Federal Tax Update – May 2021

INDIVIDUALS

In Fletcher v. Commissioner, TC Summary Opinion 2021-9, the Tax Court concluded that an individual who received social security disability payments beyond when eligibility ended must include those payments in her gross income for the year received subject to an offset of benefits for the year of the repayment.

In Chancellor v. Commissioner, TC Memo 2021-50, the Tax Court disallowed deductions for sales tax and charitable contributions (as well as $25,000 of unsubstantiated business expenses) where the taxpayer claimed her records were stolen and her testimony was vague such as her statement that she “had people that I was charitable to” including “helping with my family.”

In Bailey v. Commissioner, TC Memo 2021-55, a CPA who had previously lost his license lost multiple substantiation issues in Tax Court, the Court finding that he was unable to substantiate personal deductions as well as business deductions; in Peeples v. Commissioner, TC Summary Opinion 2021-12, the Tax Court denied all pre-2018 employee business expenses claimed by a construction worker as he provided no substantiation for his travel and special clothing.

RETIREMENT AND ESTATE PLANNING

In Estate of Jackson v. Commissioner, TC Memo 2021-48, the Tax Court in a 271 page opinion decided generally in favor of Michael Jackson’s estate on valuation issues related to intangibles, citing Jackson’s tarnished reputation, and largely rejected the expert testimony on behalf of IRS noting that the value in his image and likeness resulted from the post-death branding by his executors.

In Estate of Morrissette v. Commissioner, TC Memo 2021-60, the Tax Court determined that Code sections 2036 and 2038 do not apply to transfers made as part of split dollar agreements because of the “bona fide sale” exception.

In Estate of Grossman v. Commissioner, TC Memo 2021-65, the Tax Court allowed the marital deduction when an estate was left to the third wife despite a New York court previously finding that a Mexican divorce from the first wife was invalid; notwithstanding that the Tax Court held that New York law applied, the Court also found that New York applied the “place of celebration” test such that the third marriage, valid in Israel, must be recognized.

In Andrews v. United States, 127 AFTR2d 2021-________, the Court of Federal Claims declined to make an analogy between failure to file an extension and erroneous tax advice and found that an attorney’s failure to extend the estate tax return was not reasonable cause for abatement of the late filing and late payment penalties.

BUSINESS

In Jenkins v. Commissioner, TC Memo 2021-54, the Tax Court found that multiple corporations were “alter egos” of individuals where the search warrant led to corporate seals for 11 companies and a passport and license plates from the “Kingdom of Kerguelen” (desolate islands 3,000 miles off the southern tip of Africa and grouped with several rock formations technically a part of France).

In Berry v. Commissioner, TC Memo 2021-52, the Tax Court concluded that $9,900 in drag racing income over a two year period with far greater expenses was not part of the business purpose of a construction company in which the driver was a stockholder but belonged on a personal return (at least to the extent the expenses could be substantiated).

In Adler v. Commissioner, TC Memo 2021-56, the Tax Court denied deductions for business expenses including amounts paid to construction workers that could not be substantiated and were not evidenced by Form W-2 or 1099.

In Frederick-Bey v. Commissioner, TC Summary Opinion 2201-11, the Tax Court disallowed most of almost $60,000 in expenses claimed by a network marketer who reported gross income of $7,500, stating that the taxpayer failed to tie in the expenses to the business.

In Preimesberger v. United States, 127 AFTR2d 2021-________, a California Federal District Court declined to give summary judgment to the Government on imposition of the Trust Fund Recovery Penalty on a 10 percent stockholder when Medicare reimbursements to a nursing home were late and the terms of a line of credit allowed payment only of net payroll; Federal regulations prohibited closure of the facility which would have avoided the unpaid taxes.

In Action on Decision 2021-2, IRS expressed its disagreement with the Sixth Circuit Court of Appeals decision in Machacek v. Commissioner, 122 AFTR2d 2018-6268, which reversed the Tax Court and held that the benefit of split dollar insurance to an S corporation stockholder was taxable as a distribution and not as compensation.

In Chief Counsel Advice 202118009, IRS determined that any dividend income, including constructive dividends, received by a shareholder from a C corporation is subject to the Medicare tax on net investment income.

In Chief Counsel Advice 202118016, IRS set forth the issues associated with “monetized installment sale transactions” and found that they typically result in a deemed payment under either the “pledging rule” or the “economic benefit” doctrine.

