Monthly Archives: April 2023

What is the Difference Between an HSA and a Health FSA?

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Article Highlights:

Flexible Spending Accounts
Common Features of an FSA
FSA Allowable Medical Expenses
Unused Amounts (Use It or Lose It)
HealthSavings Accounts
Enrolled in Medicare
Covered Under a High-deductible Health Plan
HSAContributions and Contribution Limits
HSA as a Supplemental Retirement Vehicle
FSA-HSA Comparison Table

The tax code provides two tax advantageous plans for taxpayers to pay medical expenses. One is a Flexible Spending Account (FSA) and the other is a Health Savings Account (HSA). The two are often misunderstood and their provisions are frequently mixed up by taxpayers who then fail to take advantage of the tax benefits available from these accounts.
This article explains the workings, qualifications, and tax benefits of each with a side-by-side comparison chart of the two programs. Both have a common theme: contribution to both is made withpre-tax dollars (they reduce taxable income) and distributions to pay qualified medical expenses are tax free.After that the two plans are quite different.
Flexible Spending Accounts (FSAs)
There are three types of FSAs: dependent care assistance, adoption assistance and medical care reimbursements. This article will only be dealing with the latter, often referred to as aHealth FSA.A Health Flexible Spending Account is part of a qualified cafeteria plan offered by an employer, that allows employees to contribute pre-tax dollars annually to be used by the employee to pay medical expenses of the employee, their spouse, and dependents during the year. The maximum contribution is annually inflation adjusted, and for 2023 is $3,050 (up from $2,850 in 2022).In the case of a married couple where each spouse has an FSA account with an employer, both can contribute the maximum.
Since an FSA is an employer plan, an employee cannot take it with them if they leave their employment. Thus, FSAs are not transferrable and cannot be rolled into an individual’s health savings plan.
Common Features of an FSA – Funds can be used for health insurance deductibles, copays, medication, and other health care related out-of-pocket costs. For ease of use, most FSA accounts come with a debit card. Employees can spend the money in the account before it’s fully funded.
FSA Allowable Medical Expenses Include Those For:

The diagnosis, cure, mitigation, treatment, or prevention of disease, or for the purpose of affecting any structure or function of the body,
Prescription Drugs,
Medication available without a prescription (an over-the-counter medicine or drug) that is prescribed),
Insulin,
Transportation primarily for and essential to medical care,
Supplementary medical insurance for the aged,
Feminine menstrual products, and
Personal Protective Equipment (COVID)

No Double Dipping – Medical expenses reimbursed from the FSA cannot be claimed as a Schedule A medical itemized deduction.
Unused Amounts (Use It or Lose It) – Unused amounts at the plan’s year end are generally forfeited by the employee. However, a plan can have either:

A grace period of up to 2½ months after the end of the plan year in which to use up the unused amount or
Allow up to 20% of the annual contribution limit ($610 for 2023)of unused amounts from the end of the plan year to be used to pay or reimburse qualified medical expenses in the following year.

Unused amounts more than the carryover amounts are forfeited (cannot be returned to the employee). The carryover amount does not reduce the maximum contribution amount allowed for the carryover year.
FSA participants need to pay close attention to their FSA account balances to ensure they do not forfeit any funds at year’s end.
Health Saving Accounts (HSAs)
Individuals must meet the following requirements to contribute to an HSA:

Not be claimed as a dependent on anyone else’s tax return.
Not be enrolled in Medicare.
Covered under a high-deductible health plan (HDHP) and not be coveredunder any other health plan which is not an HDHP, unless the other coverage is permitted insurance or coverage for accidents, disability, dental care, vision care, or long-term care.

Enrolled in Medicare – The IRS has interpreted being ‘enrolled in Medicare’ to mean both eligibility for and enrollment in Medicare. An individual who is otherwise eligible, but who is not enrolled in Medicare Part A, may contribute to an HSA until the month enrolled in Medicare.
Covered Under a High-deductible Health Plan – HDHPs come in two varieties: Self-Only plans and Family plans. Use the flow chart below to determine if a plan qualifies as a high-deductible health plan.

