Section 1400 Taxation and Advice

INDIVIDUALS 1400 Taxation and Advice 1410 Taxation 1410.01 Alternative minimum tax and credit for prior year A special alternative minimum tax (AMT is payable to the extent that it exceeds the taxpayer’s regular tax before credits. a. For 2023, the exemption amounts are $126,500 for joint returns or qualifying surviving spouses with dependent child, $81,300 for unmarried individuals, $63,250 for married individuals filing separate returns, and $28,400 for estates and trusts. b. For 2023, the above exemption amounts are reduced (not below zero) to an amount equal to 25% of the amount by which the AMTI (alternative minimum taxable income) of the taxpayer exceeds the phaseout amounts, increased for joint and qualifying surviving spouses with dependent child to $1,156,300 and to all others (other than trusts and estates) to $578,150. c. Basically, the alternative minimum tax is computed as follows: + or – + = – =  = – = – = (1) Regular taxable income Adjustments Tax preferences AMTI Exemption amount AMT base 26% under threshold (28% over threshold) Tentative tax before foreign credit Foreign tax credit Tentative minimum tax Regular tax (less foreign tax credit) Alternative minimum tax Adjustments (plus or minus) include such items as the following: (a) Itemized deductions (b) Standard deduction 231 INDIVIDUALS (2) d. 1410.02 (c) Excess ACRS deductions (accelerated depreciation) (d) Circulation expenditures (magazines and newspapers) (e) Research and experimental expenditures (f) Mining exploration and development costs (g) Passive activity losses (h) Certain installment sales (i) Long‐term construction contracts (j) Incentive stock options (k) Alternative tax net operating loss Tax preferences may arise in the following areas: (a) Percentage depletion (b) Intangible drilling costs (c) Seven percent (7%) of excluded gain on qualified small business stock (d) Accelerated depreciation (e) Certain tax‐exempt interest An AMT tax credit may be available when regular taxable income is greater than AMTI (alternative minimum taxable income). The regular tax liability, in this situation, may be offset by a credit representing minimum tax liabilities from prior years attributable to timing differences. The AMT credit carries forward indefinitely. Penalties and exceptions on premature distributions from qualified retirement plans and IRAs An early withdrawal from an Individual Retirement Account (IRA) or a qualified retirement plan prior to age 59½ is subject to being included in gross income plus a 10 percent additional penalty. There are exceptions to the 10 percent penalty such as using the funds for an immediate and heavy need such as to pay medical insurance premiums after a job loss. 232 INDIVIDUALS 1410.03 1410.04 Household employees a. Gross amounts of domestic wages paid in cash (in excess of $2,600 for 2023), and payroll taxes thereon, must be reported to the taxing authorities. b. Usually for businesses, Social Security and Medicare withholdings are reported on IRS Form 941/944. Form 1040, Schedule H, may be used to report federal employment taxes on cash wages paid to household employees. Federal employment taxes that may be paid with Schedule H include Social Security, Medicare, withheld federal income, and federal unemployment (FUTA) taxes. c. Wages paid for domestic services are subject to federal unemployment tax if they exceed $1,000 per quarter for 2023, aggregating wages paid to all employees. The employer’s required payment for federal unemployment (FUTA) tax cannot be withheld from the employee’s wages; it must be paid from the employer’s own funds. d. The employee’s share of the Social Security and Medicare tax can be withheld from the domestic service employee’s wages. e. Withholding federal income taxes for household employees is required only if requested by the employee and agreed to by the employer. Such withholding would be reported on Schedule H. and filed with Form 1040. Underpayment penalties and interest Just like any other taxes required to be paid, the IRS will impose a penalty for underpayment of tax as well as interest. 1410.05 Conditions for filing a claim for refund (e.g., amended returns) If an employer makes an error in withholding taxes or overpays taxes, an amended 941X should be filed to correct the error. 233 INDIVIDUALS 1410.06 Self‐employment tax Self‐employment tax must be paid as an addition to the tax if net earnings from self‐employment are $400 or more. A completed Schedule SE (IRS Form 1040) is included with the self‐employed person’s income tax return. Although the net self‐employment earnings base changes annually, the tax rate remains constant at 15.3%. This is 12.4% for Old Age, Survivor, and Disability Insurance (OASDI) and 2.9% for the Hospital Insurance Plan (HIP). The maximum amount of income subject to this tax varies according to the type of insurance. 