Independent contractor vs. employee status: The DOL issues new final rule

The U.S. Department of Labor’s (DOL’s) test for determining whether a worker should be classified as an independent contractor or an employee for purposes of the federal Fair Labor Standards Act (FLSA) has been revised several times over the past decade. Now, the DOL is implementing a new final rule rescinding the employer-friendly test that was developed under the Trump administration. The new, more employee-friendly rule takes effect March 11, 2024.

Role of the new final rule

Even though the DOL’s final rule isn’t necessarily controlling for courts weighing employment status issues, it’s likely to be considered persuasive authority. Moreover, it’ll guide DOL misclassification audits and enforcement actions.

If you’re found to have misclassified employees as independent contractors, you may owe back pay if employees weren’t paid minimum wage or overtime pay, as well as penalties. You also could end up liable for withheld employee benefits and find yourself subject to various federal and state employment laws that apply based on the number of affected employees.

The rescinded test

The Trump administration’s test (known as the 2021 Independent Contractor Rule) focuses primarily on whether, as an “economic reality,” workers are dependent on employers for work or are in business for themselves. It examines five factors. And while no single factor is controlling, the 2021 rule identifies two so-called “core factors” that are deemed most relevant:

• The nature and degree of the employer’s control over the work, and

• The worker’s opportunity for profit and loss.

If both factors suggest the same classification, it’s substantially likely that classification is proper.

The new test

The final new rule closely shadows the proposed rule published in October 2022. According to the DOL, it continues the notion that a worker isn’t an independent contractor if, as a matter of economic reality, the individual is economically dependent on the employer for work. The DOL says the rule aligns with both judicial precedent and its own interpretive guidance prior to 2021.

Specifically, the final rule enumerates six factors that will guide DOL analysis of whether a worker is an employee under the FLSA:

1. The worker’s opportunity for profit or loss depending on managerial skill (the lack of such opportunity suggests employee status),

2. Investments by the worker and the potential employer (if the worker makes similar types of investments as the employer, even on a smaller scale, it suggests independent contractor status),

3. Degree of permanence of the work relationship (an indefinite, continuous or exclusive relationship suggests employee status),

4. The employer’s nature and degree of control, whether exercised or just reserved (control over the performance of the work and the relationship’s economic aspects suggests employee status),

5. Extent to which the work performed is an integral part of the employer’s business (if the work is critical, necessary or central to the principal business, the worker is likely an employee), and

6. The worker’s skill and initiative (if the worker brings specialized skills and uses them in connection with business-like initiative, the worker is likely an independent contractor).

In contrast to the 2021 rule, all factors will be weighed — no single factor or set of factors will automatically determine a worker’s status.

The final new rule does make some modifications and clarifications to the proposed rule. For example, it explains that actions that an employer takes solely to comply with specific and applicable federal, state, tribal or local laws or regulations don’t indicate “control” suggestive of employee status. But those that go beyond compliance and instead serve the employer’s own compliance methods, safety, quality control, or contractual or customer service standards may do so.

The final rule also recognizes that a lack of permanence in a work relationship can sometimes be due to operational characteristics unique or intrinsic to particular businesses or industries and the workers they employ. The relevant question is whether the lack of permanence is due to workers exercising their own independent business initiative, which indicates independent contractor status. On the other hand, the seasonal or temporary nature of work alone doesn’t necessarily indicate independent contractor classification.

The return, and clarification, of the factor related to whether the work is integral to the business also is notable. The 2021 rule includes a noncore factor that asks only whether the work was part of an integrated unit of production. The final new rule focuses on whether the business function the worker performs is an integral part of the business.

For tax purposes

In a series of Q&As, the DOL addressed the question: “Can an individual be an employee for FLSA purposes even if he or she is an independent contractor for tax purposes?” The answer is yes.

The DOL explained that the IRS applies its version of the common law control test to analyze if a worker is an employee or independent contractor for tax purposes. While the DOL considers many of the same factors as the IRS, it added that “the economic reality test for FLSA purposes is based on a specific definition of ‘employ’ in the FLSA, which provides that employers ‘employ’ workers if they ‘suffer or permit’ them to work.”

In court cases, this language has been interpreted to be broader than the common law control test. Therefore, some workers who may be classified as contractors for tax purposes may be employees for FLSA purposes because, as a matter of economic reality, they’re economically dependent on the employers for work.

Next steps

Not surprisingly, the DOL’s final new rule is already facing court challenges. Nonetheless, you should review your work relationships if you use freelancers and other independent contractors and make any appropriate changes. Remember, too, that states can have different tests, some of which are more stringent than the DOL’s final rule. Contact your employment attorney if you have questions about the DOL’s new rule. We can assist with any issues you may have regarding independent contractor status for tax purposes.

© 2024

The IRS unveils ERTC relief program for employers

Since July 2023, the IRS has taken a series of actions in response to what it has termed a “flood of ineligible claims” for the Employee Retention Tax Credit (ERTC). Most recently, it launched a Voluntary Disclosure Program (VDP). The program presents a valuable, but temporary, opportunity for eligible employers.

Flood of invalid ERTC claims

The ERTC is a refundable tax credit intended for businesses that 1) continued paying employees while they were shut down due to the pandemic in 2020 and 2021, or 2) suffered significant declines in gross receipts from March 13, 2020, to December 31, 2021.

With the credits worth up to $26,000 per retained employee, fraudulent promoters and marketers quickly pounced, offering to help employers file claims in exchange for large upfront fees or percentages of the money received. But the requirements for the credit are stringent, and many employers were misled into filing claims that have proven to be invalid, leaving those claimants at risk of liability for credit repayment, penalties and interest, as well as other tax problems.

IRS’s response

In the face of the deluge of invalid claims, the IRS intensified audits and criminal investigations of both promoters and businesses filing suspect claims. As of December 2023, it had more than 300 criminal cases underway with claims worth nearly $3 billion, and thousands of ERTC claims had been referred for audit.

The IRS also has instituted a moratorium on the processing of new ERTC claims. And, in October 2023, the agency began offering a withdrawal option for eligible employers that filed a claim but haven’t yet received, cashed or deposited a refund. Withdrawn claims will be treated as if they were never filed, so taxpayers need not fear repayment, penalties or interest.

In late December 2023, the IRS announced another ERTC relief initiative, the VDP. The program is intended for employers that claimed and received credit money but weren’t entitled to it.

VDP nuts and bolts 

Employers that participate in the VDP may benefit in several ways. For example, they’re required to repay only 80% of the credit received (if repayment in full isn’t possible, the IRS may authorize an installment plan). They also aren’t required to repay any interest received on an ERTC refund or amend their income tax returns to reduce wage expense.

These employers won’t be subject to penalties or underpayment interest if the 80% repayment is made before the signed closing agreement is returned to the IRS. The 20% reduction won’t be treated as taxable income, and the IRS won’t audit the ERTC on employment tax returns for the tax periods covered by the closing agreement.

An employer can apply for the VDP for each tax period in which:

• Its ERTC claim was 1) processed and paid as a refund that has been cashed or deposited, or 2) paid in the form of a credit applied to that or another tax period,

• It believes it wasn’t entitled to the ERTC,

• It isn’t under IRS audit for employment taxes,

• It isn’t under IRS criminal investigation, and

• The IRS hasn’t reversed, or notified the employer of its intent to reverse, the ERTC to zero (for example, with a letter or notice disallowing the credit).

Notably, the IRS is sending up to 20,000 letters with proposed tax adjustments for the 2020 tax year to recover ineligible claims, in addition to 20,000 denial letters it sent earlier. The agency continues to work on the 2021 tax year, with more mailings to come. When an employer is identified through this work as receiving excessive or erroneous ERTCs, the IRS will pursue normal tax assessment and collection procedures.

If a third-party payer filed an employment tax return that reported an employer’s ERTC-related wages and credits, the employer can participate in the VDP only through the third-party payer. It’ll be rejected if it applies with its own employer identification number.

Act now

Bear in mind that not every ERTC claim was invalid. If you’re at all uncertain about the validity of your claim, regardless of whether you’ve received payment, we can help you navigate this increasingly complex area of your tax liability. The VDP is open only until March 22, 2024, though, so don’t delay.

© 2024

Businesses must electronically file Form 8300, Report of Cash Payments Over $10,000, beginning January 1, 2024

The Internal Revenue Service today announced that starting Jan. 1, 2024, businesses are required to electronically file (e-file) Form 8300, Report of Cash Payments Over $10,000, instead of filing a paper return. This new requirement follows final regulations amending e-filing rules for information returns, including Forms 8300.

Businesses that receive more than $10,000 in cash must report transactions to the U.S. government. Although many cash transactions are legitimate, information reported on Forms 8300 can help combat those who evade taxes, profit from the drug trade, engage in terrorist financing, or conduct other criminal activities. The government can often trace money from these illegal activities through payments reported on Form 8300 that are timely filed, complete, and accurate.