HSA Contributions and Contribution Limits – Individuals may establish an HSA either independently or with their employer. If made with an employer, and the individual subsequently leaves the employment, the individual can roll the funds into their own HSA or take a taxable distribution subject to a 20% penalty.
In addition to the individual, others can make contributions to the HSA, including employers as well as other persons (e.g., family members) subject to the annual inflation adjusted contribution limits. Those limits for 2023 are:

$3,850 for self-only coverage
$7,750 for family coverage
$1,000 additional amount for those aged 55 and older.

An account holder gets the deduction for contributions to his HSA even if someone else (e.g., a family member) makes the contributions. Employercontributions to an HSA are excluded from the employee’s income – so these contributions are not deducted on the employee’s tax return. Distributions for qualifying medical expenses are tax-free.
HSA Allowable Medical Expenses – Generally the eligible medical expenses are the same as allowed for FSAs. The qualified medical expenses must be incurred only after the HSA has been established. Medical expenses paid or reimbursed by HSA distributions cannot also be claimed as a medical expense for itemized deduction purposes.
HSA as a Supplemental Retirement Vehicle – Establishing and contributing to an HSA can be more than just a way for individuals to save taxes and gain control over their medical care expenditures. It can also be a retirement vehicle, especially for taxpayers who are maxed out on their other retirement plan options or who can’t contribute to an IRA because of the income limitations.
There is no requirement that medical expenses must be paid or reimbursed from the HSA, so a taxpayer can maximize tax-free growth in the account by using funds from other sources to pay routine medical costs. Later, distributions can be used tax-free to pay post-retirement medical expenses. Or, if used for non-medical purposes, a retiree aged 65 or older will pay income tax on the distribution, but not a penalty. Those younger than 65 who use their HSA funds for other than qualified medical purposes pay a penalty of 20% of the amount distributed in addition to income tax on the distribution. Unlike IRAs, no minimum distributions are required to be made from HSAs at any specific age.
FSA-HSA Comparison Table
The following table compares the key differences between Health Flexible Spending Accounts and Health Savings Accounts:

As you can see, either an FSA or HSA can help you pay your out-of-pocket medical expenses. On top of that, contributions are made on a pre-tax basis directly reducing your taxable income. If in an employer plan, in addition to reducing your taxable income, contributions reduce payroll taxes. Plus an HSA can be a supplemental retirement vehicle.
Please give this office a call if we can help you utilize the tax benefits of a health FSA or an HSA.

Want to Improve Your Cash Flow? Shorten the Amount of Time it Takes to Get Paid

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To say that things are uncertain right now when it comes to the economy is, in all probability, a bit of an understatement.
Inflation is at levels we haven’t seen in decades. Employment costs are rising across the board. Materials in a number of industries are more expensive than ever – if you can even get them at all thanks to still-ongoing issues with the fragile global supply chain.
All of these issues can make it difficult for organizations to tackle one of their most essential challenges of all: cash flow. According to one recent study, approximately 82% of all businesses that fail do so due to poor cash flow management or just a general misunderstanding of the idea itself.
Thankfully, this is only a hurdle if you allow it to be. Modernizing your back office processes can, among other things, help to dramatically reduce the amount of time it takes to get paid. That in turn can help with any current or potential cash flow issues, which is an excellent position to be in.

Improving Cash Flow, One Change at a Time
By far, one of the best ways to reduce the amount of time it takes to get paid by clients and other vendors involves asking for payment deposits at the beginning of any new business relationship.
This particular method helps to accomplish a few different things all at once. For starters, if a client owes you $1,000 for a job that has already been completed, they’re more likely to settle the total balance if they’ve already paid $250 of it versus having paid none of it. If they’ve already put forth a deposit before any work even started, they’re motivated to quickly see things through to completion and are less likely to delay things any longer than they need to.
It’s also a great way to help get at least some money coming in the door all the time so if a client does end up paying the remaining balance late, you were able to get at least part of it ahead of time.
Another option that you’ll want to leverage has to do with switching to digital invoices. If you haven’t already done so, understand in no uncertain terms that this is no longer a recommendation – it is a requirement.
Think about it from a purely logistical perspective if nothing else. If you send an invoice to a client via USPS and it takes five business days to reach them, and then another five days pass before they act on it, and then another five days pass before you finally receive that payment check in the mail, that’s 15 full days (at an absolute minimum) where your money was in limbo. A digital invoice, on the other hand, can be sent in seconds and paid just as quickly. Not only that, but you’re freeing up the valuable time of your back-office employees so that they can focus on more important matters.