In Chief Counsel Advice 202118019, IRS indicated that “reviewed  year partners” may need to adjust basis as the result of IRS adjustments even if the tax is paid by the partnership and not pushed out to such partners.

PROCEDURE

In CIC Services v. Internal Revenue Service, 127 AFTR2d 2021-________, a unanimous US Supreme Court reversed the Sixth Circuit Court of Appeals and narrowed the ability of IRS to avoid suits for injunctive relief; the Court permitted a challenge through the injunctive process to reporting requirements in micro-captive transactions, finding that the action was not an impermissible suit “for the purpose of restraining the assessment or collection of a tax.”

In In Re:  Givans, 127 AFTR2d 2021-________, a Florida Bankruptcy Court concluded that tax refund checks were tenants by the entirety property and not part of one spouse’s bankruptcy estate although all income was that of the bankrupt spouse. 

In Mason v. Commissioner, TC Memo 2021-64, the Tax Court determined that IRS Appeals abused its discretion by refusing in a Collection Due Process hearing to review an Offer in Compromise that had been returned by the Centralized Unit which believed it was submitted for delay.

In Ginos v. Commissioner, TC Summary Opinion 2021-14, the Tax Court denied innocent spouse status to a former wife after balancing the factors including hardship which was found nonexistent because she had remarried an individual who was paying all of her expenses.

In Chief Counsel Advice 202118010, IRS ruled that its levy cannot reach funds placed in the account on the same day but after the time when the levy was actually made. 

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Dissecting 2021’s Tax Proposals: What CPAs Need to Know

From Biden’s ambitious legislative agenda to the bills sponsored by his Democratic colleagues, here are the most important tax proposals CPAs and their clients should be aware of.

Over the past few weeks, President Joe Biden has outlined an ambitious agenda composed of three parts: the Made in America Tax Plan, the American Jobs Plan, and the American Families Plan. All three plans include major tax implications: The Made in America Tax Plan would increase corporate taxes to pay for the $2.3 trillion in infrastructure investment contained in the American Jobs Plan, while the American Families Plan would raise tax rates on taxpayers earning more than $400,000 a year and increase capital gains taxes. At the same time, other big tax bills are being floated: Sen. Bernie Sanders released his For the 99.5 Percent Act, Sen. Elizabeth Warren introduced the Ultra-Millionaire Tax Act, and a Democratic coalition proposed the Sensible Taxation and Equity Promotion (STEP) Act.

With so many tax measures in the works, here are the most important changes CPAs and financial planners should be considering and discussing with their clients.

Higher Individual Income Tax Rates
In the American Families Plan, Biden proposes raising the top individual tax rate on earners with more than $400,000 of annual income from 37 percent to 39.6 percent. Individuals earning more than $1 million would be subject to ordinary income tax rates as high as 39.6 percent on their long-term capital gains and qualified dividends.

Expansion of the Net Investment Income Tax
Under current law, a 3.8 percent net investment income tax is imposed on investment income. Biden’s proposal doesn’t give many details but references expanding this tax to all income in excess of $400,000, including active business income.

Elimination of Tax-Free Like-Kind Exchanges
Currently, gains on transfers of real estate can be tax-free if the taxpayer defers the gain on a property by exchanging it for a different one. Biden’s plan would eliminate this strategy for gains exceeding $500,000.

Elimination of Carried Interest
Biden’s plan calls for the elimination of the favorable capital gains tax treatment of carried interest. Although the benefit of capital gains rates on carried interest would be eliminated by the general increase in tax rates for high-wealth individuals, Biden has expressed an intent to make structural changes to the treatment of carried interest so that any future reduction in capital gains rates would not benefit allocations on carried interest.

New Ultra-Wealth Tax
Warren’s Ultra-Millionaire Tax Act would implement an annual 2 percent tax on wealth over $50 million and a 3 percent tax on wealth that exceeds $1 billion.

