above.
24. Which of the following is correct regarding the QBI carryforward?
A. Sec 199A regulations clarify that QBI cannot be less than zero.
B. The carryforward of QBI does not affect the current-year deduction for purposes
of other sections of the code.
C. An overall loss after adding qualified REIT dividends and PTP income, the loss
from the REIT or PTP is carried forward and used to offset REIT/PTP income in
the succeeding year or years for Sec. 199A purposes.
D. All of the above.
25. Which of the following is not true regarding QBI?
A. The business income deduction applies at the partner and shareholders level.
B. SSTBs are not considered qualified businesses for individuals whose taxable
income exceeds certain thresholds.
C. Guaranteed payments paid to a partner in a partnership meet the definition of W-2
wages.
D. The taxpayer QBI amounts are calculated separately for each Qualified Business
and then combined to determine the taxpayers QBI deduction.
26. In 2019, which of the following is the correct answer regarding Qualified Business
Income?
A. A deduction for one-half of the self-employment tax, is subtracted from the
ordinary business income to determine the QBI amount.
B. Excess QBI deductions cannot be carried over to 2020.
C. Guaranteed payments from a partnership are included in QBI.
D. The QBI of a relevant pass-through entity is figured at the individual level.
27. Linus is an accountant and earned $85,000 of profit from his sole proprietorship. Linus is
married and his wife Lucy is an employee of ABC Corp. and earns wages of $198,000.
They have capital gain distributions of $65,400 and interest income of $12,000. Which
item will not be entered on Form 8995 to compute QBI?
A. Profit from sole proprietorship
B. Interest income
C. Lucy’s employee wages
D. All of the above
28. Of the professions below which is not a “Specified Service Business” for the computation
of the QBI deduction?
A. Lawyer
B. Financial advisor
C. Engineer
D. Professional basketball player
29. In regards to QBI, rental activity is defined and a safe harbor exists. With that in mind,
which of the following statements is correct?
A. A record of income and expenses must be kept separately for all rental activity.
B. Contemporaneous records are include hours of services performed.
C. Arranging financing for the rental is not considered a rental service.
D. All of these above are true statements.
30. Select the correct acquisition requirement for bonus deprecation.
A. The original use of the property must meet the requirements of IRC §§179(d)(2)(A),
179(d)(2)(B), 179(d)(2)(C) and 179(d)(3).
B. The property must not have been used by the taxpayer any time prior to acquisition.
C. The property can be new or used.
D. All of the above.
31. Under TCJA, which of the following is a component qualifying property for bonus
depreciation?
A. MACRS property that has a recovery period, regardless of any election made by
the taxpayer under the alternative depreciation system, of 20 years or less.
B. Computer software for which a deduction is allowable without regard to the bonus
depreciation rules.
C. The property meets either an original use requirement or acquisition requirement;
and was placed in service by the taxpayer before January 1, 2027.
D. All of the above.
32. Which of the statements below is not correct regarding vehicle expense for a vehicle used for
business?
A. A taxpayer can use either the standard mileage rate or the actual expense amount
when figuring the vehicle expense deduction. However, if the taxpayer wants to
use the standard mileage rate in future years, he or she must use the standard
mileage rate in the first year the vehicle is put in service.
B. An employee can take the standard mile rate if a vehicle is used for business; it is
reported as an itemized unreimbursed employee business expense deduction in
2020.
C. Beginning January 2020, the standard mileage rate lowers to 57.5 cents.
D. The standard mileage rate is figured using the total business miles multiplied by
the standard mileage rate.
33. Which of the following is a true statement regarding Section 179?
A. 2020 Section 179 deduction applies to new and used equipment, as well as off-
the-shelf software.
B. To take the deduction for tax year 2020, the equipment must be financed or
purchased and put into service between January 1, 2020 and the end of the day on
December 31, 2020.
C. 2020 Spending Cap on equipment purchases is the maximum amount that can be
spent on equipment before the Section 179. Deduction available to his or her
company begins to be reduced on a dollar for dollar basis.
D. All of the above.
34. When qualifying property is placed in service between September 28, 2017, and December
31, 2022, what is the maximum amount of bonus depreciation allowed?
A. 100%
B. 90%
C. 50%
D. None of the above.
35. When constructing a building which of the following is added to the land value?
A. Demolition costs
B. Building permit charges
C. Payments to contractors
D. None of the above
36. Which item below is not added to the cost of an intangible asset?
A. The cost to buy the asset.
B. The cost to create the asset.
C. The time invested by the creator.
D. All of the above.
37. Which of the adjustments decreases the adjusted basis?
A. Capital improvements (having a useful life of more than one year).
B. Assessments for local improvements.
C. Section 179 expense
D. Zoning costs
38. Which of the following categories of people do not qualify as ministers?
A. Those in traditional clergy roles (e.g., priests, pastors, rabbis) who typically
perform sacerdotal functions and conduct worship.
B. Those who work for secular organizations to the extent they perform sacerdotal
functions and conduct worship.
C. Those who control and maintain religious organizations at the local church or
denomination level.
D. Teachers at the day care associated with the church.
39. Which of the following is correct regarding a minister’ housing allowance?
A. The housing allowance is included in taxable income and subject to self-
employment tax.
B. The housing allowance is excluded from gross income, but subject to self-
employment tax.
C. The employer can leave the amount of the housing allowance to the minister.
D. None of the above are incorrect.
40. Which of the following is The Estate Tax exclusion for a married couple in 2020?
A. The exclusion for a married couple in 2020 is $11,580,000.
B. The exclusion is $23,160,000 for a married couple.
C. The exclusion for a married couple in 2020 is double the exclusion for a married
couple in 2019.