The new requirement for e-filing Forms 8300 applies to businesses mandated to e-file certain other information returns, such as Forms 1099 series and Forms W-2. Electronic filing and communication options will be simpler and will make it easier to interact with the IRS. Beginning with calendar year 2024, businesses must e-file all Forms 8300 (and other certain types of information returns required to be filed in a given calendar year) if they're required to file at least 10 information returns other than Form 8300.

For example, if a business files five Forms W-2 and five Forms 1099-INT, then the business must e-file all their information returns during the year, including any Forms 8300. However, if the business files fewer than 10 information returns of any type, other than Forms 8300, then that business does not have to e-file the information returns and is not required to e-file any Forms 8300. However, businesses not required to e-file may still choose to do so.

Waivers

A business may file a request for a waiver from electronically filing information returns due to undue hardship. For more information, businesses can refer to Form 8508, Application for a Waiver from Electronic Filing of Information Returns PDF. If the IRS grants a waiver from e-filing any information return, that waiver automatically applies to all Forms 8300 for the duration of the calendar year. A business may not request a waiver from filing only Forms 8300 electronically.

The business must include the word "Waiver" on the center top of each Form 8300 (Page 1) when submitting a paper-filed return.

If a business is required to file fewer than 10 information returns, other than Forms 8300, during the calendar year, the business may file Forms 8300 in paper form without requesting a waiver.

If a business files less than 10 information returns, it can still choose to e-file Forms 8300 electronically if it chooses to do so.

Exemptions

If using the technology required to e-file conflicts with a filer's religious beliefs, they are automatically exempt from filing Form 8300 electronically. The filer must include the words "RELIGIOUS EXEMPTION" on the center top of each Form 8300 (page 1) when submitting the paper filed return.

Late returns

A business must self-identify late returns. A business must file a late Form 8300 in the same way as a timely filed Form 8300, either electronically or on paper. A business filing a late Form 8300 electronically must include the word "LATE" in the comments section of the return. A business filing a late Form 8300 on paper must write "LATE" on the center top of each Form 8300 (page 1).

Recordkeeping

A business must keep a copy of every Form 8300 it files, as well as any supporting documentation and the required statement it sends to customers, for five years from the date filed.

Filing electronically will provide a confirmation that the form was filed; however, e-file confirmation e-mails alone don't meet the record-keeping requirement. When e-filing, filers must also save a copy of the form prior to finalizing the form submission. They should associate the confirmation number with the saved copy. Prior to finalizing the form for submission, businesses should save a copy of the form electronically or print a copy of the form.

E-filing

Many businesses have already found the free and secure e-filing system to be a more convenient and cost-effective way to meet the reporting deadline of 15 days after a transaction. They get free email acknowledgment of receipt of the form when they e-file. Businesses can batch e-file their reports, which is especially helpful to those required to file many forms.

To file Forms 8300 electronically, a business must set up an account with the Financial Crimes Enforcement Network's BSA E-Filing System. The IRS will ensure the privacy and security of all taxpayer data.

For more information, call the Bank Secrecy Act E-Filing Help Desk at 866-346-9478 or email them at bsaefilinghelp@fincen.gov. For more information about the BSA E-Filing System, businesses can complete a technical support request at Self Service Help Ticket. The help desk is available Monday through Friday from 8 a.m. to 6 p.m. EST.

For more information about the reporting requirement, see E-file Form 8300: Reporting of large cash transactions on IRS.gov.

To help businesses prepare and file reports, the IRS created a video - How to Complete Form 8300 – Part I, Part II. The short video points out sections of Form 8300 for which the IRS commonly finds mistakes and explains how to accurately complete those sections.

IRS Reminds Employers of New Electronic Filing Requirements for Forms W-2, W-2c

The IRS reminds employers that the new lower threshold for required electronic filing of information returns applies to tax year 2023 Forms W-2, Wage and Tax Statement, because they are required to be filed by January 31, 2024.

In T.D. 9972 (TAXDAY, 2023/02/22, I.1), the required electronic filing threshold for certain information returns (including the 1099 series forms and most Forms W-2) was reduced from 250 returns to 10 returns. This new lower threshold is effective for information returns required to be filed in calendar years beginning with 2024. Employers determine whether they must file their information returns electronically by adding the number of information returns and the number of Forms W-2 they must file in a calendar year. If the total is 10 or more, they must file the returns electronically.

Corrected information returns, like Form W-2c, should be treated separately and are not included in this calculation. The employer must file Form W-2c which corrects the original Form W-2 in the same way that the original Form W-2 was filed, electronically or on paper.

Further information on Forms W-2 and W-2c can be found at: About Form W-2 and About Form W-2c.

State of Michigan Exempts Delivery and Installation Charges from MI Sales Tax

The State of Michigan has passed new laws (Public Acts 20 and 21) that exempt delivery and installation charges from Michigan sales tax. Sales after April 25, 2023, can exclude sales tax on delivery and installation charges if those items are separately stated on the invoice. The State will also be retroactively canceling sales tax on delivery and installation charges for any tax not currently paid to the State. 

Click here to access the State of Michigan's guidelines regarding these laws and how they will impact your business. Reach out to the FMD team with any questions you might have.

Act Now to Reduce Your Business’s 2022 Tax Bill

It’s been a tumultuous year for many businesses, and the current economic climate promises more uncertainty for the short term, if not longer. Regardless of how your company has fared so far in 2022, there’s still time to make moves that may reduce your federal tax liability. Read on for some strategies worth your consideration.

Time your income and expenses

When it comes to year-end tax reduction strategies, the granddaddy of them all — for businesses that use cash-basis accounting — is probably the practice of accelerating deductions into the current tax year and deferring income into the next year. You can accelerate deductions by, for example, paying bills or employee bonuses due in 2023 before year end and stocking up on supplies. Meanwhile, you can defer income by holding off on invoicing until late December or early January.

You should consider this strategy only if you don’t expect to see significantly higher profits next year. If you think you will, flip the approach, accelerating income and pushing deductions into the future when they’ll be more valuable. Also, bear in mind that reducing your income could reduce your qualified business income (QBI) deduction, depending on your business entity.

Maximize your QBI deduction

Pass-through entities (that is, sole proprietors, partnerships, limited liability companies and S corporations) can deduct up to 20% of their QBI, subject to certain limitations based on W-2 wages paid, the unadjusted basis of qualified property and taxable income. The deduction, created by the Tax Cuts and Jobs Act (TCJA), is set to expire after 2025, absent congressional action, so make the most of it while you can.

You could increase your deduction by increasing wages (for example, by converting independent contractors to employees or raising pay for existing employees) or purchasing capital assets. (Of course, these moves usually have other consequences, such as higher payroll taxes, that you should weigh before proceeding.) You can avoid the income limit by timing your income and deductions, as discussed above.

If the W-2 wage limitation doesn’t limit the QBI deduction, S corporation owners can increase their QBI deductions by reducing the wages the business pays them. (This won’t work for sole proprietorships or partnerships, which don’t pay their owners salaries.) Conversely, if the wage limitation does limit the deduction, S corporation owners might be able to take a greater deduction by boosting their wages.

Accelerate depreciation — while you can

The TCJA also increased the Section 168(k) first-year bonus depreciation to 100% of the purchase price, through 2022. Beginning next year, the allowable deduction will drop by 20% each year until it evaporates altogether in 2027 (again, absent congressional action). Combining bonus depreciation with the Section 179 deduction can produce substantial tax savings for 2022.

Under Sec. 179, you can deduct 100% of the purchase price of new and used eligible assets in the year you place them in service — even if they’re only in service for a day or two. Eligible assets include machinery, office and computer equipment, software, and certain business vehicles. The deduction also is available for improvements to nonresidential property.

The maximum Sec. 179 deduction for 2022 is $1.08 million and it begins phasing out on a dollar-for-dollar basis when your qualifying property purchases exceed $2.7 million. The maximum deduction also is limited to the amount of your income from the business, although unused amounts can be carried forward indefinitely.

Alternatively, you can claim excess amounts as bonus depreciation, which is subject to no limits or phaseouts in 2022. Bonus depreciation is available for computer systems, software, vehicles, machinery, equipment, office furniture and qualified improvement property (generally, interior improvements to nonresidential property).

For all their immediate appeal, bonus depreciation and Sec. 179 expensing aren’t always advisable. You may, for example, want to skip accelerated depreciation if you claim the QBI deduction. The deduction is limited by your taxable income, and depreciation reduces such income.

It might be wise to have some depreciation available to offset your income in 2023 through 2025 so you can claim the QBI deduction while it’s still around. You might think twice, too, if you have expiring net operating losses, charitable contributions or credit carryforwards that are affected by taxable income.

The good news is that you don’t have to decide now. As long as you place qualified property in service by December 31, 2022, you have the option of choosing the most advantageous approach when you file your tax return in 2023.

Get real about your bad debts

Business owners are sometimes slow to accept that they’re going to go unpaid for services rendered or goods delivered. If you use accrual-basis accounting, though, facing the facts can land you a bad debt deduction.

