taxes from a to z


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.,, 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:

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.

L is for Legal Entity.

A legal entity – for legal and tax purposes – has an existence separate from that of the owners. Your choice of legal entity can affect the number and identity of shareholders and partners, equity structure, control, management, and the kind of funding you might be eligible to receive.

When you’re making a choice about the legal entity, remember two key things:

  1. Legal entity choice is state-specific. It doesn’t happen at the federal level. You incorporate or organize at the state level. The laws of the individual state matter: not all entity choices are respected or treated the same in every state.
  2. Your choice of legal entity may be different from your tax entity. Incorporation or organization with the Department of State in your state does not constitute a tax election with the Internal Revenue Service (IRS). For example, you can incorporate as a C corporation but elect with IRS to be taxed as an S corporation. You could also organize as an LLC but opt to be taxed as a partnership, S corporation, C corporation, or be disregarded.

There are several legal entities that you might find appealing, depending on your circumstances. Here are some of the most popular:

Sole Proprietorship. The sole proprietorship is the most simple form of business entity. There is no formal procedure to form a sole proprietorship – no forms to fill out, no agreements to sign, and no documents to file with the state. Since there are few formal accounting requirements, the transferability of personal and business assets in and out of the business is easy. The downside of the lack of formal requirements is that the owner of the sole proprietorship can be personally liable for the business’ debts and obligations. That means that personal assets – like your house – can be treated, for liability purposes, as business assets.

For federal tax purposes, taxpayers do not file a separate tax return for a sole proprietorship. Income and expenses from the business are reported on Form 1040, Schedule C.

General and Limited Partnerships. Partnerships are almost as easy to form as a sole proprietorship: it’s an association of two or more persons to carry on a business for profit. Like a sole proprietorship, in most states there are no formal procedures to form a partnership – no forms to fill out, no agreements to sign, and no documents to file – though it’s certainly desirable from a business and legal perspective. In a general partnership, partners share, jointly and severally, in the liability for business obligations.

  • A limited partnership is a bit different because it is typically defined as a partnership formed by one or more general partners and one or more limited partners. 
  • General partners are treated much like what we think of as “typical” partners: they have joint and several liability for the debts of the partnership and often exercise control over the partnership. In contrast, limited partners may have limited liability (this depends on state law and how much control those limited partners exercise).

For federal tax purposes, while a partnership does file a separate return (a federal form 1065), income and losses associated with the partnership pass through to the individual partners. Items of income or loss retain their character and are reported to each partner in proportion to their interest, as determined either by statute or partnership agreement. Each partner is then responsible for reporting that information on their individual tax returns.

Limited Liability Partnership. A Limited Liability Partnership (“LLP”) is similar to a general partnership, but while a general partnership can exist on an informal basis, an LLP must register with the state. The benefit of registration – a formal acknowledgment of the entity – is that the LLP takes on a form of limited liability similar to that of a corporation. Typically, that means that partners aren’t liable for the bad behavior of the other partners though the level of liability can vary from state to state. There is generally unlimited personal liability for contractual obligations of the partnership, such as promissory notes and mortgages (again, this varies by state).

For federal tax purposes, an LLP is treated as a pass-through entity, similar to a general partnership.

Limited Liability Limited Partnership. No, that’s not a mistake. Some states recognize a Limited Liability Limited Partnership (“LLLP”). If you consider that an LLP is a general partnership with limited liability, think of an LLLP as a limited partnership with limited liability.

For federal tax purposes, an LLLP is treated as a pass-through entity, similar to a general partnership.

Limited Liability Company. The Limited Liability Company (“LLC”) is probably the most popular form of business entity today. It’s a hybrid entity that offers the liability protection of a corporation with the option to be taxed as a partnership or a corporation. An LLC is made up of members, as opposed to shareholders. Individual members are typically protected from liability so long as corporate formalities are observed. That means that you do need to register with the state and pay attention to state laws (like filing annual reports). On the plus side, LLCs have far fewer corporate formalities than other corporations.

