TAX CHANGE SUMMARY: We are pleased to provide you a more indepth overview of important tax law changes that may affect the filing of your 2020 tax return. (Does not include changes enacted in December, 2020)
Due to the coronavirus pandemic and the enactment of legislation to offset economic burdens, there is a lot to consider in planning for the preparation of your 2020 tax return.
- The SECURE Act was signed into law in December of 2019. This legislation extended several expiring deductions and tax credits and provided changes to retirement-related rules.
- The Families First Coronavirus Response Act (Families First Act), the first piece of COVID-19 tax-related legislation, was signed into law in early March, 2020. It provides tax credits for employers and self-employed individuals.
- The Coronavirus Aid, Relief, and Economic Security Act (CARES Act), the biggest piece of legislation for the year, was enacted in late March.
- Finally, in December, the Consolidated Appropriations Act, 2021 (CA2021) provided additional economic stimulus as well as other tax relief (as of 12/23 it has not yet been signed into law).
Individual Tax Brackets Up Slightly
After being adjusted for inflation, individual tax brackets for 2020 have increased slightly. For 2020, the top tax rate of 37 percent applies to incomes over $518,400 (single and head of household), $622,050 (married filing jointly and surviving spouse), and $311,025 (married filing separately). However, high-income taxpayers are also subject to the 3.8 percent net investment income tax and/or the .9 percent Medicare surtax. For taxpayers subject to one or both of these additional taxes, there are certain actions (discussed below) that can be taken to mitigate the damage of these additional taxes.
For high-income clients, it's important to determine whether the 3.8 percent net investment income tax and/or the .9 percent additional Medicare tax imposed on wages, compensation, and self-employment income applies. These taxes only apply if the net investment income or wages, compensation, and self-employment income exceed a threshold amount. The threshold amounts are $250,000 (joint return or surviving spouse), $125,000 (married individual filing a separate return), and $200,000 (all others). No tax deduction is allowed for either tax.
For married couples, employers do not take a spouse's self-employment income or wages into account when calculating Medicare tax withholding for an employee. If a married couple will exceed the $250,000 threshold in 2020, and has not made enough tax payments to cover the additional .9 percent tax, a Form W-4 should be filed with the taxpayer's employer before year end to have an additional amount deducted from the client's compensation. Otherwise, penalties for the underpayment of tax may apply.
CARES Act Rebates
Under the CARES Act, eligible individuals are entitled to a credit (i.e., recovery rebate credit) against their income tax for the first tax year beginning in 2020 equal to (1) $1,200 ($2,400 in the case of a joint return), plus (2) an amount equal to the product of $500 multiplied by the number of qualifying children. The rebate credit, which the IRS refers to as an economic impact payment (EIP), is a payment made in 2020 to an eligible individual based generally on the individual's 2019 adjusted gross income (AGI). Individuals with a 2019 adjusted gross income (AGI) that did not exceed a certain amount were eligible for EIPs of $1,200 in the case of single individuals, $2,400 in the case of joint filers, and $500 in the case of each qualifying child of the taxpayer. EIPs were reduced by 5 percent of the amount by which the taxpayer's 2019 AGI exceeded (1) $150,000 in the case of a joint return, (2) $112,500 in the case of a head of household, and (3) $75,000 in the case of a taxpayer not described in (1) or (2).
Example: Al and Joan are married and their AGI for 2019 was $170,000. They are eligible for an EIP in 2020 of $1,400 ($2,400 - $1,000 ($20,000 ($170,000 - $150,000) x 5%)).
For purposes of the EIP, an eligible individual is any individual other than (1) any nonresident alien individual, (2) any individual with respect to whom a dependency deduction is allowable to another taxpayer for a tax year beginning in the calendar year in which the individual's tax year begins, and (3) an estate or trust.
Where an eligible individual did not file a 2019 tax return, the individual was eligible for an EIP based on information reported on the individual's 2018 federal income tax return. If that eligible individual did not file a 2018 return, the IRS was authorized to provide an EIP based on information with respect to that eligible individual for calendar year 2019 provided in (1) Form SSA-1099, Social Security Benefit Statement, or (2) Form RRB-1099, Social Security Equivalent Benefit Statement. Supplemental Security Income (SSI) recipients and recipients of compensation and benefit payments from the Department of Veterans Affairs (VA) should have received a $1,200 payment automatically, despite not having filed an income tax return for 2019 or 2018.
