Article Highlights:

Physical Injury
Wrongful Death
Emotional Distress
Employment Discrimination
Sexual Harassment
Human Trafficking Restitution
Wrongful Incarceration
Damages Related to Business Interests
Legal Expenses

Frequent questions that arise are: Are amounts received from settlement of lawsuits and other legal remedies taxable? Are the legal fees paid in connection with these payments tax deductible? The tax code specifies that all income is taxable from whatever source derived, unless exempted by the Internal Revenue Code. The tax code does provide an exclusion from income for certain damage awards but not for others. The companion issue to damage awards is the deductibility of the legal fees associated with the damage awards and settlements. This article looks at a variety of situations and the tax ramifications. Physical Injury – Damages received on account of personal physical injuries or physical sickness are excludable from income whether recovery is by suit or agreement, or the amounts are received as a lump sum or in periodic payments. When a legal action originates with a physical injury or physical sickness, then all damages (other than punitive) are treated as payments due to physical injury or physical sickness whether the recipient of the damages is the injured party. Wrongful Death – Is considered physical injury or physical sickness for purposes of the income exclusion. In addition, where state law provides that only punitive damages can be awarded in wrongful death suits, punitive damages are excludable. Emotional Distress – Emotional distress isn’t considered physical injury or physical sickness for purposes of the income exclusion. However, the tax code allows the exclusion of damages received for emotional distress to the extent not more than the amount paid for medical care related to emotional distress. Employment Discrimination – No exclusion is allowed for damages received in a suit involving employment discrimination or injury to reputation, which is accompanied by a claim of emotional distress. However, the exclusion would apply to a claim of emotional distress, which was related to a physical injury or physical sickness. Sexual Harassment Damages and Settlements – Tax reform put restrictions on business deductions related to sexual harassment damages and settlements as well as impacting the taxability of any award or settlement.

Impact on a Business – No business deduction is allowed for any settlement, payout, or attorney fees related to sexual harassment or sexual abuse if such payments are subject to a nondisclosure agreement.
Impact on an Award Recipient – Damages for sexual harassment and gender discrimination are not excludable and thus are fully taxable. The issue of sexual harassment qualifying as excludable physical injury or sickness has been in court on several occasions – always with the same result (it’s taxable).

Human Trafficking Restitution Payments – A defendant convicted of a human trafficking offense is required to make restitution payments to the victim. These payments are excludable from the victim’s gross income for federal income tax purposes. The payments may be to compensate the victim for costs of medical services, physical and occupational therapy or rehabilitation, transportation, temporary housing, childcare expenses, lost income, attorneys’ fees and other costs and losses the victim suffers because of the offense. Wrongful Incarceration – Compensation received for a wrongful incarceration is not taxable. A wrongfully incarcerated individual is defined as either:
(1) an individual who was convicted of a criminal offense under Federal or state law, who served all or part of a sentence of imprisonment relating to such offense, and who was pardoned, granted clemency, or granted amnesty because of actual innocence of the offense; or (2) an individual for whom the conviction for such offense was reversed or vacated and for whom the indictment, information, or other accusatory instrument for such offense was dismissed or who was found not guilty at a new trial after the conviction was reversed or vacated.
Damages Related to Business Interests – Generally damages related to business interests are income to the business except for damages related to injury to property. The damages are not taxable to the extent the basis of the property is reduced. Legal Expenses – Unfortunately in most cases the legal fees end up not being deductible. The reason for that is when they are deductible, they are a tier 2 miscellaneous itemized deduction. But the current tax law has suspended all tier 2 miscellaneous deductions through 2025, so the bottom line, with some exceptions explained later, is that the legal fees are not deductible.
Example: Melinda, was injured in an automobile accident and engaged a legal firm to handle her claim with the insurance company. The legal firm’s fee was 40% of the insurance company settlement.
The insurance company paid $100,000. The legal firm got $40,000 and Melinda got $60,000. However, since the legal fees are not deductible Melinda ends up paying taxes on the entire $100,000 settlement. However, there are exceptions. Legal fees related to a taxpayer’s business or rental are deductible as a business expense. If the action was related to property, the expenses would be added to the property’s basis. An above-the-line deduction (meaning it is deductible as an adjustment to gross income, not an itemized deduction) is allowed for attorneys’ fees and costs paid by, or on behalf of, a taxpayer in connection with a claim of unlawful discrimination, certain claims against the federal government, or a private cause of action under the Medicare Secondary Payer statute. This deduction is claimed on Form 1040, Schedule 1, line 24h (2021 version). As you can see, determining what damage awards are taxable and whether the associated legal expenses are deductible is complicated, and even if allowed, a deduction may not provide any tax benefit. As every circumstance is unique, you are encouraged to call this office to determine what the tax ramifications might be in your situation.