For federal tax purposes, an LLC is generally treated as a pass-through entity. While most LLCs are taxed as a partnership because it’s typically more advantageous, there may be situations when corporate tax treatment might be preferred (for example, when the individual members of an LLC are foreign). An LLC can also opt to be taxed as an S corporation (more on that in a bit).

Single Member Limited Liability Company. A Single Member Limited Liability Company (SMLLC) is what it sounds like on the tin: a formally organized LLC with a single member. 

The advantage of an SMLLC is that it may be treated as a “disregarded entity” for federal tax purposes. That means that the taxpayer does not file a separate tax form for the business; instead, income and expenses are reported on Form 1040, Schedule C, just like a sole proprietor.

C Corporation. A C corporation is what most people think of when we think of a business. In a typical C corporation, the business is owned by individual shareholders who hold stock certificates or shares (yes, we still call them certificates even though it’s rare that you have a piece of paper evidencing your ownership). The shareholders vote on policy issues, but the decisions on company policy are left to the Board of Directors. The catch? The Board of Directors is typically elected by the shareholders. The day to day work of running the company is performed by the officers of the corporation (think CEOs and COOs). The general appeal of a C corporation is limited liability: individual shareholders are not usually responsible for the company’s debts, obligations, and actions.

For federal tax purposes, a C corporation is a separate taxable entity that figures income or loss each year and pays tax on taxable income using Form 1120. C corporations are taxed at the federal level at a flat 21% (post-TCJA). Shareholders also pay tax at their individual income tax rates for any dividends or other distributions paid out during the year (since tax is already paid on the company’s profits, the term “double taxation” comes from).

S Corporation. An S Corporation is a bit tricky because the term actually refers to a tax election. That means that another entity (a corporation, LLC, or PC) is created at the state level, and an election is made to be taxed as an S corporation. By federal law, S corporations have some restrictions: they must have only one class of stock and have a limited number of domestic (no foreign) shareholders.

S corporations are treated as pass-through entities for purposes of taxation – but not precisely like a partnership. There is a separate tax return called a Form 1120-S, which reflects some differences in how income or losses are treated compared to a partnership. However, like a partnership, most items of income or loss retain most of their character and are reported to shareholders in proportion to their interest, as determined either by statute or Shareholder Agreement.

There may be other corporate entity forms available, but these are the big ones. Remember that these are just the basics: some states may have variations on a theme. I recommend that you consult with a professional before jumping in with both feet.

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.

K is for Kiddie Tax.

If you have an excellent memory, you might recall that I also used K for Kiddie Tax last year. And normally, I don’t like to repeat a letter in the series. So, what gives? Changes in the law.

The Tax Cuts and Jobs Act made a fairly unpopular change to the kiddie tax, marking unearned income to be taxed at the rates paid by trusts and estates. Those rates can be as high as 37%. And while that sounds the same as for individuals, it’s not. Tax rates for trusts and estates “climb the brackets” faster than individuals which means that since the rates are compressed, you hit the top rate much sooner. 

However, in 2019, Congress passed the Setting Every Community Up for Retirement Enhancement Act or the Secure Act. The Secure Act effectively repealed the kiddie tax bits of the TCJA, meaning that the kiddie tax was returned to the way it was in 2017 (did you get all that?).

The effective date for the new rules – which are really the old rules – is supposed to begin with the 2020 tax year, but you can elect to have it apply to the 2018 and 2019 tax years.