The 2020 tax returns include a schedule for reconciling any advance refund amount received during 2020 (using 2019 or 2018 information) with what should have been received. If the EIP due to a taxpayer is less than the actual amount received (because, for example, a qualifying child was born to the taxpayer during 2020), the difference is a refundable credit against the individual's 2020 income tax liability. If, however, the result is negative (because, for example, the taxpayer's AGI was higher in 2020 and was in the income phase-out range), the taxpayer's 2020 tax liability is not increased by that negative amount. In addition, a taxpayer that did not receive any EIP is entitled to claim the recovery rebate amount on his or her 2020 income tax return.
Observation: Under the CARES Act, no EIPs can be sent to taxpayers after December 31, 2020.
Finally, the EIP is not includible in gross income.
Under changes made by the Tax Cuts and Jobs Act of 2017 (TCJA), taxpayers subject to the "kiddie tax" were taxed at the trust and estate tax rates for years after 2017. Although the trust and estate tax rates are similar to the individual tax rates previously used to calculate the kiddie tax, the tax brackets are much lower, meaning higher rates of tax applied to lower levels of income. The SECURE Act reversed the changes made by the TCJA, effective for tax years after 2019. However, the SECURE Act also allows taxpayer to choose whether to apply the TCJA rules or the post-2019 rules in calculating the kiddie tax for 2018 or 2019 tax returns. Thus, for 2018 or 2019 tax returns that calculated a kiddie tax using the trust and estate tax rates, amended returns might be appropriate.
Generally, a return filed as married filing separately is not beneficial for tax purposes. However, in some unique cases, such as when one party earns substantially less or when one party may be subject to IRS penalties for issues relating to their tax reporting, it may be advantageous to file as married filing separately. Additionally, if one spouse was not a full-year U.S. resident, an election is available to file a joint tax return where such joint filing status would otherwise not apply and this may help reduce a couple's tax liability.
Standard Deduction versus Itemized Deductions
At the outset, it's important to determine if a client has enough deductions to itemize or if there are steps that can be taken which will give a taxpayer enough deductions to itemize. For 2020, the standard deduction amounts are: $12,400 (single); $18,650 (head of household); $24,800 (married filing jointly); and $12,400 (married filing separately). If a client's itemized deductions in 2020 will be close to his or her standard deduction amount, evaluate whether alternating between bunching itemized deductions, such as charitable contributions or medical expenses, into 2020 and taking the standard deduction in 2021 (or vice versa) could provide a net-tax benefit over the two-year period.
Medical Expenses, Health Savings Accounts, and Flexible Savings Accounts
For 2020, medical expenses are deductible as an itemized deduction to the extent they exceed 7.5 percent of adjusted gross income. In 2021, that limitation increases to 10 percent of adjusted gross income. To be deductible, medical care expenses must be primarily to alleviate or prevent a physical or mental disability or illness. Thus, the cost of vitamins or a vacation taken to relieve stress and anxiety don't count. What does count are expenses paid for health insurance premiums, out-of-pocket costs for medicine, and amounts paid for transportation to get medical care. Deductible medical expenses also include amounts paid for qualified long-term care services and premiums paid for a qualified long-term care insurance contract. Qualified long-term care services are necessary diagnostic, preventive, therapeutic, curing, treating, mitigating, rehabilitative services, and maintenance and personal care services that are required by a chronically ill individual, and must be provided pursuant to a plan of care prescribed by a licensed health care practitioner. To be deductible as a medical expense, qualified long-term care insurance premiums must meet certain criteria (e.g., the contract must be guaranteed renewable) and the deduction for such premiums is limited to an amount that is based on the taxpayer's age before the close of the tax year.
Consider whether it might be advantageous for a client to contribute to a health saving account (HSA) if he or she does not already have one. These tax-advantaged accounts help individuals, who have high-deductible health plans (HDHPs), pay for medical expenses. Amounts contributed to an HSA are deductible in computing adjusted gross income. These contributions are deductible whether the client is itemizing deductions or not. Distributions from an HSA are tax free to the extent they are used to pay for qualified medical expenses (i.e., medical, dental, and vision expenses). For 2020, the annual contribution limits are $3,550 for an individual with self-only coverage and $7,100 for an individual with family coverage.