Article Highlights:

Non-Resident Alien Spouse
Foreign Rentals
Foreign Pensions
Foreign Income Exclusion
FBAR
Statement of Specified Foreign Financial Assets
Credit of Foreign Tax Paid
Canadian Registered Retirement Savings & Income Plans
Reporting Receipt of Foreign Gifts or Bequests
Reporting Ownership or Transactions with Foreign Trusts
Annual Information Return for Foreign Trust with U.S. Owner
Ownership or Voting Power in Foreign Corporation

Anymore, we have a worldwide economy and with that comes a variety of tax issues. Some of these may be relevant to you. The following issues, some of which you may not be aware of, apply to individuals. In addition, some are subject to severe penalties when not complied with. Non-Resident Alien Spouse It is becoming more frequent that a U.S. citizen or U.S. resident alien is married to a nonresident alien. In this circumstance the couple has filing options for U.S. tax purposes. Generally, a U.S. citizen or a U.S. resident alien (sometimes referred to as a green card holder) who is married to a nonresident alien must file their U.S. tax return using the filing status Married Filing Separate. This filing status has higher tax rates and certain limitations that do not apply to other filing statuses. The nonresident alien spouse would have to file a nonresident U.S. tax return on any U.S. source income. However, tax law allows a person who is a nonresident alien at the end of the taxable year, and who is married to a U.S. citizen, or a U.S. resident alien, to be treated as a U.S. resident for income tax purposes and file a Married Filing Joint return, if both spouses so elect. In doing so both spouses must agree to subject their worldwide income for the taxable year to U.S. taxation. Once made, and as long as one of the spouses is a U.S. citizen or resident alien, the election applies for the election year and all future years until it is terminated. If the election is terminated, neither spouse is eligible to make the election for any subsequent tax year. Making this election requires a careful analysis of the tax ramifications of combining incomes, not only for the current year but all future years. Also, the couple could be subject to an FBAR filing requirement discussed later. Foreign Rentals Generally, foreign rental property is reported on the U.S. tax return in the same manner as a domestic rental. However, there are some differences in rental depreciation. For residential property, if the property were in the U.S. the depreciable recovery period would be 27.5 years but for a foreign rental the recovery period would be 30 years straight line. Similarly, for commercial rentals 40 years instead of 39.5. The passive loss rules apply to a foreign rental in the same manner as a domestic rental so any consolidated net losses are limited to $25,000 but this limit is reduced (phases out) for taxpayers with an adjusted gross income (AGI) between $100,000 and $150,000. If the landlord hires a non-resident alien in the foreign country to perform services related to the foreign rental activity, there are no U.S. reporting or withholding requirements. However, the foreign person providing those services should complete Form W-8BEN and return it to the landlord as proof that the individual is not subject to U.S. taxation. Last, but not least, if a foreign bank account is maintained to receive rental income and disperse rental expense payments, and the owner of the property has signature or other authority over the account, then there may be an FBAR reporting requirement discussed later. Foreign Pensions A foreign pension or annuity distribution is a payment from a pension plan or retirement annuity received from a source outside the United States such as a:

foreign employer;
trust established by a foreign employer;
foreign government or one of its agencies (including a foreign social security pension);
foreign insurance company;
foreign trust or other foreign entity designated to pay the annuity.

Just as with domestic pensions or annuities, the taxable amount generally is the gross distribution minus the cost (investment in the contract) unless there is a tax treaty provision covering the taxation of the pension. Another issue is whether the pension is taxable to the U.S., the individual’s country of residence, other country or the pension’s country of origin. This is commonly determined by the tax treaty between the U.S. and the country of origin. Generally, most tax treaties allow the country of residence to tax the pension or annuity under its domestic laws. This is true unless a special treaty provision specifically amends that treatment. The following are some commonly encountered treaty provisions:

Canada – Canadian Old Age Security (OAS) pensions and Canada/Quebec Pension Plan (CPP/QPP) benefits received by U.S. residents are treated for tax purposes as if they were U.S. Social Security payments. U.S Social Security benefits received by a Canadian resident are taxable to Canada. Beneficiaries of a Canadian RRSP, RRIF, Registered Pension Plan, or deferred profit-sharing plan are taxable to the U.S. if the recipient is a U.S. Resident.
United Kingdom – UK pensions received by a U.S. resident are taxable to the U.S. and U.S. pensions received by a resident of the UK are taxable to the UK. Each country can only tax the amount that would have been taxed in the other country.