Here’s what you need to know:

  1. Earned income, or income from wages, salary, tips, or self-employment, is not subject to the kiddie tax. That income is taxed under the normal rules.
  2. The kiddie tax applies to unearned income. Unearned income typically means investment income like dividends, capital gains, and interest; those amounts are subject to the kiddie tax. If your child is under the age of 19 (or under the age of 24 and a full-time student), the kiddie tax applies once unearned income hits $2,200 (for the 2019 tax year). If that’s the case, your child has unearned income subject to the kiddie tax and must file a federal form 8615, Tax for Certain Children Who Have Unearned Income (downloads as a PDF). But if your child’s only income is interest and dividend income (including capital gain distributions) and totals less than $11,000, you may be able to elect to include that income on your own return rather than file a return for your child. See Form 8814, Parents’ Election To Report Child’s Interest and Dividends (downloads as a PDF).
  3. The kiddie tax is largely figured as gross income less deductions. For 2019, the standard deduction amount for an individual who may be claimed as a dependent by another taxpayer cannot exceed the greater of $1,100 or the sum of $350 and the individual’s earned income, but not an amount which exceeds the regular standard deduction amount ($12,200). For 2020, the numbers are largely the same except that the regular standard deduction amount is $12,400.

So, with all of that, how do you calculate the tax? Here’s the formula:

Child’s net earned income + child’s net unearned income – child’s standard deduction = child’s taxable income

  • A child’s net earned income is taxed at the regular rates for a single taxpayer; and
  • A child’s net unearned income that exceeds the unearned income threshold ($2,200 for 2019) is subject to the kiddie tax and is taxed at the parents’ rates.

Keep in mind that these rules apply to children who are dependents. Those who are not dependents because of their age or filing status (such as children who are married), level of support or those who are emancipated have a different set of rules. Other exceptions may apply: for example, children with earned income totaling more than half the cost of their support are not subject to the kiddie tax rules.

Again, the rules can be complicated depending on your specific facts and circumstances. If you’re still scratching your head, be sure to consult 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.

J Is For Jeopardy Assessment.

Okay, I should come clean from the beginning: This post doesn’t involve Alex Trebek. I know, that part stinks. But even Trebek-less, jeopardy assessments are pretty interesting.

You already know that the Internal Revenue Service (IRS) has very specific procedures for assessments and collections. But sometimes, they have to do things a bit differently. And jeopardy assessments are one of those things.

Jeopardy assessments are made – before the IRS makes an assessment of a deficiency – when the agency believes that assessment or collection would be endangered if regular procedures were followed. So, if the collection of an unassessed liability is in jeopardy, the IRS can make an immediate assessment and pursue collection without the need to follow those “normal” procedures.

When a jeopardy assessment is made, the tax, penalties, and interest become immediately due and payable.

To make a jeopardy assessment, at least one of these factors must be present:

  1. the taxpayer is or appears to be designing quickly to depart from the United States or to conceal him/herself;
  2. the taxpayer is or appears to be designing quickly to place his/her property beyond the reach of the government either by removing it from the United States, by concealing it, by dissipating it, or by transferring it to another person; or
  3. the taxpayer’s financial solvency is or appears to be imperiled.

There are many factors that can influence whether to make a jeopardy assessment, including when a taxpayer may be involved in illegal activity. That could include organized crime, wagering cases, and receiving income from illegal sources.

And it doesn’t stop there: as mentioned earlier, once the jeopardy assessment has been made, if the IRS believes that the collection of the tax might be in danger, the IRS can also bypass the normal notice procedures and go ahead with a levy.

But, a jeopardy assessment isn’t the end: remedies are available. Those remedies are largely the same as those available to all taxpayers including filing a petition to have a court examine the assessment.

If this sounds pretty scary, be aware that these powers aren’t limitless. Jeopardy assessments are to be used when reasonable and appropriate – and as authorized by law. You can find the authority for jeopardy assessments in the Tax Code:

  • IRC 6861 (where the due date for filing of a return has expired);
  • IRC 6862 (taxes other than income, estate, gift, and certain excise taxes);
  • IRC 6867 (where the owner of a large amount of cash is not identified)

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.

I Is For Inflation.

Inflation is the measure of the rate at which the average price of goods and services increases over a period of time. As prices go up, typically the buying power of currency – in our case, the dollar – goes down so that currency buys less than it did before. Put another way, inflation is a decrease in buying power so that it costs more money to buy the same thing as before.