Changes to Estate and Gift Taxes
The 2021 estate tax exemption threshold is $11.7 million per individual (indexed for inflation) with a top tax rate of 40 percent. After 2025, this amount is scheduled to revert to the pre-2018 exemption, an indexed amount that would equate to approximately $5.8 million. While not in the his American Families Plan, Biden’s campaign platform would accelerate the reduction and lower the exemption to $3.5 million with a flat tax rate of 45 percent. Sanders’ For the 99.5 Percent Act also proposes to reduce the estate tax exemption amount to $3.5 million for an individual or $7 million for a married couple. Sanders’ proposal would tax estates of $3.5 million to $10 million at 45 percent, but larger estates would be taxed at higher rates, topping out at 65 percent for estates of $1 billion or more. Additionally, Sanders’ plan proposes that certain estate planning trust strategies and structures, such as valuation discounts of non-businesss transfers, grantor-retained annuity trusts (GRATs), spousal lifetime access trusts (SLATs), or dynasty trusts, could be modified or eliminated, changes which could be effective as early as the date of the enactment of the bill into law. Sanders’ plan would also reduce the current gift tax exemption to only $1 million from $11.7 million and impose a new annual limit of $30,000 on non-taxable gifts that cannot be immediately liquidated such as gifts to trusts, in any one year, effective Jan. 1, 2022.

Elimination of the “Basis Step-up”
The American Families Plan includes a proposal to eliminate the basis step-up by taxing all unrealized gains in excess of $1 million for individuals or $2.5 million for couples as of the date of death.  The STEP Act also would eliminate the “basis step-up” at death, retroactive to Jan. 1, 2021. Currently, a future capital gains tax upon disposition of an inherited asset is based on its value at the time of death or six months later, referred to as the basis step-up. The STEP Act would cause gain recognition on assets transferred by gift, by a distribution from a trust, and upon death, subject to limited exceptions.

Interestingly, Biden’s plans thus far have not included several of his key campaign proposals, such as limits on itemized deductions, changes to retirement plan contributions, increased payroll taxes, and changes to estate tax exemptions and rates.  The $10,000 state and local tax limitation was also not addressed.  This may mean more tax proposals are on the way—and if even half of the above-mentioned proposals become law, there will be enormous changes to the tax system which we need to start preparing for now. This is the perfect time to reach out to your clients to discuss these proposed changes and to propose new tax strategies for them and their families.

Federal Tax Update – April 2021

INDIVIDUALS

In Haghnazarzadh v. Commissioner, TC Memo 2021-47, the Tax Court agreed with IRS that over $6.7 million in unexplained bank deposits constituted income to a couple who provided no specifics in their testimony that the deposits were non taxable.

In Baum v. Commissioner, TC Memo 2021-46, a couple was denied a theft loss for $300,000 that they had invested in a water purification company as they were unable to prove fraud or false representations in the inducement; the Court noted in any event that there was a “reasonable prospect of recovery” in bankruptcy proceedings.

In Action on Decision 2021-1, IRS announced its nonacquiescence in Schrieber v. Commissioner, TC Memo 2017-32, in which the Tax Court decided that a retirement plan interest that could not be cashed in or borrowed against does not count as an asset for purpose of the insolvency exclusion.

In Letter Ruling 202114001, IRS determined that a male same sex couple cannot deduct surrogacy expenses paid to the sister of one of the couple but can deduct their own directly attributable expenses.

In Letter Ruling 202115004, IRS allowed revocation of an election out of the installment method where the regular preparer was sick and the taxpayer hired a new accountant who reported the entire gain on the return in the year of sale, IRS noting that the taxpayer did not use hindsight in requesting relief and was not motivated by an intent to “avoid” taxes.

BUSINESS

In Berry v. Commissioner, TC Memo 2021-42, the Tax Court determined that a check of $250,000 from a major client of a development company intended to start an unrelated auto racing activity constituted income to the recipient corporation where it could not prove the intention of a capital contribution or loan. 

In De Los Santos v. Commissioner, 156 TC No. 9, the Tax Court concluded that the compensatory element of split dollar life insurance is income to an S corporation shareholder and is not a distribution attributable to the stock.

In Mylan Inc. v. Commissioner, 156 TC No. 10, the Tax Court determined that legal fees incurred as part of the process to obtain FDA approval of drugs had to be capitalized; however, the Court ruled that legal expenses incurred in defending against patent infringement claims were deductible as ordinary and necessary business expenses.

In Olsen v. Commissioner, TC Memo 2021-41, the Tax Court denied depreciation deductions and solar energy tax credits to investors in a tax shelter alleged to be a solar business; the Court found that the underlying assets were never placed in service and that there was no attempt to derive a genuine profit aside from the purported tax savings benefit.

In Plentywood Drug v. Commissioner, TC Memo 2021-25, the Tax Court disagreed with IRS and found that four pharmacy owners were being paid fair market rent by their controlled corporation notwithstanding the lack of a written lease and the informal manner in which they determined the rent by calling up shops in town and the neighboring town. 

In Patients Mutual Assistance Collective Corporation v. Commissioner, 127 AFTR2d 2021-________, the Ninth Circuit Court of Appeals agreed with the Tax Court that a large marijuana dispensary did not get to inventory disallowed expenses as a “workaround” to the denial of business expenses beyond cost of goods sold.

In United States v. Edwards, 127 AFTR2d 2021-________, the Eleventh Circuit Court of Appeals agreed with a Georgia Federal District Court that a business owner who became aware of unpaid payroll taxes after they had accrued was personally liable because he did not use all unencumbered funds to pay the back taxes notwithstanding that he tried to keep the company going to preserve its ability to repay the tax debt.

In Notice 2021-25, IRS confirmed that the 100 percent business meals deduction for 2021 and 2022 applies not only to meals on premises but also otherwise eligible takeout meals though not from an establishment such as a grocery store, drug store or convenience store that primarily sells food not for immediate consumption.

PROCEDURE

In United States v. Rum, 127 AFTR2d 2021-________, the Eleventh Circuit Court of Appeals agreed with a Florida District Court that an individual who owned several stores and opened a numbered overseas bank account was liable for the willfulness penalty for failing to file an FBAR; the taxpayer attempted to blame his failure on preparers but two returns were marked as self-prepared.

In Landa v. United States, 127 AFTR2d 2021-________, the Court of Federal Claims concluded that the IRS definition of “beneficial interest” controls whether an individual has a reporting requirement for a foreign bank account and not the local law of the particular country; the Court also concluded that the 50 percent willfulness penalty is not a “cruel and unusual punishment.”

In Mendu v. United States, 127 AFTR2d 2021-259, the Court of Federal Claims determined that the FBAR penalty is not a tax requiring full payment in order to obtain court jurisdiction, meaning that a taxpayer can pay a minimal amount to challenge imposition.

In United States v. Page, 127 AFTR2d 2021-________, an Arizona Federal District Court concluded that the two-year period for IRS to recover erroneous refunds, in this case almost $300,000, is measured from the date of receipt of the check and not from its negotiation which was more than one year later. 

In Mattson v. United States, 127 AFTR2d 2021-1539, the Court of Federal Claims determined that a couple did not sign amended returns and IRS properly did not process a claim for refund.

In In Re:  Juntoff, 127 AFTR2d 2021-________, an Ohio Bankruptcy Court opined that the shared responsibility payment is not a tax measured by income or gross receipts and is not an excise tax on a transaction and, accordingly, is dischargeable in bankruptcy.

In United States v. Helton, 127 AFTR2d 2021-________, the Sixth Circuit Court of Appeals agreed with a Tennessee Federal District Court that a self-employed attorney could not discharge otherwise dischargeable income tax debts for years in which he drove an expensive car, purchased numerous luxury gifts for his wife and ate at restaurants almost every day.

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Federal Tax Update – March 2021

INDIVIDUALS

Public Law 117-2, the American Rescue Tax Plan of 2021:

●          Creates a $1,400 credit in 2021 for most individuals with an additional $1,400 for each dependent phased out at adjusted gross income between $150,000-$160,000 for married couples, $112,500-$120,000 for heads of household and $75,000-$80,000 for single individuals; an advanced payment is based on 2020 AGI (2019 if the 2020 return is unfiled) and may not be offset by federal and state tax debt or unpaid support.

●          Makes taxfree the first $10,200 of unemployment benefits received by an individual in 2020 if the return shows modified adjusted gross income of less than $150,000; an exclusion of up to $20,400 is available on a joint return if each spouse had over $10,200 in benefits.

●          Excludes discharge of most government, school and private student loans from income for 2021-2025.

●          Modifies the child tax credit for 2021 to increase the amount to $3,600 for a child under 6 and to $3,000 for a child 6-17 (up from age 16) with a phaseout at 5 percent of excess modified AGI to the pre-2021 level beginning at $150,000 for married couples, $112,500 for heads of household and $75,000 for single individuals; an advanced payment of 50 percent of the credit is available July 1, 2021 with a phased-in repayment obligation on the first $2,000 in overpayments by those with modified AGI over $60,000-$120,000 for married couples, $50,000-$100,000 for heads of household and $40,000-$80,000 for singles.

●          Modifies the earned income tax credit for 2021 to allow higher 2019 income to be used in computations while lowering the minimum age for eligibility for those without children from 25 to 19 (to 24 for students) and eliminating the upper age limit of 65 while increasing the maximum credit from $543 to $1,502 by adjusting the minimum income necessary for the credit as well as the phaseout amount.

●          Permanently raises the disqualifying investment income limitation for the earned income credit from $3,650 to $10,000 adjusted for COLA, modifies the childless earned income credit to be claimed by individuals whose children do not have social security numbers and allows the earned income credit to be claimed on a married filing separate return if the individual lives with a qualifying child for more than one-half of the year and does not live with spouse for the last six months of the year (or have a separation or divorce instrument).

●          Modifies the dependent care credit for 2021 to create refundability, increases the cap on qualifying expenses from $3,000 to $8,000 for those with one child and from $6,000 to $16,000 for two or more children and increases the credit rate to 50 percent of expenses for those with adjusted gross income under $125,000 phasing down to 20 percent at $185,000 and phasing out from 20 percent to zero between $400,000 and $440,000.

In In Re:  Petty, 127 AFTR2d 2021-________, a Florida Bankruptcy Court noted that issuance of a Form 1099-C by the mortgage lender to charge off the debt for accounting purposes does not make the debt legally uncollectible, stating that the form should not have been issued in the absence of actual discharge.

In Clay v. Commissioner, 127 AFTR2d 2021-________, the Eleventh Circuit Court of Appeals agreed with the Tax Court that casino profits divided among members of a Native American nation are taxable as such income was not exempted in the settlement agreement with the nation as the treaty exemption applies only to transferred land and money.

In Mathews v. Commissioner, TC Memo 2021-28, the Tax Court reached a different result than in a prior case, here as to gross income from ministry shown on a Schedule C where the preparer wrote down $11,000 in income and $31,000 in expenses that did not exist; the Court disallowed the deductions but did not tax the full-time trucking company employee on the phony gross receipts.

In Martin v. Commissioner, TC Memo 2021-35, the Tax Court disallowed a decade-old net operating loss for lack of substantiation of the losses in the early years.

In Chiarelli v. Commissioner, TC Memo 2021-27, the Tax Court denied a deduction for alleged contributions to Goodwill and the Salvation Army of almost $100,000 of household items described as being in excellent condition; however, the taxpayer left huge portions Form 8323 unanswered; in Pankratz v. Commissioner, TC Memo 2021-26, the Tax Court declined to excuse noncompliance and permit the charitable deduction of amounts in excess of $3.5 million for a building and oil and gas projects where the taxpayer did not review his own return to see if the required appraisals were included.

In Pichardo v. Commissioner, TC Summary Opinion 2021-7, the Tax Court reiterated that employee business expenses under pre-2018 law were only deductible if the employee was barred from reimbursement by written policy or ad hoc decision with the employee having to prove the inability to get reimbursement; the taxpayer lost on this issue but would also have lost for inadequate substantiation.

In Announcement 2021-7, IRS announced that amounts paid for personal protective equipment such as masks and hand sanitizers for the primary purpose of preventing COVID may be deducted as medical expenses subject to the 7.5 percent floor and are eligible for reimbursement under various flexible spending arrangements. 

RETIREMENT AND ESTATE PLANNING

Public Law 117-2, the American Rescue Tax Plan of 2021, increases the time period for defined benefit plans to make up certain actuarial shortfalls from seven to 15 years, effective for 2019 plan years.

In Catania v. Commissioner, TC Memo 2021-33, the Tax Court agreed with IRS that a withdrawal from an IRA between ages 55 and 59½ for living expenses is subject to the penalty for early withdrawal though withdrawn funds were in an employer plan until moved to an IRA at age 55.

In Notice 2021-21, IRS extended the period for opening IRAs and/or making 2020 contributions until the lengthened individual return deadline of May 17, 2021.

BUSINESS

Public Law 117-2, the American Rescue Tax Plan of 2021:

●          Increases for 2021 the maximum exclusion on employer paid dependent care from $5,000 to $10,500.

●          Extends the employer payroll tax credit for paid sick and family leave for six months through September 30, 2021, restarting the 10-day limit on April 1, 2021, expanding it thereafter to include time off for vaccinations and increasing the maximum from $10,000 to $12,000.