If a client works for an employer who offers a Flexible Spending Account (FSA), and the client has not already signed up for an FSA account, it's worth encouraging the client to do so. This will allow him or her to pay medical and dental bills with pre-tax money. The maximum amount that can be set aside in 2021 is $2,750. While FSA funds can be used to pay deductibles and copayments, they cannot be used for insurance premiums. FSA funds can also be used for medical equipment, such as crutches, and prescription medications.
Several CARES Act provisions made improvements to health-care related rules. For example, under the CARES Act, an HDHP temporarily can cover telehealth and other remote care services without a deductible, or with a deductible below the minimum annual deductible otherwise required by law. Also, as a result of changes made by the CARES Act, effective beginning in 2020, the definition of "qualified medical expense" for Archer MSA, HRA, and FSA purposes has been amended to include over-the-counter medications, such as Tylenol, and menstrual care products. Previously, over-the-counter medications were considered qualified medical expenses only if prescribed by a physician.
While the tax benefits of making charitable contributions and taking an itemized deduction for such contributions were tamped down as a result of the increase in the standard deduction in the TCJA, the CARES Act modified the charitable contribution rules for 2020 tax returns. As a result, an eligible individual can claim an above-the-line deduction of up to $300 for qualified charitable contributions made during 2020. This deduction is not available for contributions made after 2020. An eligible individual is an individual who does not itemize deductions. Contributions of noncash property, such as securities, do not qualify for this deduction.
In addition, for clients with substantial charitable contributions, the CARES Act modified the percentage limitation rules that may have otherwise limited the client's charitable contribution deduction. For charitable contributions made during 2020, any qualified contribution is allowed as a deduction to the extent that the aggregate of such contributions do not exceed the excess of the taxpayer's charitable contribution base over the amount of all other charitable contributions. Excess contributions are eligible for a five-year carryover.
Donating appreciated assets, such as stock, to a charity can also help a client reap a bigger tax deduction. Generally, the higher the appreciated value of an asset, the bigger the potential value of the tax benefit. By donating appreciated assets, such as stock, a client can avoid the capital gains tax that would otherwise be due if the stock were sold while also reaping a nice charitable contribution deduction. For example, if a client owns stock with a fair market value of $1,000 that was purchased for $250 and the client's capital gains tax rate is 15 percent, the capital gains tax on the sale would be $113 ($750 gain x 15%). By donating that stock instead of selling it, a client in the 24 percent tax bracket gets an ordinary income deduction is worth $240 ($1,000 FMV x 24% tax rate). So the client saves the $113 in capital gains tax that would otherwise be generated on the sale of the stock and that amount goes to the charity instead. Thus, the after-tax cost of the gift of appreciated stock is $647 ($1,000 - $240 - $113) compared to the after tax cost of a donation of $1,000 cash which would be $760 ($1,000 - $240). However, it's important to also keep in mind that tax deductions for contributions of appreciated long-term capital gain property may be limited to a certain percentage of adjusted gross income depending on the amount of the contribution and the type of property contributed.
Finally, if a client has an individual retirement account and is 70 1/2 years old and older, he or she can make a charitable contribution directly from the IRA. This is more advantageous than taking a distribution and making a donation to the charity that may or may not be deductible, depending on whether the taxpayer is itemizing deductions. By making the donation directly from an IRA to a charity, the client eliminates having the IRA distribution included in his or her income. This in turn reduces adjusted gross income (AGI) and, because various tax-related items, such as the medical expense deduction or the taxability of social security income or the 3.8 percent net investment income tax, are calculated based on AGI, the reduced AGI can potentially increase medical expense deductions, reduce the tax on social security income, and/or reduce any net investment income tax.
Income, Deductions, and Exclusions from Income Relating to Taxpayer's Residence
Home Office Expenses: The fact that more individuals are working from home means clients will be asking about potential deductions relating to such work. For employees, expenses relating to working from home are not deductible. TCJA eliminated the deductibility of such expenses when it suspended the deduction for miscellaneous itemized expenses that was available before 2018. However, for self-employed individuals, tax deductions are still available. Because individuals are limited to a maximum $10,000 deduction for state income and property taxes, allocating a portion of such expenses to the portion of a taxpayer's home used for business, can increase deductions for these amounts that would otherwise be lost.
