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taxes from a to z

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It’s my annual Taxes from A to Z series! If you’re wondering how to figure basis for cryptocurrency or whether you can claim home office expenses during COVID, you won’t want to miss a single letter.

V is for Voluntary Withholding.

You already know that if you expect to owe tax at tax time, you should make estimated tax payments. But there’s an additional way that you can pay the government so that you don’t have to write a big check at the end: you can choose to have voluntary withholding from your benefits during the year. This is similar to withholding on your paycheck and means that you should owe less at tax time (or preserve your refund if you’re entitled to one).

Why might you owe? You might be receiving unemployment compensation (yes, it’s taxable), Social security benefit along with other income, Social security equivalent Tier 1 railroad retirement benefits, Commodity Credit Corporation loans, certain crop disaster payments under the Agricultural Act of 1949 or under Title II of the Disaster Assistance Act of 1988, or dividends and other distributions from Alaska Native Corporations to its shareholders. If you’re not certain whether your payment is eligible for voluntary withholding, just ask.

To request voluntary withholding, use Form W-4V (downloads as a PDF) to ask the payer to withhold federal income tax. It’s a very simple form. It looks like this:

W-4v

Just complete the personal information and tick the box that indicates the percentage you want to have withheld. There are limits on how much you can withhold. For unemployment compensation, the payer is permitted to withhold 10% from each payment. For any other government payment listed above, you may choose to have the payer withhold federal income tax of 7%, 10%, 12%, or 22% from each payment. There are no other options.

You should ask your payer when income tax withholding will begin. It will continue until you change or stop it, or if your payments stop.

You can find the rest of the series here:

It’s my annual Taxes from A to Z series! If you’re wondering how to figure basis for cryptocurrency or whether you can claim home office expenses during COVID, you won’t want to miss a single letter.

U is for Undue Hardship.

If you’d read any posts on extensions – like this one – you are aware that filing for an extension is generally an extension of the time to file, and not the time to file. It’s almost the extension mantra.

But did you know that there actually is an extension available for payments – but there’s a pretty high bar.

First things first. The form is Form 1127, Application for Extension of Time for Payment of Tax Due to Undue Hardship (downloads as a PDF). It’s used to request an extension of time under section 6161 for payment of the tax shown on your return or an amount determined as a deficiency (an amount you owe after an examination of your return). It’s not meant to be a substitute for a regular extension or to set up an installment agreement.

You can file Form 1127 if you will owe any of the following, and paying the tax when it is due will cause an undue hardship. 

  • Income taxes
  • Self-employment income taxes
  • Withheld taxes on nonresident aliens and foreign corporations
  • Taxes on private foundations and certain other tax-exempt organizations
  • Taxes on qualified investment entities
  • Taxes on greenmail (popular in the 1980s but not so much now)
  • Taxes on structured settlement factoring transactions
  • Gift taxes (but not estate taxes)

Form 1127 can also be filed if you receive a notice and demand for payment (or tax bill) for any of the following if paying them at the time they are due will cause undue hardship: 

  • Normal taxes and surtaxes
  • Taxes on private foundations and certain other tax-exempt organizations
  • Taxes on qualified investments
  • Gift taxes

But here’s the key. You can only use the form if you can prove undue hardship. “Undue hardship” means more than an inconvenience: you must show that you would sustain a substantial financial loss if required to pay a tax or deficiency on the due date. The mere inability to pay does not ordinarily result in penalty relief. Under Treas. Reg. 301.6651–1(c), you must also show that you exercised ordinary business care and prudence for the liability. The IRS will look at all of the facts and circumstances, including your financial situation, and the amount and nature of your spending compared to your income. The IRS will consider whether you made reasonable efforts to conserve sufficient assets in a marketable form (you can’t have converted them to illiquid assets or restricted them in some way) and still could not pay all or part of your tax when it came due.

But you know how I noted earlier that an extension to file isn’t an extension to pay? The reverse is also true: undue hardship generally does not affect your ability to file. You can substitute this form for an extension to file (and it usually doesn’t provide a basis for penalty relief in a failure to file situation). 

You should file Form 1127 as soon as you know of a tax liability or a tax deficiency that you cannot pay. If the liability is for an upcoming return, file on or before the due date of that return, not including extensions. If you are requesting an extension of time to pay an amount determined as a deficiency, file on or before the due date for payment indicated in the tax bill. 

Typically, the IRS won’t give you more than six additional months to pay the tax shown on a return. However, other than taxes due under sections 4981 (excise tax on undistributed income of real estate investment trusts), 4982 (excise tax on undistributed income of regulated investment companies), and 5881 (greenmail), you may be granted an extension for more than six months if you are out of the country. And you must pay the tax before the extension runs out: do not wait to receive a bill from the IRS.

