June 15 – Employer’s Monthly Deposit Due If you are an employer and the monthly deposit rules apply, June 15 is the due date for you to make your deposit of Social Security, Medicare and withheld income tax for May 2021. This is also the due date for the non-payroll withholding deposit for May 2021 if the monthly deposit rule applies.June 15 – Corporations Deposit the second installment of estimated income tax for 2021 for calendar year corporations.

June 1 – Final Due Date for IRA Trustees to Issue Form 5498
Final due date for IRA trustees to issue Form 5498, providing IRA owners with the fair market value (FMV) of their IRA accounts as of December 31, 2020. The FMV of an IRA on the last day of the prior year (Dec 31, 2020) is used to determine the required minimum distribution (RMD) that must be taken from the IRA if you are age 72 or older during 2021. Note: the CARES Act waived 2020 RMDs.June 10 – Report Tips to Employer
If you are an employee who works for tips and received more than $20 in tips during May, you are required to report them to your employer on IRS Form 4070 no later than June 10. Your employer is required to withhold FICA taxes and income tax withholding for these tips from your regular wages. If your regular wages are insufficient to cover the FICA and tax withholding, the employer will report the amount of the uncollected withholding in box 12 of your W-2 for the year. You will be required to pay the uncollected withholding when your return for the year is filed.
June 15 – Estimated Tax Payment Due
This is the last day to timely make your second quarter estimated tax installment payment for the 2021 tax year. Our tax system is a ‘pay-as-you-earn’ system. To facilitate that concept, the government has provided several means of assisting taxpayers in meeting the ‘pay-as-you-earn’ requirement. These include:

Payroll withholding for employees;
Pension withholding for retirees; and
Estimated tax payments for self-employed individuals and those with other sources of income not covered by withholding.

When a taxpayer fails to prepay a safe harbor (minimum) amount, they can be subject to the underpayment penalty. This penalty is equal to the federal short-term rate plus 3 percentage points, and the penalty is computed on a quarter-by-quarter basis.
Federal tax law does provide ways to avoid the underpayment penalty. If the underpayment is less than $1,000 (the ‘de minimis amount’), no penalty is assessed. In addition, the law provides “safe harbor” prepayments. There are two safe harbors:

The first safe harbor is based on the tax owed in the current year. If your payments equal or exceed 90% of what is owed in the current year, you can escape a penalty.
The second safe harbor is based on the tax owed in the immediately preceding tax year. This safe harbor is generally 100% of the prior year’s tax liability. However, for taxpayers whose AGI exceeds $150,000 ($75,000 for married taxpayers filing separately), the prior year’s safe harbor is 110%.

Example: Suppose your tax for the year is $10,000 and your prepayments total $5,600. The result is that you owe an additional $4,400 on your tax return. To find out if you owe a penalty, see if you meet the first safe harbor exception. Since 90% of $10,000 is $9,000, your prepayments fell short of the mark. You can’t avoid the penalty under this exception.
However, in the above example, the safe harbor may still apply. Assume your prior year’s tax was $5,000. Since you prepaid $5,600, which is greater than 110% of the prior year’s tax (110% = $5,500), you qualify for this safe harbor and can escape the penalty.
This example underscores the importance of making sure your prepayments are adequate, especially if you have a large increase in income. This is common when there is a large gain from the sale of stocks, sale of property, when large bonuses are paid, when a taxpayer retires, etc. Timely payment of each required estimated tax installment is also a requirement to meet the safe harbor exception to the penalty. If you have questions regarding your safe harbor estimates, please call this office as soon as possible.
CAUTION: Some state de minimis amounts and safe harbor estimate rules are different than those for the Federal estimates. Please call this office for particular state safe harbor rules.
June 15 – Taxpayers Living Abroad
If you are a U.S. citizen or resident alien living and working (or on military duty) outside the United States and Puerto Rico, June 15 is the filing due date for your 2020 income tax return and to pay any tax due. If your return has not been completed and you need additional time to file your return, file Form 4868 to obtain 4 additional months to file. Then, file Form 1040 or 1040-SR by October 15. However, if you are a participant in a combat zone, you may be able to further extend the filing deadline (see below).
Caution: This is not an extension of time to pay your tax liability, only an extension to file the return. If you expect to owe, estimate how much and include your payment with the extension. If you owe taxes when you do file your extended tax return, you will be liable for both the late payment penalty and interest from the due date.
Combat Zone – For military taxpayers in a combat zone/qualified hazardous duty area, the deadlines for taking actions with the IRS are extended. This also applies to service members involved in contingency operations, such as Operation Iraqi Freedom or Enduring Freedom. The extension is for 180 consecutive days after the later of:

The last day a military taxpayer was in a combat zone/qualified hazardous duty area or served in a qualifying contingency operation, or has qualifying service outside of the combat zone/qualified hazardous duty area (or the last day the area qualifies as a combat zone or qualified hazardous duty area), or
The last day of any continuous qualified hospitalization for injury from service in the combat zone/qualified hazardous duty area or contingency operation, or while performing qualifying service outside of the combat zone/qualified hazardous duty area.

In addition to the 180 days, the deadline is also extended by the number of days that were left for the individual to take an action with the IRS when they entered a combat zone/qualified hazardous duty area or began serving in a contingency operation.
It is not a good idea to delay filing your return because you owe taxes. The late filing penalty is 5% per month (maximum 25%) and can be a substantial penalty. It is generally better practice to file the return without payment and avoid the late filing penalty. We can also establish an installment agreement, which allows you to pay your taxes over a period of up to 72 months.
Please contact this office for assistance with an extension request or an installment agreement.