The IRS allows businesses to deduct “worthless” debts, in full or in part, that they’ve previously included in their income. To show that a debt is worthless, you need to show that you’ve taken reasonable steps to collect but without success. You aren’t required to go to court if you can show that a judgment from a court would be uncollectible.

You still have time to take reasonable steps to collect outstanding debts. It’s important to keep detailed records of these efforts. If you determine you can’t collect, you may be able to deduct some or all of those debts for 2022.

Start or replace your retirement plan

If you’ve put off establishing a retirement plan, or simply outgrown the plan you started years ago, you have time to possibly trim your taxes this year — and likely improve your employee recruitment and retention at the same time — by starting a new plan. Eligible employers can claim a tax credit of up to $5,000, for the first three years, for the costs of starting a SEP IRA, SIMPLE IRA or a qualified plan such as a 401(k) plan.

The credit is 50% of your costs to set up and administer the plan and educate your employees about it. You can claim up to the greater of $500 or the lesser of:

• $250 multiplied by the number of non-highly compensated employees who are eligible to participate in the plan, or

• $5,000.

You can begin to claim the credit in the tax year before the year the plan becomes effective. And, if you add an auto-enrollment feature, you can claim a tax credit of $500 per year for a three-year period beginning in the first taxable year the feature is included.

Leverage your startup expenses

If you launched a new business this year, you might qualify for a limited deduction for certain costs. The IRS allows you to deduct up to $5,000 of startup costs and $5,000 of organizational costs (such as the costs of creating a partnership). The deduction is reduced by the amount by which your total startup or organizational costs exceed $50,000. You must amortize any remaining costs.

An eligible cost is one that you could deduct if it were paid or incurred to operate an existing business in the same field. Eligible costs also must be paid or incurred before the active business begins. Examples include business analysis costs, advertisements for the business’s opening, travel and other costs related to lining up prospective distributors, suppliers or customers, and certain salaries, wages and fees.

Turn to us for planning advice

Many of the strategies detailed here involve tradeoffs that require thoughtful evaluation and analysis. We can help you make the right choices to minimize your company’s tax bill.

© 2022

CHIPS Act poised to boost U.S. businesses

The Creating Helpful Incentives to Produce Semiconductors for America Act (CHIPS Act) was recently passed by Congress as part of the CHIPS and Science Act of 2022. President Biden is expected to sign it into law shortly. Among other things, the $52 billion package provides generous tax incentives to increase domestic production of semiconductors, also known as chips. While the incentives themselves are narrowly targeted, the expansion of semiconductor production should benefit a wide range of industries.

In particular, it could reduce the risks of future supply chain issues for the many goods and devices that rely on semiconductor chips, from cell phones and vehicles to children’s toys. The law also is intended to address national security concerns related to the reliance on foreign production of semiconductors.

The impetus

Although the United States developed and pioneered chip technology, many legislators have determined that the country has become too reliant on foreign producers. According to the government, American companies still account for almost half of all revenues in the global semiconductor industry, but the U.S. share of global chip production has fallen from 37% in 1990 to only 12% today. Seventy-five percent of semiconductor production occurs in East Asia. This situation poses a national and economic security threat, according to Congress.

Government subsidies are responsible for up to 70% of the cost difference in producing semiconductors overseas, giving foreign producers a 25% to 40% cost advantage over U.S. producers. The grants in the CHIPS Act, combined with a new tax credit, are intended to fully make up for this cost differential and thereby incentivize the “re-shoring” of semiconductor production.

The new tax credit

The CHIPS Act creates a temporary “advanced manufacturing investment credit” for investments in semiconductor manufacturing property, to be codified in Section 48D of the Internal Revenue Code. The Sec. 48D credit amounts to 25% of qualified investment related to an advanced manufacturing facility — that is, a facility with the primary purpose of manufacturing semiconductors or semiconductor manufacturing equipment.

Qualified property is tangible property that:

• Qualifies for depreciation or amortization,

• Is constructed, reconstructed or erected by the taxpayer or acquired by the taxpayer if the original use of the property begins with the taxpayer, and

• Is integral to the operation of the advanced manufacturing facility.

It also can include a building, a portion of a building (other than a portion used for functions unrelated to manufacturing, such as administrative services) and certain structural components of a building.

The credit is available for qualified property placed in service after December 31, 2022, if construction begins before January 1, 2027. If construction began before the CHIPS Act was enacted, though, only the portion of the basis attributable to construction begun after enactment is eligible.

Taxpayers generally are eligible for the credit if they aren’t designated as a “foreign entity of concern.” That term generally refers to certain entities that have been deemed foreign security threats under previous defense authorization legislation or those with conduct that has been ruled detrimental to U.S. national security or foreign policy.

The CHIPS Act additionally excludes taxpayers that have made an “applicable transaction” (for example, the early disposition of investment credit property under Sec. 50(a)). Applicable transactions also include any “material expansion” of the taxpayer’s semiconductor manufacturing capacity in China or other designated “foreign countries of concern.” The law provides for recapture of the credit if a taxpayer enters such a transaction within 10 years of claiming the credit.

Notably, eligible taxpayers can claim the credit as a payment against tax — what’s known as “direct pay.” In other words, taxpayers can receive a tax refund if they don’t have sufficient tax liability to use the credit. Without this option, eligible taxpayers could struggle to monetize their credits.

Additional provisions

The CHIPS Act also provides:

• $39 billion in subsidies to build, expand or modernize domestic facilities and equipment for semiconductor fabrication, assembly, testing, advanced packaging or research, and development,

• $200 million for workforce development and training, and

• $1.5 billion to spur wireless supply chain innovation.

It includes almost $170 billion for governmental research and development, as well.

Stay tuned

If your business might qualify for the new tax credit, keep an eye out for additional IRS guidance on just how it will work, including the direct pay provision. We can help you make the most of this and other tax credits.

© 2022`

Yes, Employers Can Still Claim the Employee Retention Credit Via an Amended Tax Return

According to the IRS, employers can still claim the employee retention credit (ERC) by filing amended employment tax returns, even though the coronavirus (COVID-19) pandemic-era tax credit aimed at helping employers and employees during the health crisis expired last year.

ERC begins. 

The ERC is a provision from the Coronavirus Aid, Relief, and Economic Security Act (CARES; P.L. 116-136) Act that allowed for a tax credit against certain employment taxes for eligible employers that paid qualified wages, including certain health plan expenses, to certain employees. This began on March 12, 2020 and was initially to end at the end of 2020 (see Payroll Guide ¶20,905 ).

ERC amended and extended. 

The ERC was extended until June 30, 2021 by the Consolidated Appropriations Act (CAA;  P.L. 116-260) and further extended through the end of 2021 by the American Rescue Plan Act of 2021 (ARPA;  P.L. 117-2).

Early ERC termination. 

However, the Infrastructure Investment and Jobs Act (Infrastructure Act;  P.L. 117-58) retroactively terminated the ERC for most employers, beginning on October 1, 2021. Recovery startup businesses were the only employers allowed to claim the credit through the end of 2021. A recovery startup business is any employer that began operations after February 15, 2020 subject to certain average annual gross receipts requirements.

Reporting and claiming the ERC. 

Generally, eligible employers claimed the ERC by reporting their total qualified wages and the related health insurance costs for each quarter on their  Forms 941 (Employer's Quarterly Federal Tax Return).

Revised employment tax forms. 

In order to account for COVID-19 tax credits like the ERC, the IRS had to revise Form 941 (and other forms in the 941 series) several times. The IRS also revised  Form 941-X (Adjusted Employer's Quarterly Federal Tax Return or Claim for Refund).

Using a adjusted return to claim the ERC. 

The current version of the Form 941-X has multiple line numbers for making corrections and amendments regarding the ERC. These adjustments are reported on Form 941-X as follows: 

1.       Line 18a is for the nonrefundable portion of the ERC,

2.       Line 26a is for the refundable portion of the ERC,

3.       Line 30 is for the qualified wages of the ERC,

4.       Line 31a is for qualified health plan expenses for the ERC,

5.       Line 31b is a checkbox indicating if the employer is eligible for the ERC in the third or fourth quarter of 2021 solely because the employer is a recovery startup business, and

6.       Line 33a is for the qualified wages paid from March 13, 2020 through March 31, 2020 for the ERC. 

Worksheets for adjusting the ERC. 

There are also two worksheets in Form 941-X instructions that related to the ERC. Worksheet 2 is the adjusted ERC for wages paid after March 12, 2020 and before July 1, 2021. Worksheet 4 is the adjusted ERC for wages paid after June 30, 2021 and before January 1, 2022 (October 1, 2021 for most employers, except startup recovery businesses).

Period of limitations for amended employment tax returns. 

According to the Form 941-X instructions, employers may correct overreported taxes on a previously filed Form 941 if the Form 941-X is filed within three years of the date Form 941 was filed or two years from the date you paid the tax reported on Form 941, whichever is later.