So what does that have to do with tax? 

For one, many government benefits – like Social Security benefits – are tied to inflation.The procedures outlined at section 215(i)(2)(A) of the Social Security Act generally require the government to examine the overall cost of living and determine whether an increase in benefits is necessary. The easiest way for most folks to determine whether those numbers will be on the way up or down is to look at the consumer price index (CPI). The U.S. Bureau of Labor Statistics reports whether the CPI has moved up or down. That’s important because the CPI measures the cost of goods and services – in other words, your cost of living. The CPI tends to signal what’s going to happen with interest rates – and inflation. A number of those the items you’ll see in the Tax Code are dependent on inflation.

The same is true for many tax characteristics – like tax brackets – which change based on the economy. And beginning in 2018, thanks to the Tax Cuts and Jobs Act (TCJA) , the “normal” CPI has been replaced with a “chained” CPI. The chained CPI measures consumer responses to higher prices rather than simply measuring higher prices. 

Here’s an example of the two (CPI and chained CPI) are calculated:

Let’s say that in 2019, coffee was $10/pound and tea was $10/pound. And because I tend to drink more coffee, I bought 10 pounds of coffee and 2 pounds of tea. 

In 2020, let’s say that coffee jumped to $15/pound and tea went up to a mere $11/pound. 

Even though I love coffee, let’s say I switched to tea because it was cheaper (again, this is just a hypothetical – I am not, I repeat, not changing my coffee consumption) and bought 5 pounds of coffee and 7 pounds of tea. I still bought 12 pounds of caffeinated beverages but I altered the proportions because of the pricing. The theory is that most folks react in a similar manner – you alter your spending to compensate for increases.

Here’s how the “normal” CPI calculations based solely on price increases would look:

(10 x 15) + (2 x 11)/(10 x 10) + (2 x 10) = 1.4333

But the “chained” CPI calculations which reflect the change in my behavior would look like this:

(5 x 15) + (7 x 11)/ (10 x 10) + (2 x 10) = 1.267

In my examples, the “chained” CPI results in a lower number – that tends to be the pattern. While that means a lower payout for benefits – like Social Security – over time, it’s considered by many to be a more accurate capture of spending power.

The annual inflation rate for the United States is 0.1% for the 12 months ending May 2020; that’s the lowest rate of inflation in about five years. The Federal Reserve doesn’t have a formal inflation target, but generally, an acceptable inflation rate is around 2%. The next inflation update is scheduled for release on July 14, 2020.

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.

H is for Head of Household.

I know what you’re thinking: Head of Household is an easy one. That’s because we’re so used to seeing it: one of the first pieces of information you share with the Internal Revenue Service (IRS) is your filing status. Your filing status impacts your tax rates, your qualification for certain tax deductions and credits, and more.

You can choose from one of five filing statuses on a federal tax return:

  • Single;
  • Married Filing Jointly;
  • Married Filing Separately;
  • Head of Household; and
  • Qualifying Widow(er) With Dependent Child.

Easy-peasy, right?

Maybe not. One of the things that I have realized this filing season – largely due to the scramble to understand how to qualify for stimulus checks – is that there are many misconceptions about filing status. And Head of Household is at the top of the list.

So, first, the basics. For federal income tax status, marital status is determined by state law as of the last day of the calendar year. If you are married on December 31, you are considered married for the year (married filing jointly or married filing separately). If you’re not married on December 31 because you were never legally married or you were legally separated or divorced according to the laws of your state, you are not married (single, head of household, or qualifying widow(er) with dependent child). It typically doesn’t matter what happens in between.

Most of those filing status options are pretty straightforward. But head of household can be tricky. You can file as head of household IF:

  1. You are unmarried or considered unmarried on the last day of the year; AND
  2. You paid more than half the cost of keeping up a home for the year; AND
  3. qualifying person lived with you in the home for more than half the year (except for temporary absences, such as school). However, if the qualifying person is your dependent parent, he or she doesn’t have to live with you.

