Not Ready to File by May 17?

For the second year in a row, the income tax filing deadline is delayed. This year, the filing due date for the IRS and most states is May 17th instead of the “normal” April 15th. Despite the delay, the tax deadline can sneak up on you. If you’re in a panic because you haven’t started gathering your tax documents, you can probably relax. 

You can request a tax filing extension to postpone from May 17th to October 15th. You don’t need to provide a reason for needing the extension, but it does take a little time to get it done right and avoid possible underpayment penalties.

Three tips for getting an income tax filing extension:

  1. You Must Apply

Individuals can request a tax filing extension by filing IRS Form 4868, Application for Automatic Extension of Time to File U.S. Individual Income Tax Return, online at the IRS website, via approved tax software, or in paper form. It must be sent or postmarked no later than midnight on the original due date. The extension is automatically approved if a refund is expected or if the estimated amount due is paid with the extension request.

  1. Pay Amounts Due

Use the IRS Form 4868 instructions at https://www.irs.gov/pub/irs-pdf/f4868.pdf to estimate your 2020 income tax liability. Compare your estimated taxes to your tax withholding or quarterly estimated payments and enter the numbers on the extension request. If you owe more in taxes than you’ve paid in, the balance due must be paid with the extension request. Failure to pay the amount due results in an underpayment penalty and interest accrued daily on the unpaid balance.

  1. Check Your State

Each state has its own set of rules and processes for its residents to request an income tax filing extension. As mentioned above, most states followed the IRS and delayed their 2020 tax filing deadline, but some did not match the IRS’ May 17th deadline. Check your state’s tax department website for deadline updates and links to information about requesting an extension of time to file for 2020.

Rushing at the last minute is stressful and causes mistakes, especially with an already stressful activity like filing your income tax returns. Get more time to file your 2020 federal income tax return by requesting a tax filing extension. Go to the IRS website at https://www.irs.gov/forms-pubs/extension-of-time-to-file-your-tax-return for details and help estimating any taxes you owe with the extension request.

About the Home Office Deduction

Tax clients ask me all the time about taking a home office deduction. That topic has come up even more often since COVID-19 has so many people working at home. However, everyone with an office at home isn’t eligible for a home office deduction, even if she or he owns a business. Lots of rules apply. It can be pretty confusing. 

So, let’s “un-confuse” the topic:

  1. Who is eligible for a home office deduction?

Only individuals who own a business are eligible for the deduction. Yes, some employees used to be eligible under special circumstances, but those rules changed at the end of 2017. Now, only business owners who use space in her or his home exclusively and regularly to substantially conduct business operations can consider taking a home office deduction. No non-business activity can be conducted in a home office. That means no personal items in the home office, even clothes in the closet.

  1. What home expenses can be deducted?

Deductible home office expenses are either direct or indirect, based on the expense type and business percentage of the home used for business. The most common method used to calculate the business percentage is dividing the square footage used exclusively for business by total square footage. Shared spaces, like hallways, cannot be included in office space.  

  • Direct Expenses: Expenses that benefit only the home area that is exclusively used for business, such as painting or repairs in the home office, are direct expenses that are fully deductible.
  • Indirect Expenses: Expenses for keeping up and running the entire home, such as the mortgage interest, real estate taxes, insurance, utilities, and general repairs are deductible based on the business use percentage, described above.

Expenses to maintain the non-living home space, such as lawn care, are not deductible. For business owners who don’t want to hassle with tracking all the various home office expenses, the IRS has a Simplified Option that allows a standard deduction of $5 per square foot, limited to 300 square feet.  

Eligibility for a home office deduction is determined by a lot of rules that can be confusing. We address the basics here, but there’s more to it. Details and examples are on the IRS website at https://www.irs.gov/businesses/small-businesses-self-employed/home-office-deduction.

RMD Rule Reminder

Keeping up with tax rule changes was never easy. But the flurry of tax changes in response to the COVID-19 pandemic has been absolutely head-spinning. A few of those changes impact the rules for required minimum distributions (RMDs) from retirement accounts. RMD rules are how the IRS prevents taxpayers from avoiding tax payments on retirement funds that were invested pre-tax, or before any taxes were paid on the income used for the retirement investment.

On December 20, 2019, the Setting Every Community Up for Retirement Enhancement Act (aka “Secure Act”) was signed into law. The Secure Act changed IRA distributions and contributions in three big ways:

  • Required Minimum Distribution (RMD) Age Increase

Under prior tax law, RMDs had to begin no later than April 1 following the year in which a person turned age 70½. For taxpayers who were not already age 70½ by December 31, 2019, the age to start taking RMDs is extended to 72. Distributions don’t have to be postponed to 72; it’s just an option. What’s better – waiting or not – depends on individual circumstances.

  • Contribution Age Restrictions Repealed 

Before the Secure Act, workers over age 70½ were not eligible to make contributions to an IRA. That contribution age limit has been eliminated. Yea! Slight damper on that celebration, though – the same rules about who can and cannot deduct a traditional IRA contribution apply, regardless of age. 

  • Inherited IRA “Stretch Distributions” Eliminated for Non-Spouses

Traditional IRAs that are inherited by someone other than the owner’s spouse can no longer be distributed over the life of the beneficiary. Distributions now must be taken within a ten-year period after inheritance. This new rule eliminates the options for non-spouse beneficiaries to use inherited traditional IRAs as part of his or her own retirement planning.

So, what does this mean for 2021 RMDs?

  • Individuals who reached 70½ in 2019 or earlier and were not required to take an RMD for 2020 are required to take an RMD for 2021 by December 31, 2021. 
  • Individuals who did not reach age 70½ in 2019 will reach age 72 in 2021 will have their first RMD due by April 1, 2022, and their second RMD due by December 31, 2022. 
  • To avoid having both amounts included in their income for the same year, the taxpayer can make the first withdrawal by December 31, 2021, instead of waiting until April 1, 2022. After the first year, all RMDs must be made by December 31.

Tax rules are always changing. Keeping up is always challenging. For help to meet the challenge, checkout the IRS website – HTTPS://WWW.IRS.GOV/NEWSROOM/TAX-TIME-GUIDE-IRS-REMINDS-TAXPAYERS-OF-RECENT-CHANGES-TO-RETIREMENT-PLANS.

Taxes for Married Couples in Businesses

Married couples who also operate a business together live a complex life. Commingling personal and business, experiencing 100% togetherness, is tough enough. Throwing taxes into the mix could be the straw that breaks the proverbial camel’s back and busts that togetherness apart. But it doesn’t have to be that way.

By default, according to the IRS, two or more individuals in business together without incorporating operate as a partnership. Partnerships are a complicated way to operate from a tax perspective. Partnerships file a separate income tax return, and each partner receives a Form K-1 to report for her or his pro-rata share of income and expenses, used to prepare the partner’s individual income tax return. Partners must also track the basis of partnership interest and any loans to or from the partnership, which impacts how distributions are taxed.

Married couples can get an exception to all those partnership complexities, if each spouse is an owner and materially participates in operating a business that is not formed as a Limited Liability Company (LLC). Instead of a partnership, spouses can elect to treat the business as a joint venture. The joint venture election breaks down to four simple steps:

  • Make the Qualified Joint Venture Election by filing a joint individual tax return. Spouses must consider profits and losses based on spouse’s interest and level of material participation in the business. Once the election is made, if the spouses receive an IRS notice asking for a partnership tax return, they should call or write to the IRS advising them of the qualified joint venture election.
  • Divide Profit and Loss between Spouses by dividing all items of income, gain, loss, deduction, and credit between them in accordance with each spouse’s level of material participation in the joint venture. The percentage allocation should be consistent for all items and reflect the relative percentage of participation. Allocations should be documented and updated for any changes in participation.
  • File Two Separate Business Schedules on the spouses’ individual income tax return. Each business schedule (i.e., IRS Schedule C or Schedule F) should be prepared with each spouse’s allocated share of income and expenses. The net profit or loss for the business schedules for each spouse is combined and reported on Form 1040, Schedule 1, Line 3. Net combined profit or loss is included in overall total income.
  • Report Net Profit as Self-Employment Income so each spouse’s earning from self-employment are credited and the applicable self-employment taxes are paid. Spouses who elect qualified joint venture status are treated as sole proprietors for federal tax purposes. A separate Schedule SE to report self-employment tax must be filed for each spouse to accurately report the net self-employment income.

Need more details about simplifying tax complexities when you are running a business as a married couple? The IRS has it for you here – https://www.irs.gov/businesses/small-businesses-self-employed/election-for-married-couples-unincorporated-businesses.

Beware of Scams During Tax Season

Scam artists prey on their victims all year long, but scam activity seems to spike during tax season. It must be “prime time” to snare victims because they are more abundant – everyone is preparing and filing their returns to meet the April 15 deadline. Scammers can’t resist all those opportunities to fool or intimidate taxpayers who are in the middle of an unpleasant task that makes them nervous and vulnerable, especially online.

Since 2014, the IRS has announced its “Dirty Dozen” top tax scams. The top twelve for 2020 include five scams that are more likely to occur during tax season, targeting taxpayers with malicious intent to steal their refunds, bank account number, or personal information. Here are alerts to watch out for on the five tax-related scams highlighted by the IRS:

  • Phishing: Taxpayers should be alert to potential fake emails looking to steal personal information. Don’t click on links claiming to be from the IRS, or any other sender you’re not expecting or that you do not know. Be wary of emails with embedded links or invitations to see or learn more − they may be nothing more than scams to steal personal information.
  • Unscrupulous Return Preparers: Most tax professionals provide honest, high-quality service, but dishonest preparers pop up every filing season. They commit fraud, harming innocent taxpayers, or talk taxpayers into doing illegal things, like inflating deductions. These scammers may also have taxpayers deposit refunds into tax preparer accounts.
  • Offer in Compromise Mills: Misleading tax debt resolution companies can exaggerate the chance to settle tax debts for “pennies on the dollar” through an Offer in Compromise (OIC) for a hefty fee. Later, the taxpayer learns that she or he is not one of the small number of individuals who are qualified to even apply for an OIC, after the fee is paid and it’s too late.
  • Fake Charities: Criminals frequently exploit natural disasters and other times of crisis by setting up fake charities to steal from well-intentioned people trying to help in times of need. Unfortunately, this is nothing new. The current COVID-19 pandemic and recent winter storms in Texas are examples where scammers take advantage of your compassion.
  • EIP or Refund Theft: Refund fraud and theft remain a pervasive threat. In this past year, criminals also turned their attention to stealing Economic Impact Payments (EIP) as provided by the Coronavirus Aid, Relief, and Economic Security (CARES) Act. Scammers often defraud taxpayers by promising payments more quickly but divert the payments instead.

Don’t get caught up in one of these top tax scams while you are busy filing your 2020 income tax returns. To learn more about these scams and how to protect yourself, check out the IRS website at https://www.irs.gov/newsroom/irs-unveils-dirty-dozen-list-of-tax-scams-for-2020-americans-urged-to-be-vigilant-to-these-threats-during-the-pandemic-and-its-aftermath

Final Worker Classification Rules

Lawsuits about worker classification weren’t front-page news before Uber and Lyft started fighting traditional interpretations of the law by treating workers as independent contractors. What used to be boring hiring details are big headlines about big-name court cases fighting over whether workers are employees or independent contractors. And, as you can imagine, worker classification issues have gotten bigger as the gig economy has exploded.

Uber, Lyft, and other businesses that provide apps for gig workers fought and won legal battles to classify those workers as independent contractors, not employees. Using the independent contractor classification saves businesses money in employer payroll taxes and other employee-related expenses. Workers classified as independent contractors assume more responsibility and cost, like paying self-employment taxes and making quarterly tax payments.

Recent court rulings about worker classification have created some confusion among employers. The U.S. Department of Labor (DOL) stepped in to help businesses and workers comply with applicable tax law. DOL recently issued a final rule that takes effect on March 8, 2021, to clarify the standards for determining whether a worker should be considered an employee or an independent contractor.

Three aspects of the final DOL rules that businesses and workers should know:

  • An “economic reality” test is used to determine whether a worker is an independent contractor or is “economically dependent on an employer for work” (i.e., an employee). The rule defines two “core factors” to help businesses determine whether a worker is economically dependent on someone else’s business or is in business for her- or himself.
  • The first of the two core factors isn’t just one thing; it relates to a series of conditions. These include the degree of control of the employer over the work, the amount of skill required to perform the work, and the degree of permanence of the working relationship. For example, an independent contractor is free from the control and direction of the hirer, is sufficiently skilled to work autonomously, and is providing services that are temporary or intermittent.
  • The second core factor relates to whether the work being performed is integrated with or separate from the overall business. An independent contractor performs work that is outside the usual course of the hiring entity’s business, either a specialized skill or temporary need for additional resources.

Worker classification issues have gotten bigger, along with the expansion of the gig economy. Determining whether a worker is considered an independent contractor or an employee can be complicated, which is why DOL issued clarifying rules. Worker classification decisions assign responsibilities and costs to the employer or the worker, so it’s important to get it right.

Need more information? The IRS addresses worker classification at https://www.irs.gov/businesses/small-businesses-self-employed/independent-contractor-self-employed-or-employee.

2021 Tax Filing Starts February 12

Tax filing season officially starts for individuals on Friday, February 12th, when the IRS begins accepting and processing 2020 income tax returns. Ordinarily, tax filing starts in the third week of January. However, with all the last-minute tax changes in 2020, including a second round of Economic Impact Payments, the IRS needed extra time to update its systems.  

The IRS has already started begun accepting business returns and individual returns from taxpayers who are eligible to use IRS Free File partners (https://www.irs.gov/filing/free-file-do-your-federal-taxes-for-free). The IRS anticipates that nine out of ten taxpayers will receive their refund within 21 days of filing electronically if there are no issues with the tax return.

The IRS has five tips to avoid having issues with your return:

  • There is no extension of the April 15 tax filing deadline. If you need more time to file, you can extend filing until October 15, by filing Form 4868, Application for Automatic Extension of Time to File U.S. Individual Income Tax Return. But remember, it’s an extension of time to file, not to pay. Pay any taxes due with the extension request, no later than April 15.
  • Taxpayers are urged to file returns electronically as soon as they have the 2020 tax documentation that they need. Filing early is a good idea for several reasons. First, processing volumes are lower at the IRS and state tax agencies, resulting in faster refunds. Filing early also gets ahead of potential scammers filing a fraudulent tax return with a valid tax ID. 
  • Returns involving the Earned Income Tax Credit (EITC) or Additional Child Tax Credit (ACTC) need additional processing time to help the IRS stop fraudulent refunds and claims from being issued to identity thieves. By law, refunds for EITC and ACTC taxpayers cannot be issued before mid-February. Because the IRS isn’t processing returns until February 12, their refunds should start arriving in the first week of March.
  • Electronic tax refunds and payments are the safest and fastest method for financial transactions with federal and state tax agencies. Your tax preparer can usually set them up using authorized tax software. Tax agency websites include links for payments via bank account or credit card. However, these sites don’t have a refund option.
  • Advance stimulus payments, a.k.a. Economic Impact Payments, do not reduce a taxpayer’s refund or payment due for 2020. Eligible taxpayers who received less than the maximum stimulus payment amount could claim the Recovery Rebate Credit and increase her or his 2020 federal income tax refund. Anyone who received the maximum amount does not need to include any information about the payment when filing.

The IRS begins accepting and processing 2020 income tax returns on February 12, about three weeks later than usual because of last-minute tax law changes passed in December. Taxpayers who want a smooth tax filing experience should follow these five IRS tips.

Finding a Tax Pro

Finding the right tax professional to “fix” your taxes is a lot like finding the right plumber or to fix your kitchen sink. There are many to choose from, but it’s a challenge to make sure you find someone who is knowledgeable, experienced, and dependable. With a tax pro, you also want someone with whom you feel comfortable confiding your financial details.

So, how do you find that elusive experienced and dependable confidant to prepare and file your income tax returns? Well, you can ask friends, hit the Internet, or head to the local tax preparation office. That can get you a few tax pros to interview. Yes, interview. Plan to interview two or three recommended tax pros to feel confident that she or he is qualified and that you feel comfortable interacting with her or him.

These three interview questions are a “must” for finding the right tax pro:

  • How Do You Keep Up with Tax Law Changes?

Tax laws are constantly changing. Some changes are major, as we saw three years ago with the 2017 Tax Cuts and Jobs Act. It’s important to work with a tax preparer who keeps up with all those changes, so you don’t have to. A qualified tax preparer will describe attending conferences, webinars, or other methods to stay current.

  • What Experience and Credentials Do You Have?

Tax preparation is an unregulated industry where anyone can participate, so asking about years of experience, training and education is essential. Preparers with professional credentials, such as a CPA or Enrolled Agent (EA), are required to complete annual continuing education requirements and follow ethical and professional standards. 

  • How Do You Communicate with your Clients?

Does the tax preparer meet regularly with clients? Is she or he available to you if a tax-related question or issue comes up? Make sure you feel comfortable with the tax preparer’s style, manner, and process. If not, keep looking. You’ll be sharing a lot of personal information so you must be comfortable.

Plan to interview two or three tax pros referred by friends or online reviews to find a tax professional who is knowledgeable, experienced, and with whom you feel comfortable confiding your financial details. Need help getting started? The IRS has a website for you with tips and tools – https://www.irs.gov/tax-professionals/choosing-a-tax-professional.