Mortgage Interest Deduction: For clients who sold principal residence during the year and acquired a new principal residence, the mortgage interest deduction may be limited. For mortgages of more than $750,000 obtained after December 14, 2017, the deduction is limited to the portion of the interest allocable to $750,000 ($375,000 in the case of married taxpayers filing separately). For a mortgage on a principal residence acquired before December 15, 2017, the limitation applies to mortgages of $1,000,000 ($500,000 in the case of married taxpayers filing separately) or less. However, for clients operating a business from home, an allocable portion of the mortgage interest is not subject to these limitations.
Deductions for Interest on Home Equity Debt: Interest on home equity debt may be deductible where a client used the debt to buy, build, or substantially improve his or her home. For example, interest on a home equity loan used to build an addition is typically deductible, while interest on the same loan used to pay personal expenses, such as credit card debt, is not. Thus, it's important to document the portion of the debt for which an interest deduction is taken.
Gain or Loss on the Sale of a Home: If a client sold his or her home this year, up to $250,000 ($500,000 for married filing jointly) of the gain on the sale is excludible from income. However, this amount is reduced if part of the home was rented out or used for business purposes. Generally, a loss on the sale of a home is not deductible. But again, if a portion of the home was rented or was otherwise used for business, the loss attributable to that portion of the home is deductible.
Exclusion from Gross Income of Discharge of Qualified Principal Residence Indebtedness: Under Code Sec. 108(a)(1)(E), gross income does not include the discharge of indebtedness of a taxpayer if the debt discharged is qualified principal residence indebtedness which is discharged before January 1, 2021. This provision was originally scheduled to expire at the end of 2019 but instead was extended through 2020 by the SECURE Act.
Treatment of Mortgage Insurance Premiums as Qualified Residence Interest: Under Code Sec. 163(h)(3)(E), taxpayers can treat amounts paid during 2020 for qualified mortgage insurance as qualified residence interest. The insurance must be in connection with acquisition debt for a qualified residence. This provision was originally scheduled to expire at the end of 2019 but instead was extended through 2020 by the SECURE Act.
Child-Related Credits and Exclusions from Income
Child and Dependent Tax Credit: For 2020, you may claim as much as a $2,000 credit for each child under age 17. In addition, a $500 nonrefundable credit is available for qualifying dependents other than qualifying children. Where the credit exceeds the maximum amount of tax due, it may be refundable. The maximum amount refundable for 2020 is $1,400 per qualifying child. The $500 credit applies to two categories of dependents: (1) qualifying children for whom a child tax credit is not allowed, and (2) qualifying relatives. The amount of the credit is reduced for taxpayers with modified adjusted income over $200,000 ($400,000 for married filing jointly) and eliminated in full for taxpayers with modified adjusted gross income over $240,000 ($440,000 for married filing jointly). Under Reg. Sec. 1.152-2(e)(1), in defining a qualifying relative for purposes of various provisions of the Code that refer to the definition of dependent in Code Sec. 152, including, without limitation, for purposes of the $500 credit under Code Sec. 24(h)(4), the Code Sec. 151(d) exemption amount referenced in Code Sec. 152(d)(1)(B) is treated as $4,150 (adjusted for inflation), for tax years in which the Code Sec. 151(d)(5)(A) exemption amount is zero.
Dependent Care Credit: Where a client paid someone to care for a child, or another dependent, so that he or she could work, a child and dependent care credit may be available. The credit is available to individuals who, in order to work or to look for work, have to pay for child care services for dependents under age 13. The credit is also available for amounts paid for the care of a spouse or a dependent of any age who is physically or mentally incapable of self-care. The credit is not available for amounts paid to a dependent or a taxpayer under age 19. The credit is 20 to 35 percent of employment-related expenses depending on the taxpayer's adjusted gross income for the year. Employment-related expenses incurred during any tax year which may be taken into account cannot exceed $3,000, if there is 1 qualifying individual, or $6,000 if there are two or more qualifying individuals with respect to the taxpayer for such tax year. Unlike other credits that are not available to individuals with income above a certain level, this credit is available to everyone, no matter what their income is.