Article Highlights:

Notice CP508C
Seriously Delinquent Tax Debt
State Department Certification
Passport Restrictions
Lifting Restrictions
Overseas When Restrictions Applied

The IRS has begun issuing notice CP508C to taxpayers with ‘seriously delinquent’ tax debt and the service has resumed its program of notifying the State Department of taxpayers’ unpaid federal debts. The U.S. Department of State generally will not renew a passport or issue a new passport to taxpayers after receiving a certification of ‘seriously delinquent’ tax debt from the IRS, and they may revoke or place limitations on current passports. Generally, you can use your passport until you’re notified by the U.S. Department of State that it’s taking action to revoke or limit your passport. Once a taxpayer receives the notice CP508C, they have 30 days to dispute the notice. Taxpayers are cautioned to retain the notice until the issue is resolved. The IRS contact number is in the top right-hand corner of the CP508C notice. If the debt has already been satisfied, the taxpayer will need to have proof of payment available. Seriously Delinquent Tax Debt – Seriously delinquent tax debt is an individual’s unpaid, legally enforceable federal tax debt totaling more than $54,000 (including interest and penalties) for which:

Notice of federal tax lien has been filed and all administrative remedies under the Internal Revenue Code have lapsed or been exhausted, or
A levy has been issued.

The seriously delinquent tax debt amount that triggers the IRS to notify the State Department is inflation adjusted, so the $54,000 amount applies to 2021 and will no doubt increase for 2022.Getting the Certification Reversed – Once IRS has certified the ‘seriously delinquent’ tax debt to the U.S. Department of State the IRS will reverse the certification when:

The tax debt is fully satisfied or becomes legally unenforceable.
The tax debt is no longer seriously delinquent.
The certification is erroneous. A previously certified debt is no longer seriously delinquent when:
The taxpayer and the IRS enter into an installment agreement allowing the debt to be paid over time.
The IRS accepts an offer in compromise to satisfy the debt.
The U.S. Department of Justice enters into a settlement agreement to satisfy the debt.
Collection is suspended because the taxpayer requests innocent spouse relief.
The taxpayer makes a timely request for a collection due process hearing in connection with a levy to collect the debt.

Additionally, a certified debt is no longer seriously delinquent for any taxpayer:

Who is in bankruptcy.
Who is identified by the IRS as a victim of tax-related identity theft.
Whose account the IRS has determined is currently not collectible due to hardship.
Who is located within a federally declared disaster area
Who has a request pending for an installment agreement with the IRS.
Who has a pending offer in compromise with the IRS.
Who has an IRS-accepted adjustment that will satisfy the debt in full.

How long will it take to get a certification reversed? Once the tax problem with the IRS has been resolved in one of the instances included above, the IRS will, within 3 days, reverse the certification and provide notification to the U.S. Department of State. If a taxpayer is already overseas when the State Department takes action to revoke or limit the taxpayer’s passport, the agency will either limit the passport only for return travel to the U.S. or issue a limited passport that only permits return travel. If you have any questions related to a tax delinquency or need assistance with an installment agreement or one of the other options discussed, please give this office a call.

Article Highlights:

Tax Return Mistakes are Common
Fixing Tax Return Mistakes
Amended Return
Superseding Return
Don’t Procrastinate in Responding to IRS

Generally speaking, tax return mistakes are a lot more common than you probably realize. Taxes have grown complicated and COVID tax relief has made many changes; the paperwork required to file proper tax returns is often convoluted. This is especially true if you’re filing your taxes yourself. The 2020 tax year certainly does not qualify as a “normal year.” Congress passed numerous tax laws before, during and after 2020 that apply to 2020, making it one of the more complicated tax years in recent memory. Even seasoned tax professionals had a hard time digesting all of the changes that they and their clients are now dealing with, requiring hours of continuing education. All of this is to say that if you’ve just discovered that you’ve made a significant mistake on your tax return, the first thing you should do is stop and take a deep breath, and then call this office. It happens. It’s understandable. There are steps that you can take to correct the situation quickly — you just have to keep a few key things in mind, including that the mistake could be in your favor. Fixing Tax Return Mistakes – Here’s What You Need to Know:

You have three years from the date that you originally filed your tax return (or two years from the date you paid the tax bill in question) to make any corrections necessary to fix your mistakes or oversights.
There’s a good chance that the IRS will catch an income omission, math errors, or an incorrect deduction or tax credit, in which case the IRS will probably send you a letter letting you know what happened and what you need to do to correct it.
If fixing the mistake ultimately results in you owing more taxes, you should pay that difference as quickly as possible. Penalties and interest will keep accruing on that unpaid portion of your bill for as long as it takes for you to pay it, so it’s in your best interest to take care of this as soon as you.

Many errors include not claiming tax benefits you are entitled to and cause you to pay more tax than required. You may have overstated or understated your income, received a late tax document or K-1. To correct issues on an already filed return you generally need to file an amended return. An amended return is used to make corrections to previously filed returns. The possible corrections include, but are not limited to:

Overstating or understating income
Changing an incorrect filing status
Adding or deleting dependents
Taking care of discrepancies in terms of deductions or tax credits

If any of the above apply to the error you’ve just discovered, you can — and absolutely should — file an amended return. If you catch the error prior to the filing due date of the return, instead of filing an amended return, you can file what’s called a “superseding return” to replace the original return. The difference is that when you file a superseding return you submit a complete new return to take the place of the one originally filed, while with an amended return, you fill out a special form (1040-X) and attach only backup forms or schedules that pertain to the change. A sudden increase in your tax liability notwithstanding, it’s again important to understand that errors on your income taxes aren’t really worth stressing out about. The IRS understands that sometimes mistakes happen, and they have a variety of processes in place designed to help make things right. If you have received a notice from the IRS about an error on your tax return, don’t procrastinate in handling it – address the issue(s) raised by the IRS raised right away. The same applies if you have discovered an error. Either way, you can contact this office for assistance with responding to the IRS, preparing a superseding or an amended return, and requesting penalty abatement.