The instructions also say that employers may correct underreported taxes on a previously filed Form 941 if the Form 941-X is filed three years of the date the Form 941 was filed.

The IRS refers to these time frames as a "period of limitations." And, for purposes of the period of limitations, Forms 941 for a calendar year are considered filed on April 15 of the succeeding year if filed before that date.

Employers can still claim the ERC. 

Through an IRS media relations correspondence,  Thomson Reuters  has confirmed that employers can still claim the ERC, even if the employer never claimed the credit during the time period the ERC was available.

This is because the window of opportunity to amend employment tax overpayments has not yet expired with relation to the period of time the ERC was available. So, if an employer currently discovers that it was eligible for the ERC when the credit was available, the employer would file a Form 941-X to report the overpayment in employment taxes and ultimately claim the ERC after its termination date.

Qualifying credit tool still available.  Thomson Reuters  developed an Employee Retention Credit Eligiblity Tool that helps employers determine if they qualify for the employment tax credit. The Tool is free and is still active for employers to use and to see if they may qualify for this credit. 

 Reach out to your FMD Advisor to determine whether you qualify.

New tax reporting requirements for payment apps could affect you

If you run a business and accept payments through third-party networks such as Zelle, Venmo, Square or PayPal, you could be affected by new tax reporting requirements that take effect for 2022. They don’t alter your tax liability, but they could add to your recordkeeping burden, as well as the number of tax-related documents you receive every January in anticipation of tax-filing season.

Form 1099-K primer

Form 1099-K, “Payment Card and Third-Party Network Transactions,” is an information return that reports certain payment transactions to the IRS and the taxpayer who receives the payments. Since it was first introduced in 2012, the form has been used to report payments:

1. From payment card transactions (for example, debit, credit or stored-value cards), and

2. In settlement of third-party network transactions, when above a certain minimum threshold amount.

For 2021 and prior years, the threshold was defined as gross payments that exceeded $20,000 and more than 200 such transactions. Note that no minimum threshold applies to payment card transactions — all such payments must be reported.

Taxpayers should receive a Form 1099-K from each “payment settlement entity” (PSE) from which they received payments in settlement of reportable payment transactions (that is, a payment card or third-party network transaction) during the tax year. Form 1099-K reports the gross amount of all reportable transactions for the year and by month. The dollar amount of each transaction is determined on the transaction date.

In the case of third-party network payments, the gross amount of a reportable payment doesn’t include any adjustments for credits, cash equivalents, discounts, fees, refunds or other amounts. In other words, the full amount reported might not represent the taxable amount.

Businesses (including independent contractors) should consider the amounts reported when calculating their gross receipts for income tax purposes. Depending on filing status, the amounts generally should be reported on Schedule C (Form 1040), “Profit or Loss From Business, Sole Proprietorship;” Schedule E (Form 1040), “Supplemental Income and Loss;” Schedule F (Form 1040), “Profit or Loss From Farming;” or the appropriate return for partnerships or corporations.

Understanding the new rules

The American Rescue Plan Act (ARPA), which was signed into law in March of 2021, brought significant changes to the requirements regarding Form 1099-K. The changes are intended to improve voluntary tax compliance.

Beginning in 2022, the number of transactions component of the threshold for reporting third-party network transactions is eliminated, and the gross payments threshold drops to only $600. The change is expected to boost the number of Forms 1099-K many businesses receive in January 2023 for the 2022 tax year and going forward.

The ARPA also includes an important clarification. Since Form 1099-K was introduced, stakeholders have been uncertain about which types of third-party network transactions should be included. The ARPA makes clear that these transactions are reportable only if they’re for goods and services. Payments for royalties, rent and other transactions settled through a third-party network are reported on Form 1099-MISC, “Miscellaneous Information.”

The ARPA changes heighten only the reporting obligations of third-party payment networks; they don’t affect individual taxpayer requirements. They might, however, reduce your odds of inadvertently underreporting income and paying the price down the road.

Taking steps toward accurate reporting

While the increased reporting doesn’t require any specific changes of affected taxpayers, you’d be wise to institute some measures to ensure the reporting is accurate. For example, consider monitoring your payments and the amounts so you know whether you should receive a Form 1099-K from a particular PSE. Notably, you’re required to report the associated income regardless of whether you receive the form.

You’ll also want to step up your recordkeeping to allow you to reconcile any Forms 1099-K with the actual amounts received. If you have multiple sources of income, track and report each separately even if you receive a single Form 1099-K with gross payments for all of the businesses. For example, if you process both retail sales and rent payments on the same card terminal, your tax preparer would report the retail sales on Schedule C and the rent on Schedule E.

If you permit customers to get cash back when using debit cards for purchases, the cash back amounts will be included on Form 1099-K. Those amounts generally aren’t included in your gross receipts or businesses expenses, though, making it critical that you track cash-back activity to prevent inclusion.

Amounts reported could be inaccurate if you share a credit card terminal with another person or business. Where required, consider filing and furnishing the appropriate information return (for example, Form 1099-K or Form 1099-MISC) for each party with whom you shared a card terminal. In addition, keep records of payments issued to every party sharing your terminal, including shared terminal written agreements and cancelled checks.

Other potential landmines include:

1. Incorrect amounts due to mid-tax year changes in entity type (for example, from a sole proprietorship to a partnership),

2. Forms issued to you as an individual, with your Social Security number, rather than to your C corporation, S corporation or partnership, with its taxpayer identification number,

3. Incorrect amounts due to a mid-tax year sale or purchase of a business, and

4. Duplicate payments that appear on both a Form 1099-K and either a Form 1099-MISC or a Form 1099-NEC, “Nonemployee Compensation.”

If you receive a form with errors in your taxpayer identification number or payment amount, request a corrected form from the PSE and maintain records of all related correspondence.

Don’t dawdle

It may seem tempting to put off the steps necessary to establish solid recordkeeping procedures for payments from third-party networks, but that would be a mistake. We can help you set up the necessary processes and procedures now so you’re in compliance and not scrambling at tax time.

© 2022

2022 deadlines for reporting health care coverage information

Ever since the Affordable Care Act was signed into law, business owners have had to keep a close eye on how many employees they’ve had on the payroll. This is because a company with 50 or more full-time employees or full-time equivalents on average during the previous year is considered an applicable large employer (ALE) for the current calendar year. And being an ALE carries added responsibilities under the law.

What must be done

First and foremost, ALEs are subject to Internal Revenue Code Section 4980H — more commonly known as “employer shared responsibility.” That is, if an ALE doesn’t offer minimum essential health care coverage that’s affordable and provides at least “minimum value” to its full-time employees and their dependents, the employer may be subject to a penalty.

However, the penalty is triggered only when at least one of its full-time employees receives a premium tax credit for buying individual coverage through a Health Insurance Marketplace (commonly referred to as an “exchange”).

ALEs must do something else as well. They need to report:

1. Whether they offered full-time employees and their dependents the opportunity to enroll in minimum essential coverage under an eligible employer-sponsored plan,

2. Whether the offered coverage was affordable and provided at least minimum value, and

3. Certain other information the IRS uses to administer employer shared responsibility.

The IRS has designated Forms 1094-C and 1095-C to satisfy these reporting requirements. Each full-time employee, and each enrolled part-time employee, must receive a Form 1095-C. These forms also need to be filed with the IRS. Form 1094-C is used as a transmittal for the purpose of filing Forms 1095-C with the IRS.

3 key deadlines

If your business was indeed an ALE for calendar year 2021, put the following three key deadlines on your calendar:

February 28, 2022. This is the deadline for filing the Form 1094-C transmittal, as well as copies of related Forms 1095-C, with the IRS if the filing is made on paper.

March 2, 2022. This is the deadline for furnishing the written statement, Form 1095-C, to full-time employees and to enrolled part-time employees. Although the statutory deadline is January 31, the IRS has issued proposed regulations with a blanket 30-day extension. ALEs can rely on the proposed regulations for the 2021 tax year (in other words, forms due in 2022).

In previous years, the IRS adopted a similar extension year-by-year. The extension in the proposed regulations will be permanent if the regulations are finalized. No other extensions are available for this deadline.

March 31, 2022. This is the deadline for filing the Form 1094-C transmittal and copies of related Forms 1095-C with the IRS if the filing is made electronically. Electronic filing is mandatory for ALEs filing 250 or more Forms 1095-C for the 2021 calendar year. Otherwise, electronic filing is encouraged but not required.

Whether you’re a paper or electronic filer, you can apply for an automatic 30-day extension of the deadlines to file with the IRS. However, the extension is available only if you file Form 8809, “Application for Extension of Time to File Information Returns,” before the applicable due date.

Alternative method

If your company offers a self-insured health care plan, you may be interested in an alternative method of furnishing Form 1095-C to enrolled employees who weren’t full-time for any month in 2021.