Adoption Credit and Exclusion from Income of Adoption Reimbursements: An adoption credit of $14,300 is available for the adoption of a special needs child as well as other children. The credit is available for each child adopted and is generally based on expenses expended in the adoption. However, the credit for the adoption of a special needs child is $14,300, regardless of the amount expended on the adoption. The available adoption credit begins to phase out for taxpayers with modified adjusted gross income in excess of $214,520 and is completely phased out for taxpayers with modified adjusted gross income of $254,520 or more. In addition, reimbursements of qualified adoption expenses or amounts paid by an employer for an adoption, up to $14,300, are excludible from income.
Education-Related Tax Items
There are several education-related tax deductions, credits, and exclusions from income that practitioners need to consider for clients who either attend, or have children who attend, school.
Deduction for Qualified Tuition and Related Expenses: The SECURE Act extended through 2020 the deduction for qualified tuition and related expenses. Under this provision, taxpayers with modified adjusted gross income within certain limits may deduct up to $4,000 of qualified education expenses paid during the year. The deduction under Code Sec. 222(e) for tuition and related expenses is based on qualified education expenses a taxpayer pays for an eligible student who is: (1) himself or herself; (2) his or her spouse; or (3) a dependent for whom the taxpayer would be entitled to claim an exemption on his or her tax return under pre-TCJA rules. The maximum deduction is limited to $4,000 of expenses for taxpayers with modified adjusted gross income that does not exceed $65,000 ($130,000 in the case of a joint return). For taxpayers with modified adjusted gross income that exceeds those amounts, the maximum deduction is $2,000, as long as the taxpayer's adjusted gross income does not exceed $80,000 ($160,000 in the case of a joint return). The deduction cannot be claimed by anyone who can be claimed as a dependent of another or anyone with a filing status of married filing separately. Further, no deduction is allowed for expenses for which the individual is claiming an American Opportunity Tax Credit or Lifetime Learning Credit for the year.
Tax-Free Distributions Qualified Tuition Programs: A Code Sec. 529 qualified tuition plan is a tax-advantaged investment vehicle designed to encourage saving for the future education expenses of the plan beneficiary. Tax-free distributions from a Code Sec. 529 qualified tuition program (QTP) of up to $10,000 are allowed for qualified higher education expenses. Qualified higher education expenses for this purpose include tuition expenses in connection with a designated beneficiary's enrollment or attendance at an elementary or secondary public, private, or religious school, i.e. kindergarten through grade 12. It also includes expenses for fees, books, supplies, and equipment required for the participation in certain apprenticeship programs and qualified education loan repayments in limited amounts. A special rule allows tax-free distributions to a sibling of a designated beneficiary (i.e., a brother, sister, stepbrother, or stepsister). As a result, a 529 account holder can make a student loan distribution to a sibling of the designated beneficiary without changing the designated beneficiary of the account. However, under Code Sec. 529(c)(3)(B), if the total QTP distributions to a designated beneficiary exceed the adjusted qualified higher education expenses of that beneficiary for the year, a portion of those distributions is taxable to the beneficiary. Code Sec. 529(c)(6) also provides that an additional 10 percent penalty tax generally applies to a taxable distribution from a QTP.
Deduction for Qualified Tuition and Related Expenses: An above-the-line deduction of up to $4,000 is allowed for qualified education expenses paid by a taxpayer for him or herself, a spouse, and/or a dependent. However, among other requirements, the deduction cannot be claimed by anyone who can be claimed as a dependent of another, anyone with a filing status of married filing separately, anyone whose modified adjusted gross income is more than $80,000 ($160,000 if filing a joint return), and anyone who claims an American opportunity, Hope, or lifetime learning credit for the year.
Deduction for Eligible Teacher Expenses: A deduction from gross income is available for eligible teacher expenses of up to $250 paid during 2020. If spouses are filing jointly and both were eligible educators, the maximum deduction on the joint return is $500. However, neither spouse can deduct more than $250 of his or her qualified expenses.
Exclusion from Income for Savings Bond Interest: If a client paid qualified higher education expenses during the tax year and also redeemed a qualified U.S. savings bond, the interest on the bond is excludible from income if the taxpayer's modified adjusted gross income level is below certain thresholds.