Not only that, but a lot of digital invoicing systems also integrate with a lot of the financial software that you’re likely already using. So you’ll have less paperwork to keep track of on your end and you’ll be able to easily see who has paid and who hasn’t (thus requiring a phone call to follow up). This will lead to more accurate financial statements overall, giving you a better foundation for making actionable decisions moving forward.
Finally, if you want to motivate people to pay you quickly, you need to give them as many options as possible when it comes to precisely that. The easier it is for someone to take your desired step, the more likely they are to take it.
Many businesses got away with just accepting cash or checks in the past but those days are no more. You should also, at a minimum, accept credit and debit cards. You could even choose to explore certain digital payment options like PayPal, Zelle, and others. Give people the chance to pay on their own terms and they’re less likely to delay the process any longer than necessary.

In the end, addressing cash flow concerns is not something that you “do once and forget about.” It’s an ongoing process that you must remain proactive about or else economic uncertainty (not to mention client or vendor uncertainty) could exacerbate things significantly. But by taking steps like asking for payment deposits, embracing digital invoices, and offering more options when it comes to paying, you can reduce the amount of time it takes to get paid at all – thus improving cash flow along the way.

Why You Should Be Using Tags in QuickBooks Online, and How to Create Them

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QuickBooks Online is a great tool for creating, storing, and sending sales and purchase forms, and for building detailed customer and vendor profiles. Maybe that’s all you want it to do. But to get the most out of this web-based accounting application, you should really be using its classification tools so you can view related transactions as groups and learn how specific parts of your business are doing.
Tags are the newest tool for this task. They’re customizable labels that allow you to track whatever you want, for whatever elements of your business that you want to track. You could determine how much you’re making and spending on different jobs. You could also track transactions related to, for example, ad campaigns, sales reps, and project managers. You’ll create and store tags as groups that you can view on one page. You can add them on the fly, and even run specialized reports. They’re extremely flexible tools that help you analyze your business in unique ways.
How Are They Different?
You may have encountered tags in other applications. In QuickBooks Online, they’re different from the other classification tools provided. You’ll assign categories to transactions primarily for tax purposes (how much did you spend on advertising or utilities or deductible meals?). Classes help you separate groups of income and expenses for job costing, budgeting, etc. And locations allow you to track income, expenses, and assets by geographic locations.
Tags, on the other hand, are unlimited. You can track virtually any related sets of transactions.
How Do You Create Tags?
Before you can start creating tags, you have to create a Group to assign them to. Click the gear icon in the upper right and select Tags under Lists. This will take you to the Tags home page. Click New and then Tag group. A vertical pane will slide out from the right. Choose a Group name and specify a color. Click Save. Add a tag in the Tag name field and click Add.

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Once you’ve created a group, you can start adding tags.

Keep adding tags until you have all you want. You can always add more later. When you’re finished, click Done. Back at the Tags home page, you’ll see your new group listed.
How Do You Use Tags In Transactions?
Tags have no impact on your accounting books. They simply provide information to you in lists and reports.
Let’s say you run a small clothing store. You want to be able to see quickly which seasons have the most sales and which employees sell the most. You could create two groups: Clothing seasons and Employees. You want to create sales receipts to compare seasonal and by-employee sales.
Click New in the upper left corner and select Sales receipt under Customer. Select the Customer name or + Add new. Or leave it blank since it’s not required here. Check the date. Click in the Tags field to open your options there. Choose the season and the employee. You are allowed to assign as many tags as you like to a transaction, but only one for each group. Complete the rest of the receipt and save the receipt. You can add tags to any transaction that contains a field for them.

You can add tags to any transaction that contains a field for them.