CAUTION: These treaty provisions are with the U.S. Federal government and not with the individual states. Consult the individual state’s rules. Foreign Income Exclusion U.S. citizens and resident aliens are taxed on their worldwide income, whether they live inside or outside of the U.S. However, qualifying U.S. citizens and resident aliens who live and work abroad may be able to exclude from their income all or part of their foreign salary or wages, or amounts received as compensation for their personal services. In addition, they may also qualify to exclude or deduct certain foreign housing costs. To qualify for the foreign earned income exclusion, a U.S. citizen or resident alien must:

Have foreign earned income (income received for working in a foreign country, including payroll disbursements from a U.S. employer and self-employment income);
Have a tax home in a foreign country; and
Meet either the bona fide residence test or the physical presence test.

The foreign earned income exclusion amount is adjusted annually for inflation. For 2021, the maximum is $108,700 ($112,000 for 2022) per qualifying person. If the taxpayers are married and both spouses (1) work abroad and (2) meet either the bona fide residence test or the physical presence test, each one can choose the foreign earned income exclusion. Together, they can exclude as much as $217,400 for the 2021 tax year ($224,000 for 2022), but if one spouse uses less than 100% of his or her exclusion, the unused amount cannot be transferred to the other spouse. In addition to the foreign earned income exclusion, qualifying individuals may also choose to exclude or deduct a foreign housing amount from their foreign earned income. The amount of qualified housing expenses eligible for the housing exclusion and housing deduction is generally limited to 30% of the maximum foreign earned income exclusion. The housing amount limitation is $32,610 for the 2021 tax year ($33,600 for 2022). Generally, to qualify, most individuals use the physical presence test which requires the taxpayer to be physically present in a foreign country for 330 full days during a consecutive 12-month period (not a calendar year). Where the 330-day period overlaps two years the exclusion is prorated for each year. Foreign Account Reporting Requirements (FBAR) All United States entities (including citizens and resident aliens as well as corporations, partnerships, and trusts) with financial interests in or authority over one or more foreign financial accounts (e.g., bank accounts and securities) need to report these relationships to the U.S. Treasury if the aggregate value of those accounts exceeds $10,000 at any time during the year. Failure to file the required forms can result in severe penalties. The U.S. government wants this information for a couple of pretty obvious reasons. One, foreign financial institutions may not have the same reporting requirements as U.S.-based financial institutions. For example, they probably won’t issue the 1099 forms to report interest, dividends and sales of stock. By requiring those in the U.S. to divulge their foreign account holdings, the IRS can more easily cross-check to see if foreign income is being reported on the individual’s tax return. The second (and probably more significant) reason is that the information in the report can be used to identify or trace funds used for illegal purposes or to identify unreported income maintained or generated overseas. This reporting requirement is not included with a tax return but is a separate filing with the U.S. Treasury’s Financial Crimes Enforcement Network. The due date of the report is the same as the April filing date for individual tax returns, April 18, 2022, for 2021 returns (except for residents of Maine and Massachusetts where the due date is April 19, 2022), and there is an automatic extension to the October individual extended due date, October 17, 2022, for 2021 returns. A civil penalty of up to $10,000 may be imposed for a non-willful failure to report; the penalty for a willful violation is the greater of $100,000 or 50% of the account’s balance at the time of the violation. Both the $10,000 and $100,000 amounts are subject to inflation adjustment, which, as of January 24, 2022, brings them to $14,489 and $144,886, respectively. A willful violation is also subject to criminal prosecution, which can result in a fine of up to $250,000 and jail time of up to five years. CAUTION: On Schedule B of the Form 1040 tax return, you must state whether you have a financial interest in or signature authority over one or more foreign financial accounts. If you answer yes but don’t file the FBAR, your failure to file may be considered willful, which could subject you to the larger fine and jail time.You may have an FBAR requirement and not even realize it. For instance, say that you have relatives in a foreign country who have put your name on their bank account in case of an emergency; if the value of that account exceeds $10,000 at any time during the year, you will need to file the FBAR. The same would be true if your name was added to several of your foreign relatives’ smaller-value accounts that add up to more than $10,000 at any time during the year. As another example, if you gamble at an online casino that is located in a foreign country and your account exceeds the $10,000 limit at any time during the year, you will need to file the FBAR. Statement of Specified Foreign Financial Assets You may also have to file IRS Form 8938, which is similar to the FBAR but applies to a wider range of foreign assets and has a higher dollar threshold. This form is filed with your income tax return. If you are married and filing jointly, you must file Form 8938 if the value of your foreign financial assets exceeds $100,000 at the end of the year or $150,000 at any time during the year. If you live abroad, these thresholds are $400,000 and $600,000, respectively. For other filing statuses, the thresholds are half of the amounts above. The penalty for failing to file Form 8938 is $10,000 per year; if the failure continues for more than 90 days after the IRS provides notice of your failure to file, the penalty can be as high $50,000. Credit for Foreign Tax Paid With the worldwide economy we are all living in, more and more individuals are making investments in foreign countries, and may pay a foreign tax on their foreign earnings. These earnings are also taxable to the U.S. To compensate for potentially being taxed twice on the same income, the U.S. allows a tax credit, or an itemized deduction if the taxpayer itemizes their deductions, for the foreign income taxes paid. CAUTION: if you are a partner in a partnership or a shareholder in an S corporation you should contact your managing partner or shareholder before filing a Form 1116 to claim a foreign tax credit. Filing the Form 1116 on your 1040 or 1040-SR can have ramifications related to the filing of the partnership or S corporation tax returns. Reporting Receipt of Foreign Gifts or Bequests Foreign gifts or bequests received by a U.S. person, other than an exempt organization, must be reported to the federal government on Form 3520 if the gift exceeds $100,000 from a nonresident alien individual or a foreign estate, including foreign persons related to that nonresident alien individual or foreign estate. In addition, amounts more than $16,815 for 2021 ($16,649 in 2020 and $17,339 for 2022) from foreign corporations or foreign partnerships, including foreign persons related to such foreign corporations or foreign partnerships, that are treated as gifts must be reported on the Form 3520. Reporting Ownership or Transactions with Foreign Trusts Form 3520 is also used to report ownership in a foreign trust or transactions carried out with a foreign trust. Failure to file Form 3520 or providing incomplete or incorrect information can be subject to some severe penalties. Annual Information Return for Foreign Trust with U.S. Owner A foreign trust with a U.S. owner must file Form 3520-A in order for the U.S. owner to satisfy its annual information reporting requirements. Each U.S. person treated as an owner of any portion of a foreign trust is responsible for ensuring that the foreign trust files Form 3520-A and furnishes the required annual statements to its U.S. owners and U.S. beneficiaries. Ownership or Voting Power in Foreign Corporation Generally, a U.S. citizen or resident alien (or one who files a joint return with a U.S. citizen or resident alien) who owns a 10% or more interest in a foreign corporation or commands control over more than 50% of the voting power in a foreign corporation must file Form 5471. Please contact this office if any of the discussed issues might apply to you so we can help you take advantage of the benefits and comply with the reporting requirements.