Education Credits: A client who pays qualified education expenses, and has modified adjusted gross income below $80,000 or $160,000 (for joint filers) may be eligible for an American Opportunity Tax Credit of up to $2,500 per year for each eligible student. Above those income thresholds, a partial credit may be available. The amount of the credit for each student is computed as 100 percent of the first $2,000 of qualified education expenses paid for the student and 25 percent of the next $2,000 of such expenses paid. Additionally, a Lifetime Learning credit may be available in an amount equal to 20 percent of so much of the qualified tuition and related expenses paid during the tax year (for education furnished during any academic period beginning in such tax year) as does not exceed $10,000. However, the expenses taken into account for this credit cannot be the same as expenses taken into account for the American Opportunity Tax Credit. The credit is phased out for taxpayers with modified adjusted gross income between $59,000 and $69,000 ($118,000 and $138,000 for joint filers).
Exclusion from Income for Repayment of Student Loan Debt: The CARES Act excludes from income certain student loan debt repaid by an individual's employer. Thus, if an employer repaid up to $5,250 of a client's student loan debt after March 27, 2020, and before 2021, the repayment of that debt is excludible from income.
Coronavirus-Related Plan Distributions: Clients impacted by the coronavirus (which is essentially anyone) can withdraw up to $100,000 from their retirement plan without penalty. The amount, if not paid back, is generally includible in income over a three-year period and, to the extent the distribution is eligible for tax-free rollover treatment and is contributed to an eligible retirement plan within a three-year period, is not includible in income.
Waiver of Required Minimum Distributions for 2020: The CARES Act waived required minimum distributions (RMDs) for 2020. Individuals who received their RMD before the CARES Act had the opportunity to roll the funds back into a retirement account as long as it was done before September 1, 2020.
Repeal of Age Limit on Making IRA Contributions: The age limit for making contributions to a traditional individual retirement account (IRA), previously 70 1/2 years old, was repealed in 2020. Thus, anyone who is otherwise eligible may make a contribution to a traditional IRA.
Penalty-free Retirement Plan Distributions for Births or Adoptions: A new type of retirement plan distribution was added to the list of early distributions that are excepted from the 10-percent penalty for early withdrawals. A penalty-free distribution from an applicable eligible retirement plan of up to $5,000 is allowed for either a qualified birth or adoption distribution.
Increase in RMD Age: The required beginning date for RMDs has been increased to 72 years old from 70 1/2 years old. The former rules apply to employees and IRA owners who attained age 70 1/2 prior to January 1, 2020. The new provision is effective for distributions required to be made after December 31, 2019, with respect to individuals who attain age 70 1/2 after December 31, 2019.
Retirement Plan Contributions: Clients can save a lot of taxes by making the maximum contributions to a qualified retirement plan. Individuals under 50 years old who work for an employer that has a 401(k) plan can defer up to $19,500 of income into that plan for 2020. Catch-up contributions of $6,500 are allowed for individuals who are 50 or over. For a SIMPLE 401(k), the maximum pre-tax contribution for 2020 is $13,500. That amount increases to $16,500 for individuals who are 50 or older. The maximum IRA deductible contribution for 2020 is $6,000 and that amount increases to $7,000 if you are 50 or over.
Alternative Minimum Tax
The odds of a taxpayer being hit with the alternative minimum tax (AMT) were greatly reduced with the enactment of TCJA, which increased the AMT exemption and the AMT phase-out thresholds. However, it can still be an issue for higher income clients. For 2020, the AMT exemption is $72,900 for a single filer, $113,400 for married filing jointly, and $56,700 for married filing separately. The exemption begins to phase out by an amount equal to 25 percent of the amount by which alternative minimum taxable income exceeds $1,036,800 in the case of married individuals filing a joint return and surviving spouses and $518,400 in the case of unmarried individuals and married individuals filing separate returns. As a result, high-income taxpayers with household incomes above those thresholds, with large amounts of itemized deductions or significant AMT income (AMTI) from exercising stock options, could be at risk for the AMT.
If a taxpayer has a Schedule C business, allocating mortgage interest or property taxes to the taxpayer's Schedule C business will prevent those amounts from being added back and increasing the taxpayer's AMTI.