If you go back to the Tags home page, you’ll see that each of the tags you just assigned contain an entry for 1 transaction in the Transaction column. Click Run report to see a Profit and Loss by Tag Group report. You’ll also find this report when you click Reports in the toolbar. In addition, you’ll find the Transaction List by Tag Group report. And you can always return to the Tags home page to see your groups, tags, and related transactions in list view.
What If You Don’t Want To Track Tags?
If you don’t plan to use tags (at least not right away), you can turn the tag field off on transactions. Click the gear icon in the upper right, then select Account and settings. Click the Sales tab in the toolbar. At the bottom of the first section here, Sales form content, you’ll see Tags. Click it, then click the on/off button until the green area disappears. Then click Save. Click the Expenses tab and turn off the line that reads Show Tags field on expense and purchase forms. Click Save.
Make Use of QuickBooks Online’s Classification Tools
Like we said earlier, QuickBooks Online works great for creating records and transactions and running reports. But you’ll understand just how powerful it is at making connections between related data by using classes, categories, locations, and now, tags. Still confused about the differences between these tools and how you would use them to get the information you need? Let’s set up a session to go over them and to answer other questions you might have about QuickBooks Online.

May 2023 Individual Due Dates

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May 10 – Report Tips to Employer
If you are an employee who works for tips and received more than $20 in tips during April, you are required to report them to your employer on IRS Form 4070 no later than May 10. Your employer is required to withhold FICA taxes and income tax withholding for these tips from your regular wages. If your regular wages are insufficient to cover the FICA and tax withholding, the employer will report the amount of the uncollected withholding in box 8 of your W-2 for the year. You will be required to pay the uncollected withholding when your return for the year is filed.
May 31 – Final Due Date for IRA Trustees to Issue Form 5498
Final due date for IRA trustees to issue Form 5498, providing IRA owners with the fair market value (FMV) of their IRA accounts as of December 31, 2022. The FMV of an IRA on the last day of the prior year (Dec 31, 2022) is used to determine the required minimum distribution (RMD) that must be taken from the IRA if you are age 72 or older during 2023.
Weekends & Holidays:If a due date falls on a Saturday, Sunday or legal holiday, the due date is automatically extended until the next business day that is not itself a legal holiday.
Disaster Area Extensions:Please note that when a geographical area is designated as a disaster area, due dates will be extended. For more information whether an area has been designated a disaster area and the filing extension dates visit the following websites:
FEMA: https://www.fema.gov/disaster/declarationsIRS: https://www.irs.gov/newsroom/tax-relief-in-disaster-situationsFor example, disaster-area taxpayers in most of California and parts of Alabama and Georgia now have until Oct. 16, 2023, to file various federal individual and business tax returns and make tax payments.

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May 2023 Business Due Dates

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May 1 – Federal Unemployment TaxDeposit the tax owed through March if it is more than $500.May 10 – Social Security, Medicare and Withheld Income Tax File Form 941 for the first quarter of 2023. This due date applies only if you deposited the tax for the quarter in full and on time.May 15 – Employer’s Monthly Deposit Due If you are an employer and the monthly deposit rules apply, May 15 is the due date for you to make your deposit of Social Security, Medicare and withheld income tax for April 2023. This is also the due date for the non-payroll withholding deposit for April 2023 if the monthly deposit rule applies.
Weekends & Holidays:
If a due date falls on a Saturday, Sunday or legal holiday, the due date is automatically extended until the next business day that is not itself a legal holiday.
Disaster Area Extensions:
Please note that when a geographical area is designated as a disaster area, due dates will be extended. For more information whether an area has been designated a disaster area and the filing extension dates visit the following websites:
FEMA: https://www.fema.gov/disaster/declarationsIRS: https://www.irs.gov/newsroom/tax-relief-in-disaster-situations
For example, disaster-area taxpayers in most of California and parts of Alabama and Georgia now have until Oct. 16, 2023, to file various federal individual and business tax returns and make tax payments.