You can find the rest of the series here:

It’s my annual Taxes from A to Z series! If you’re wondering how to figure basis for cryptocurrency or whether you can claim home office expenses during COVID, you won’t want to miss a single letter.

T is for Tax Home.

You probably think of your tax home as where you live – and that may be the case for some taxpayers. For federal income tax purposes, however, the Internal Revenue Service (IRS) typically defines your tax home as “the entire city or general area where your main place of business or work is located, regardless of where you maintain your family home.”  

Main place of business

If you regularly work in more than one location, your tax home is the general area where your main place of business or work is located. When thinking about your main place of business, you’ll want to take into account the length of time you usually need to spend at each location for business purposes, the degree of business activity in each area, and the relative significance of the financial return from each area. But according to the IRS, the most important consideration is the length of time you spend at each location.

No main place of business or work from home

But what if you don’t have a regular or main place of business because of the nature of your job? Or what if you work from home? In those cases, your tax home may be the place where you regularly live.

Business Expenses

The definition of your tax home is commonly used when dealing with travel, meals, and lodging expenses. While you can’t deduct personal expenses, you may be able to deduct travel expenses, which are the ordinary and necessary expenses of traveling away from home for business. You’re considered to be traveling away from home if your duties require you to be away from the general area of your tax home for a period that is substantially longer than an ordinary day’s work, and you need to get sleep or rest to meet the demands of your work while away.

While unreimbursed business expenses are no longer deductible on Schedule A, some travel expenses are still deductible. For example, if you’re self-employed, you can still deduct travel expenses on Schedule C (Form 1040 or 1040-SR), Profit or Loss From Business (Sole Proprietorship) (PDF).

Foreign homes (and foreign tax homes)

Your tax home is also important when looking at other tax benefits, like foreign-earned income exclusion, the foreign housing exclusion, or the foreign housing deduction. Even though those involve traveling further afield, the definition is still the same: your tax home is the general area of your main place of business, employment, or post of duty, regardless of where you maintain your family home. Your tax home is where you are permanently or indefinitely engaged to work as an employee or self-employed individual. 

Residence or Domicile

That language can be confusing for some of us because of the attachment that we have to the word home. But for federal income tax purposes, your “tax home” may not be where you live. And, your tax home may not be the same as your residence or domicile for tax purposes. Those terms typically don’t involve your business. I like to say that your residence is where you intend to live, and your domicile is where you intend to die.

If you’re not sure what qualifies as your tax home, check with your tax professional.

You can find the rest of the series here:

It’s my annual Taxes from A to Z series! If you’re wondering how to figure basis for cryptocurrency or whether you can claim home office expenses during COVID, you won’t want to miss a single letter.

S is for Sunset.

Tax rules change a lot. But some of what is sometimes billed as change isn’t so much new as it is a reversion to the old. Take the Tax Cuts & Jobs Act (TCJA), for example. Passed in 2017, most of the provisions that apply to individual taxpayers, including individual tax cuts, the increased standard deduction, and the expanded child tax credit, are set to expire at the end of 2025. When that happens, the law goes back to the way that it was before the provisions were implemented. When that happens, it’s called a “sunset,” which, I know, sounds way prettier than it actually is.

But how do we get to the point where Congress opts for a sunset instead of permanent change? You can thank the Congressional Budget Act of 1974. As part of the CBA, Congress created something called reconciliation. The idea of reconciliation is to allow certain spending, revenues, and debt-limit legislation to go through the bill process at a faster pace – there are fewer procedural hoops and reconciliation doesn’t allow for long debates in the Senate. Also, the minority party can typically filibuster a bill in the Senate unless there are 60 votes to move ahead, but that’s prohibited under reconciliation.

Both the House and Senate can tackle their own versions of reconciliation bills. They start in each chamber as budget resolutions with reconciliation instructions. But if the two chambers come up with different versions, they have to work out the differences. If and when they reach a compromise version, both then take an up-or-down vote on the final version: the final versions in the House and the Senate must be exactly the same.

Of course, as Congress likes to do, it tried to broaden the use of reconciliation for other things. That led to the establishment of the Byrd Rule in the Senate. Under the Byrd rule, named after former Senator Robert Byrd (D-WV), any legislation that would significantly increase the federal deficit beyond the ten-year budget window, or is otherwise “extraneous” can be blocked. “Extraneous” provisions include those that change Social Security or are outside the jurisdiction of the committee. If the Byrd rule applies, instead of a simple majority, 60 votes are needed to push a reconciliation bill through the Senate.