1410.07 Excess Social Security withholding Should an employee work for two or more employers and the combination of those wages exceed the total social security maximum to be withheld for the calendar year, the employee is entitled to a credit on their personal return for the excess social security taxes withheld. 1410.08 Tax provisions for members of the clergy A licensed, commissioned, or ordained minister who performs ministerial services as an employee may be able to exclude from gross income the fair rental value of a home provided as part of compensation (a parsonage) or a housing allowance provided as compensation if it is used to rent or otherwise provide a home. A minister who is furnished a parsonage may exclude from gross income the fair rental value of the parsonage, including utilities. However, the amount excluded can't be more than reasonable compensation for the minister's services. 1410.09 Income in respect of decedent (e.g., allocations) For the year of a taxpayer’s death, you generally should file a final tax return. Determine the income you should include, generally, as of the date of death, and file a short year tax return for the year of death. Income after the date of death should be included on the estate or beneficiary’s tax return, as appropriate. a. 234 If the deceased taxpayer was married, and the surviving spouse qualifies to file a joint return, include income for the deceased taxpayer up to the date of death. Include INDIVIDUALS income for the surviving spouse for the entire year. A short year tax return is not required. 1410.10 b. If the deceased taxpayer used the cash method of reporting income, include only income items that were actually or constructively received up to the date of death. c. Issuers of certain forms (Form 1099‐INT and Form 1099‐ DIV) should issue separate forms for interest paid to the decedent and interest paid to the estate or other recipient. If not, you can request a corrected form. Otherwise, you should include all interest/dividends on the return, and then show any interest received as a nominee separately, subtracting it from the subtotal and writing “Nominee Distribution” on the adjustment line. d. For most deductions, including itemized deductions, include only those paid on or before the date of death. e. The full amount of some deductions and credits, such as the standard deduction, earned income credit, child tax credit, and credit for the elderly or the disabled, can be taken on the final tax return. f. See IRS Publication 559, Survivors, Executors, and Administrators, for additional information on specific income or deduction items to be included on the final tax return. Healthcare individual responsibility payment and exceptions The individual shared responsibility provision of the Affordable Care Act is no longer applicable for 2023. The premium tax credit is still applicable. 1410.11 Net investment income tax The net investment income tax is a 3.8 percent surtax on a portion of a taxpayer’s modified adjusted gross income over certain thresholds. The net investment income tax thresholds for 2023 are $200,000 for single or head of household taxpayers, $250,000 for married filing jointly taxpayers, or $125,000 for married filing separately taxpayers. 235 INDIVIDUALS 1410.12 Additional Medicare tax Employers are required to withhold additional Medicare taxes, above the 1.45% Medicare tax rate, at a rate of 0.9% on all Medicare wages in excess of $200,000 paid to an employee. 1410.13 Uncollected Social Security and Medicare tax If an employee was treated as an independent contractor and Social Security and Medicare taxes were not collected on their wages, Form 8919 should be filed. 1410.14 Other taxes (e.g., first time homebuyer credit repayment, IRC Section 965 transition tax) First‐Time Homebuyer Credit The first‐time homebuyer credit was a credit offered in 2008‐2011 to certain qualified homebuyers. In certain years, the credit was a loan that must be repaid. In other years, the credit must be repaid if the home was sold within a certain time period. The homebuyer credit is repaid as an additional tax on a taxpayer’s federal tax return. The repayment calculates to annual repayments of $500 per year on a maximum $7,500 tax credit. Transition Tax Section 965 requires United States shareholders (as defined under section 951(b)) to pay a transition tax on the untaxed foreign earnings of certain specified foreign corporations as if those earnings had been repatriated to the United States. 