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The Gen Z Freelance Movement and the Tax and Bookkeeping Challenges That Come With It

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If it seems like more and more employees are turning to freelance work these days, you’re not imagining things. According to one recent study, there are currently 73.3 million freelancers in the United States alone. The fast-paced mobile era that we’re now living in, coupled with the advent of the fabled “Gig Economy” and companies like Uber and Lyft, have certainly helped bring this about. But what is fascinating isn’t necessarily how many freelance workers there are – it’s who, exactly, is doing the freelancing.
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Another study indicated that Generation Z in particular seems particularly fascinated by the idea of striking out on their own, with 53% of them having chosen self-employment of this nature in most cases. Approximately 50% of all Generation Z respondents to one survey, meaning those who fall between the ages of 18 and 22), engaged in freelance work of some kind.
It makes sense that people would want to have more control over their own employment and their ability to earn a living. That doesn’t mean it is easier than “traditional employment,” however – especially when it comes to the financial side of the equation. Bookkeeping and especially taxes present significant challenges that people need to understand before choosing to go down this path moving forward.
The Financial Side of Generation Z and Freelancing: An Overview
One of the biggest challenges that freelance workers of all generations have to deal with has to do with the idea of paying self-employment taxes.
Not only is it easy to suddenly find yourself working a freelance job – it can also happen very quickly. This is true to the point where someone may have made the decision without taking the time to research what the long-term implications actually are. One of the most pressing of those is self-employment taxes. In addition to whatever it is decided that you owe by way of income tax, you’ll owe an additional 15.3% on the first $160,200 of net profits no matter what.

This money is designed to cover Social Security and Medicare taxes – factors that are usually handled by a traditional employer. In a freelance situation, that burden falls on you. If you’re not aware that you have to pay this amount, or if you’re not able to accurately estimate what it might be given your income, it could end in a significantly larger tax bill than you had assumed you’d be facing.
Along the same lines, many new freelancers in particular are surprised to find out that they’re supposed to pay taxes throughout the year – not just once like everyone else. Indeed, quarterly estimated tax payments are mandatory and if you don’t handle this, you could be hit with penalties before you even have a chance to properly file.
If you get hit with a large tax bill at the end of the year because you hadn’t been paying quarterly, you could always ask for a monthly payment plan with the IRS to settle your balance. Note, however, that this does not mean that your next round of estimated tax payments won’t immediately come due. This is a situation where it is easy to fall behind on your taxes and, with penalties and interest, watch that “Past Due Balance” grow and grow. Even though things will be “fine” from a certain perspective so long as you keep up with your agreed-upon monthly payments, it could still be difficult to “get ahead” once again.
For many freelance employees, figuring out what deductions they’re allowed to take given their job is not just a tax challenge – it’s a general bookkeeping one as well. This will largely depend on what type of freelance work you’re doing. If you’re working for a company like Lyft or Uber, for example, you should be tracking the miles you drive while you’re on the clock. You’ll be able to deduct a portion of not only your gas but also your maintenance and insurance costs based on that information. But you can only do so if you’ve been tracking it accurately all along.

Typically, expenses fall into two distinct categories. “Ordinary” expenses are those that are common and that are traditionally accepted for your business. “Necessary” expenses, on the other hand, are those that are deemed “necessary” for your business.
The aforementioned business mileage while working for a ride-sharing company would be a common expense, for example. The same is true of any dues that you have to pay to even take the job, or subscriptions that are being paid out to organizations related to your business. Necessary expenses would be certain tools and other pieces of equipment that you cannot perform your job without.
Some of these challenges are the reason why, according to another recent study, 70% of people see freelancing as a viable career option when it exists alongside a traditional 9 to 5 job. Have a traditional employer handle at least some of the tax burden in a way that makes things easier overall. That doesn’t mean you can get away with not thinking about bookkeeping and taxes at all, however, as the universal challenges outlined above go a long way towards proving.

If nothing else, all of this serves as an important reminder of why people need to enlist the help of an experienced financial professional to handle bookkeeping, tax, and related challenges. It’s clear that the instinct to “do it all themselves” is a strong one within Generation Z. If it wasn’t, they wouldn’t be collectively so passionate about freelance work in the first place.
But this is one of those situations where it is extraordinarily easy to “get things wrong” and if you do, you could wind up in a financial situation that is difficult to recover from. Enlisting the help of a financial professional can help prevent these problems from happening early on, allowing Generation Z (and everyone else, for that matter) to enjoy all the benefits of freelancing with as few of the potential downsides as possible.