Article Highlights:

Bureau of the Fiscal Service
Allowable Refund Offsets
Disputing an Offset
Injured Spouse Claim

We all look forward to receiving our tax refunds, but what if you were expecting a refund and it never arrived? It may be because you have outstanding federal or state debts—and not just tax-related debts. The Treasury Department’s Bureau of the Fiscal Service (BFS) issues federal tax refunds, and Congress authorizes BFS to reduce your refund through its Treasury Offset Program (TOP) to pay:

Past-due child and parent support;
Federal agency non-tax debts;
State income tax obligations; or
Certain unemployment compensation debts owed to a state (generally, these are debts for (1) compensation paid due to fraud or (2) contributions owed to a state fund that weren’t paid).

So, if you owe a debt that’s past due, all or part of your federal income tax refund may go to pay your outstanding federal or state debt if it has been submitted for tax refund offset by an agency of the federal or state government. BFS will send you a notice if an offset occurs reflecting the original refund amount, your offset amount, the agency receiving the payment, and the address and telephone number of the agency. BFS will notify the IRS of the amount taken from your refund once your refund date has passed. You should contact the agency shown on the notice if you believe you don’t owe the debt or if you’re disputing the amount taken from your refund. The IRS should be contacted only if your original refund amount shown on the BFS offset notice differs from the refund amount shown on your tax return. If you don’t receive a notice, contact the BFS’s TOP call center at 800-304-3107 (or TTY/TDD 866-297-0517), Monday through Friday 7:30 a.m. to 5 p.m. CST. If you choose to wait and see what happens when you file your return, BFS will send you a notice if an offset occurs. If you wish to dispute the amount taken from your refund, you will have to contact the agency that submitted the offset claim. It will be shown on the notice you will receive from the BFS. If your payment was reduced because a federal or state agency thinks you owe money, you should have received a letter from that agency. Call or write to them at the contact information on the letter. If you can’t find that information, you can get it by calling 800-304-3107. Only the agency that told BFS to collect the debt can work with you to return any part of the payment that should not have been taken from your refund. If you filed a joint tax return and only one spouse is responsible for the debt, the other spouse may be entitled to part or all of the refund. To request a refund for the spouse not responsible for the offset, you can file for an injured spouse allocation. The IRS will compute the injured spouse’s share of the joint refund. If you lived in a community property state during the tax year, the IRS will divide the joint refund based upon state community property law. Not all debts are subject to a tax refund offset. If your debt was submitted for offset, BFS will reduce your refund as needed to pay off the debt and send it to the agency you owe. Any portion of your remaining refund after offset is issued in a check or is direct deposited as originally requested on the tax return. The Treasury Offset website includes a Q&A section. With regard to the COVID-19 pandemic Economic Impact Payments (EIPs) that were issued in 2020 and early 2021, the second EIPs authorized in late December of 2021, are not subject to offset for any reason through the Treasury Offset Program. However, the first EIPs created by the CARES Act could have been entirely offset, up to the amount of an individual’s child support debt. The EIPs are advance payments of the Recovery Rebate Credit that is part of your 2020 tax return. To the extent that you have an overpayment of your 2020 income tax liability, the Recovery Rebate Credit can be reduced to pay debts you owe to Federal or state agencies. In the future, if you have an outstanding debt and want to be proactive, you can contact the agency with which you have a debt to determine if your debt was submitted for a tax refund offset. Please contact this office if you need assistance filing for an injured spouse claim or have other questions about refund offsets.

Article Highlights:

Education Benefits
Education, Teachers and Educators
Child Tax Credit
Child & Dependent Care Tax Credit
Earned Income Tax Credit for Childless Workers
Paid Family Leave
Health Insurance
Corporate Tax Rate
Individual Marginal Tax Rates
Capital Gains Tax
Basis Step-up
Carried Interest
Like-kind Exchange for Real Estate
Excess Business Losses
Medicare Tax
Tax Preparer Regulation
Compliance
Bank Information Reporting

President Biden presented his proposed American Families Plan (AFP) during his Joint Session of Congress address on April 29, 2021. What follows is an overview of what is included in the plan. But this is only his wish list; Congress will need to draft proposed legislation that will have to pass in both the House of Representatives and the Senate before becoming law. With a price tag of more than $1.8 trillion, many on both sides of the political aisle think the plan is too expensive. As with virtually all legislation, the provisions will be debated, altered and deleted during Congressional negotiations. The final bill, if passed, may be quite different than the original proposed version. BENEFITS Education Benefits – The AFP primarily incorporates education benefits that, if passed, would add four years of free public education and provide federal funds to certain higher education institutions. More specifically, it would address:

Pre-Kindergarten Education – Provide free universal preschool to all three- and four- year-olds.
Community College Education – Provide two years of tuition-free community college education, including for DREAMers.
Pell Grants – Increase Pell Grants by approximately $1,400 to assist low-income families and DREAMers.
College Retention and Completion Rates – Include a $62 billion grant program to invest in completion and retention activities at colleges and universities (particularly community colleges) that serve high numbers of low-income students. States, territories and tribes will receive grants to provide funding to colleges that adopt innovative, proven solutions for student success.
Subsidized Tuition – For families earning less than $125,000, provide two years of subsidized tuition at historically black colleges and universities and other minority-serving institutions. The plan would expand and create additional grants for these schools to strengthen their academic, administrative and fiscal capabilities, including by creating or expanding educational programs in high-demand fields such as STEM, computer sciences, nursing and related health care.