1410.15 ABLE Accounts In general, a person can take distributions from their ABLE account to pay for any qualified disability expenses such as expenses for maintaining or improving their health, independence, or quality of life. Qualified disability expenses include those for education; housing; transportation; employment training and support; assistive technology; personal support services; health, prevention and wellness; financial management; administrative services; legal fees; expenses for oversight and monitoring; and funeral and burial. If distributions from a person’s ABLE account during a year are not more than their qualified disability expenses for that year, no 236 INDIVIDUALS amount is taxable for that year. If the total amount distributed during a year is more than their qualified disability expenses for that year, the earnings portion of the distribution is included in their income for that year. The includible portion is calculated as follows:  (Qualified portion of distribution ÷ Total distribution) × Earnings portion of distribution = Nontaxable earnings amount In addition, the tax on any distribution included in a person's taxable income is increased by 10%. This tax is figured on Form 5329, Part II, and is filed even if the taxpayer is not otherwise required to file a federal income tax return. 237 INDIVIDUALS 1420 Advising the Individual Taxpayer 1420.01 When advising an individual taxpayer on how to report and calculate the tax return, consider all circumstances. When there are multiple avenues that can be taken, advise the taxpayer of the most beneficial or option with the least burden of proof. Always advise taxpayers to keep appropriate records and documentation and to follow the appropriate tax laws. 1420.02 Reporting obligations for individuals In addition to reporting income and deductions on the income tax return (Form 1040), individuals may be responsible for other reporting requirements. These include reporting a foreign person’s U.S. source income on Form 1042‐S, Form 1099 reporting (for example, a Form 1099‐MISC for amounts you paid a nonemployee as compensation), wages paid to employees, partnership withholding on effectively connected income, and withholding of tax on dispositions of United States real property interests. Some of these reporting requirements also have withholding requirements. Ask questions to see if the taxpayer is required to report any obligations. 1420.03 Property sales (e.g., homes, stock, businesses) Taxpayers who sell any type of property during the year may have a gain or loss to report. This includes both personal and business property. Each sale is classified as ordinary or capital, depending on whether the asset is considered capital or noncapital. Capital assets include most assets you own for personal purposes, pleasure, or investment. This includes stocks, bonds, your personal residence, household furnishings, collections (coin, stamp, etc.) Any other asset, generally, is a noncapital asset, including property used in your business, stocks you hold mainly for sale to customers, inventories, patents and other similar intellectual property, and other items. IRS Publication 544 has lists containing examples of capital and noncapital assets. Report the sale of most capital assets on Schedule D. a. 238 You cannot claim a loss on most personal‐use assets (such as household furnishings or a car you drive only for personal use), though you must report the gain on the sale of a personal‐use asset. INDIVIDUALS b. The sale of a partnership interest is generally treated as the sale of a capital asset. If the taxpayer has gain or loss from unrealized receivables or inventory items, treat that portion of the sales as an ordinary gain or loss. c. Corporation interests are stocks. When a taxpayer sells interest in a corporation, treat the sale as any other stock sale. If the taxpayer sells a business, treat it as the sale of each individual asset rather than the sale of one asset. Use the residual method to allocate the basis and sale price of each business asset. This method determines the buyer’s basis in the asset, the gain or loss from the transfer, and how much of the consideration is for goodwill and other intangible property. Using this method, allocate the consideration among the assets in a set order, starting with cash and general deposit accounts. You cannot allocate more to an asset than its fair market value on the purchase date. 1420.04 Education planning (e.g., lifetime learning credit, IRC Section 529 plans) Many taxpayers prefer to plan for their children’s (or their own) education in advance. Besides scholarships and grants, the tax code provides several methods for tuition relief. a. Lifetime learning credit and American Opportunity Tax Credit: Taxpayers can use education credits to reduce the tax by a portion of the amount spent on education. This method can only be used for tuition already paid and is limited based on the taxpayers modified AGI. b. Coverdell Education Savings Account (ESA): Taxpayers with modified AGI under certain limits ($110,000, $220,000 for married filing jointly) can establish a Coverdell ESA to put aside funds a designated beneficiary can use for qualified education expenses. This is a trust or custodial account. This includes both higher education expenses and elementary and secondary education expenses. Taxpayers can make nondeductible contributions of up to $2,000 for each designated beneficiary. The beneficiary can withdraw distributions tax‐free to pay qualified education expenses. Distributions 239 INDIVIDUALS that are not used to pay qualified education expenses are taxed. 