Benefits of Qualified Opportunity Funds Waning

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Article Highlights:

Qualified Opportunity Fund
Qualified Opportunity Zones
Deferred Gains
5- and 7-Year Holding Periods
2026 End of Deferral
0-Year Holding Period

A Qualified Opportunity Fund (QOF) is an investment vehicle which is organized as a corporation or a partnership for the purpose of investing in qualified opportunity zone property acquired after December 31, 2017. The QOF must hold at least 90% of its assets in qualified opportunity zone (QOZ) property but a taxpayer may not invest directly in QOZ property.
Qualified Opportunity Zones (QOZ)are population census tracts that are generally in low-income communities and that were specifically designated as QOZs after being nominated by the governor of the state or territory in which the community is located and approved by the Treasury Secretary, who then certified the community as a QOZ. The purpose of a QOZ is to spur economic growth and job creation in low-income communities while providing tax benefits to investors.
Starting back in 2018, a taxpayer who had a capital gain on the sale or exchange of any property to an unrelated party could elect to defer, and potentially partially exclude, the gain from gross income if the gain was reinvested in a Qualified Opportunity Fund (QOF) within 180 days of the sale or exchange. Unlike Sec 1031 deferrals (tax deferred exchanges), only the amount of the gain, not the amount of the proceeds of sale, needed to be reinvested to defer the gain.
As an incentive to invest inQualified Opportunity Funds, the basis of the QOF investment was increased by 10% of the deferred gain if the taxpayer retained the QOF investment for 5 years. That was increased to 15% if the QOF was retained for 7 years. In other words, if the investment was held at least 5 years, 10% of the original gain is excluded, or if held 7 years, 15% of the original gain is excluded.
However, any gain deferred into a QOF becomes taxable the earlier of when the QOF investment is sold or December 31, 2026. Thus, if an individual invests in a QOF in 2023, that only leaves 4 years before the deferred gain becomes taxable at the end 2026. This means an investor just now investing in a QOF doesn’t have enough time to hold the investment the required 5 or 7 years to benefit from the 10% or 15% step up in basis when the deferral has to be reported on the 2026 return. However, the gain deferral is still available and is not taxable until the 2026 return is filed.
As illustrated nearby, to meet the meet the 7-year holding requirement the QOF must have been purchased before 1/1/2020 and prior to 1/1/2022 to meet the 5-year holding period.

One benefit remains. If the QOF is held for 10 years or longer before it is sold, the taxpayer can elect to increase the basis to the fair market value amount. The effect of this adjustment is that none of the appreciation since the QOF was purchased is taxable when it is sold. This provision applies only to the investment in the QOF that was made with deferred capital gains.
Please give this office a call if you have questions.

Posted in Tax

Not Required to File a Tax Return? Reasons You May Want to Anyway!

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Article Highlights:

Filing Thresholds
Tax Withholding
Tax Credits
Earned Income Tax Credit
Child Tax Credit
American Opportunity Tax Credit

Generally, individuals are required to file a tax return for a year if their income exceeds the standard deduction for their filing status for that year. But even if they are not required to file it may be beneficial to do so. They could be missing out on huge refunds.
The standard deduction is inflation adjusted each year and the table illustrates the standard deductions for 2023.
There are two exceptions: married individuals filing separately must file if their gross income is $5 or more and self-employed individuals must file if their gross self-employment income is $400 or more.

Filing Status
2023 Standard Deduction

Married Taxpayers Filing Jointly
$25,900

Surviving Spouse
$25,900

Head of Household
$19,400

Single
$12,950

Additional amounts are added to the amounts above for each filer (and spouse if filing jointly) who is age 65 and over or blind. These additional amounts are $1,500 for married individuals filing jointly and a surviving spouse; $1,850 for others.
Just because someone is not required to file a return does not mean they shouldn’t. Failing to file a return could end up leaving large sums of money on the table. Here are some examples.