Rather than automatically furnishing the written statement to those employees, you can make the statement available to them by posting a conspicuous plain-English notice on your website that’s reasonably accessible to everyone. The notice must state that they may receive a copy of their statement upon request. It needs to also include:

1. An email address for requests,

2. A physical address to which a request for a statement may be sent, and

3. A contact telephone number for questions.

In addition, the notice must be written in a font size large enough, including any visual clues or graphical figures, to highlight that the information pertains to tax statements reporting that individuals had health care coverage. You need to retain the notice in the same location on your website through October 17, 2022. If someone requests a statement, you must fulfill the request within 30 days of receiving it.

Identify your obligations

Although the term “applicable large employer” might seem to apply only to big companies, even a relatively small business with far fewer than 100 employees could be subject to the employer shared responsibility and information reporting rules. We can help you identify your obligations under the Affordable Care Act and assess the costs associated with the health care coverage that you offer.

© 2022

Michigan Pass-Through Entity Tax Enacted – What You Need to Know for 2021 and 2022

Post updated 2/24/2022

Michigan Gov. Gretchen Whitmer signed House Bill 5376 on December 20, 2021, which allows owners of Flow-Through Entities (S-Corporations & Partnerships) the option to pay and deduct their state and local income taxes at the business-entity level instead of individually.

The new tax election option is not available to disregarded entities. 

The Entity Level tax rate is 4.25% (Same rate as the Michigan individual income tax rate). 

This new tax mirrors the so-called State and Local Tax (SALT) cap workaround enacted by several other states and is designed to avoid the $10,000 federal limit on individual itemized deductions for state and local taxes.

Importantly, the new tax election is available retroactively for years beginning in 2021.  Therefore, pass-through entities, and their owners, may want to consider making this election for the current tax year.

·       The election to file for the 2021 tax year must be made by the 15th day of the fourth month after the taxpayer’s tax year-end and the tax due must be paid with the election (April 15, 2022 for calendar year taxpayers).

·       The election to file for tax years 2022 and beyond must be made by the 15th day of the third month after the taxpayer’s year end and the first quarter tax estimate must be made with the election (March 15, 2022 for calendar year taxpayers).

·       This election is an irrevocable election for a three-year filing period.

To ensure a 2021 Federal tax deduction, cash basis taxpayers had to act quickly as the Michigan estimate needed to be paid before December 31, 2021, to be deductible at the Federal level.  If taxpayers were unable to make a payment by December 31, 2021, the benefit is not lost – it is simply deferred to the 2022 tax year.

The Michigan Department of Treasury continues to issue ongoing guidance relative to the implementation of the law and administration of payment and tax filing procedures.  At this time, all payments are to be made through the Michigan Treasury Online website (MTO) and all returns will need to be electronically filed through the same site by the taxpayers, or their designated representatives.

Your FMD Advisors are following this closely.  If you have any questions, please contact your FMD Advisor right away.   

For further information on this topic feel free to visit the following link to the State of Michigan Website:  https://www.michigan.gov/taxes/0,4676,7-238-43976-574512--,00.html

The Infrastructure Investment and Jobs Act includes tax-related provisions you’ll want to know about

Almost three months after it passed the U.S. Senate, the U.S. House of Representatives has passed the Infrastructure Investment and Jobs Act (IIJA), better known as the bipartisan infrastructure bill. While the bulk of the law is directed toward massive investment in infrastructure projects across the country, a handful of noteworthy tax provisions are tucked inside it. Here’s what you need to know about them.

Early termination of the Employee Retention Credit

The IIJA terminates the Employee Retention Credit (ERC) created by the CARES Act earlier than originally planned. The American Rescue Plan Act (ARPA) had extended the credit to eligible employers for the third and fourth quarters of 2021. Under the new law, the ERC — which for 2021 is worth up to $7,000 per qualifying employee per quarter — is no longer available for wages paid after September 30, 2021 (rather than December 31, 2021), except for so-called “recovery startup businesses.”

The ARPA generally defines recovery startup businesses as those that began operating after February 15, 2020, and have annual gross receipts for the three previous tax years of less than or equal to $1 million. These employers can claim the ERC for up to $50,000 total per quarter for the third and fourth quarters of 2021, without showing suspended operations or reduced receipts.

New information reporting on digital assets

The IIJA requires brokers to report to the IRS the cost basis of digital assets transferred by their clients to nonbrokers, similar to how securities brokers report stock and bond trades. “Digital assets” are defined as “any digital representation of value which is recorded on a cryptographically secured distributed ledger or any similar technology.” This definition could ensnare not only cryptocurrencies like Bitcoin and Ethereum, but also certain nonfungible tokens (NFTs). The IIJA expands the definition of the term “broker” to include those who operate trading platforms for digital assets, such as cryptocurrency exchanges.

In addition, the IIJA modifies existing tax law to treat digital assets as cash. As a result, individuals engaged in a trade or business must submit IRS Form 8300, “Report of Cash Payments Over $10,000 Received in a Trade or Business,” when they receive such amounts in one transaction or multiple related transactions.

The digital assets provisions take effect for returns required to be filed, and statements required to be furnished, after December 31, 2023. The IRS is expected to provide guidance before that time, but some businesses may find that accepting cryptocurrencies for payment isn’t worth the reporting burden.

Miscellaneous tax provisions

The IIJA extends several excise taxes used to fund highway spending, extends and modifies certain Superfund excise taxes, and allows private activity bonds for qualified broadband projects and carbon dioxide capture facilities. It extends pension funding relief and expands certain IRS administrative relief for taxpayers affected by federally declared disasters and “significant fires.”

More to come

The majority of the Democrats’ proposed tax law changes, to the extent they survive ongoing negotiations, will be included in the Build Back Better Act (BBBA). The BBBA could, for example, have significant provisions regarding the child tax credit, the cap on the state and local tax deduction, and limits on the business interest expense deduction. We’ll keep you current on the developments that could affect both your personal and business’s bottom lines.

© 2021

Working remotely from “out of state” can be taxing

The COVID-19 pandemic has required many people to work remotely, either from home or a temporary location. One potential consequence of remote work may surprise you: an increase in your state tax bill.

During the pandemic, it’s been fairly common for people to work remotely from another state — across state lines from the employer’s place of business or even across the nation. If that describes your situation, you may need to file tax returns in both states, potentially triggering additional state taxes. But the outcome depends on applicable law, which varies from state to state.

Watch out for double taxation

Generally, a state’s power to tax a person’s income is based on concepts such as domicile and residence. If you’re domiciled in a state — that is, you have your “true, fixed permanent home” there — the state has the power to tax your worldwide income. A state also may tax your income if you’re a “resident.” Usually, that means you have a dwelling in the state and spend a minimum amount of time there.

It’s possible to be domiciled in one state but a resident of another, which may require you to pay taxes to both states on the same income. Many states offer relief from such double taxation by providing credits for taxes paid to other states. But it’s still possible for remote work to result in higher taxes — for example, if the state where your employer is based, and where you usually live, has no income tax but you work remotely from a state with an income tax.

A state also may be able to tax your income if it’s derived from a source within the state, even if you aren’t a resident or domiciliary. Several states have so-called “convenience rules”: If you’re employed by an organization in the state, but live and work in another state for your convenience (not because the job requires it), then you owe income tax to the state where the employer is based.

If that happens, you also may owe tax to the state where you reside, which may or may not be reduced by credits for taxes paid to the other state. Some states have agreed not to impose their taxes on remote workers who are present in their state as a result of the pandemic. But in many other states there’s a risk of double taxation.

Know your options

If you’ve worked remotely from out of state in 2021, consult your tax advisor to determine whether you’re liable for taxes in both states. If so, ask if there are steps you can take to soften the blow.

©2021

Rental real estate - Determining if a property is a business or an investment

If you own rental real estate, its classification as a trade or business rather than an investment can have a big impact on your tax bill. The distinction is especially important because of the 20% Section 199A deduction for certain sole proprietors and pass-through entity owners.

The 199A deduction is available for qualified business income (QBI), which can come from an eligible trade or business, but not from an investment. So, assuming you otherwise meet the requirements, qualifying your rental real estate activities as a trade or business may yield substantial tax savings. Fortunately, an IRS Revenue Procedure establishes a safe harbor.

A brief review

The 199A deduction is too complex to cover fully here. But, in general, it allows owners of sole proprietorships and pass-through entities — partnerships, S corporations and, generally limited liability companies (LLCs) — to deduct as much as 20% of their net business income, without the need to itemize.

Eligible owners are entitled to the full deduction so long as their taxable income doesn’t exceed an inflation-adjusted threshold (for tax year 2021, $164,900 for singles and heads of households; $329,800 for joint filers). Above the threshold, the deduction may be reduced or eliminated for businesses that perform certain services or lack sufficient W-2 wages or depreciable property.

Rental real estate guidance

According to the IRS, for purposes of the 199A deduction, an enterprise is a trade or business if it qualifies as such under Internal Revenue Code Section 162. That section doesn’t expressly define “trade or business” — it’s determined on a case-by-case basis based on various factors. Generally, a trade or business is an activity conducted “on a regular, continuous and substantial basis” with the aim of earning a profit.

Uncertainty over whether rental real estate qualifies, especially for taxpayers with one or two properties, prompted the IRS to issue Revenue Procedure 2019-38 to establish a safe harbor. Under the Revenue Procedure, a rental real estate enterprise (RREE) is deemed a trade or business if the taxpayer (you or a “relevant pass-through entity” in which you own an interest):

·      Maintains separate books and records for the enterprise,

·      Performs at least 250 hours of rental services per year (for an enterprise that’s at least four years old, this requirement is satisfied if you meet the 250-hour test in at least three of the last five years),

·      Keeps logs, time reports or other contemporaneous records detailing the services performed, and

·      Files a statement with his or her tax return.

The Revenue Procedure lists the types of services that count toward the 250-hour minimum and clarifies that they may be performed by the owner or by employees or contractors. It also defines an RREE as one or more rental properties held directly by the taxpayer or through disregarded entities (for example, a single-member LLC).

Generally, taxpayers must either treat each rental property as a separate enterprise or treat all similar properties as a single enterprise. Commercial and residential properties, for example, can’t be combined in the same enterprise.

Planning opportunities

There may be opportunities to restructure rental activities to take full advantage of the safe harbor. For example, Marilyn owns a rental residential building and a rental commercial building and performs 125 hours of rental services per year for each property. As noted, she can’t combine the properties into a single enterprise, so she doesn’t pass the 250-hour test.

But let’s say she exchanges the residential building for another commercial building for which she provides 125 hours of services. Then she can treat the two commercial buildings as a single enterprise and qualify for the safe harbor (provided the other requirements are met).

Don’t try this at home

The tax treatment of rental real estate is complex. To take advantage of the 199A deduction or other tax benefits for rental real estate, consult your tax advisor.

Sidebar: Are you a real estate professional?

Ordinarily, taxpayers who “materially participate” in a trade or business are entitled to deduct losses against wages or other ordinary income and to avoid net investment income tax on income from the business. The IRS uses several tests to measure material participation. For example, you materially participate in an activity if you devote more than 500 hours per year, or if you devote more than 100 hours and no one else participates more.

Rental real estate, however, is generally deemed to be a passive activity — that is, one in which you don’t materially participate — regardless of how much time you spend on it. There’s an exception, however, for “real estate professionals.”

To qualify for the exception, you must spend at least 750 hours per year — and more than half of your total working hours — on real estate businesses (such as development, construction, leasing, brokerage or management) in which you materially participate. (The hours you spend as an employee don’t count, unless you own at least 5% of the business.)

© 2021

A cost segregation study is one way to boost cash flow

If your business is planning to buy, build or substantially improve real property, a cost segregation study can help you accelerate depreciation deductions, reducing your taxes and boosting your cash flow. Even if you’ve invested in real property in previous years, you may have an opportunity to do a lookback study and catch up on the deductions you missed.

How it works

Generally, commercial real property (other than land) is depreciable over 39 years, and residential real property is depreciable over 27.5 years. A cost segregation study identifies real estate components that are properly treated as personal property depreciable over, say, five or seven years, or land improvements depreciable over 15 years. By allocating a portion of your costs to these shorter-lived assets, you can accelerate depreciation deductions and substantially reduce your tax bill. And if these assets qualify for bonus depreciation, the tax savings can be even greater.

In some cases, assets that qualify as personal property are apparent. Examples include furniture, fixtures, equipment and machinery. But often, property eligible for accelerated depreciation is less obvious. For example, building components that ordinarily would be treated as real property depreciable over 39 years may be classified as five- or seven-year property if they’re essential to special business functions.

An example: A manufacturing company built a $20 million factory and placed it in service in June 2021. To accommodate its manufacturing processes, the design called for a reinforced foundation, specialized electrical and plumbing systems, and other structural components closely related to manufacturing functions.

A cost segregation study supports allocation of $6 million of the factory’s cost to these components, which are depreciable over seven years rather than 39 years. As a result, the company increases its depreciation deductions by approximately $774,000 in Year 1, $1.05 million in Year 2 and $895,000 in year three (not counting any available bonus depreciation).

Recovering deductions

Suppose you invested in a building several years ago but allocated the entire cost to real property. Depending on how much time has passed and the documentation you have available, it may be possible to conduct a lookback study and reallocate a portion of the cost to shorter-lived personal property. Applying to the IRS for a change in accounting method may allow you to claim a catch-up deduction for the extra depreciation deductions you missed over the years.

Is it right for you?

Are you wondering if a cost segregation study would pay off for your business? Your tax advisor can help you weigh the potential tax savings against the cost of a study.

© 2021

Thinking about participating in your employer’s 401(k) plan? Here’s how it works

Employers offer 401(k) plans for many reasons, including to attract and retain talent. These plans help an employee accumulate a retirement nest egg on a tax-advantaged basis. If you’re thinking about participating in a plan at work, here are some of the features.

Under a 401(k) plan, you have the option of setting aside a certain amount of your wages in a qualified retirement plan. By electing to set cash aside in a 401(k) plan, you’ll reduce your gross income, and defer tax on the amount until the cash (adjusted by earnings) is distributed to you. It will either be distributed from the plan or from an IRA or other plan that you roll your proceeds into after leaving your job.

Tax advantages

Your wages or other compensation will be reduced by the amount of pre-tax contributions that you make — saving you current income taxes. But the amounts will still be subject to Social Security and Medicare taxes. If your employer’s plan allows, you may instead make all, or some, contributions on an after-tax basis (these are Roth 401(k) contributions). With Roth 401(k) contributions, the amounts will be subject to current income taxation, but if you leave these funds in the plan for a required time, distributions (including earnings) will be tax-free.

Your elective contributions — either pre-tax or after-tax — are subject to annual IRS limits. For 2021, the maximum amount permitted is $19,500. When you reach age 50, if your employer’s plan allows, you can make additional “catch-up” contributions. For 2021, that additional amount is $6,500. So if you’re 50 or older, the total that you can contribute to all 401(k) plans in 2021 is $26,000. Total employer contributions, including your elective deferrals (but not catch-up contributions), can’t exceed 100% of compensation or, for 2021, $58,000, whichever is less.

Typically, you’ll be permitted to invest the amount of your contributions (and any employer matching or other contributions) among available investment options that your employer has selected. Periodically review your plan investment performance to determine that each investment remains appropriate for your retirement planning goals and your risk specifications.

Getting money out

Another important aspect of these plans is the limitation on distributions while you’re working. First, amounts in the plan attributable to elective contributions aren’t available to you before one of the following events: retirement (or other separation from service), disability, reaching age 59½, hardship, or plan termination. And eligibility rules for a hardship withdrawal are very stringent. A hardship distribution must be necessary to satisfy an immediate and heavy financial need.

As an alternative to taking a hardship or other plan withdrawal while employed, your employer’s 401(k) plan may allow you to receive a plan loan, which you pay back to your account, with interest. Any distribution that you do take can be rolled into another employer’s plan (if that plan permits) or to an IRA. This allows you to continue deferral of tax on the amount rolled over. Taxable distributions are generally subject to 20% federal tax withholding, if not rolled over.

Employers may opt to match contributions up to a certain amount. If your employer matches contributions, you should make sure to contribute enough to receive the full match. Otherwise, you’ll miss out on free money!

These are just the basics of 401(k) plans for employees. For more information, contact your employer. Of course, we can answer any tax questions you may have.

© 2021

Worker classification is still important

In 2020 and 2021, many companies have experienced “workforce fluctuations.” If your business has engaged independent contractors to address staffing needs, be careful that these workers are properly classified for federal tax purposes.

Tax obligations

The question of whether a worker is an independent contractor or an employee for federal income and employment tax purposes is a complex one. If a worker is an employee, the company must withhold federal income and payroll taxes, and pay the employer’s share of FICA taxes on the wages, plus FUTA tax. Often, a business must also provide the worker with the fringe benefits that it makes available to other employees. And there may be state tax obligations as well.

These obligations don’t apply if a worker is an independent contractor. In that case, the business simply sends the contractor a Form 1099-NEC for the year showing the amount paid (if the amount is $600 or more).

No uniform definition

The IRS and courts have generally ruled that individuals are employees if the organization they work for has the right to control and direct them in the jobs they’re performing. Otherwise, the individuals are generally independent contractors, though other factors are considered.

Some employers that have misclassified workers as independent contractors may get some relief from employment tax liabilities under Internal Revenue Code Section 530. In general, this protection applies only if an employer filed all federal returns consistent with its treatment of a worker as a contractor and treated all similarly situated workers as contractors.

The employer must also have a “reasonable basis” for not treating the worker as an employee. For example, a “reasonable basis” exists if a significant segment of the employer’s industry traditionally treats similar workers as contractors. (Note: Sec. 530 doesn’t apply to certain types of technical services workers. And some categories of individuals are subject to special rules because of their occupations or identities.)

Asking for a determination

Under certain circumstances, you may want to ask the IRS (on Form SS-8) to rule on whether a worker is an independent contractor or employee. However, be aware that the IRS has a history of classifying workers as employees rather than independent contractors.

Consult a CPA before filing Form SS-8 because filing the form may alert the IRS that your company has worker classification issues — and inadvertently trigger an employment tax audit. It may be better to properly treat a worker as an independent contractor so that the relationship complies with the tax rules.

Latest developments

In January 2021, the Trump Administration published a final rule revising the Fair Labor Standards Act’s employee classification provision. The rule change was considered favorable to employers.

The Biden Administration initially delayed the effective date and then issued a Notice of Proposed Rulemaking (NPRM) to withdraw the rule. After reviewing approximately 1,000 comments submitted in response to the NPRM, it withdrew the rule change before the deferred effective date. Contact your tax advisor for any help you may need with employee classification.

© 2021

When can you deduct business-related meals . . . and how much can you deduct?

The Tax Cuts and Jobs Act (TCJA) permanently eliminated deductions for most business-related entertainment expenses paid or incurred after 2017. For example, you can no longer deduct any of the cost of taking clients out for a round of golf, to the theater or for a football game. But the TCJA didn’t specifically address the meals, beverages and snacks that often accompany entertainment activities.

Then the Consolidated Appropriations Act (CAA), which was signed into at law in December of 2020, temporarily increased the deduction for certain business-related meal expenses.

If you’re like many business owners today, you may not be sure what you can deduct or how much you can deduct. Here’s what you need to know.

A 100% deduction

The CAA allows taxpayers to deduct 100% of the cost of business-related food and beverage expenses incurred at restaurants in 2021 and 2022. In previous years, deductions for business meals at restaurants were limited to only 50% of the cost.

Under the new law, for 2021 and 2022, business meals provided by restaurants are 100% deductible, subject to the considerations identified in preexisting IRS regulations. IRS guidance in Notice 2021-25, released in April, defines “restaurants” for the purpose of this tax break to  include businesses that prepare and sell food or beverages to retail customers for immediate on-premises and/or off-premises consumption.

However, restaurants don’t include businesses that primarily sell pre-packaged goods not for immediate consumption, such as grocery stores and convenience stores. Additionally, an employer may not treat certain employer-operated eating facilities as restaurants, even if these facilities are operated by a third party under contract with the employer.

Pre-CAA regulations

In October 2020, the IRS issued final regulations which clarified that taxpayers could still deduct 50% of business-related meal expenses under the TCJA. These regs were written before the CAA change that allows 100% deductions for business-related restaurant meals provided in 2021 and 2022, but they still provide some useful guidance on the following issues:

Definition of food and beverage costs. Food or beverages means all food and beverage items, regardless of whether they are characterized as meals, snacks, or other types of food and beverages. Food or beverage costs mean the full cost of food or beverages, including any delivery fees, tips and sales tax.

Treatment of food and beverages provided with entertainment. For purposes of the general disallowance rule for entertainment expenses, the term “entertainment” includes food or beverages only if the food or beverages are provided at or during an entertainment activity (such as a sporting event) and the costs of the food or beverages aren’t separately stated.

Specifically, to be deductible, amounts paid for food and beverages provided at or during an entertainment activity must be:

·      Purchased separately from the entertainment, or

·      Stated separately on a bill, invoice or receipt that reflects the venue’s usual selling price for such items if they were purchased separately from the entertainment or the approximate reasonable value of the items.

Otherwise, the entire cost is treated as a nondeductible entertainment expense; the taxpayer can’t attempt to allocate costs between the entertainment and the food or beverages.

Treatment of business meals. Under the final regs, a deduction is allowed for business-related food or beverages only if:

·      The expense isn’t lavish or extravagant under the circumstances,

·      The taxpayer or an employee of the taxpayer is present at the furnishing of the food or beverages, and

·      The food or beverages are provided to the taxpayer or a business associate.

A business associate means a person with whom the taxpayer could reasonably expect to engage or deal with in the active conduct of the taxpayer’s business such as a customer, client, supplier, employee, agent, partner or professional advisor — whether established or prospective.

Treatment of meals while traveling on business. Under the final regs, the long-standing rules for substantiating meal expenses still applies and they can be deductible.

The regs also reiterate the long-standing rule that no deductions are allowed for meal expenses incurred for spouses, dependents or other individuals accompanying the taxpayer on business travel (or accompanying an officer or employee of the taxpayer on business travel), unless the expenses would otherwise be deductible by the spouse, dependent or other individual. For example, meal expenses for the taxpayer’s spouse would be deductible if the spouse works in the taxpayer’s unincorporated business and accompanies the taxpayer for business reasons.

Under the new law, for 2021 and 2022, meals provided by restaurants while traveling on business are 100% deductible, subject to the preceding considerations. 

Need help?

There are additional circumstances under which your business can deduct 100% of the cost of meals, other food and beverages. Contact your tax advisor if you have questions or want more information.

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Debate continues in Congress over proposed tax changes

Negotiations continue in Washington, D.C., over the future of President Biden’s agenda. Tax law changes may be ahead under two proposed laws, the Build Back Better Act (BBBA) and the Bipartisan Infrastructure Bill (BIB), also known as the Infrastructure Investment and Jobs Act. The final provisions remain to be seen, but the BBBA and, to a lesser extent, the BIB, contain a wide range of tax proposals that could affect individuals and businesses. It’s also unclear when the tax changes would become effective, if one or both of the laws are enacted.

Here’s a summary of many of the proposals that could change the tax landscape in the near future.

Proposed tax provisions for individual taxpayers

The current version of the BBBA includes several provisions that could affect the tax liability of individual taxpayers in ways both positive and negative, depending largely on their taxable income. Among other areas, the legislation addresses:

Individual tax rates. The top marginal tax rate would return to 39.6%, the rate that was in effect before the Tax Cuts and Jobs Act (TCJA) cut it to 37% beginning in 2018. This rate would apply to the taxable income of married couples that exceeds $450,000, single filers that exceeds $400,000 and married individuals filing separately that exceeds $225,000.

A surcharge on high-income taxpayers. The BBBA would establish a new 3% tax on modified adjusted gross income above $5 million for married taxpayers filing jointly and single filers and above $2.5 million for married individuals filing separately.

The capital gains and qualified dividends tax rate. The maximum rate would increase from 20% to 25% for taxpayers in the 39.6% tax bracket. The Biden administration earlier had proposed to raise it as high as 39.6%.

The net investment income tax (NIIT). The BBBA would expand the NIIT to apply to the trade or business income of high-income individuals, regardless of whether they’re actively involved in the business. The NIIT currently applies to certain investment income and business income only if it’s passive. As a result, active business income would go from being taxed at a maximum rate of 37% under the TCJA to a maximum rate of 46.4% (the 39.6% individual income tax rate plus the 3.8% NIIT plus the 3% high-income surcharge).

This change would apply when adjusted gross income (AGI) exceeds $500,000 for married couples filing jointly, $250,000 for married couples filing separately and $400,000 for other taxpayers. Business income subject to self-employment tax would be excluded.

The qualified business income (QBI) deduction. The Section 199A deduction for pass-through entities would be limited to $500,000 for married taxpayers filing jointly, $400,000 for single filers and $250,000 for married taxpayers filing separately.

The qualified small business stock (QSBS) exclusion. Capital gains from the sale of QSBS held more than five years currently are 100% excludable from gross income. The BBBA would limit the exclusion to 50% for taxpayers with an AGI over $400,000, regardless of filing status.

Retirement planning. The BBBA would prohibit IRA contributions by taxpayers whose 1) aggregate IRA and other account balances exceed $10 million and 2) taxable income exceeds $450,000 for married couples filing jointly or $400,000 for single filers or married taxpayers filing separately. These taxpayers also would have to take required minimum distributions equal to 50% of the value that exceeds $10 million and 100% of any amount over $20 million.

Roth IRA conversions. The BBBA would prohibit certain taxpayers from first making a nondeductible contribution to a traditional IRA and then converting it to a Roth IRA (to get around restrictions on who can contribute to a Roth IRA). The proposal would apply to taxpayers with taxable income exceeding $450,000 for married taxpayers filing jointly and $400,000 for single filers and married taxpayers filing separately.

Child and dependent care tax credits. The American Rescue Plan Act (ARPA), enacted earlier this year, temporarily expanded both the Child Tax Credit (CTC) and the Dependent Care Tax Credit (DCTC). The BBBA would extend the CTC through 2025 and make permanent the DCTC.

Premium tax credits (PTCs). The ARPA also expanded the availability of PTCs to subsidize the purchase of health insurance for 2021 and 2022. The BBBA would permanently expand the credits.

Banking activity reporting. The Biden administration has proposed requiring financial institutions to annually report the total amount of funds that go in and out of bank, loan and investment accounts (personal and business) that hold a value of at least $600. Reporting also would be required if the aggregate flow in and out of an account is at least $600 in a year.