D. None of the above.
41. AMT is owed when the tentative minimum tax is _____________.
A. Higher than the regular tax
B. Below the AMT exclusion
C. Lower than the regular tax
D. None of the above.
42. Which of the following accounts is not reportable on Form 114?
A. Securities
B. Brokerage
C. U.S. Savings Bonds
D. Insurance policy with a cash value
43. The CARES Act, amended section 461(l) regarding the restrictions on excess business losses.
Which of the following is not correct?
A. The CARES Act repealed the limitation for tax years 2018, 2019, and 2020.
B. Form 461, Limitation of Business Losses, has been eliminated for those years.
C. A taxpayer who filed a 2016 or a 2017 return with the limitation, can file an
amended return.
D. All of the above.
44. The CARES Act expands taxpayer’s ability to deduct NOLs arising before the 2021 taxable
year. Which of the following is a true statement?
A. Temporary Lifting of 80% Limitation on NOLs.
B. A taxpayer that is a real estate investment trust for a given tax year may not carry
back NOLs incurred during that tax year to any preceding tax year.
C. NOLs carried forward from 2018, 2019 or 2020 to taxable years beginning after
December 31, 2020 will be subject to the 80% limitation.
D. All of the above.
45. As part of its ongoing security, the IRS has changed some of the requirements for applying
for an EIN. Which of the following is true?
A. Only individuals with tax identification numbers may request an Employer
Identification Number (EIN) as the “responsible party” on the application.
B. An EIN is a nine-digit tax identification number assigned to sole proprietors,
corporations, partnerships, estates, trusts, employee retirement plans and other
entities for tax filing and reporting purposes.
C. The change will prohibit entities from using their own EINs to obtain additional
EINs.
D. All of the above.
46. To have an NOL, a loss must generally be caused by deductions from which of the
following?
A. A trade or business
B. Casualty and theft losses resulting from a federally declared disaster,
C. Rental property
D. All of the above.
47. FinCen Form 114 is an informational reporting document reporting the ownership interest or
signature authority over a foreign bank or financial account of $10,000 or more. Which of the
following persons must file Form 114?
A. An agent, nominee, attorney, or a person acting in some other capacity on behalf
of the U.S. person with respect to the account.
B. A trust of which the U.S. person has an ownership percentage in the trust for U.S.
federal tax purposes.
C. A taxpayer who owns shares in a mutual fund located in France.
D. All of the above.
48. Which of the following is required to file Form 8938, Statement of Financial Assets?
A. A U.S. citizen, filing single, living in the U.S with a custodial financial account of
$75,000 in a foreign country.
B. A U.S. resident alien filing jointly with a foreign account of $80,000.
C. Both A and B are required to file.
D. Neither A nor B are required to file.
49. Which of the following statements is correct regarding virtual currency?
A. Virtual currency is a digital representation of value, other than a representation of
the U.S. dollar or a foreign currency that functions as a unit of account, a store of
value, and a medium of exchange.
B. Bitcoin is the most common type of virtual currency.
C. According to the IRS virtual currency is other income.
D. All of the above.
50. The insolvency exclusion of income is allowed when __________________.
A. He or she has declared bankruptcy under Title 11.
B. His or her total liabilities exceed his or her total assets.
C. The taxpayer gets a cancellation of debt form from a creditor.
D. All of the above.
Fed. Tax Law
A B C D A B C D
1 A B C D 26 A B C D
2 A B C D 27 A B C D
3 A B C D 28 A B C D
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7 A B C D 32 A B C D
8 A B C D 33 A B C D
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10 A B C D 35 A B C D
11 A B C D 36 A B C D
12 A B C D 37 A B C D
13 A B C D 38 A B C D
14 A B C D 39 A B C D
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19 A B C D 44 A B C D
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23 A B C D 48 A B C D
24 A B C D 49 A B C D
25 A B C D 50 A B C D
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Example: Question 1 – How many inches are
in a foot?
A. 9 B. 6 C. 3 D. 12
Question A B C D
1 A B C X
2 A B C D
3 A B C D
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Date: _______________________
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SUBMISSION INSTRUCTIONS:
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Complete the Personal Information Form above and the Evaluation Form
EMAIL or FAX the Answer Sheet, Personal Information Form, and Evaluation Form to:
Email – [email protected] Fax – (510) 779-5251
All paper answer sheets must be emailed or faxed.
*Required Information: All required information must be completed in order for TaxEase to grade the exam.
TAXEASE REPORTS EDUCATION TO CTEC. IT IS
THE STUDENT’S RESPONSIBILITY TO COMPLETE
THEIR REGISTRATION RENEWAL WITH CTEC
ANNUALLY.
THE IRS REQUIRES THAT TAXEASE REPORT
THE STUDENTS CONTINUING EDUCATION
TO THE IRS IF THE STUDENT PROVIDES US
WITH THEIR PTIN.
2020 TaxEase Course Evaluation
2020 TAX LAW COURSE
IRS COURSE NUMBER: B8FQK-T-00035-20-S CTEC COURSE NUMBER: 3064-CE-0063
Student’s Name: ____________________________ Date: ___________________
Tax
Law
Date Program Completed
Hours Spent to Complete
Instructions: Please comment on all the following evaluation points on the programs and
assign a number grade, using 1-5 scale, with 5 being the highest.
Tax
Law
Were the stated learning objectives met?
Were the course materials accurate and relevant,
and did they contribute to the achievement of the
learning objectives?
Was the time allocated to learning adequate?
Was the course syllabus satisfactory?
Part of the course you found most beneficial:
Part of the course you found least beneficial:
Additional Comments:
Please return with your completed answer sheet