Tax Withholding – Most individuals who have wage income also have federal income tax withheld on their earnings. That withheld tax would be 100% refundable if the worker isn’t required to file a return.
A tax credit is a dollar-for-dollar offset against the tax liability. Some credits can only reduce a tax liability to zero, while others as discussed below are refundable, meaning if the credit is more than the individual’s tax any excess credit is refundable. So if an individual is not required to file and therefore owes no tax and qualifies for one or more refundable credits, it may be in their best interest to file and take advantage of the credit(s).
Earned Income Tax Credit (EITC) –The EITC is for people who work but have lower incomes. If you qualify, it could be worth up to $6,935 in 2022. The credit is a fully refundable credit, so individuals can receive the full amount of the credit even if they do not owe any taxes.If you were employed for at least part of 2022, you may be eligible for the EITC based on these general requirements and earned less than:o $16,480 ($22,610 if married filing jointly) and have no qualifying children.o $43,492 ($49,622 if married filing jointly) and have one qualifying child.o $49,399 ($55,529 if married filing jointly) and have two qualifying children.o $53,057 ($59,187 if married filing jointly) and have more than two qualifying children.
Child Tax Credit (CTC) – This is a per child credit that phases out for higher income taxpayers but is available to all categories of taxpayers that are not required to file. The full credit is $2,000 per child, but the refundable amount is limited to a maximum amount of $1,500 for 2022 ($1,600 for 2023).
American Opportunity Tax Credit (AOTC) – The AOTC provides a credit of up to $2,500 per year per eligible student with higher education expenses. Up to 40% of the AOTC is refundable, even when there is no tax liability. Thus, it can result in a refund of as much as $1,000 (40% of $2,500).Generally, an eligible student for the AOTC can be the filer and spouse and their dependents that are enrolled at an eligible educational institution for at least one academic period (semester, trimester, quarter) during the year.If someone other than the filer, a spouse or their claimed dependent directly makes a payment to an eligible educational institution for a student’s qualified tuition and related expenses, then the filer is treated as paying the expenses and qualifies for the credit.

Thus even if not required to file, individuals could still have a refund in the thousands of dollars. The IRS has indicated that about 25% of those eligible for the EITC fail to claim it. Individuals should not miss out on the refundable credits simply because they are not required to file. If you are one of those that is not required to file, contact this office to see if you can benefit by filing and for assistance in preparing the return. If you didn’t file in prior years, you may have refunds for those years as well.

Posted in Tax

Don’t Get Hit with IRS Underpayment Penalties

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Article Highlights:

Pay-as-You-Earn System
Withholding and Payment Forms
IRS On-line Withholding Estimator
Situations Triggering Underpayments
Safe Harbor Payments
True Safe Harbor

Under federal law, taxpayers must pay taxes during the year as they earn or receive income, or they can find themselves falling victim to substantial underpayment penalties. Even worse, they may have spent the money, and when tax time comes are unable to pay their past taxes and spiral into financial distress.
To facilitate the pay-as-you-earn concept, the government has provided several means of assisting taxpayers in meeting that requirement. These include:

Payroll withholding for employees – W-4;
Pension withholding for retirees – W-4P;
Voluntary withholding for Unemployment and Social Security benefits – W-4V; and
Estimated tax payments for self-employed individuals and those with other sources of income not covered by withholding – Form 1040-ES.

Employees with primarily wage income can use the IRS online tool, the Tax Withholding Estimator, to determine if their withholding closely matches their projected tax liability or if they need to adjust their tax withholding by providing a revised Form W-4 to their employer.
Employees and those with significant income from other sources, multiple jobs, rentals, side gigs, children subject to the kiddie tax, capital gains, etc., may find it appropriate to consult with this office for a more sophisticated tax projection and estimate of needed withholding and/or estimated tax payments.
Individuals should also check their tax withholding and estimated payments when:

Changes in tax law affect their situation.
They experience a lifestyle or financial change like marriage, divorce, birth or adoption of a child, home purchase, retirement, or filed chapter 11 bankruptcy.
They change jobs or have a change in wage income, such as when the taxpayer or their spouse starts or stops working or starts or stops a second job.
They have taxable income not subject to withholding, such as interest, dividends, capital gains, self-employment and gig economy income, and IRA distributions.
Reviewing their planned deductions or eligible tax credits, including items like medical expenses, taxes, interest expense, gifts to charity, dependent care expenses, education credit, Child Tax Credit or Earned Income Tax Credit.
Nonresident alien taxpayers should determine their tax withholding using the special instructions in Notice 1392, Supplemental Form W-4 Instructions for Nonresident Aliens.