Education, Teachers and Educators – The AFP includes several provisions to increase college retention and completion rates, address teacher shortages, improve teacher preparation and strengthen pipelines for teachers of color. It would double scholarships for future teachers from $4,000 to $8,000 per year while they are earning their degree and would also help current teachers earn in-demand credentials. Child Tax Credit – The President is proposing that the Child Tax Credit increases included in the American Rescue Plan Act (ARPA) be made permanent. The ARPA increased the Child Tax Credit from $2,000 per child to $3,000 per child six years old and above and $3,600 per child under six years old. It also made 17-year-olds eligible children for the credit and made the credit fully refundable and payable periodically during the year. These changes were for 2021 only. The AFP proposal would extend the ARPA increases through 2025 and make the refundability permanent. Child & Dependent Care Tax Credit – The ARPA, for 2021 only, made this credit fully refundable and provided a credit equal to 50% of the expenses before phaseout. The maximum amount of expenses that can be used to compute the credit was increased to $8,000 for one qualified individual and $16,000 for two or more qualified individuals. As under prior law, a dependent child qualifies if they are under the age 13. The maximum credit is $4,000 (50% of $8,000) for one eligible individual and $8,000 (50% of $16,000) for two or more eligible individuals. The AFP would make these changes permanent. Earned Income Tax Credit (EITC) for Childless Workers – The ARPA essentially tripled the EITC for childless workers for 2021 only. The one-year change increased the maximum credit from $543 to $1,502. Biden is asking Congress to make this increase permanent. Paid Family Leave – The AFP would create a program that would ensure workers receive partial wage replacement to take time to bond with a new child, care for a seriously ill loved one, deal with a loved one’s military deployment, find safety from sexual assault, stalking or domestic violence, heal from a serious illness of their own or take time to deal with the death of a loved one. It would guarantee twelve weeks of paid parental, family and personal illness/safe leave by year 10 of the program and also ensure that workers get three days of bereavement leave per year starting in year one. The program would provide workers up to $4,000 a month, with a minimum of two-thirds of average weekly wages being replaced, rising to 80 percent of average weekly wages for the lowest-wage workers. Health Insurance – The AFP would extend the expanded ACA health insurance premium tax credits included in the ARPA that lowered health insurance costs by an average of $50 per person per month for nine million people, and it would enable four million uninsured people to gain coverage. In addition to other provisions, individuals would be able to enroll in Medicare at age 60. TAX INCREASES TO PAY FOR THE BENEFITS Corporate Tax Rate – The proposal would increase the corporate tax rate from 21% to 28% (the rate was 35% before the 2018 tax reform). Individual Marginal Tax Rates – The proposal would increase the top marginal tax rate from 37% to 39.6% for taxpayers with taxable income in excess of $400,000. That may be an oversimplification since tax rates take into account a taxpayer’s filing status. According to Jen Psaki, the White House press secretary, the 39.6% rate would apply to families with a taxable income of $509,300 or greater and single individuals with a taxable income of $452,700 or greater. Also, keep in mind that tax rates are adjusted for inflation annually. Capital Gains Tax – The proposal would end the lower maximum capital gains rates for households making over $1 million (the top 0.3 percent of all households), thus having them pay the same 39.6% rate on all their income and equalizing the rate paid on investment returns and wages. Basis Step-up – Currently, when assets are inherited, their basis in the hands of the beneficiary is the fair market value of the asset at the date of the decedent’s death. Taxable gain when an asset is sold is the difference between the selling price and the asset’s basis. Thus, under current law, assets can be transferred to beneficiaries without any income tax liability for the beneficiaries. Under the AFP, any basis step-up would be eliminated for gains in excess of $1 million ($2.5 million per couple when combined with existing real estate exemptions), ensuring the gains will be taxed if the property is not donated to charity. The reform would be designed with protections so heirs will not have to pay taxes on family-owned businesses and farms given to them if they continue to run the business. Carried Interest – Carried interest is a share of a private equity partnership’s or fund’s profits that serves as compensation for fund managers. Because carried interest is considered a return on investment, currently it is taxed at a capital gains rate and not an ordinary income rate. The proposed tax changes would eliminate carried interest, and thus the income would be taxed at ordinary rates. Like-kind Exchange for Real Estate – Sec 1031 of the Internal Revenue Code allows taxpayers to exchange real estate used in business or for investment for other business or investment real estate and avoid taxation by deferring the gain in the replacement property. The proposed plan would eliminate Section 1031 like-kind exchanges for real estate investors when they exchange property on gains greater than $500,000. Excess Business Losses – An ‘excess business loss’ is the excess (if any) of the taxpayer’s aggregate deductions for the tax year that are attributable to trades or businesses of the taxpayer (determined without regard to whether or not the deductions are disallowed for that tax year) over the sum of
(i) the taxpayer’s aggregate gross income or gain for the tax year attributable to those trades or businesses plus (ii) $250,000 (200% of that amount for a joint return (i.e., $500,000)). This amount is adjusted for inflation.
The current limitation is through 2021. The proposed changes would permanently extend the current limitation restricting large excess business losses. Medicare Tax – Currently there is a 2.9% Medicare surtax on earned income (wages, self-employment) for taxpayers whose earnings exceed $250,000 (joint), $125,000 (married filing separate) or $200,000 (others). When added to the regular 0.9% Medicare rate, the total paid is 3.8%. There is also a 3.8% Medicare surtax on net investment income that applies when the taxpayer’s income exceeds $250,000, $125,000 or $200,000, depending on their filing status. Biden’s plan would apply the 3.8% surtax consistently to those with income over $400,000. Tax Preparer Regulation – The proposal would give the IRS the authority to regulate paid tax preparers. Currently, CPAs and Enrolled Agents have continuing education requirements, as do tax preparers in Oregon and California. However, in other states, individuals can prepare tax returns without any oversight, which results in high error rates. These unregulated preparers charge taxpayers large fees while exposing them to costly audits. Compliance – The proposal would substantially raise the IRS’s budget to increase tax compliance of high-income earners and large corporations, businesses and estates. Bank Information Reporting – The proposal would require financial institutions to report to the IRS how much money came into and out of individuals’ and businesses’ accounts each year. This material is a synopsis of key provisions of the President’s American Families Plan but does not include all proposed changes. Consult the White House fact sheet for additional provisions and details.