Article Highlights:

Employees
Self-Employed Individuals
Quarterly Payments
Underpayment Penalty
Safe Harbor Payments

Estimated tax payments are not just for the self-employed. They are for anyone whose withholding and tax credits are significantly less than their projected tax liability, and if used properly, can protect a taxpayer from underpayment penalties.Employees who will have income, Social Security, and Medicare taxes withheld from their wages generally do not need to make estimated tax payments. On the other hand, self-employed individuals must prepay their taxes by making quarterly estimated tax payments. These are referred to as estimated tax payments because the self-employed individual must estimate his or her net earnings for the year and pay taxes on a quarterly basis according to that estimate. Failure to do so will result in interest penalties.The self-employed are not the only ones who are subject to estimated tax requirements – anyone who has income on which there’s no income tax withheld, and even those whose taxes are not sufficiently withheld, may need to make estimated payments. Thus, if you have income from stock sales, property sales, investments, alimony, partnerships, S-corporations, inherited pension plans, or other sources where no tax was withheld, you may also be required to pay either estimated taxes or run the risk of an underpayment penalty. Others subject to making estimated payments are individuals who must pay special taxes such as the 3.8% tax on net investment income or the employment tax on household employees.Although these payments are called ‘quarterly’ estimates, the periods they cover do not usually coincide with a calendar quarter. For 2022 the dates are:

Quarter
Period Covered
Months
Due Date*

First
January through March
3
April 18, 2022

Second
April and May
2
June 15, 2022

Third
June through August
3
September 15, 2022

Fourth
September through December
4
January 17, 2023

*If the due date falls on a Saturday, Sunday, or holiday, the payment is due on the next business day. For taxpayers in Maine and Massachusetts, the first 2022 estimate payment is due on April 19, 2022.