Qualified Business Income Deduction
Under the qualified business income tax break of Code Sec. 199A, a 20 percent deduction is allowed against qualified business income from sole proprietorships, S corporations, partnerships, and LLCs taxed as partnerships. The deduction is available to both itemizers and non-itemizers. The rules that apply to individuals with taxable income at or below $163,300 ($326,600 for joint filers; $163,300 for married individuals filing separately) are simpler and more permissive than the ones that apply above those thresholds. The deduction phases out entirely when taxable income exceeds $213,300 (single, head of household, and married filing separately) and $376,600 (joint filers).
Deductions for Excess Business Losses
The CARES Act removed the loss limitation deduction applicable to non-corporate taxpayers who incurred excess business losses in 2018, 2019, and 2020. An excess business loss for the tax year is the excess of aggregate deductions attributable to a client's trades or businesses over the sum of aggregate gross income or gain plus a threshold amount. The threshold amount for 2020 is $259,000 or $518,000 for joint returns. Thus, for clients affected by this provision, amended returns and refund claims should be filed for the years affected.
Families First Sick Leave Credit for Self-Employed Individuals
Under the Families First Act, an eligible self-employed individual may be eligible for a refundable income tax credit for a "qualified sick leave equivalent amount." An eligible self-employed individual is one who regularly carries on any trade or business and would be entitled to receive paid leave during the tax year under the Emergency Paid Sick Leave Act (EPSLA), which was added by the Families First Act.
The EPSLA requires certain employers to provide an employee with paid sick time to the extent that the employee is unable to work or telework due to a need for leave because: (1) the employee is subject to a federal, state, or local quarantine or isolation order related to COVID-19; (2) the employee has been advised by a health care provider to self-quarantine due to concerns related to COVID-19; (3) the employee is experiencing symptoms of COVID-19 and seeking a medical diagnosis; (4) the employee is caring for an individual who is subject to an order described in clause (1) or has been advised as described in clause (2); (5) the employee is caring for the employee's son or daughter if the school or place of care of the son or daughter has been closed, or the child care provider of such son or daughter is unavailable due to COVID-19 precautions; or (6) the employee is experiencing any other substantially similar condition specified by the Secretary of Health and Human Services in consultation with the Secretary of the Treasury and the Secretary of Labor.
The qualified sick leave equivalent amount with respect to an eligible self-employed individual is an amount equal to the number of days during the tax year that the self-employed individual cannot perform services for which that individual would have been entitled to sick leave pursuant to the EPSLA (if the individual were employed by an employer), multiplied by the lesser of two amounts: (a) $511 in the case of paid sick time described in clauses (1), (2), or (3) above ($200 in the case of paid sick time described in clauses (4), (5), or (6) above); or (b) 100 percent of the average daily self-employment income of the individual for the tax year in the case of any day of paid sick time described in clauses (1), (2), or (3) above (67 percent in the case of paid sick time described in clauses (4), (5), or (6) above).
The number of days taken into account in determining the qualified sick leave equivalent amount may not exceed, with respect to any tax year, 10 days, taking into account any days taken in all preceding tax years. The individual's average daily self-employment income under the provision is an amount equal to the net earnings from self-employment for the tax year divided by 260.
As noted above, this credit is refundable as long as there is appropriate documentation to establish that the individual is an eligible self-employed individual. Where an individual is both an employee who receives qualified sick leave wages and self-employed, the individual's qualified sick leave equivalent amount is reduced (but not below zero) to the extent that the sum of the qualified sick leave equivalent amount and the qualified sick leave wages received exceeds $2,000 ($5,110 in the case of any day any portion of which is paid sick time described in clause (1), (2), or (3) above, with respect to the EPSLA).
Example: Bob is self-employed and his qualified sick leave equivalent amount is $1,500. Bob also works for a covered employer under the EPSLA and received qualified sick leave wages under clause (5) above of $1,000 to care for his son while school was closed due to COVID-19. Bob's qualified sick leave equivalent amount is reduced by $500, resulting in a credit under of $1,000.
Families First Family Leave Credit for Certain Self-Employed Individuals
Another refundable income tax credit that may be available to a self-employed client is the family leave credit under which an eligible self-employed individual is allowed an income tax credit for any tax year for a qualified family leave equivalent amount. An eligible self-employed individual is an individual who regularly carries on any trade or business and would be entitled to receive paid leave during the tax year under the Emergency Family and Medical Leave Expansion Act (EFMLEA), if the individual were an employee of an employer (other than himself or herself) that is subject to the requirements of the EFMLEA.