Article Highlights:

Changing Filing Status
Liability
Community Property States
Social Security Benefits
Capital Loss Limitations
Sec 179 Business Expensing Election
Rental Loss Limitation
Traditional IRA Contributions
Roth IRA Contributions
Education Credits
Series EE or I Bonds
Higher Education Interest
Standard Deduction
Medicare Premiums
Allocating Home Mortgage Interest
Alternative Minimum Tax (AMT)
2021 Tax Rate Tables
Child and Dependent Care Credit
Child and Dependent Credit
Earned Income Tax Credit (EITC)
Adoption Credit
Estimated Taxes Allocation
Premium Tax Credit (PTC)

Couples who are married on the last day of the tax year basically have two filing status options when filing their tax returns: either married filing jointly (MFJ) or married filing separately (MFS) returns. Generally, filing MFJ will produce the better tax result. However, other factors – usually personal or financial rather than tax-related – can come into play that cause taxpayers to choose to file MFS returns. There is one exception to the requirement that married taxpayers file either MFS or MFJ. This is where one spouse lived apart from the other spouse for the last 6 months of the year and (1) pays more than one-half of the cost of maintaining as his or her home a household (2) which is the principal place of abode for more than one-half the year of a child, stepchild or eligible foster child that (3) the taxpayer may claim as a dependent. (A nondependent child qualifies only if the taxpayer gave written consent to allow the dependency to the non-custodial parent.) When these requirements are met, the head of household status can be used. The other spouse would still file as MFS unless that spouse also qualifies for the exception. Whatever the reason for filing MFS, the consequences encountered when filing separate returns are as follows. Changing Filing Status – Once a couple files a joint return, the joint filers may not change to filing separate returns after the unextended due date of the tax return. The unextended due date is generally April 15 unless it falls on a weekend or holiday, in which case it will be the next business day. Liability – When married taxpayers file joint returns, both spouses are responsible for the tax on that return. What this means is that one spouse may be held liable for all the tax due on a return, even if all the income on that return was earned by the other spouse. This also applies to back taxes and back child support. When spouses file MFS, each is liable only for the tax on their own return. Community Property States – Where taxpayers reside in a community property state, the allocation of income when filing separate returns is governed by state law. If the spouses file separate returns, each spouse, with certain exceptions, must report one-half of the income from community property, and if the couple is estranged or uncooperative, determining the correct amount of income that each should report may be difficult. The IRS can disregard community property laws when a spouse is not informed of community income by the other spouse. However, the IRS’s ability to disregard community property laws only occurs after the fact should the IRS question the allocations. Taxpayers may be able to disregard community property rules if the spouses have an agreement (commonly referred to as a prenuptial agreement, but agreements can also be created after marriage) that their property is separate property, and thus income from such property is separate income. It is best for an attorney to draft any such agreement. Following are how some of the most common types of income are treated for federal tax purposes in community property states.

Wages – Earned income from personal service received by a husband and wife domiciled in a community property state is generally community income during the period the community is in existence. Thus, wages are community income during the period of the community and must be split evenly. Example: Bill and Chris are married and live in a community property state. Bill is employed and had wages for the year of $120,000 ($10,000/month), while Chris is not employed. If they file MFS returns, each will report $60,000 of wages as income. Let’s say they separated on July 1 (i.e., the community ended) but were still married on December 31. They file MFS returns – Bill’s return will include $90,000 of wage income ((6 months x $10,000 x 50%) + (6 months x $10,000 x 100%)) and Chris will report $30,000 of wages (50% of Bill’s $60,000 wages for January through June).
Credit for Tax Withheld on Wages – If a husband and wife domiciled in a community property state file separately for federal tax purposes and each report one-half of the community wages received during the tax year, half the credit for the income tax withheld on the community wages that are reported on separate returns is taken by each spouse.
FICA Wage Withholding – The FICA (Social Security and Medicare) withholding cannot be allocated. It has already been reported to the Social Security Administration and credited under the Social Security Number (SSN) of the individual who actually earned it.
Net earnings from self-employment – Where the net self-employed earnings of a taxpayer is community property, and the spouses file MFS returns, then:
o Self-Employment Tax – Is assessed on the taxpayer who actually earned the income. If the spouses jointly operate the trade or business, for SE tax purposes, the gross income and related deductions are allocated between the spouses based on their distributive shares of the gross income and deductions. o Income Tax – For purposes of income tax, the SE income that is community income is divided 50/50 between the spouses and the SE income that is separate income is allocated 100% to the spouse who owns it. Example: Where a married couple lives in a community property state and only one spouse is self-employed, that spouse must pay SE tax on his total gross SE income, less total business deductions, despite the fact that half of that income is attributable to the other spouse for income tax purposes.