1420.05 c. Qualified Tuition Programs (QTPs, or 529 plans): Qualified Tuition Programs work in a similar way to Coverdell ESAs, but are established and maintained by the state or an eligible educational institution. Taxpayers cannot deduct contributions to a QTP. As with a Coverdell ESA, the qualified education expenses can be to a qualified postsecondary educational institution or an elementary or secondary school. Taxpayers can contribute up to the amount necessary to provide for the qualified education expenses of the designated beneficiary and there is not an income restriction for the contributor. Distributions are not taxable if withdrawn for qualified education expenses. d. IRA Distributions: If the taxpayer has an IRA, he or she can withdraw funds from the IRA without incurring the 10% additional tax/penalty on the distribution, if the funds are used for qualified education expenses paid for the taxpayer, spouse, child, foster child, adopted child, or grandchild. You should still report the early distribution and use the appropriate exclusion to exclude the 10% penalty. This does not affect whether the distribution itself is taxable as income. Estate planning (e.g., gift versus inheritance, trusts, family partnerships, charitable giving, LTC, life insurance) When advising taxpayers in estate planning, consider the tax consequences for both the taxpayer and any beneficiaries. Estates must generally pay estate taxes when the estate is valued at $12.92 million or more for 2023. However, this is set to revert to $5 million after 2025. 240 a. For married couples, make use of the portability election, which allows a surviving spouse to add any unused federal estate tax exclusion from the first spouse to their own exclusion. This must be elected, however, so advise taxpayers to do so to avoid losing the option. b. Taxpayers who may be subject to the estate tax may want to make annual gifts up to the federal gift tax exclusion INDIVIDUALS amount, currently $17,000 per person to whom the gift is made ($34,000 if a married couple give the gift together). 1420.06 c. Consider gifting appreciable property rather than waiting for inheritance. For gifted property, the new owner’s basis depends on the donor’s adjusted basis, fair market value just before the time of the gift, and whether the new owner sells at a gain or loss. For inherited property, the basis is generally the fair market value on the date of death (with exceptions). Appreciable property may have a lower basis for the recipient if gifted rather than inherited. d. Taxpayers can take advantage of the current higher limits on charitable contributions (60% of AGI) by making charitable contributions in one year rather than spread over several years. The AGI limit was raised to 100% for cash contributions made to qualified charitable organizations in 2023. e. Make plans to pay for long‐term care if needed in the future. In addition to personal funds and health insurance programs, long‐term care insurance may be a consideration. This allows the taxpayer to purchase insurance that covers services needed for long‐term care (such as daily living assistance). f. Life insurance death benefits are not taxed federally, but must be included for estate tax purposes if the policy includes certain incidents of ownership. The taxpayer can plan for this by naming a surviving spouse as beneficiary or setting up an irrevocable life insurance trust. Retirement planning (e.g., annuities, IRAs, employer plans, early retirement rules, required minimum distribution, beneficiary ownership, charitable distributions from an IRA) Many retirement savings plans exist. The taxpayer should choose the retirement savings plan (or set of plans) that benefits their situation the most. Some, such as traditional IRAs and employer plans (401(k), are not taxed when contributions are made, but the taxpayer must pay tax when distributions are made. Others, such as Roth IRAs do not have deductible contributions, but distributions are at least partly nontaxable. 241 INDIVIDUALS 1420.07 a. Keep in mind that many plans have a required minimum distribution at age 73 if they reach age 72 after December 31, 2022. The taxpayer should account for that in retirement planning. b. Review the beneficiary ownership situation, including taxability of distributions to the beneficiary, with the taxpayer. c. Taxpayers who are age 73 if they reach age 72 after December 31, 2022, may request that the trustee of an IRA (other than SEP or SIMPLE) make a charitable contribution from an IRA on their behalf. The charitable distribution is not taxable, allowing the taxpayer to reduce taxability of the distributions. Marriage and divorce (e.g., divorce settlement, common‐law, community property) Marriage and divorce can have a tax impact in the year of the divorce or for future years. 