So what does that mean? When Congress can’t agree beyond a simple majority, they necessarily must frame it to only last for a few years. The result is a sunset.

Of course, the TCJA isn’t the first time we’ve seen a sunset. Other laws, like the Economic Growth and Tax Relief Reconciliation Act of 2001, the Jobs and Growth Tax Relief Reconciliation Act of 2003, and the Health Care and Education Reconciliation Act of 2010, also included sunset provisions.

You can find the rest of the series here:

It’s my annual Taxes from A to Z series! If you’re wondering how to figure basis for cryptocurrency or whether you can claim home office expenses during COVID, you won’t want to miss a single letter.

R is for Required Minimum Distributions.

Generally, the goal of a retirement account is to defer tax – and let the account grow – for as long as possible. But at some point, you normally have to start taking withdrawals from your IRA, SIMPLE IRA, SEP IRA, or retirement plan account when you reach age 70½ (with a Roth, you don’t have to take withdrawals until after the account owner’s death). Those mandatory withdrawals are called required minimum distributions (RMDs).

The amount of your RMD is figured by taking the account balance as of the end of the immediately preceding calendar year and dividing it by a number of years typically based on your life expectancy (some exceptions apply). You have to take at least that much each year. If you don’t take your RMD, or you don’t take enough, you’ll be subject to an excise tax. You can, however, withdraw more if you want to.

Withdrawals are taxable. That means that they will be included in your taxable income (except for any part that was taxed earlier) or that can be received tax-free (such as qualified distributions from designated Roth accounts). 

For IRAs, the beginning date for your first RMD is April 1 of the year following the calendar year in which you reach age 70½ if you were born before July 1, 1949, or April 1 of the year following the calendar year in which you reach age 72 if you were born after Jun 30, 1949. For 401(k) and 403(b) plans, profit-sharing plans, or other defined contribution plans, the beginning date for your first RMD is April 1 of the year in which you reach age 70½ if you were born before July 1, 1949, or April 1 of the year following the calendar year in which you reach age 72 if you were born after Jun 30, 1949 (or the date that you retire, if later, and if your plan allows). For each year after your required beginning date, you must withdraw your RMD by December 31.

For purposes of calculating your age, you’re considered to have reached age 70½ on the date that is 6 calendar months after your 70th birthday.

There are some important changes to RMDs in 2020. The Coronavirus Aid, Relief, and Economic Security Act (CARES Act) waives RMD payments for 2020, including for inherited IRAs. The waiver includes RMDs for individuals who turned age 70 ½ in 2019 and took their first RMD in 2020.

If you have already taken your RMD in 2020, you can choose to return it or roll it over:

  • If you have already received an RMD in 2020, you can repay the distribution to the distributing IRA no later than August 31, 2020, to avoid paying taxes on that distribution; OR
  • Since the RMD rules are suspended, RMDs taken in 2020 are considered eligible for rollover. Therefore, RMDs can be rolled over to another IRA or qualified retirement plan, or returned to the original plan. (There are some restrictions, including a one rollover per 12-month period limit and the exclusion of inherited IRAs on rollovers, so check out IRS Notice 2020-51 (PDF) for more information.)

The RMD suspension does not apply to qualified defined benefit plans (like pension plans).

More information on the CARES Act and retirement plans can be found on the IRS website at Coronavirus-related relief for retirement plans and IRAs questions and answers.

You can find the rest of the series here:

For federal income tax purposes, if you claim a charitable deduction for an item or group of similar items of donated property worth more than $5,000, you must get a qualified appraisal signed and dated by a qualified appraiser. 

So what does that mean? A qualified appraisal is an appraisal document that: 

  • Is made, signed, and dated by a qualified appraiser; 
  • Meets the relevant requirements of the Regs at §1.170A-17(a); 
  • Is dated no earlier than 60 days before the date of the contribution and no later than the date of the contribution; and 
  • Does not involve a prohibited appraisal fee (typically, that means that no part of the fee arrangement can be based on a percentage of the appraised value of the property).

A qualified appraiser is an individual with verifiable education and experience valuing the type of property for which the appraisal is performed. Generally, that means that the appraiser has earned an appraisal designation from a generally recognized professional appraiser organization or has met certain minimum education requirements and two or more years of experience. 

You must receive the qualified appraisal before the due date, including extensions, of the return on which a charitable contribution deduction is first claimed for the donated property. If the deduction is first claimed on an amended return, the qualified appraisal must be received before the date on which the amended return is filed. 