Disability and Unemployment Income – Since these are substitutes for current earnings, they are treated as community income.
Dividend & Interest Income – Interest and dividend income can be either separate or community income. This depends on whether the underlying investment that produced the income was acquired with joint or separate funds and whether the couple’s domicile was in a community or separate property state at the time the investment was acquired.
IRA & SEP Accounts – Traditional IRAs, Roth IRAs, SIMPLE IRAs, and simplified employee pension (SEP) IRAs are separate property by law; thus:
o Distributions – Are reported by the individual who owns the IRA. o Contributions – When deductible, the deduction is claimed by the individual who owns the IRA.

Social Security and Equivalent Railroad Retirement Benefits – Are treated as the income of the spouse who receives the benefits.
Pension Income – Income from qualified plan distributions can be either community income or separate income based upon the amount of separate and community income used to fund the pension account. One possible proration scenario would be prorating by the respective periods of participation in the pension while married and domiciled in a community property state or in a noncommunity property state during the total period of participation in the pension. Example: Prorating by Years – Suppose Dave has had a 401(k) plan since January 1 of 2010. He and Shirley get married on January 1, 2017. On January 1 of 2020, Dave retires and begins taking distributions from his 401(k) plan. Dave had the 401(k) plan for 10 years, three of which were during the period of his marriage to Shirley. Thus, prorating by year, Dave’s 401(k) distributions would be 70% separate income and 30% community income. If they filed married but separately, Dave would report 85% of the income (70% plus ½ of 30%) and Shirley would report 15%.

Partnership Income – Income from a partnership is based upon whether:

Income Is Attributable to the Personal Services of Either Spouse – Where the income from the partnership is attributable to the efforts of either spouse, the partnership income is community property.
Income Is Not Attributable to Personal Services – In this case, income can be either communal or separate based upon whether the partnership involves community or separate property.

Now, let’s look at some tax-related issues where filing MFS is generally unfavorable: Social Security Benefits – Social Security (SS) income is not taxable until their modified AGI (MAGI) – which is regular AGI without Social Security income plus 50% of their Social Security income, tax-exempt interest income, and certain other infrequently encountered additions – exceeds a specific threshold. The threshold is $32,000 for MFJ taxpayers. However, for taxpayers filing MFS, the threshold is zero, meaning they lose the benefit of the tax-excludable portion of Social Security benefits enjoyed by others and will have 85% of their Social Security benefits counted as income. Exception – There is an exception to this MFS penalty if the spouses lived apart for the entire tax year. The Tax Court has held that separate-filing spouses must live in separate residences to qualify as living apart. Capital Loss Limitations – When a taxpayer’s reportable sales of capital assets, such as stocks, result in a loss for the year, the loss is first used to offset capital gains; then, any excess loss is deducted from ordinary income, but the entire excess loss may not be deductible. Instead, the tax code limits the losses to $3,000, and amounts not allowed are carried over to the subsequent year. For MFS filers, that amount is reduced to $1,500. This will cause an MFS penalty, whereas the losses would all be reported on only one of the MFS returns.
Example: One spouse of a married couple has separate property that generates a $4,000 loss, which is the only capital gain or loss between them for the year. If they file jointly, they would be allowed a $3,000 capital loss deduction. If they file separately, then the spouse whose separate property generated the loss would report the entire transaction on their own separate return and would be limited to a $1,500 loss. The other spouse would not have a loss. Sec 179
Business Expensing Election – Under Section 179 of the tax code, taxpayers are allowed to expense (write off) rather than capitalize and depreciate personal tangible equipment purchased for business use. For purposes of the Sec 179 election, married taxpayers are treated as one taxpayer for determining the Section 179 limit. Thus, when filing MFS, the limit is divided equally between the taxpayers, unless they elect an unequal split. This will generally not be an issue for most taxpayers, since the Sec 179 expensing limit is $1,050,000 for 2021. Rental Loss Limitation – Rental property in the early years after acquisition will often show a tax loss. These losses are generally attributable to an accounting deduction for depreciation. The tax code includes some complicated rules related to deducting rental losses, but they are generally limited to $25,000 for taxpayers with an AGI of $100,000 or less and ratably phased out for taxpayers with AGIs between $100,000 and $150,000. MFS taxpayers are not allowed any loss unless they live apart the entire year. If they lived apart all year, the allowance is reduced to $12,500, and phaseout begins at an income level of $50,000. Traditional IRA Contributions – Deductible traditional IRA contributions are allowed for taxpayers up to $6,000 ($7,000 if age 50 or over). However, the deductibility now begins to phase out in 2021 for married joint filers if they are active participants in another plan when their AGI reaches $105,000 and is fully phased out when the AGI reaches $125,000. If only one spouse is an active participant in a qualified plan and files jointly, the phase out range is $198,000 – $208,000. If the couple files MFS, the AGI phaseout begins at zero AGI and is fully phased out at $10,000, which essentially eliminates a deductible contribution for either spouse. Plans That Create ‘Active Participation’:

A qualified annuity plan
A tax-sheltered annuity
A simplified employee pension (SEP)
An employer-sponsored qualified pension, profit-sharing or stock bonus plan
A plan established by a governmental agency for its employees, other than an unfunded deferred compensation plan for employees of state and local governments or exempt organizations (§ 457 plan)
An employee-only contributory plan exempt from tax