To figure that you, you need some further definitions.

First, you are considered unmarried on the last day of the year if:

  1. You file a separate tax return; AND
  2. You paid more than half the cost of keeping up your home for the tax year; AND
  3. Your spouse didn’t live in your home during the last six months of the tax year (your spouse is considered to have lived in your home even if he or she is temporarily absent due to special circumstances like illness, school or military service); AND
  4. Your home was the main home of your child, stepchild, or foster child for more than half the year; AND
  5. You must be able to claim that child as a dependent (unless you qualify for an exception). 

And, a qualifying person is:

  1. A qualifying child (such as a son, daughter, or grandchild who lived with you more than half the year and meets certain other tests) who is either single or is married, but you can claim as a dependent; or
  2. A qualifying relative who is your father or mother who you can claim as a dependent; or
  3. A qualifying relative other than your father or mother (such as a grandparent, brother, or sister who meets certain tests) who lived with you more than half the year, and you can claim as a dependent. This may include your child, stepchild, grandchild or other descendant of one of your children (or stepchildren or foster children), son-in-law, daughter-in-law, brother, sister, half brother, half-sister, stepbrother, stepsister, brother-in-law, sister-in-law, parent, stepfather, stepmother, father-in-law, mother-in-law, grandparent, great-grandparent, and, if related by blood, aunt, uncle, niece, or nephew.

For purposes of a qualifying person, the IRS even drew up a table for you. It’s the infamous Table 4 that you’ll see referenced over and over in head of household conversations:

You can view Table 4 in full-size by checking out IRS Pub 501, Dependents, Standard Deduction, and Filing
(downloads as a PDF).

But here’s the bit that you need to take away. According to Pub 501, “Any person not described in Table 4 isn’t a qualifying person.”

That seems pretty simple, but many family situations are not terribly simple. So let’s run through some examples that folks are often confused about.

First, spouses. Your spouse is not your dependent. And you must have a qualifying dependent to file as head of household status. So, if you are married without any other dependents, you may not claim head of household status (you would typically opt for married filing jointly). And if you are married but not considered unmarried (yes, I see those double negatives), you typically cannot claim head of household status even if you support other relatives.

What about your significant other? Your significant other may, under some circumstances, qualify as your dependent. However, your significant other is not a qualifying person under the head of household rules because he or she is not related to you.

What about your significant other’s child? Same result. You may be able to claim the child as a dependent, but the child is not a qualifying person for purposes of head of household status because the child is not actually related to you.

What about your own child if you live with your significant other? Finally, a yes. You can file as head of household if you have a qualifying child (or other qualifying person) who lives with you and your significant other so long as the child meets the other criteria.

After re-reading many of your emails, I think the confusion boils down to this one thing: a dependent is not always a qualifying person for purposes of head of household. You have to run through all of the tests.

I know that some of you may have your finger on the email button, ready to send me emails to the contrary. That may be because some websites do claim that your significant other or significant other’s child is a qualifying person for purposes of head of household. But that’s not correct. The IRS confirms as much in Pub 501 (the link is above at the chart), with the following examples:

Example 3. Your girlfriend lived with you all year. Even though she may be your qualifying relative if the gross income and support tests (explained later) are met, she isn’t your qualifying person for head of household purposes because she isn’t related to you in one of the ways listed under Relatives who don’t have to live with you .

Example 4. The facts are the same as in Example 3 except your girlfriend’s 10-year-old son also lived with you all year. He isn’t your qualifying child and, because he is your girlfriend’s qualifying child, he isn’t your qualifying relative (see Not a Qualifying Child Test , later). As a result, he isn’t your qualifying person for head of household purposes.