An underestimated penalty does not apply if the tax due on a return (after withholding and refundable credits) is less than $1,000; this is the ‘de minimis amount due’ exception. When the tax due is $1,000 or more, underpayment penalties may be assessed.The underpayment penalties are determined on a quarterly basis, so an underpayment in an earlier quarter cannot be made up for in a later quarter’s payment. However, withholding is treated as being paid ratably throughout the year. Thus, increasing withholding in the later part of the year can help make up for underpayments in earlier periods in the year. Contrarily, an overpayment in an earlier quarter is applied to the following quarter. The amount of an estimated payment is determined by estimating one-fourth of the taxpayer’s tax for the entire year; the projected tax is paid in four installments. When the income is seasonal, sporadic, or the result of a windfall, the IRS provides a special form, and the underpayment penalty is based on actual income for the period.For individuals who do not want to take the time to estimate their quarterly taxes but who still want to avoid the underpayment penalty, Uncle Sam also provides safe-harbor estimates. However, even these can be tricky. Generally, taxpayers can avoid an underpayment penalty if their withholding and estimated payments are equal to or greater than

90% of the current year’s tax liability or
100% of the prior year’s tax liability.

However, these safe harbors do not apply if the prior year’s adjusted gross income is over $150,000, in which case, the safe harbors are

90% of the current year’s tax liability or
110% of the prior year’s tax liability.

Thus, a true safe harbor, regardless to the current year’s tax liability would be withholding and estimated tax payments equal to or greater than 110% of the prior year’s tax liability.Sometimes, individuals who have withholding on some (but not all) of their sources of income will increase that withholding to compensate for the additional income sources that have no withholding. Although this may work, withholding adjustments are not as precise as quarterly payments and should be used with caution.This office can assist you in estimating payments, adjusting withholding, and setting up safe-harbor payments. Please call for assistance.

Article Highlights:

Extensions
Balance-Due Payments
Contributions to Roth or Traditional IRAs
Individual Refund Claims for the 2018 Tax Year
Missing Information

As a reminder to those who have not yet filed their 2021 tax returns, April 18, is the due date to either file a return (and pay the taxes owed) or file for an automatic extension (and pay an estimate of the taxes owed). The due date is April 18, instead of April 15, because of the Emancipation Day holiday in the District of Columbia – even if you don’t live in DC. If you live in Maine or Massachusetts, the filing due date is April 19, 2022, because of the Patriots’ Day holiday in those states. Caution should be exercised when preparing the extension application, which is IRS Form 4868. Even though this form is described as “automatic,” the extension is automatically granted only if it includes a reasonable estimate of the 2021 tax liability and only if that anticipated liability is paid along with the extension application. It is not uncommon for taxpayers to enter zero as the estimated tax liability without figuring the actual estimated amount. These taxpayers risk the IRS classifying their forms as having been improperly completed, which in turn makes the extensions invalid. If you need an extension, please contact this office so that we can prepare a valid extension for you. The extension must be filed in a timely manner; at this office, we can file your extension electronically before the due date and have any amount owed withdrawn from your bank account. Because the IRS is so backed up opening mail, we do not recommend the payment be made by mail. But if you do decide on mailing an extension, be advised that the envelope with the extension form must be postmarked on or before the April 18 due date. However, there are inherent risks associated with dropping an extension form in a mailbox; for instance, the envelope might not be postmarked in a timely fashion. Thus, those who have estimated tax due should mail their extension forms using registered or certified mail so as not to risk late-filing penalties. In addition, the April 18 deadline also applies to the following:

Balance-Due Payments for the 2021 Tax Year – Be aware that Form 4868 is an extension to file, NOT an extension to pay. The IRS will assess late-payment penalties (with interest) on any balance due, even when the extension has been granted. Taxpayers who anticipate having a balance due need to estimate this amount and include payment for that balance, either along with the extension request (as indicated above) or electronically by this firm or through the IRS website.
Contributions to a Roth or Traditional IRA for the 2021 Tax Year – April 18, 2022, is the last day for 2021 contributions to either a Roth or a traditional IRA. Form 4868 does not provide an extension for making IRA contributions.
Individual Estimated Tax Payments for the First Quarter of 2022 – The first installment of the 2022 estimated tax payment is due on April 18, 2022. If you make estimated tax payments and did not file the first installment on or before April 18, 2022, then that payment is late, and you should file it as soon as possible to mitigate any penalties.
Individual Refund Claims for the 2018 Tax Year – The regular three-year statute of limitations expires for the 2018 tax return on April 18 of this year. Thus, no refund will be granted for a 2018 return (original or amended) that is filed after April 18, 2022. Taxpayers could risk missing out on the refundable Earned Income Tax Credit, the refundable American Opportunity Tax Credit for college tuition, and the refundable child credit for the 2018 tax year if they do not file before the statute of limitations ends. Caution: The statute does not apply to balances due for unfiled 2018 returns.

If your 2021 return is still pending because of missing information, please forward that information to this office as quickly as possible so that we can ensure that your return meets the April 18 deadline. Keep in mind that the last week of tax season is very hectic, and your returns may not be completed in time if you wait until the last minute. If you know that the missing information will not be available before the April 18 deadline, then please let us know as soon as possible so that we can prepare an extension request. If you have not yet completed your returns, please call this office right away so that we can schedule an appointment and/or file an extension for you.

If you are required to pay quarterly estimated income tax, an upcoming change in interest rates being imposed by the IRS may have a direct impact on you. Effective April 1st, 2022, corporations and self-employed filers who submit quarterly estimated taxes will see a hike in the interest rates that the agency charges for both overpayments and underpayments. The new rates will be:

4% for underpayments;
6% for large corporate underpayments
4% for overpayments (3% in the case of a corporation)
1.5% for the portion of a corporate overpayment exceeding $10,000

Though these changes will not affect you if you calculate your liability correctly and pay on time each quarter, those taxpayers who have an outstanding balance or who are otherwise out of compliance with their tax obligation need to remember that the longer they take to address the situation, the more their obligation will grow as their liabilities accrue interest at a rate of 3%. If you have questions on how the new rates will affect you, feel free to contact us today.

Article Highlights:

If You Can’t Pay
Family Loans
Home Equity Loans and HELOCs
Credit Card
Short-term Payment Plan
IRS Installment Agreement
Retirement Funds
Filing Extensions
Enforced Collections
Offer-in-Compromise

Although most (74% in 2020) American taxpayers receive a refund each year when they file their income tax returns, there are those who for one reason or another end up owing. Of those who owe Uncle Sam many don’t have the means to pay what they owe by the return due date (usually in April). Generally, tax due occurs when a wage earner has under-withheld on his or her payroll or a self-employed individual failed to make adequate estimated tax payments during the year. This can be a huge problem for those who are unable to pay their liability. It is generally in your best interest to make other arrangements to obtain the funds for paying your 2021 taxes rather than be subjected to the government’s penalties and interest for payments made after April 18, 2022. Here are a few options to consider.

Family Loan – Obtaining a loan from a relative or friend may be the best bet because this type of loan is generally the least costly in terms of interest.
Home Equity Loans and HELOCs – Use the equity in your home—that is, the difference between your home’s value and your mortgage balance—as collateral. As the loans are secured against the equity value of your home, home equity loans offer extremely competitive interest rates—usually close to those of first mortgages. Compared with unsecured borrowing sources, such as credit cards, you’ll be paying less in financing fees for the same loan amount. Unfortunately, obtaining these loans takes time, so if you anticipate that you’ll need funds from such a loan to pay your taxes that are due in April, you should get the application process started right away.
Credit Card – Another option is to pay by credit card with one of the service providers that work with the IRS. However, since the IRS will not pay a credit card discount fee (the fee charged by the credit card company), you will have to pay the fees due and pay the higher credit card interest rates.
Short-Term Payment Plan – If you can fully pay the tax owed within 180 days and owe less than $100,000 including tax, penalties, and interest, you can apply for a short-term payment plan online at the IRS website. You won’t be charged a set-up fee but will still have to pay penalties and interest until the balance owed is fully paid. Setup fees will be charged if you apply for a payment plan by phone, mail, or in-person instead of online.
IRS Installment Agreement – If you owe the IRS $50,000 or less, you may qualify for a streamlined installment agreement where you can make monthly payments for up to six years. You will still be subject to the late payment penalty, but it will be reduced by half. Interest will also be charged at the current rate. There is a user fee to set up the payment plan. However, the IRS generally waives the fee for low-income taxpayers who agree to make electronic debit payments. In making the agreement, a taxpayer agrees to keep all future years’ tax obligations current. If the taxpayer does not make payments on time or has an outstanding past due amount in a future year, they will be in default of their agreement and the IRS has the option of taking enforcement actions to collect the entire amount owed. Taxpayers seeking installment agreements exceeding $50,000 will need to validate their financial condition and need for an installment agreement by providing the IRS with a Collection Information Statement (financial statements). Taxpayers may also pay down their balance due to $50,000 or less to take advantage of the streamlined option.
Tap a Retirement Account – This is possibly the worst option for obtaining funds to pay your taxes because you are jeopardizing your retirement lifestyle and the distributions are generally taxable at your highest bracket, which adds more taxes to your existing problem. In addition, if you are under age 59½, the withdrawal is also subject to a 10% early withdrawal penalty that compounds the problem even further.