I know that wording sounds odd (“receive the qualified appraisal” rather than submit), but that’s because you generally do not need to attach the qualified appraisal to your tax return (some exceptions apply). You should, however, keep a copy for as long as the statute of limitations is applicable.

The appraisal must include:

  1. A description of the property in sufficient detail for a person who is not generally familiar with the type of property to determine that the property appraised is the property that was (or will be) contributed; 
  2. The physical condition of any tangible property; 
  3. The date (or expected date) of contribution; 
  4. The terms of any agreement or understanding entered into (or expected to be entered into) by or on behalf of the donor and donee that relates to the use, sale, or other disposition of the donated property;
  5. The name, address, and taxpayer identification number of the qualified appraiser (if the appraiser is a partner, an employee, or an independent contractor engaged by a person other than the donor, the name, address, and taxpayer identification number of the partnership or the person who employs or engages the appraiser); 
  6. The appraiser’s qualifications, including the appraiser’s background, experience, education, and any membership in professional appraisal associations; 
  7. A statement that the appraisal was prepared for income tax purposes; 
  8. The date (or dates) on which the property was valued; 
  9. The appraised fair market value (FMV) on the date (or expected date) of contribution; 
  10. The method of valuation used to determine FMV; and 
  11. The specific basis for the valuation, such as any specific comparable sales transaction. 

Some kinds of appraisals – like art appraisals – may require additional detail.

See Pub 561 for more information on appraisals and charitable deductions.

You can find the rest of the series here:

It’s my annual Taxes from A to Z series! If you’re wondering how to figure basis for cryptocurrency or whether you can claim home office expenses during COVID, you won’t want to miss a single letter.

P is for Personal Exemption.

A personal exemption used to be an easy way to reduce your taxable income. 

If you were not claimed as someone else’s dependent, you could claim a personal exemption. Married persons who file jointly could claim two personal exemptions. Additionally, you could claim a personal exemption for each of your dependents.

The math worked out like this: you would figure your eligible family members and multiply that amount by the personal exemption amount. So, if you were married and had one child, you would multiply three times the personal exemption amount (for the 2017 tax year, the personal exemption was $4,050 per person).

As part of the Tax Cuts and Jobs Acts (TCJA), personal exemptions were eliminated for the tax years 2018 through 2025. Since there are no currently personal exemption amounts, it makes sense to revisit your dependents and make sure that you’re claiming the right number: there’s typically no advantage to claiming a dependent solely for the exemption.

You can find the rest of the series here:

It’s my annual Taxes from A to Z series! If you’re wondering how to figure basis for cryptocurrency or whether you can claim home office expenses during COVID, you won’t want to miss a single letter.

O is for Ordinary and Necessary.

To claim a deduction for business expenses, Section 162 of the Tax Code requires that the expense is “ordinary and necessary.” According to the Internal Revenue Service (IRS), an ordinary expense is one that is common and accepted in your trade or business. The IRS defines a necessary expense as “one that is helpful and appropriate for your trade or business.”

No matter what the industry, that is the standard that the IRS will use. So, any time that you question whether something is deductible, as a first step, ask yourself is this “ordinary” and “necessary”?

  • An ordinary expense is one that is common and accepted in your industry. It’s the one time that you care about what your competitors are doing. No matter what your mother says, it does matter whether everyone else is doing it, too.
  • A necessary expense is one that is helpful and appropriate for your trade or business. You don’t have to prove that you couldn’t be in business without the expense – more or less, it needs to make good business sense.

Again, for an expense to be deductible, it needs to be both.

You can find the rest of the series here:

It’s my annual Taxes from A to Z series! If you’re wondering how to figure basis for cryptocurrency or whether you can claim home office expenses during COVID, you won’t want to miss a single letter.

N is for Nexus.

Nexus is a legal term for a connection; it’s important in the tax world because, under the Constitution, states must establish a connection between a taxpayer and the state in order to impose taxes.

For years, the rule was that only those companies with a physical presence inside a state can be required to collect sales tax, “continuing value of a bright-line rule in this area.” With respect to brick and mortar stores, that’s pretty easy: Are you physically located in the state or not?

The idea that you could only impose sales tax on sales where a retailer maintained a physical presence in a state had previously been established in National Bellas Hess, Inc. v. Department of Revenue of Ill., 386 U. S. 753 and was affirmed in Quill Corp. v. North Dakota (91-0194), 504 U.S. 298 (1992). But the advent and growth of internet sales complicated the issue: When Quill was decided fewer than 2% of Americans had access to the internet.

But the advent and growth of internet sales have complicated the issue. As states become increasingly aware of the amount of revenue they’re losing, they are seeking better ways to collect. Increasingly, that means that they are demanding that retailers be responsible for figuring and remitting the tax – and the requirements may differ from state to state.

