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New charitable contribution rules

The CARES Act makes two significant changes to the rules governing charitable deductions for individuals.

Individuals will be able to claim a $300 above-the-line deduction for cash contributions made to public charities in 2020. This rule effectively allows a limited charitable deduction to any taxpayer claiming the standard deduction. For this deduction, married taxpayers who file a joint return are considered one taxpayer and are limited to $300.

For individuals, the limitation on charitable deductions that is generally 60% of modified adjusted gross income (the contribution base) doesn’t apply to cash contributions made to public charities in 2020. Instead, an individual’s qualifying contributions, reduced by other contributions, can be as much as 100% of the contribution base. No connection between the contributions and COVID-19 is required. Note: This higher limit does not apply to donations to private foundations or donor-advised funds.

Economic impact payments: How will they affect your 2020 return?

As part of the Coronavirus Aid, Relief, and Economic Security Act (CARES Act), the IRS made economic impact payments (EIPs) to certain taxpayers. The eligibility for and the amount of an EIP generally depended on the taxpayer’s 2019 federal income tax return. If one wasn’t filed at the time of eligibility, the IRS used the taxpayer’s 2018 federal income tax return. If you received an EIP, the IRS mailed a Notice 1444 to your last known address. That form shows the amount of your EIP. Keep this notice with your tax records.

The EIP is considered an advance credit against your 2020 tax. You are not required to include the payment in taxable income on your 2020 tax return or pay income tax on the payment. When you file your 2020 federal income tax return next year, the EIP will not reduce your refund or increase the amount of tax you owe.

If the EIP was based on your 2018 tax return and your circumstances changed in 2019, you may claim any additional credit for which you are eligible on your 2020 return. This may occur, for example, if you had a child or if your income was lower in 2019. Conversely, if your payment was based on your 2018 return and circumstances changed so that you would have received a smaller amount based on your 2019 return, you are not required to repay the excess or reduce your 2020 refund.

Payroll tax deferral – What this means for you

On Aug. 8, 2020, a Presidential Memorandum was issued allowing employers the option to defer withholding and payment of the employee’s portion of Social Security tax if the employee’s wages are below $4,000 on a bi-weekly basis. The relief is available for employers and generally applies to wages paid starting Sept. 1, 2020, through Dec. 31, 2020.

On the surface, this seems like a great benefit. Workers who participate in the president’s payroll tax deferral will see a temporary increase in their take-home pay, but it’s not without consequences. Should you choose to go this route, your employees will likely see smaller than normal paychecks in early 2021.

Under this new rule, employers can stop withholding the 6.2 percent of the employee’s portion of Social Security tax from paychecks through the end of 2020. However, if you opt to participate, you’ll need to recoup that money by increasing the amount of taxes withheld from your employees’ paychecks from January through April 2021.

The result is that workers whose taxes are deferred would see bigger paychecks this year and smaller than normal paychecks next year, unless legislation is enacted to forgive the deferred taxes. At this point there is no indication that will happen.

Recent legislation changes some IRA rules

The CARES Act suspends the required minimum distribution (RMD) rules for 2020. This means any RMD a taxpayer would have been required to make before Dec. 31, 2020, as well as any RMD required to be made by April 1, 2020, based on meeting the required beginning date in 2019, is not required. However, if the RMD due on April 1, 2020, was made before Jan. 1, 2020, it may not be rolled over or redeposited.

If you received distributions from your IRA in 2020, you might be able to spread the tax over the course of three years if you were diagnosed with coronavirus, if your spouse or dependent was diagnosed with coronavirus or if you experienced adverse financial consequences while being quarantined, furloughed, laid off or had work hours reduced; were unable to work due to lack of child care because of the disease; or a business you operated closed or had reduced hours due to the pandemic.

The Setting Every Community Up for Retirement Enhancement Act of 2019 (SECURE Act) also made changes to the RMD rules, including raising the RMD to age 72 for individuals who had not yet attained age 701/2 by Dec. 31, 2019, and limiting the type of beneficiaries who can continue to receive RMDs over the beneficiary’s life expectancy. Nonspouse beneficiaries can no longer stretch inherited IRA distributions over their lifetime. Distributions must be made within 10 years of the IRA owner’s death.

The additional 10% tax on early distributions from IRAs and defined contribution plans such as a 401(k) is waived for distributions made between Jan. 1 and Dec. 31, 2020, if you or a family member was infected with COVID-19 or were economically harmed by COVID-19. Penalty-free distributions are limited to $100,000 and, subject to plan guidelines, may be re-contributed to the plan or IRA. Income arising from the distributions is spread out over three years unless you elect to not have the three-year spread apply.

Year-end tax saving strategies

The year is almost over, and you want to reduce your taxable income. What options are still available? The answer depends on your specific financial position.

If you have investments that are doing poorly, you might want to consider selling them so you can claim a capital loss. You can claim a capital loss to the extent you have capital gains, plus an additional $3,000. If you sold stock earlier in the year at a gain, selling stocks at a loss now will offset that gain and reduce your taxable income.