It’s confusing – so much so that the IRS requires preparers to complete a form confirming that they’ve performed due diligence for head of household filing status. It’s Form 8867, Paid Preparer’s Due Diligence Checklist (downloads as a PDF). The penalty per failure to be diligent is $530 for returns or claims for refund filed in 2020.

 If you’re still not sure whether you qualify as head of household, you may want to try the IRS’ interactive filing status tool. You can find it 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.

G is for GILTI.

GILTI – which ranks up there as one of the best tax acronyms of all-time – stands for global intangible low-taxed income.

In the days before the Tax Cuts and Jobs Act (TCJA), the United States took the position that resident taxpayers, including corporations, were subject to tax on their worldwide income. But as you well know, not all corporations paid tax on their worldwide income. With a few elections and a presence overseas – even an insignificant one – those businesses could defer tax earned by foreign subsidiaries until the funds were repatriated to the US.

You might recall some of those pre-TCJA discussions – like this one from Steve Jobs – where some companies made clear that they were happy to keep money parked overseas until the US changed its policy.

In 2017, it did. 

Now, the post-TCJA rule is that income earned by active foreign subsidiaries of US companies is typically exempt from US tax even if those funds are repatriated. But that rule applies to income earned from activities like manufacturing, not passive income. Income from passive income remains taxable.

That sounds great for those multinational companies. But the worry was that it might encourage those multinational companies with intangible assets that are easily moved – like trademarks and copyrights (remember, many of the companies making the move overseas are pharma or tech companies) – from shifting those assets offshore.

Enter new section 951A.

Under the new rules, a US shareholder of a foreign corporation must include in income its global intangible low-taxed income – or GILTI. The rules are extensive and the calculations can be confusing, but here’s the gist: those taxpayers are now subject to a 10.5% minimum tax on that income (the GILTI). Let me explain that number.

GILTI is defined as the total active income earned by a US company’s foreign subsidiaries that exceeds 10% of the company’s depreciable tangible property. Or put another way: GILTI = Net CFC Tested Income – Net Deemed Tangible Income Return (NDTIR).

  • A CFC (controlled foreign corporation) is any foreign corporation that is more than 50% owned by U.S. shareholders.
  • NDTIR = 10% x QBAI, or Qualified Business Asset Investment – Interest Expense

A corporation can generally deduct 50% of GILTI and claim a foreign tax credit for 80% of foreign taxes paid or accrued on the income. Keep in mind that the US corporate tax rate is now a flat 21%. So if the tax rate in a foreign country is 0%, the effective US tax rate on GILTI will be 10.5%, or 50% of the 21%. Make sense? With that as a baseline, the result is supposed to make tax rate shopping abroad less appealing.

The calculation changes for taxable years beginning after December 31, 2025, when the deduction changes from 50% to 37.5%, resulting in a minimum 13.125% effective US tax rate.

I know, I just lost you (and to be fair, most folks except a handful of international tax experts). But since this is meant to be a primer, here’s what you need to know: since GILTI computations can be complicated, companies must carefully consider tax planning – including location – when considering a move abroad. Without tax planning, those traditional, pre-TCJA strategies for setting up subsidiaries may no longer be tax advantageous. And that was, of course, the point of the law in the first place.

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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.

E is for Extended Due Dates.

We all know that the normal tax filing season deadline is April 15. But this tax filing season is far from normal.

Due to COVID-19, the original tax filing deadline and tax filing payment due date for 2019 was extended from April 15, 2020, to July 15, 2020. On June 29, 2020, the Department of the Treasury and the Internal Revenue Service (IRS) announced that the 2019 tax filing deadline would not be extended further and remains July 15, 2020. 

Some exceptions apply – like for victims of those April storms

But otherwise, individual taxpayers who cannot meet the July 15 due date can request an automatic extension of time to file. Keep in mind that the extension is a six-month extension from the original filing date of April 15, meaning that an extension will extend the time to file to October 15, 2020. It is not a six-month extension from the extended due date of July 15, 2020. For more on filing for extension, click here.

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