Roth IRA Contributions – Even though contributions up to $6,000 ($7,000 if age 50 or over) are allowed, unlike traditional IRA contributions, Roth IRA contributions are not deductible. Since Roth IRAs enjoy tax-free accumulation contributions, Congress decided contributions should not be available to high-income taxpayers. Thus, for 2021 the contributions now begin to phase out for married taxpayers with AGIs of $198,000 and are fully phased out when the AGI reaches $208,000. However, for MFS taxpayers, the phase out range is $0 to $10,000, essentially eliminating a contribution for either spouse. This AGI limitation applies regardless of whether the taxpayer is an active participant in a qualified plan. Education Credits – Tax law includes two tax credits to aid taxpayers who are paying higher education tuition and certain expenses for themselves and their children. The American Opportunity Tax Credit provides a tax credit up to $2,500 per eligible student, of which 40% is refundable. The second credit is the Lifetime Learning Credit, which provides a nonrefundable credit of up to $2,000 per tax return. Both credits are phased out for higher income taxpayers. However, for those filing MFS, no credit is allowed at all. Series EE or I Bonds – An individual who pays qualified higher education expenses with redemption proceeds from Series EE or I bonds issued after 1989 can potentially exclude the bonds’ interest from their income. However, no exclusion is available to a taxpayer using the MFS filing status. Higher Education Interest – An ‘above-the-line’ deduction (i.e., a deduction from AGI) is allowed for interest payments due and paid on any ‘qualified student loan,’ regardless of when a taxpayer first incurred the loan. The maximum deduction per year is $2,500. This is a per-return limit, not a per-student limit. However, MFS filers cannot deduct any amount of higher education interest. Standard Deduction – Married taxpayers filing jointly benefit from a 2021 standard deduction of $25,100, while the standard deduction for those filing as MFS is $12,550 (half of $25,100). However, if either spouse filing MFS itemizes their deductions, the standard deduction for the other spouse becomes zero, which forces that spouse to also itemize their deductions even if less than $12,550. Exception: Where a married individual qualifies to file as head of household as discussed at the beginning of this article, that spouse can take the standard deduction even if the other spouse itemizes. Filing Requirements – For years 2018-2025, an individual is required to file a federal return if their gross income exceeds their standard deduction amount. For MFJ couples, the standard deduction for 2021 is $25,100, but taxpayers filing as MFS are required to file a return if their gross income is $5 or more. Medicare Premiums – For those who qualify for Medicare, the premiums are based upon a taxpayer’s modified adjusted gross income (MAGI) and filing status from the tax return two years prior. As the Medicare chart for 2021 shown below illustrates, the rates for individuals filing MFS are substantially higher than for other Medicare participants.

MONTHLY MEDICARE B PREMIUMS

FILING STATUS
MAGI from 2 Years Prior (2019)
2021 PREMIUM

Married Filing Jointly (MFJ)
$176,000 or less
$148.50

–
$176,001 – $222,000
$207.90

–
$222,001 – $276,000
$297.00

–
$276,001 – $330,000
$386.10

–
$330,001– $749,999
$475.20

–
$750,000 and Above
$504.90

Married Filing Separately (MFS) (Lived together)
$88,000 or less
$148.50

–
$88,001 – $412,000
$475.20

–
$412,001 and Above
$504.90

Married Filing Separately (MFS) (Lived apart the entire year)
$88,000 or less
$148.50

–
$88,001 – $111,000
$207.90

–
$111,001 – $138,000
$297.00

–
$138,001 – $165,000
$386.10

–
$165,001 – $499,999
$475.20

–
$500,000 and Above
$504.90

Example: For a married couple living together in 2019 with a joint MAGI of $200,000, we can compare the results with them listed as married filing separately and married filing jointly to see what the difference in Medicare premiums will be in 2021.
Married Filing Separately – Assume they evenly divide their joint MAGI, so each has a MAGI of $100,000. Using the MFS (lived together) table above, their individual premiums would $475.20 per month or $5,702.40 per year. Their combined 2021 premiums would be, , , , , , , , , , , , , , , $11,404.80 Married Filing Jointly – If they had filed MFJ, their MAGI would have been $200,000. Using the married filing jointly tables, their individual premiums would be $207.90 per month or $2,494.80 per year. Their combined 2021 premiums would be, , , , , , , , , , , , , , , .$ 4,989.60 Thus, because they filed as MFS in 2019, their 2021 Medicare premiums increased by, , .., , , , , , , , , , , , , , , , , , , , $6,415.20 Allocating Home Mortgage Interest – There are limits on the amount of primary-home and second-home mortgage interest that can be deducted. However, when determining interest limits, married but separate taxpayers are treated as though they were one taxpayer. Thus, they are limited to an amount split between them that would have been allowed them on a joint return. If they own two homes, each may deduct the interest on only one, unless they both consent in writing that the deduction for both homes is to be taken by one spouse. Alternative Minimum Tax (AMT) The AMT came into being some time ago as a way to curtail tax shelters, deductions and credits for high-income taxpayers by imposing a tax computed in a more restrictive and complicated manner. The authors of the AMT also included special provisions for MFS taxpayers that include:

AMT Tax Exemption – The AMT exemption exempts an amount of AMT income from the AMT tax. The 2021 AMT exemption amount is $114,600 for a couple filing jointly, but the amount is cut in half ($57,300) for spouses when filing MFS.
AMT Tax Exemption Phaseout – The AMT exemption amount is phased out for higher-income taxpayers. The AMT phaseout for MFS taxpayers has a lower threshold that is half the amount that applies to spouses who file jointly. As a result, for 2021, although the phaseout threshold begins at $1,047,200 for spouses filing jointly, it begins at $523,600 for MFS spouses.
AMT Tax Rates – The 2021 AMT tax rates are 26% for alternative minimum taxable incomes of $199,900 or less and increase to 28% for higher amounts. For MFS taxpayers, the $199,900 amount is cut in half, resulting in the 28% rate occurring faster for those filing MFS.