The lack of a consistent approach raised the question of whether Quill deserved a second look. That’s what the Supreme Court heard in South Dakota v. Wayfair, Inc., Overstock.com, Inc., and Newegg, Inc. — sometimes just referred to as Wayfair. In Wayfair, the Supreme Court offered an answer: States have broad authority to require online retailers to collect sales taxes.

(You can read more on Wayfair here. You can read the majority opinion, together with the concurring opinions and the dissent, which downloads as a PDF, here.)

You can find the rest of the series here:

It’s my annual Taxes from A to Z series! If you’re wondering how to figure basis for cryptocurrency or whether you can claim home office expenses during COVID, you won’t want to miss a single letter.

M is for Mark-To-Market.

One of the big buzz phrases from 2019 was “mark-to-market” taxation. That implies that it’s a novel way to look at tax – but it’s actually not. At least not in theory. The concept of mark-to-market already exists in some areas of tax such as international taxation and as it applies to traders. However, the idea of mark-to-market taxation for everyday taxpayers is somewhat different.

But before we dive into mark-to-mark taxation, it’s important to understand how our current tax system treats appreciated assets. 

When you buy assets for investment – like stocks – you hope that they will continue to gain value. But the reality is that stocks go up and down. And every time the market dips, that doesn’t equal a realized loss, and when the market goes back up, that doesn’t equal a realized gain. To realize a gain or a loss for tax and accounting purposes, you have to do something with the stock. Typically, that means that you sell it or otherwise dispose of it. So, gains and losses aren’t determined moment to moment, but instead on how much your cost basis has gone up or down from the time you acquired the asset to the disposition of the asset.

Basis is, at its most simple, the cost that you pay for assets. The actual cost is sometimes referred to as “cost basis” because you can make adjustments to basis over time. When it comes to stocks, your basis is generally equal to the original cost of the shares; if you participate in a DRIP or other reinvestment plan, your basis is your cost plus the cost of each subsequent purchase/reinvestment subject, of course, to other adjustments for splits and the like. When you dispose of the asset at sale or transfer, sometimes called a taxable event, the value of the stock or asset at that moment is what matters. Nothing else matters. It doesn’t matter if the stock went up and down a hundred times in the middle. Your realized gain or loss is figured by calculating the difference from purchase (plus adjustments) to sale. All that stuff in the middle is, for tax and accounting purposes, just a bunch of squiggly lines.

At tax time, you currently report your realized gains and losses on a Schedule D, and then transfer the results to the reconciliation page on your Form 1040. You don’t file a Schedule D if you don’t have any realized gains or losses: even if the value of your shares went up and down significantly. If there’s no sale or disposition, there’s nothing to report.

But mark-to-market taxation is the idea that you should be able to capture the value of appreciation each year. In other words, you would track (and pay tax) on the value of gains in the year they accrue, and not simply when you dispose of/transfer/sell/give away the assets. In theory, you’d achieve the same basic result as you would now – but you’d eliminate the deferral.

 Here’s an example.

  • Let’s say that I bought a share of stock in 2015 worth $100. And let’s assume it was worth as follows over the next few years: $110 in 2016, $120 in 2017, $150 in 2018, $200 in 2019, and $300 in 2020.
  • Under our current system, if I sold the stock in 2020, I’d have a capital gain of $200 ($300 less $100 basis). But I wouldn’t pay tax in 2016, 2017, 2018, or 2019 on the gain.
  • But if we taxed the appreciation each year, I’d still have a total taxable gain of $200, but it would be broken down into pieces: $10 in 2016, $10 in 2017, $30 in 2018, $50 in 2019, and $100 in 2020. And $10 + $10 + $30 + $50 + $100 = $200. That’s the same as before, just paid out over time instead of at the end.

That’s pretty simple to track if assets keep going up… But what happens if they go down? That’s the tricky part. Depending on the structure of the system, you could perhaps use the losses to offset other income, or allow taxpayers to carry those losses forward or back, as we do now for certain investment income.

So what’s the appeal of mark-to-market taxation? The idea is that you wouldn’t have unrealized or deferred gains for lengthy periods, which would create a reliable stream of revenue for the tax authorities. Some policymakers also believe it could close the tax gap by eliminating potential opportunities for tax evasion or fraud. But adding to the tax burden as you go isn’t popular for all taxpayers: that’s why most proposals have tended to focus on high-income taxpayers (largely by way of creating an exemption).

Mark-to-market taxation can be controversial, and you can sort out on your own whether you’re a fan. But, at least now, you know the basics.

You can find the rest of the series here: