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IRS Provides Tax Relief to California Storm Victims

by Amber Stevenson

The IRS has provided disaster tax relief to victims of California storms that began on January 8, 2023. According to the IRS, storm victims who live or have a business in the disaster area now have until May 15, 2023, to file various federal individual and business tax returns and to make tax payments. The full notice can be read at (IR 2023-03, 1/10/2023)

Disaster area. The disaster area includes the following counties: Alameda, Colusa, Contra Costa, El Dorado, Fresno, Glenn, Humboldt, Kings, Lake, Los Angeles, Madera, Marin, Mariposa, Mendocino, Merced, Mono, Monterey, Napa, Orange, Placer, Riverside, Sacramento, San Benito, San Bernardino, San Diego, San Francisco, San Joaquin, San Luis Obispo, San Mateo, Santa Barbara, Santa Clara, Santa Cruz, Solano, Sonoma, Stanislaus, Sutter, Tehama, Tulare, Ventura, Yolo, and Yuba.

Postponed deadlines. The IRS has postponed various tax filing and payment deadlines that occurred beginning on January 8, 2023. As a result, individuals and households who live or have a business in the disaster area will have until May 15, 2023, to file returns and pay taxes that were originally due during this period.

This tax relief includes business returns due on March 15 and business and individual returns due on April 18, 2023. In addition, farmers who forgo making an estimated tax payment in January and normally file their returns by March 1, now have until May 15, 2023, to file their 2022 return and pay any tax due.
The May 15, 2023, deadline also applies to:

  1. The quarterly estimated tax payments normally due on January 17, 2023, and April 18, 2023.
  2. The quarterly payroll and excise tax returns normally due on January 31 and April 30, 2023.

In addition, penalties on payroll and excise tax deposits due on or after January 8, 2023, and before January 23, 2023, will be abated if the tax deposits are made by January 23, 2023.

Relief is automatic. The IRS will automatically apply this tax relief to any taxpayer with an address in the disaster area (“affected taxpayers”). However, affected taxpayers that receive a penalty notice from the IRS for a return that has a due date falling within the postponement period (January 8, 2023, to May 15, 2023) should call the phone number on the notice to have the penalty abated.

In addition, taxpayers who live or have a business outside the disaster area but whose tax records are in the disaster area and workers assisting in disaster relief activities should call the IRS at 866-562-5227 to ask for this tax relief.

Disaster losses. Victims in the disaster area who suffered uninsured or unreimbursed disaster-related losses can choose to claim them on either the current year (2023) or prior year 2022 return. Taxpayers claiming disaster losses should write the FEMA declaration number—3691-EM—on any return claiming such a loss.

As of this posting, California has not conformed to this relief but we expect they will shortly.

Please keep in mind that this relief doesn’t apply to information returns such as Forms W-2, 1094, 1095, 1097, 1098 or 1099 series; to Forms 1042-S, 3921, 3922 or 8027. These forms still have their normal due dates.

Using S Corporations to Reduce Self-Employment Income

by Amanda Domitrowich

Income that you generate conducting your business as a sole proprietorship (or through a wholly-owned limited liability company (LLC)) is subject to both income tax and self-employment tax. The self-employment tax is imposed on 92.35% of self-employment income at a 12.4% rate for social security up to the social security maximum ($142,800 for 2021; $147,000 for 2022) and at a 2.9% rate for Medicare. An additional 0.9% Medicare tax is imposed on income exceeding $250,000 for married couples ($125,000 for married persons filing separately) and $200,000 in all other cases. No maximum tax limit applies to the Medicare tax. Similarly, if you conduct your business as a partnership in which you are a general partner, in addition to income tax you would be subject to the self-employment tax on your distributive share of the partnership’s income. On the other hand, if you conduct your business as an S corporation you will be subject to income tax, but not self-employment tax, on your share of the S corporation’s income.

An S corporation is not subject to tax at the corporate level. Instead, the corporation’s items of income, gain, loss, and deduction are passed through to the shareholders. However, the income passed through to the shareholder is not treated as self-employment income. Thus, by using an S corporation, you can avoid self-employment income tax.

There is a problem, however, in that IRS requires that the S corporation pay you reasonable compensation for your services to the S corporation. The compensation is treated as wages subject to employment tax (split evenly between the corporation and the employee), which is equivalent to the self-employment tax. If the S corporation does not pay you reasonable compensation for your services, IRS may treat a portion of the S corporation’s distributions to you as wages and impose social security taxes on the deemed wages. There is no simple formula regarding what is reasonable compensation. Presumably, reasonable compensation would be the amount that unrelated employers would pay for comparable services under like circumstances. There are many factors that would be taken into account in making this determination.

Give us a call today to discuss the practical aspects of conducting your business through an S corporation and how much the S corporation would have to pay you as compensation.

Computing a Net Operating Loss for an Individual

by Amanda Domitrowich

Speaking broadly, you may be able to benefit by carrying what is called a “net operating loss” (NOL) into a different year-a year in which you have taxable income-and taking a deduction (the “NOL deduction”) for the loss against that year’s income.

The NOL deduction equals the total of your NOL carryovers and NOL carrybacks to the particular tax year. But, for tax years after 2020, the deduction will be subject to an 80%-of-taxable income limitation.

Your NOLs for tax years 2018, 2019 and 2020 are carried back for five years. But, NOLs for 2021 and later tax years generally can’t be carried back (although farm losses can be carried back two years). And, NOLs for tax years after 2017 are generally carried forward indefinitely.

You must carry the NOL first to the earliest year allowed, and, then, successively, to the next earliest year, etc. until the loss is used up. But, if it would benefit you more to just carry a NOL forward, you can waive carryback of that loss.

To determine the amount of your NOL for a particular tax year, you don’t just use the negative taxable income reported on your tax return for that year. Instead, several modifications must be made to compute the amount of your NOL. These include the following:

  • (1) You cannot use your personal or dependency exemptions-for the years in which these are available (i.e., after 2025 and before 2018).
  • (2) You cannot use any NOL from a different year.
  • (3) “Nonbusiness” capital losses (those arising outside of your trade or business, or your employment) can only be used against “nonbusiness” capital gains. Excess capital losses cannot increase your NOL.
  • (4) “Nonbusiness” deductions (e.g., charitable donations, deductible medical expenses, mortgage interest, alimony, etc.) can only be used against “nonbusiness” income (interest, dividends, etc.). That is, they cannot directly increase your NOL. However, if you have nonbusiness capital gains in excess of nonbusiness capital losses (see (3), above), you can use your “excess” nonbusiness deductions against these gains. (Note that casualty losses are treated as fully usable “business deductions” for these purposes.)
  • (5) Finally, “business” capital losses can only be used against “business” capital gains, except that if you still have nonbusiness capital gains after netting nonbusiness capital losses and excess nonbusiness deductions against them, you can use your business capital losses against them.

Example. N has a loss of $20,000 from business operations for the year. N also has (i) nonbusiness capital gains of $9,000 and nonbusiness capital losses of $4,000, and (ii) nonbusiness income of $13,000 and nonbusiness deductions of $14,000 (not including personal or dependency exemptions). N has no business capital gains or losses.

N’s “starting point” for calculating N’s NOL is N’s $20,000 business loss. N’s capital losses reduce N’s capital gains to $5,000 ($9,000 − $4,000). N’s nonbusiness deductions wipe out N’s nonbusiness income ($13,000 − $14,000), leaving N with $1,000 “excess” nonbusiness deductions. N can use the $1,000 excess nonbusiness deductions to further reduce N’s capital gains to $4,000. But, the $4,000 of capital gains do reduce N’s NOL from $20,000 to $16,000. The final result: N incurs a $16,000 NOL for the tax year.

Note that N’s taxable income will show a loss that’s greater than N’s $16,000 NOL, because N’s taxable income includes items such as personal exemption that aren’t allowed in figuring N’s NOL. Only the $16,000 NOL, however, can be carried forward to other years for use as a deduction.

The above computations can grow quite complex, depending upon your circumstances.

In addition to the rules above, special rules allow farmers to retain a pre-2018, two-year NOL carryback election and then applicable 80%-of-taxable-income limitation, for farming losses arising in 2018, 2019 or 2020 tax years, and to revoke a previously made waiver of the two-year carryback for 2018 or 2019 farming losses, and apply the five-year carryback instead. Obviously, there’s a lot to consider in determining the amount of your NOL, and whether to claim an NOL deduction. Please contact us today and we will be happy to discuss further.

Individual Estimated Tax Payments – Who Should Pay Them and Why?

by Amanda Domitrowich

Individuals must pay 25% of a “required annual payment ” by Apr. 15, June 15, Sept. 15, and Jan. 15, to avoid an underpayment penalty. When that date falls on a weekend or holiday, the payment is due on the next business day.

The required annual payment for most individuals is the lower of 90% of the tax shown on the current year’s return or 100% of the tax shown on the return for the previous year. However, if the adjusted gross income on your previous year’s return was over $150,000 (over $75,000 if you are married filing separately), you must pay the lower of 90% of the tax shown on the current year’s return or 110% of the tax shown on the return for the previous year.

Most people who receive the bulk of their income in the form of wages satisfy these payment requirements through the tax withheld by their employer from their paycheck. Those who make estimated tax payments generally do so in four installments. After determining the required annual payment, they divide that number by four and make four equal payments by the due dates.

But you may be able to use the annualized income method to make smaller payments. This method is useful to people whose income flow is not uniform over the year, perhaps because of a seasonal business. For example, if your income comes exclusively from a business that you operate in a resort area during June, July, and August, no estimated payment is required before Sept. 15. You may also want to use the annualized income method if a significant portion of your income comes from sales of securities that are made at various times during the year.

If you fail to make the required payments, you may be subject to an underpayment penalty. The penalty equals the product of the interest rate charged by IRS on deficiencies, times the amount of the underpayment for the period of the underpayment.

However, the underpayment penalty doesn’t apply to you:

  • (1) if the total tax shown on your return is less than $1,000 after subtracting withholding tax paid;
  • (2) if you had no tax liability for the preceding year, you were a U.S. citizen or resident for that entire year, and that year was 12 months;
  • (3) for the fourth (Jan. 15) installment, if you file your return by that Jan. 31 and pay your tax in full; or
  • (4) if you are a farmer or fisherman and pay your entire estimated tax by Jan. 15, or pay your entire estimated tax and file your tax return by Mar. 1

In addition, IRS may waive the penalty if the failure was due to casualty, disaster, or other unusual circumstances and it would be inequitable or against good conscience to impose the penalty. The penalty can also be waived for reasonable cause during the first two years after you retire (after reaching age 62) or become disabled. Third quarter estimated taxes for 2022 are coming due on September 15th. If you think you may be eligible to determine your estimated tax payments under the annualized income method, or you have any other specific questions about how the estimated  tax rules apply to you, please contact our office today!

Simplified Employee Pensions (SEPs)

by Amanda Domitrowich

Are you thinking about setting up a retirement plan for yourself and your employees, but are concerned about the financial commitment and administrative burdens involved in providing a traditional pension or profit-sharing plan? An alternative program you may want to consider is a “simplified employee pension,” or SEP.

SEPs are intended as an alternative to “qualified” retirement plans, particularly for small businesses like yours. The relative ease of administration and the complete discretion you, as the employer, are permitted in deciding whether or not to make annual contributions, are features that are especially attractive. Here’s how these plans work.

If you don’t already have a qualified retirement plan, you can set up a SEP simply by using the IRS model SEP, Form 5305-SEP. By adopting and implementing this model SEP, which doesn’t have to be filed with the IRS, you will have satisfied the SEP requirements. This means that you, as the employer, will get a current income tax deduction for contributions you make on behalf of your employees. Your employees will be taxed not when the contributions are made, but at a later date when distributions are made, usually at retirement. Depending on your specific needs, an individually-designed SEP-instead of the model SEP-may be appropriate for you.

When you set up a SEP for yourself and your employees, you will make these deductible contributions to each employee’s IRA, called a SEP-IRA, which must be IRS-approved. The maximum amount of deductible contributions that you can make to an employee’s SEP-IRA, and that he or she can exclude from income, is the lesser of: (i) 25 percent of compensation, and (ii) $61,000 (for 2022). The deduction for your contributions to employees’ SEP-IRAs isn’t limited by the deduction ceiling applicable to an individual’s own contribution to a regular IRA. Your employees control their individual IRAs and IRA investments, the earnings on which are tax-free.

There are other requirements which you have to meet to be eligible to set up a SEP. Essentially, all regular employees must elect to participate in the program, and contributions can’t discriminate in favor of the highly compensated employees. But these requirements are minor compared to the bookkeeping and other administrative burdens connected with traditional qualified pension and profit-sharing plans. The detailed records that traditional plans must maintain to comply with the complex nondiscrimination regulations aren’t required for SEPs. And employers aren’t required to file annual reports with IRS-Forms 5500-which, for a pension plan, could require the services of an actuary. What record-keeping is required can be done by a trustee of the SEP-IRAs-usually a bank or mutual fund.

We are happy to meet with you to explain your SEP options in greater detail as well as answer any questions you may have. Give us a call today!

Charitable Donations of Appreciated Stock

by Amanda Domitrowich

If you are planning to make a relatively substantial contribution to a charity, college, etc., you should consider donating appreciated stock from your investment portfolio instead of cash. Your tax benefits from the donation can be increased and the organization will be just as happy to receive the stock.

This tax planning tool is derived from the general rule that the deduction for a donation of property to charity is equal to the fair market value of the donated property. Where the donated property is “gain” property, the donor does not have to recognize the gain on the donated property. These rules allow for the “doubling up,” so to speak, of tax benefits: a charitable deduction, plus avoiding tax on the appreciation in value of the donated property.

Example: Tim and Tina are twins, each of whom attended Yalvard University. Each plans to donate $10,000 to the school. Each also owns $10,000 worth of stock in ABC, Inc. which he or she bought for just $2,000 several years ago.

Tim sells his stock and donates the $10,000 cash. He gets a $10,000 charitable deduction, but must report his $8,000 capital gain on the stock.

Tina donates the stock directly to the school. She gets the same $10,000 charitable deduction and avoids any tax on the capital gain. The school is just as happy to receive the stock, which it can immediately sell for its $10,000 value in any case.

Caution: While this plan works for Tina in the above example, it will not work if the stock has not been held for more than a year. It would be treated as “ordinary income property” for these purposes and the charitable deduction would be limited to the stock’s $2,000 cost.

If the property is other ordinary income property, e.g., inventory, similar limitations apply. Limitations may also apply to donations of long-term capital gain property that is tangible (not stock), and personal (not realty).

Finally, depending on the amounts involved and the rest of your tax picture for the year, taking advantage of these tax benefits may trigger alternative minimum tax concerns.

If you’d like to discuss this method of charitable giving more fully, including the limitations and potential problem areas, please give us a call.

Exclusion of Gain on Sale or Exchange of Your Principal Residence

by Amanda Domitrowich

Under these rules, up to $250,000 of the gain from the sale of single person’s principal residence is tax-free. For certain married couples filing a joint return, the maximum amount of tax-free gain doubles to $500,000.

Like most tax breaks, however, the exclusion has a detailed set of rules for qualification. Besides the $250,000/$500,000 dollar limitation, the seller must have owned and used the home as his or her principal residence for at least two years out of the five years before the sale or exchange. In most cases, sellers can only take advantage of the provision once during a two-year period.

However, a reduced exclusion is available if the sale occurred because of a change in place of employment, health, or other unforeseen circumstances where the taxpayer fails to meet the two-year ownership and use requirements or has already used the exclusion for a sale of a principal residence in the past two years. A sale or exchange is by reason of unforeseen circumstances if the primary reason for the sale or exchange is the occurrence of an event that the taxpayer does not anticipate before purchasing and occupying the residence. Unforeseen circumstances that are eligible for the reduced exclusion include involuntary conversions, certain disasters or acts of war or terrorist attacks, death, cessation of employment, change of employment resulting in the taxpayer’s inability to pay certain costs, divorce or legal separation, multiple births from the same pregnancy, and events identified by IRS as unforeseen circumstances (for example, the September 11 terrorist attacks). The amount of the reduced exclusion equals a fraction of the $250,000/$500,000 dollar limitation. The fraction is based on the portion of the two-year period in which the seller satisfies the ownership and use requirements.

These rules can get quite complicated if you marry someone who has recently used the exclusion provision, if the residence was part of a divorce settlement, if you inherited the residence from your spouse, if you sell a remainder interest in your home, if there are periods after 2008 in which the residence isn’t used as your (or your spouse’s) principal residence, or if you have taken depreciation deductions on the residence. Also, the exclusion does not apply if you acquired the residence within the previous five years in a “like-kind” exchange in which gain was not recognized.

Let us know if you have any questions about the exclusion or would like additional information. We are happy to go over the specifics of your situation with you to determine whether a sale of your residence would qualify for this valuable tax break.

Paying Yourself – What is Considered Reasonable Compensation by the IRS?

by Amanda Domitrowich

A corporation can deduct the compensation that it pays, but not its dividend payments. Thus, if funds are withdrawn as dividends, they’re taxed twice, once to the corporation and once to the recipient. Money paid out as compensation is taxed only once, to the employee who receives it.

However, there’s a limit on how much money you can take out of the corporation in this way. The law says that compensation can be deducted only to the extent that it’s reasonable. Any unreasonable portion is nondeductible and, if paid to a shareholder, may be taxed as if it were a dividend. As a practical matter, IRS rarely raises the issue of unreasonable compensation unless the payments are made to someone “related” to the corporation, such as a shareholder or a member of a shareholder’s family.

How much compensation is “reasonable”? There’s no simple formula. IRS tries to determine the amount that similar companies would pay for comparable services under like circumstances. Factors that are taken into account include:

  • the employee’s duties;
  • the amount of time required to perform those duties;
  • the employee’s ability and accomplishments;
  • the complexities of the business;
  • the gross and net income of the business;
  • the employee’s compensation history; and
  • the corporation’s salary policy for all its employees.

There are a number of concrete steps you can take to make it more likely that the compensation you earn will be considered “reasonable,” and therefore deductible by your corporation. For example, you can:

  • Use the minutes of the corporation’s board of directors to contemporaneously document the reasons for the amount of compensation paid. For example, if compensation is being increased in the current year to make up for earlier years in which it was too low, be sure that the minutes reflect this. (Ideally, the minutes for the earlier years should reflect that the compensation paid in those years was at a reduced rate.)
  • Avoid paying compensation in direct proportion to the stock owned by the corporation’s shareholders. This looks too much like a disguised dividend and will probably be treated as such by IRS.
  • Keep compensation in line with what similar businesses are paying their executives (and keep whatever evidence you can get of what others are paying—such as salary offers to your executives from comparable companies—to support what you pay if you’re later questioned).
  • If the business is profitable, be sure to pay at least some dividends. This avoids giving the impression that the corporation is trying to pay out all of its profits as compensation.

As in most tax situations, planning ahead avoids problems later. Contact our office today to discuss this or any other aspect of your current or deferred compensation strategies.

Create Online Tax Accounts Now!

by Kassandra Cristobal

Have you created your online accounts with the Internal Revenue Service (IRS) and Franchise Tax Board (FTB) yet? We encourage ALL of our clients to create or update their online accounts with the IRS and relevant state tax agencies. With online accounts, taxpayers gain access to important tax information including balances due, payments made, tax records, and more.

In many cases, you can locate or request relevant information via your online account which will minimize or eliminate the need to sit on hold with tax agencies. Plus, account creation takes just a few minutes! Individual taxpayers have the ability to create both Federal IRS and California FTB accounts, however businesses are only able to create California FTB accounts at this time.

The following and more can be done via your online accounts:

Both IRS and FTB:

  • View account balance, including taxes due from prior year returns
  • Make electronic payments and create payment plans
  • View tax payment history, including past estimated tax payments
  • View Notices and Letters of correspondence
  • View and authorize Power of Attorney (POA) for outside parties

IRS:

  • View tax records relating to advance payments of the Child Tax Credit and Economic Impact Payments (EIPs)

FTB:

  • View past copies of your California tax returns
  • Send a secure message to an FTB representative with questions regarding your account
  • Authorize Full Online Account Access for your tax professional representative(s)
  • View tax payment history, including the new Pass-Through Entity (PTE) Elective Tax payment

Federal IRS

Log-In Page: https://www.irs.gov/payments/your-online-account

The IRS has partnered with ID.me, an IRS-trusted technology provider, to provide identity verification for IRS applications. Individual taxpayers and tax professionals are required to verify with ID.me for a secure login.

Please note, existing IRS username and passwords no longer work as of Summer 2022. As such, we suggest creating an ID.me account and completing the identity verification process now.

How to sign-up:

Select “Sign in to your Online Account” and either create a new account or sign-in using a previous login.

If you have an existing ID.me account from a state government or federal agency, you can sign-in without verifying your identity again. If you’re a new user, you’ll have to create a new ID.me account.

To create your account, you will need:

  • A valid email address.
  • Your birthdate.
  • Your Social Security Number (SSN).
  • Your current mailing address.
  • Your mobile phone number (must be a smart phone with internet and texting capabilities)
  • Your ID (driver’s license, passport, or state ID)

Tips for creating your ID.me account:

  • Make sure you have access to a computer, your smartphone, and your email. You’ll be asked to go between all 3 in order to verify your identity.
  • You’ll need to use your smartphone to take a photo of your ID.
  • You’ll need to use your smartphone or your computer’s webcam to take a computer-generated selfie photo.

California FTB

Log-In Page: https://www.ftb.ca.gov/myftb/index.asp

Step-by-step Instructions: https://www.ftb.ca.gov/myftb/help/how-to-guides/individuals/register.pdf

How to sign-up:

You must have a recent California tax return on file in order to register for a MyFTB Individual account. If you filed a joint tax return, you must each register for a separate MyFTB Individual account.

To create your account, you will need:

  • A valid email address.
  • Your Social Security Number (SSN).
  • Your current mailing address.
    • Important! If you moved since you filed your last tax return, call the FTB to update your mailing address before you register for a MyFTB account, (800) 852-5711.
  • Information from a filed California tax return for one of the last five tax years.

After you create your account, you will receive a letter in the mail containing a Personal Identification Number (PIN). The PIN will be mailed via the United States Postal Service within 3 to 5 business days. Please allow 10 business days to receive the PIN. You have 21 days from the date you register to enter your PIN to activate your account.

This is a one-time use PIN is used to activate your MyFTB account. You will not need it again to login. You will need to enter this PIN online in order to activate and gain access to your account.

Please note: Individual taxpayers also have the option of activating their account via online “personal question” screening instead of the mailed PIN.

How to Estimate a Company’s Obligation to Collect Sales Tax Under South Dakota v Wayfair (17-494, 06/21/2018, U.S.)

by: Tony Pimentel

Wayfair sold products to South Dakota residents, however, it did not collect sales tax as it did not have a physical presence in South Dakota.  Under the physical presence test, it did not have to do so. South Dakota could have subpoenaed the required data and collected the use tax from its citizens, but it decided it was much easier to file suit to force Wayfair to collect the tax. The Supreme Court sided with South Dakota and ordered Wayfair to collect the tax based on the enabling statute.

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