Filing Extensions – Don’t mistake the ability to apply for an extension of time to file your tax return as also being an extension to pay any tax liability. It is not and does not grant you an extension of time to pay. The penalties and interest on the amount due will continue to apply as of the original due date of the return.Enforced Collections – If the taxes cannot be paid timely, and the IRS is not notified why the taxes cannot be paid, the law requires that enforcement action be taken, which could include the following:

Issuing a Notice of Levy on salary and other income, bank accounts or property (IRS can legally seize property to satisfy the tax debt)
Assessing a Trust Fund Recovery Penalty for certain unpaid employment taxes.
Issuing a Summons to the taxpayer or third parties to secure information to prepare unfiled tax returns or determine the taxpayer’s ability to pay.

Note: To collect delinquent tax debts, certain federal payments (vendor, OPM, SSA, federal salary, and federal employee travel) disbursed by the Department of the Treasury, Bureau of Fiscal Service (BFS)) may be subject to a levy through the Federal Payment Levy Program (FPLP). Fresh Start Initiative – The IRS also has what is called the “Fresh Start” initiative to offer more flexible terms in its existing Offer-in-Compromise program which, under certain circumstances allows taxpayers to settle their tax debt for reduced amounts. This enables financially distressed taxpayers to clear up their tax problems faster than in the past. While resolving tax problems might previously have taken four or five years, taxpayers may now be able to resolve their problems in as little as two years. If you have questions about the payment options or an offer-in-compromise, please call this office for assistance. Don’t just ignore your tax liability because that is the worst thing you can do.

Article Highlights:

Sec 199A Deduction
Qualified Business Income
Threshold
Specified Service Businesses
Limitations
Wage Limitation
Aggregating Amounts

Several years ago, when Congress changed the tax-rate structure for C corporations to a flat rate of 21% instead of the former graduated rates that topped out at 35%, they also came up with a new deduction for businesses that are not organized as C corporations. This tax break will be available only through tax year 2025 unless it is extended by Congress. As a result, the current tax code provides a substantial tax benefit for most non-C-corporation business owners in the form of a deduction that is equal to 20% of their qualified business income (QBI). This deduction is most known as a pass-through income deduction because it applies to income from pass-through business entities such as partnerships and S corporations. This category also includes income from sole proprietorships, rentals, and farms; Real Estate Investment Trust (REIT) dividends; pass-through income from publicly traded partnerships; and cooperative dividends. The shorthand term for this deduction is the Sec 199A deduction, as 199A is the Internal Revenue Code section number for this provision. Let’s look at how this deduction works. QBI – QBI is defined as the net amount of income, gains, deductions, and losses with respect to trades or businesses that are conducted within the United States. QBI does not include:

Wages
Capital gains or losses,
Interest income,
Dividends or payments in lieu of dividends,
Annuity income not received in connection with a trade or business,
Gain or loss from foreign currency transactions,
Trade or business of being an employee,
Reasonable compensation from an S-corporation, or
Guaranteed payments from a partnership.