As Democrats weigh including this proposal in one of the bills, it has received pushback from banks and privacy advocates. A revised version includes a $10,000 threshold, and exemptions for some common transactions, such as payments from payroll processors and mortgage payments, also are under consideration.

Proposed tax provisions for businesses

The BBBA and BIB would also bring dramatic changes to the tax landscape for some businesses. In particular, their tax bills could be influenced by proposals related to the following:

The corporate tax rate. The BBBA would replace the TCJA’s flat rate of 21% with a graduated rate structure. The first $400,000 of income would be subject to an 18% rate, with the 21% rate retained for income between $400,000 and $5 million. The graduated corporate rate would max out at 26.5% for income exceeding $5 million.

Personal service corporations and corporations with taxable income exceeding $10 million would be subject to a flat 26.5% rate. The pre-TCJA top corporate tax rate was 35%.

Excess business losses. The TCJA limits the amount of excess business losses that pass-through entities and sole proprietors can use to offset ordinary income to $250,000, or $500,000 for married taxpayers filing jointly, adjusted for inflation. The limit is set to expire at the end of 2025, but the BBBA would make it permanent.

The bill also would create a new carryforward for unused excess business losses, rather than carrying them forward as net operating losses.

The business interest deduction. Internal Revenue Code Section 163(j) limits the deduction for business interest incurred by both corporate and noncorporate taxpayers. Under the proposal, the limit wouldn’t apply to partnerships and S corporations at the entity level. It instead would apply to the partners and shareholders.

Research and experimentation expenses. Under the TCJA, research and experimentation expenditures incurred in 2022 and later years aren’t immediately deductible; rather, they generally must be amortized over five years. The BBBA would delay the effective date for the amortization requirement to 2026.

The employee retention credit. The BIB would terminate this credit earlier than originally planned. Instead of being available for all of 2021, it would no longer be available for the fourth quarter, except for recovery startup businesses.

Carried interest. Currently, carried interests are taxed as short-term capital gains unless the gains were on property held for at least three years. The BBBA would extend the holding period to qualify for long-term capital gain treatment to five years — except for real estate businesses and taxpayers with less than $400,000 of AGI. The carried interest rules also would be expanded to cover all property treated as generating capital gains.

International transactions. The BBBA includes numerous proposals that would change the taxation of cross-border transactions and trim some of the tax advantages enjoyed by multinational corporations. For example, it would reduce the deductions for global intangible low-taxed income (GILTI) and foreign-derived intangible income. It would determine GILTI and foreign tax credit limits on a country-by-country basis. It also would make changes to the base erosion and anti-abuse tax.

Estate tax provisions

The BBBA would be much less taxpayer-friendly than the TCJA when it comes to gift and estate taxes and strategies. Most notably:

The gift and estate tax exemption. The TCJA doubled the gift and estate tax exemption to $10 million through 2025. That amount is annually adjusted for inflation (for 2021, it’s $11.7 million). The BBBA would return the exemption to its pre-TCJA limit of $5 million in 2022. The amount would continue to be adjusted annually for inflation.

Grantor trusts. The assets in these trusts would no longer be excluded from a taxable estate if the deceased is deemed the owner of the trust. In addition, sales between individuals and their grantor trusts would be taxed as if they were transfers between the individual and a third party. And distributions from a grantor trust to an individual other than the grantor or the grantor’s spouse would be treated as a taxable gift from the grantor.

Valuation discounts. Taxpayers would no longer be able to claim discounts for gift and estate tax purposes on transfers of interests in entities that hold nonbusiness assets (that is, passive assets held for the production of income and not used for an active trade or business). For example, discounts couldn’t be used to reduce the value of transferred interests in family-owned entities that hold securities.

Note: An earlier proposal to end the stepped-up basis tax break on inherited assets is no longer in the current version of the BBBA.

Stay tuned 

It’s impossible to say which proposals will survive the ongoing negotiations intact. We’ll keep you up to date if and when the final legislation is enacted. In the meantime, contact us if you have concerns about how the proposed tax provisions may affect you personally or your business.

© 2021

Disasters and your taxes: What you need to know

Homeowners and businesses across the country have experienced weather-related disasters in recent months. From hurricanes, tornadoes and other severe storms to the wildfires again raging in the West, natural disasters have led to significant losses for a wide swath of taxpayers. If you’re among them, you may qualify for a federal income tax deduction, as well as other relief from the IRS.

Eligibility for the casualty loss deduction

Casualty losses can result from the damage, destruction or loss of property due to any sudden, unexpected or unusual event. Examples include floods, hurricanes, tornadoes, fires, earthquakes and volcanic eruptions. Normal wear and tear or progressive deterioration of property doesn’t constitute a deductible casualty loss. For example, drought generally doesn’t qualify.

The availability of the tax deduction for casualty losses varies depending on whether the losses relate to personal-use or business-use items. Generally, you can deduct casualty losses related to your home, household items and personal vehicles if they’re caused by a federally declared disaster — meaning a disaster that occurred in an area that the U.S. president declares eligible for federal assistance. Casualty losses related to business or income-producing property (for example, rental property) can be deducted regardless of whether they occur in a federally declared disaster area.

Casualty losses are deductible in the year of the loss, usually the year of the casualty event. If your loss stemmed from a federally declared disaster, you can opt to treat it as having occurred in the previous year. You may receive your refund more quickly if you amend the previous year’s return than if you wait until you file your return for the casualty year.

The role of reimbursements

If your casualty loss is covered by insurance, you must reduce the loss by the amount of any reimbursement or expected reimbursement. (You also must reduce the loss by any salvage value). Reimbursement also could lead to capital gains tax liability.

When the amount you receive from insurance or other reimbursements (less any expense you incurred to obtain reimbursement, such as the cost of an appraisal) exceeds the cost or adjusted basis of the property, you have a capital gain. You’ll need to include that gain as income unless you’re eligible to postpone reporting the gain.

You may be able to postpone the reporting obligation if you purchase property that’s similar in service or use to the destroyed property within the specified replacement period. You also can postpone if you buy a controlling interest (at least 80%) in a corporation owning similar property or if you spend the reimbursement to restore the property.

Alternatively, you can offset casualty gains with casualty losses not attributable to a federally declared disaster. This is the only way you can deduct personal-use property casualty losses incurred in areas not declared disaster areas.

The loss amount vs. the deduction

For personal-use property, or business-use or income-producing property that isn’t completely destroyed, your casualty loss is the lesser of:

1. The adjusted basis of the property immediately before the loss (generally, your original cost, plus improvements and less depreciation), or

2. The drop in fair market value (FMV) of the property as a result of the casualty (that is, the difference between the FMV immediately before and immediately after the casualty).

For business-use or income-producing property that’s completely destroyed, the amount of the loss is the adjusted basis less any salvage value and reimbursements.

If a single casualty involves more than one piece of property, you must figure the loss on each separately. You then combine these losses to determine the casualty loss.

An exception applies to personal-use real property, such as a home. The entire property (including improvements such as landscaping) is treated as one item. The loss is the smaller of the decline in FMV of the entire property and the entire property’s adjusted basis.

Other limits may apply to the amount of the loss you may deduct, too. For personal-use property, you must reduce each casualty loss by $100 (after you’ve subtracted any salvage value and reimbursement).

If you suffer more than one casualty loss during the tax year, you must reduce each loss by $100 and report each on a separate IRS form. If two or more taxpayers have losses from the same casualty, the $100 rule applies separately to each taxpayer.

But that’s not all. For personal-use property, you also must reduce your total casualty losses by 10% of your adjusted gross income, after you’ve applied the $100 rule. As a result, smaller personal-use casualty losses often provide little or no tax benefit.

The requisite records

Documentation is critical to claim a casualty loss deduction. You’ll need to be able to show:

1. That you were the owner of the property or, if you leased it, that you were contractually liable to the owner for the damage,

2. The type of casualty and when it occurred,

3. That the loss was a direct result of the casualty, and

4. Whether a claim for reimbursement with a reasonable expectation of recovery exists.

You also must be able to establish your adjusted basis, reimbursements and, for personal-use property, pre- and post-casualty FMVs.

Additional relief

The IRS has granted tax relief this year to victims of numerous natural disasters, including “affected taxpayers” in Alabama, California, Kentucky, Louisiana, Michigan, Mississippi, New Jersey, New York, Oklahoma, Pennsylvania, Tennessee and Texas. The relief typically extends filing and other deadlines. (For detailed information for your state visit: https://bit.ly/3nzF2ui.)

Note that you can be an affected taxpayer even if you don’t live in a federally declared disaster area. You’re considered affected if records you need to meet a filing or payment deadline postponed during the applicable relief period are located in a covered disaster area. For example, if you don’t live in a disaster area, but your tax preparer does and is unable to pay or file on your behalf, you likely qualify for filing and payment relief.

A team effort

If you’ve incurred casualty losses this year, tax relief could mitigate some of the financial pain. We can help you maximize your tax benefits and ensure compliance with any extensions.

© 2021