Do you have a high deductible health plan (HDHP)? Consider contributing to a health savings account (HSA). For 2020, you can contribute $3,550 for self-only coverage or $7,100 for family coverage. If you are age 55 or older, you can sock away an additional $1,000 a year. You can contribute up until the due date of your return. You can contribute to an HSA if your qualifying HDHP has a minimum annual deductible of $1,400 for self-only coverage or $2,800 for family coverage.

Maximize 401(k) contributions for which the 2020 limit is $19,500. Employees age 50 or older by year end may also make an additional contribution of $6,500, for a 2020 total limit of $26,000. Take advantage of your employer matching contribution. Review and make appropriate adjustments to the contributions you make to your employer’s 401(k) retirement plan for the remainder of this year and for next year. It’s also a good idea to review your investment elections and their periodic performance.

Another strategy, while not reducing taxable income, is to make Roth IRA contributions. The benefit of the Roth IRA is that the earnings on the IRA will not be taxable to you upon distribution (assuming distributed after reaching age 59-1/2). The ability to make a Roth IRA contribution continues even if you’re participating in an employer savings plan like a 401(k), so it’s not subject to the “active participant” rules that may prevent employees who participate in an employer plan from making deductible contributions to traditional IRAs. Your ability to make a Roth IRA contribution in 2020 will be reduced if your adjusted gross income (AGI) in 2020 exceeds $196,000 and you file married filing jointly (MFJ), or $124,000 if you file as a single taxpayer. You won’t be able to contribute to a Roth IRA in 2020 if you are MFJ and your 2020 AGI equals or exceeds $206,000. The AGI cutoff for single filers is $139,000 or more. Married filing separate (MFS) taxpayers who live together lose the Roth option once AGI hits $10,000.

For 2020 and later, there is no longer an age limit on making regular contributions to a traditional or Roth IRA. The sum of all traditional and Roth IRA contributions for 2020 is limited to $6,000, rising to $7,000 if you’re age 50 or older by the end of 2020.

Finally, consider adjusting your federal withholding. If you face a penalty for underpayment of federal estimated tax, you may be able to eliminate or reduce it by completing a new Form W-4 and increasing your withholding. You should review your withholding to ensure enough tax is withheld if you hold multiple jobs, you and your spouse both work or someone else can claim you as a dependent. If you became married or single in 2020, have added or lost a dependent or expect increased itemized deductions, be sure to provide your employer with an updated Form W-4 to adjust withholding.

Note: Allowances are no longer used on the redesigned 2020 Form W-4. In the past, withholding allowance values were tied to personal exemption amounts. Due to changes in law, currently you cannot claim personal exemptions or dependency exemptions. The 2020 form change is meant to increase transparency, simplicity and accuracy of the form.

 

 

Is it a hobby or a business?

Do you earn side income?

Whether it’s something you’ve been doing for years or something you just started to make extra money, the IRS says taxpayers must report income earned from hobbies in 2020 on next year’s tax return. If it’s a business, certain expenses incurred in the operation are deductible.

What’s the difference between a hobby and a business? A business operates to make a profit. People engage in a hobby for sport or recreation, not to make a profit.

Here are nine things to consider when determining if an activity is a hobby or a business:

  • Whether the activity is carried out in a businesslike manner and the taxpayer maintains complete and accurate books and records.
  • Whether the time and effort put into the activity show intent to make it profitable.
  • Whether they depend on income from the activity for their livelihood.
  • Whether any losses are due to circumstances beyond the taxpayer’s control or are normal for the startup phase of their type of business.
  • Whether they change methods of operation to improve profitability.
  • Whether the taxpayer and their advisors have the knowledge needed to carry out the activity as a successful business.
  • Whether the taxpayer was successful in making a profit in similar activities in the past.
  • Whether the activity makes a profit in some years and how much profit it makes.
  • Whether the taxpayer can expect to make a future profit from the appreciation of the assets used in the activity.

 

This is the year you may need a new W-4

If personal income has been impacted by the COVID-19 virus, you might want to update your W-4 form to ensure that the IRS isn’t withholding too much or too little from your paycheck.

People who should check their withholding include those:

  • who received unemployment at any time during the year
  • work two or more jobs or who only work for part of the year
  • who are part of two-income families
  • with children who claim credits such as the child tax credit
  • with older dependents, including children age 17 or older
  • who itemized deductions on their 2019 tax return
  • with high incomes and more complex tax returns
  • with large tax refunds or large tax bills for 2019

People should generally increase withholding if they hold more than one job at a time or have income from sources not subject to withholding. If adjustments aren’t made for these situations, they will likely owe additional tax and possibly penalties when filing their tax return.

On the other hand, people should generally decrease their withholding if they are eligible for income tax credits or deductions other than the basic standard deduction.

The IRS offers a Tax Withholding Estimator that gives workers, retirees, and self-employed individuals a step-by-step method to help determine if they should adjust their withholding. Those who need to make adjustments should fill out a new W-4 form and submit it to their employer.

Those school expenses might be tax deductible

Attention teachers: Eligible teachers and other educators can deduct certain unreimbursed expenses on their tax return next year.

Who is considered an eligible educator?

The taxpayer must be a kindergarten through grade 12 teacher, instructor, counselor, principal or aide. They must also work at least 900 hours a school year in a school that provides elementary or secondary education as determined under state law.

Things to know

Educators can deduct up to $250 of trade or business expenses that were not reimbursed. As teachers prepare for the school year, they should remember to keep receipts after making any purchase to support claiming this deduction.

The deduction is $500 if both taxpayers are eligible educators and file their return using the status married filing jointly. These taxpayers cannot deduct more than $250 each.

Qualified expenses are amounts the taxpayer paid themselves during the tax year.

Examples of expenses the educator can deduct include:

  • Professional development course fees
  • Books
  • Supplies
  • Computer equipment, including related software and services
  • Other equipment and materials used in the classroom

 

Vehicles

Businesses can deduct vehicle expenses. There are two ways to take expenses: the standard mileage rate or the actual expenses. The standard mileage rate for 2020 is 57.5¢ per business mile. Actual expenses are the expenses you incur using the vehicle for business purposes. You must choose one or the other, you cannot take both. If you choose the standard mileage rate, you must do so in the year the vehicle is first used for business.

If you take actual expenses, you can depreciate the car. Generally, the car is a capital asset, the deduction for which must be taken over the class life of the asset.

Actual expenses include depreciation, lease payments, registration fees, licenses, insurance, repairs, gas, garage rent, tires, oil, parking fees and tolls.

If you elect to take standard mileage, you cannot deduct depreciation, lease payments, maintenance and repairs, gasoline, oil, insurance and registration fees. If you use the car less than 100% for business, you must keep contemporaneous records of your vehicle use.

You may use §179 depreciation to recover some of the cost of a newly purchased vehicle if you use the vehicle for business purposes more than 50% of the time. Depreciation for vehicles is subject to the same limitations as other assets. You may also claim the bonus depreciation for a vehicle. If the vehicle was purchased after Sept. 27, 2017, you can claim up to 100% of the basis of the car. In addition to bonus depreciation, the taxpayer may choose to depreciate the car under one of the methods discussed previously. However, these deductions are limited.

The maximum depreciation deduction for passenger automobiles acquired after Sept. 27, 2017, and placed into service during 2018 or later are shown in the chart below.

The depreciation deduction limits for 2020 were not yet released at the time of writing. They are expected to come out this sum­mer. I can help you compare your options for a car used in your business.

Date Placed in Service________1st Year______2nd Year______3rd Year______4th Year +
2019__________________________$18,100______$16,100________$9,700________$5,760
2018__________________________$18,000______$16,000________$9,600________$5,760

Depreciation primer

Depreciation is a complex calculation that represents the wear and tear on property over its useful life. The amount of depreciation depends on the basis, the class life, the method and the convention.

Generally, the basis of property purchased for your business is the cost plus any settlement costs. If you convert property from personal to business use, the basis is the lesser of the fair market value on the date of the conversion or your adjusted basis.

The class life is determined by the type of property that is being depreciated. These class lives range from three-year property, such as tractors and horses, to nonresidential real property with a recovery period of 39 years.

The method generally used is Modified Accelerated Cost Re­covery System (MACRS). MACRS has two ways to depreciate: 150% declining balance and 200% declining balance. Property can also be depreciated on the straight-line method, where an equal amount is allowed as depreciation each year over the life of the property.

The default convention is half-year, meaning that the property is considered to be placed into service at the midpoint of the tax year. However, you should depreciate nonresidential real property and residential rental using the mid-month convention. This treats all property placed into service in a month as being placed into service at the midpoint of the month. Finally, you use the mid-quarter convention if mid-month is not required and the value of property you placed in service in the last three months of the tax year exceeds 40% of all property placed in service.

These are the rules for regular depreciation. There are two other types of depreciation: bonus depreciation and §179 expensing.

Certain business property is eligible for §179 expensing. To qualify, the property must be acquired for business use by purchase. Generally, the deduction for §179 is the cost of the qualifying property. However, you do not have to elect §179 for the entire cost of the property. The amount that you can deduct is limited to $1,040,000 in 2020. The deduction begins to phase out, dollar-for-dollar, at $2,590,000.

Bonus depreciation can be taken in the first year you place a piece of property into service. You can take 100% bonus depreciation for property acquired after Sept. 27, 2017, and placed into service before Jan. 1, 2023. Eligible property includes tangible property with a class life of 20 years or less as well as other specialized property. Bonus depreciation is allowed for both new and used property until Dec. 31, 2026. You can elect out of bonus depreciation for each class of property placed into service.