The pass-through deduction is not a business deduction; it is deducted on a taxpayer’s 1040 after the adjusted gross income is calculated. It is allowed regardless of whether the taxpayer claims the standard deduction or itemizes deductions. Since it is not a business deduction, it does not affect the computation of self-employment tax. Where QBI is less than zero, it is treated as a loss from a qualified business on the next year’s computation of QBI. Complicated Computation – Congress ignored simplification when it created this deduction, which can be quite complicated, and which includes limitations at the entity level and for the combined deductions from all entities; furthermore, it is subject to a limitation based on the individual’s taxable income. Thresholds & Caps – When determining the 20% of QBI deduction for each entity, the de-ductible amount may be reduced, phased-out or phased-in based on that year’s taxable income (without regard to the deduction itself). The 2021 thresholds for each limitation are $164,900 (170,050 in 2022) for individuals and $329,800 ($340,100 in 2022) for joint filers. The maximum of any phase-out or phase-in is $50,000 more than the threshold for individuals and $100,000 more for joint filers, so the maximums are $214,900 for individuals and $429,800 for joint filers ($220,050 and $440,100 for 2022). For those filing married separate, the 2021 threshold and cap amounts are $164,925 and $214,925, respectively, and for 2022, the amounts are the same as for individuals as noted above. Specified Service Business – Special rules apply to specified service businesses, which are generally businesses that rely on the skill and reputation of the owners or employees. These include businesses focusing on health, law, accounting, actuarial science, performing arts, consulting, athletics, financial services, brokerage services, and so on. This category specifically does not include engineering or architecture businesses and trades or businesses whose services consist of investment-type activities. For specified service businesses, if the taxable income is equal to or below the threshold, the entity’s deductible amount is the full 20% of QBI. When the taxable income is above the threshold, the deduction is pro-rata phased out between the threshold and the cap. Thus, a specified service business entity has no deduction when the taxable income exceeds $214,900 for individuals or $429,800 for joint filers ($220,050 and $440,100 for 2022) or $214,925 for 2021 and $220,050 for 2022 for married separate filers. Wage Limitation – Before learning how the deduction is determined for other business entities, one must understand the wage limitation and how it is determined. An entity’s deduction is limited to the lesser of 20% of QBI or the wage limitation. The wage limitation is the greater of

50% of the W-2 wages from the business or
25% of the W-2 wages from the business plus 2.5% of the unadjusted basis of the business’s qualified property.

Other Businesses – Computing the deduction for other entities gets significantly more complicated depending upon the taxable income. The computations fall into three categories:

Taxable income below the threshold amount described above,
Taxable income above the threshold but less than the cap amount noted above, and
Taxable income exceeding the cap.

Income below the threshold – The entity’s deductible amount is the full 20% of QBI. Income above the threshold but less than the cap – This is the most complicated computation because the wage limit is phased-in between the threshold and the cap; it only applies to a pro-rata portion of the deduction. Income above the cap – The deduction is equal to the lesser of the wage limitation or 20% of QBI.
Example: A single taxpayer has a taxable income of $125,000. He runs a small car-repair business that has a net profit (QBI) of $100,000. Because his taxable income is below the threshold, his deduction for the business entity is $20,000 (20% of $100,000). Example: A married taxpayer with a taxable income of $500,000 is a shareholder in an S corporation. The K-1 from the S corporation shows pass-through income (QBI) of $300,000. The pro-rata share of that taxpayer’s wages that were paid by the corporation is $100,000, and the pro-rata share of the taxpayer’s qualified business property is $75,000. Because the taxable income is above the cap, the deduction for this business entity is the lesser of the wage limitation or 20% of the QBI. The wage limitation is the greater of $50,000 (50% of the $100,000 in wages) or $26,875 (25% of the $100,000 in wages plus 2.5% of the $75,000 in qualified business property). Thus, the wage limitation is $50,000. This is less than $60,000 (20% of the $300,000 in QBI), so the taxpayer’s deduction for this business is limited to $50,000. With taxable income of $500,000, this taxpayer’s marginal tax bracket is 35%. This means that the $50,000 QBI deduction will save the taxpayer $17,500 of tax.
Aggregating Amounts – Once the deductions have been determined for each of a taxpayer’s business entities, they are combined in a rather complicated computation. First, the total deduction is added to 20% of the taxpayer’s REIT dividends and all the taxpayer’s publicly traded partnership income and cooperative dividends (after limitations). The final step is to compare this combined deduction amount to 20% of the taxpayer’s adjusted taxable income (i.e., taxable income minus capital gains); the lesser of the two becomes the actual deductible amount. As you can see, this deduction provides a great tax benefit for business owners, but it can be quite complicated. Please contact this office with your questions and for assistance in determining your deduction.