Once an individual has determined they need to change their tax withholding, the individual should complete a new Form W-4 to give to their employer. Individuals with other types of income should provide the payor with either a new Form W-4P or Form W-4V, as applicable. Those making estimated payments can mail the payment along with the Form 1040-ES to the address included on the form or use the IRS on-line payment system to make a payment electronically.
When a taxpayer fails to prepay a safe harbor (minimum) amount, they can be subject to the underpayment penalty. This nondeductible interest penalty is higher than what might be earned from a bank. The penalty is applied quarterly, so for example, making a fourth quarter estimated payment only reduces the fourth-quarter penalty. However, withholding is treated as paid ratably throughout the year, so increasing withholding at the end of the year can reduce the penalties for the earlier quarters. This can be accomplished with cooperative employers or by taking an unqualified distribution from a pension plan, which will be subject to 20% withholding, and then returning the gross amount of the distribution to the plan within the 60-day statutory rollover limit.
Federal law and most states have so-called safe harbor rules, meaning if you comply with the rules, you won’t be penalized. There are two Federal safe harbor amounts that apply when the payments are made evenly throughout the year.

The first safe harbor is based on the tax owed in the current year. If your payments equal or exceed 90% of your current year’s tax liability, you can escape a penalty.
The second safe harbor—and the one taxpayers rely on most often—is based on your tax in the immediately preceding tax year. If your current year’s payments equal or exceed 100% of the amount of your prior year’s tax, you can escape a penalty, regardless of the amount of tax you may owe when you file your current year’s return. If your prior year’s adjusted gross income was more than $150,000 ($75,000 if you file married separate status), then your payments for the current year must be 110% of the prior year’s tax to meet the safe harbor amount.

There is also a ‘de minimis amount due’ of $1,000. If the amount owed is less than $1,000 the underpayment penalties do not apply.
Where taxpayers get into trouble is when their income goes up or their withholding goes down for the current year versus the prior year. Examples are having a substantial increase in income, such as when investments are cashed in, thereby increasing income but without any corresponding withholding or estimated payments. Another frequently encountered situation is when a taxpayer retires and their payroll income is replaced with pension and Social Security income without adequate withholding. Taxpayers who don’t recognize these types of situations often find themselves substantially underpaid and subject to the underpayment penalty when tax time comes around.
The bottom line is that 100% (or 110% for upper-income taxpayers) of your prior year’s total tax is the only true safe harbor because it is based on the prior year’s tax (a known amount), whereas the 90% of the current year’s tax amount is a variable based on the income for the current year, and often that amount isn’t determined until it is too late to adjust the prepayment amounts.
That being said, there are times when using the 100%/110% safe harbor method doesn’t make a lot of financial sense. For example, let’s say that in the prior year, you had a large one-time payment of income that boosted up your tax to $25,000, which is $10,000 more than you normally pay. You know that you won’t have that extra income in the current year. Rather than rely on the 100%/110% of prior tax safe harbor, where you’d be prepaying $10,000 more than your current year’s tax is likely to be, it may be appropriate to use the 90% of current-year tax safe harbor, determined by making a projection of your current year tax, and as the year goes along, monitoring your income and the tax paid in to be sure you are on track to reach the 90% goal.
Unlike employees, a self-employed individual must either estimate his or her net earnings for the year (or use the 100%/110% safe harbor) and pay taxes on a quarterly basis according to that estimate or safe harbor. Failure to do so will result in interest penalties.
Although these payments are called ‘quarterly’ estimates, the periods they cover do not usually coincide with a calendar quarter.

Quarter
Period Covered
Months
Due Date*

First
January through March
3
April 15

Second
April and May
2
June 15

Third
June through August
3
September 15

Fourth
September through December
4
January 15

* If the due date falls on a Saturday, Sunday, or holiday, the payment is due on the next business day.
The rules discussed apply to federal pre-payments. The rules vary for the states.
Please contact this office for assistance. If you have a substantial increase in income, you should contact this office promptly so that your withholding or estimated tax payments can be adjusted to avoid a penalty.