242 a. When taxpayers get married or divorced during a tax year, the tax rates may be different than anticipated. File new Forms W‐4 with employers as soon as possible, and refigure estimated tax payments based on new tax situations. b. For divorce settlements reached on or after January 1, 2020, alimony is neither included in income of the recipient or deductible for the payer. For divorce settlements before that date, it is included in income/deductible, unless the agreement is modified to specifically state otherwise. c. Divorce settlements can affect whether dependents can be claimed on the tax return (for child tax credit, etc.). Plan appropriately for the tax consequence. d. Transfers during a divorce may be taxable, including pensions, annuities, and other retirement plans and stocks or brokerage funds. Also, if one spouse buys property from the other during the divorce, the income on the sale may be taxable. INDIVIDUALS 1420.08 Items that will affect future/past returns (e.g., carryovers, net operating loss, Schedule D, Form 8801, negative QBI carryover) Due to limitations of losses on current year returns, many losses may need to be carried to other tax returns. 1420.09 a. Unused capital losses can be carried forward to future years until they are used. Short‐term and long‐term capital loss carryovers must be carried over and used separately, but are subject to the same limit each year. b. NOLs arising in years 2018, 2019, or 2020 can be carried back 5 years or forward. If the NOL is carried back to a year where the TCJA 80% of taxable income limitation applied (prior to 2021), this limitation was temporarily suspended by the provisions of the CARES Act. If the NOL is carried forward to a year beginning after December 31, 2020, the 80% limitation applies. Farmers may enjoy the same benefit. However, those farmers who had previously elected the 2 year‐carryback that was available to them prior to the enactment of the CARES Act, can preserve their 2 year‐carryback. c. A taxpayer with an unused credit for prior‐year minimum tax can carry that credit forward to the next tax year. Use Form 8801, Credit for Prior Year Minimum Tax – Individuals, Estates, and Trusts, to figure or apply the carryforward. d. An unused Qualified Business Income deduction can be carried forward. Use the worksheet in Forms 8995 and 8995‐A or IRS Publication 535 to figure any net loss carryforward or apply the net loss carryforward from prior years. Injured spouse An injured spouse is a taxpayer whose tax refund is appropriated for the past‐due debts of a spouse or former spouse. 243 INDIVIDUALS 1420.10 Innocent spouse An innocent spouse can be relieved of responsibility for paying tax, interest, and penalties if the taxpayer’s spouse or former spouse improperly or fraudulently reported items or omitted items on a jointly filed tax return. 1420.11 Estimated tax and penalty avoidance Taxpayers are expected to make estimated tax payments for the current tax year if both of the following apply: a. the taxpayer expects to owe at least $1,000 in tax for the current tax year after subtracting your withholding and refundable credits. b. the taxpayer expects that their tax withholding and refundable credits to be less than the smaller of: 1) 90% of the tax on the current year’s tax return, or 2) 100% of the tax on the prior year’s tax return (110% for taxpayers with AGI exceeding $150,000). Failure to do so may result in both underpayment and late payment penalties for the taxpayer. The penalty for substantial understatement of income is the larger of 10% of the correct tax or $5,000. 1420.12 Adjustments, deductions, and credits for tax planning (e.g., timing of income and expenses) Taxpayers should plan in advance for certain adjustments, deductions, and credits to maximize the tax benefit. 244 a. Contributions to certain retirement plans can be deducted, reducing the taxable income on the return. In addition, taxpayers with lower income may be able to take a credit for retirement contributions. b. Expenses for qualified education expenses, childcare, adoption, and certain other expenses for your child can be used for credits. Taxpayers should ensure that they keep appropriate records and pay these expenses only as required by tax law in order to have a tax benefit from the expense. INDIVIDUALS Review financial and life‐changing plans with the taxpayer in order to accurately plan the tax consequences or benefit of these decisions. Also, ensure that the taxpayer makes adjustments to withholding or estimated tax payments appropriately to avoid a penalty or unusually large balance due. Form 1040‐ES is filed with each estimated payment. If a taxpayer changes his or her name because of marriage, divorce, etc. and they made estimated tax payments using their former name, the taxpayer should attach a statement to the front of the form. On the form, the following information should be given: all of the estimated tax payments the taxpayer (and the taxpayer's spouse, if filing jointly) made for the current tax year and the name(s) and SSN(s) under which the taxpayer made the payments. ‘In addition, the taxpayer should be advised to report the change, if they have not already, to their local Social Security Administration office before filing the tax return to prevent delays in processing the tax return. 1420.13 Character of transaction (e.g., use of capital gain rates versus ordinary income rates) Ordinary income tax is paid on earnings from interest, dividends, employment, royalties, or self‐employment. Capital gains tax is paid on income that is derived from the sale or exchange of an asset, such as a stock or property. Typically, capital tax rates on long term capital gains are taxed at a more favorable (lower) tax rate. 1420.14 Advantages and disadvantages of MFJ/MFS/HOH filing statuses in various scenarios Married taxpayers have the option to select married filing jointly or married filing separately on their federal income tax returns. The IRS strongly encourages most couples to file joint tax returns by extending several tax breaks to those who file together. In the vast majority of cases, it's best for married couples to file jointly, but there may be a few instances when it's better to submit separate returns. a. Married taxpayers who file together can usually qualify for multiple tax credits such as the earned income tax credit, the American Opportunity and Lifetime Learning Education 245 INDIVIDUALS tax credits, the credit for adoption expenses and child and dependent care tax credits. b. Married taxpayers who select to file separately receive few tax considerations. In most instances, separate tax returns result in higher taxes. The standard deduction for separate filers is far lower than that offered to joint filers. In rare instances, filing separately may result in tax savings. An example of this type of instance would include if one of the spouses has a large amount of out‐of‐pocket medical expenses to claim and jointly the taxpayers would not be able to deduct the costs. The best approach is to prepare the married taxpayers return both as filing jointly and as filing separately to determine which method results in the greater tax savings. 1420.15 Health Insurance Under the health care law, certain health coverage is called minimum essential coverage (MEC). A taxpayer generally cannot take the premium tax credit (PTC) for an individual in their tax family for any month that the individual is eligible for minimum essential coverage, except for coverage in the individual market. Minimum essential coverage includes the following:  Individual market coverage (including qualified health plans)  Most coverage through government‐sponsored programs (including Medicaid coverage, Medicare parts A or C, the Children's Health Insurance Program (CHIP), certain benefits for veterans and their families, TRICARE, and health coverage for Peace Corps volunteers)  Most types of employer‐sponsored coverage  Grandfathered health plans  Other health coverage designated by the Department of Health and Human Services as minimum essential coverage Minimum essential coverage does not include coverage consisting solely of excepted benefits. Excepted benefits include 246 INDIVIDUALS vision and dental coverage not part of a comprehensive health insurance plan, workers’ compensation coverage, and coverage limited to a specified disease or illness. 1420.16 Social Security Income To find out whether any of a taxpayer’s Social Security benefits may be taxable, compare the base amount for their filing status with the total of:  one‐half of their benefits plus  all their other income, including tax‐exempt interest. When making this comparison, do not reduce the taxpayer’s other income by any exclusions for:  interest from qualified U.S. savings bonds,  employer‐provided adoption benefits,  foreign earned income or foreign housing, or  income earned by bona fide residents of American Samoa or Puerto Rico. The base amount for the various filing statuses is:  $25,000 if the taxpayer is single, head of household, or a qualifying surviving spouse;  $25,000 if the taxpayer is married filing separately and lived apart from their spouse for the entire year;  $32,000 if the taxpayer is married filing jointly; or  $0 if the taxpayer is married filing separately and lived with their spouse at any time during the year. 247