The EFMLEA requires certain employers to provide public health emergency leave to employees under the Family and Medical Leave Act of 1993 (FMLA). This requirement generally applies when an employee is unable to work or telework due to a need for leave to care for a son or daughter under age 18 because the school or place of care has been closed, or the child care provider is unavailable, due to a public health emergency. For this purpose, a public health emergency is an emergency with respect to COVID-19 declared by a federal, state, or local authority.
An employer that is required to provide this additional family and medical leave is allowed a tax credit in respect of the leave. In general, under the provision, a self-employed individual is allowed a similar tax credit in situations in which a credit would be allowed if the individual were an employee of an employer subject to the leave requirements.
The qualified family leave equivalent amount with respect to an eligible self-employed individual is an amount equal to the number of days (up to 50) during the tax year that the self-employed individual cannot perform services for which that individual would be entitled to paid leave pursuant to the EFMLEA (if the individual were employed by an employer), multiplied by the lesser of two amounts: (1) 67 percent of the average daily self-employment income of the individual for the tax year, or (2) $200. The individual's average daily self-employment income under the provision is an amount equal to the individual's net earnings from self-employment for the year divided by 260.
If an eligible self-employed individual receives qualified family leave wages, the individual's qualified family leave equivalent amount is reduced (but not below zero) to the extent that the sum of the qualified family leave equivalent amount and the qualified family leave wages received exceeds $10,000.
Example: John is an eligible self-employed individual who has a qualified family leave equivalent amount of $5,000. John also works for an employer, who is a covered employer under the EFMLEA, and received qualified family leave wages of $9,000 from that employer to care his son while school was closed due to COVID-19. John's qualified family leave equivalent amount is reduced by $4,000 resulting in a qualified family leave credit of $1,000.
This has been a strange year to say the least. The quarantining, working from home, and virtual home schooling has taken its toll on everyone. Part of that toll has been an increase in divorces. For clients with divorces pending at the end of the year, practitioners may want to project the differences in a final tax bill based on filing a joint return or filing as married filing separately. For clients that divorced during the year, head of household filing status, with its increased standard deduction, is appropriate if the client has dependents living at home for more than half of the year and the client paid more than half of the upkeep of the home. For clients who will be changing their name, the Social Security Administration (SSA) needs to be notified. Similarly, the SSA should be notified for a dependent whose name has been changed. A mismatch between the name shown on the tax return and the SSA records can cause problems in the processing of tax returns and may even delay tax refunds.
On the other hand, if a spouse died during 2020, the client can still use married filing jointly as the filing status. While the year of death is the last year for which a joint return can be filed with a deceased spouse, the client may be eligible to use the head-of-household filing status next year or the year after that if he or she is considered a "surviving spouse." A surviving spouse is one (1) whose spouse died during either of the two tax years immediately preceding the tax year; and (2) who maintains as a home a household which constitutes for the tax year the principal place of abode (as a member of such household) of a dependent who is a son, stepson, daughter, or stepdaughter of the taxpayer, and with respect to whom the clients is entitled to a dependency exemption deduction for the years in which such exemption deductions are available. Even if the client does not qualify as a surviving spouse, he or she may nevertheless qualify as a head of household if the applicable requirements are met.
Impact of Future Legislation
Because it is unclear what, if any, tax legislation may be coming next year, it is probably best to base year-end tax planning on existing law.
Disclaimer: This publication does not, and is not intended to, provide legal, tax or accounting advice, and readers should consult their tax advisors concerning the application of tax laws to their particular situations. This analysis is not tax advice and is not intended or written to be used, and cannot be used, for purposes of avoiding tax penalties that may be imposed on any taxpayer. The information contained herein is general in nature and based on authorities that are subject to change. Neither Keystone By Design nor Parker Tax Publishing (publisher of the above) guarantee neither the accuracy nor completeness of any information and is not responsible for any errors or omissions, or for results obtained by others as a result of reliance upon such information. Neither Keystone By Design nor Parker Tax Publishing (publisher) assume no obligation to inform the reader of any changes in tax laws or other factors that could affect information contained herein.