2021 Tax Rate Tables – The IRS annually publishes tax rate schedules for each filing status. The 2021 rate schedules are reproduced below, and the higher tax rates kick in at lower income levels for MFS.

TABLE #1 – Married Individuals Filing Joint Returns and Surviving Spouses

If Taxable Income (TI) Is:
Tax Is:

Not Over
$19,900
–
–
–
10% of TI
–

Over
$19,900
but not over
$81,050
$81,050
Plus 12% of excess over
$19,900

Over
81,050
but not over
$172,750
$9,328
Plus 22% of excess over
$81,050

Over
$172,750
but not over
$329,850
$29,502
Plus 24% of excess over
$172,750

Over
$329,850
but not over
$418,850
$67,206
Plus 32% of excess over
$329,850

Over
$418,850
but not over
$628,300
$95,686
Plus 35% of excess over
$418,850

Over
$628,300
–
–
$168,993.50
Plus 37% of excess over
$628,300

TABLE #4 – Married Individual Filing Separately

If Taxable Income (TI) Is:
Tax Is:

Not Over
$9,950
–
–
–
10% of TI
–

Over
$9,950
but not over
$40,525
$995
Plus 12% of excess over
$9,950

Over
$40,525
but not over
$86,375
$4,664
Plus 22% of excess over
$40,525

Over
$86,375
but not over
$164,925
$14,751
Plus 24% of excess over
$86,375

Over
$164,925
but not over
$209,425
$33,603
Plus 32% of excess over
$164,925

Over
$209,425
but not over
$314,150
$47,843
Plus 35% of excess over
$209,425

Over
$314,150
–
–
$84,496.75
Plus 37% of excess over
$314,150

Child and Dependent Care Credit – A married taxpayer filing MFS cannot claim the credit or exclude dependent care benefits unless the taxpayer and his or her spouse are legally separated under a decree of divorce or separate maintenance. However, the custodial parent can exclude the dependent care benefits per the limits. Married taxpayers qualifying as head of household may claim the credit or exclude the dependent care benefits. Child and Dependent Credit – Married taxpayers filing MFS can claim the child and dependent credit. But the credit now begins to phase out in 2021 when the MFS filer’s modified AGI reaches $200,000, whereas for those filing MFJ, the phaseout threshold is $400,000. Earned Income Tax Credit (EITC) – To claim the EITC, an individual must have income from working, referred to in tax law as earned income. Where a married taxpayer is able to file as head of household as discussed at the beginning of this article and lives in a state that has community property laws, earned income for the credit does not include any amount earned by the taxpayer’s spouse that is treated as belonging to the taxpayer under community property laws. That amount is not earned income for the credit, even though a taxpayer must include it in gross income on his or her tax return. Adoption Credit – Taxpayers meeting certain circumstances can take a dollar-for-dollar tax credit for the adoption expenses they incurred in 2021, up to $14,440. However, a married individual filing a separate return (MFS) is only able to take the credit if all of the following apply:

The credit is not phased out for higher income. The phaseout range for 2021 is $216,660 to $256,660 (this range is the same for all filing statuses).
The spouses lived apart during the last 6 months of the year.
The eligible child lived in the MFS individual’s home for more than half of the year.
The MFS filer provided over half the cost of keeping up their home.

Estimated Tax Payments Allocation – When married taxpayers file as MFS, they will have sometimes made a prepayment toward their income taxes by filing estimated taxes either individually or jointly, and those payments must be allocated between their MFS returns. The IRS has established the following procedure for allocating estimated tax payments.
Separate Returns, Separate Estimates – If the taxpayer and spouse made separate estimated tax payments for the year and file separate returns, they can take credit only for their own payments. Separate Returns, Joint Estimates – If the taxpayers made joint estimated tax payments, they must decide how to divide the payments between the returns. One can claim all of the estimated tax paid and the other none, or they can divide it in any other way they agree on. If they cannot agree, they must divide the payments in proportion to each spouse’s individual tax as shown on their separate returns for the year. Example – James and Evelyn Brown made joint estimated tax payments totaling $3,000. They decide to file separate returns and cannot agree on how to divide the $3,000. Since they cannot agree upon how to divide the payments, they must divide the payments in proportion to their separate tax liabilities. James’ tax is $4,000 and Evelyn’s is $1,000. Since they cannot agree upon how to divide James’ share = 4,000/5,000 x 3,000 = $2,400 Evelyn’s share = 1,000/5,000 x 3,000 =$ 600
Premium Tax Credit (PTC) – The PTC is a health insurance subsidy the government pays to lower income individuals who obtain their family health insurance through a government marketplace. Generally, a married taxpayer filing separately (MFS) cannot claim the premium tax credit (PTC) and thus must repay all advance premium tax credit (APTC) received through the marketplace. There are two exceptions:

Individuals who qualify as victims of domestic abuse or spousal abandonment, and
Taxpayers whose household income is less than 400% of the federal poverty level will have their payback limited based on household income relative to the federal poverty level. For 2020, Congress suspended the payback altogether, but it is to resume for 2021.

As you can see, there are quite a number of issues to think about when filing MFS. If you are considering such a move, it may be appropriate to consult with this office in advance. If you have already filed MFS, there may be some significant tax refunds available by amending your separate returns to a joint return. Please contact this office for assistance.