●          Extends the employee retention credit for six months through 2021, increasing the maximum credit for 2021 from $20,000 to $28,000; businesses started after February 15, 2020 with gross receipts under $1 million get a maximum credit of $50,000 for 2021 and those whose receipts are less than 10 percent of the equivalent 2019 quarter have no ceiling.

●          For 2021 and 2022 expands eligibility for the premium tax credit  by eliminating the phaseout and reducing the required contribution toward the premium to 0 percent to 8.5 percent of household income and for 2021 treats a single week of receiving unemployment compensation as automatically meeting income eligibility rules.

In Gaylor Land & Development v. Commissioner, TC Memo 2021-30, the Tax Court denied a $1.2 million deduction for a construction company’s payment to a captive insurance company for lack of risk shifting and distribution where the risks tied back to one entity and were not spread out to show independence by the captive.

In Purple Heart Patient Center v. Commissioner, TC Memo 2021-38, the Tax Court denied a medical marijuana dispensary a deduction even for cost of goods sold where substantiation was destroyed and cost of goods sold could not be reliably estimated.

In Max v. Commissioner, TC Memo 2021-37, the Tax Court agreed with IRS that the process of designing clothing including fit testing and fabric testing, is not eligible for the research credit as the production process is nontechnical and concerned more with style, taste and seasonality.

In Ward v. Commissioner, TC Memo 2021-32, the Tax Court treated all distributions from an S corporation as compensation to an attorney who failed to take any salary for the entity.

In Chief Counsel Advice 202111012, IRS concluded that the inclusion of gambling expenses with gambling losses through 2025 applies only to individuals, even if in the business of gambling, and not to casinos or similar.

PROCEDURE

In Walton v. Commissioner, TC Memo 2021-40, the Tax Court ruled that an accuracy related penalty applies when gross receipts were understated on the return although the taxpayer claimed that she had told her CPA of the proper number while giving the preparer only the 1099s that she could locate. 

In United States v. Boyd, 127 AFTR2d 2021-________, the Ninth Circuit Court of Appeals reversed a California Federal District Court and found that IRS could impose only a single $10,000 penalty per year for nonwillful failure to file an FBAR for 14 accounts; in United States v. Giraldi, 127 AFTR2d 2021-________, a New Jersey Federal District Court agreed, however, the Courts remain deeply divided.

In Kimble v. United States, 127 AFTR2d 2021-________, the Federal Circuit Court of Appeals agreed with the Court of Federal Claims that failure to report an inherited Swiss bank account on an FBAR for many years constituted willfulness despite the taxpayer respecting the wishes of her father to keep it secret in case of persecution and the need to leave the country; in United States v. Gentges, 127 AFTR2d 2021-________, a New York Federal District Court found an individual to have willfully violated the FBAR reporting requirement where he did not review the return and the preparer’s software defaulted to a “no” in the absence of input to the contrary.

In Jones v. Mnuchin, 127 AFTR2d 2021-________, a Georgia Federal District Court once again found that the deprivation of passports to tax delinquents does not violate their constitutional rights, the Court rejecting arguments under the Privileges & Immunities Clause as well as the First, Fifth, Ninth and Fourteenth Amendments; in Rowen v. Commissioner, 156 TC No 8, the Tax Court found that the legislation restricting passports in the case of serious tax delinquents does not violate the Due Process Clause.

In McNeil v. United States, 127 AFTR2d 2021-________, a District of Columbia Federal District Court ruled that the failure of IRS to send a prior notice to a taxpayer that his tax debt is “seriously delinquent” does not render an IRS attempt at passport revocation to be unenforceable.

In Patrick’s Payroll Services v. Commissioner, 127 AFTR2d 2021-_______, the Sixth Circuit Court of Appeals agreed with the Tax Court that the language allowing substantive issues be brought up at a CDP hearing – “did not receive any statutory notice of deficiency for such tax liability or did not otherwise have an opportunity to dispute such tax liability” – requires that both of the two conditions be met and that the word “or” did not create disjunctive qualifications; in Jeffers v. Commissioner, 127 AFTR2d 2021-________, the Seventh Circuit Court of Appeals agreed with the Tax Court that a taxpayer cannot raise substantive issues in a CDP hearing upon notice of levy where the taxpayer did not seek Appeals review following a notice of lien. 

In Sleeth v. Commissioner, 127 AFTR2d 2021-________, the Eleventh Circuit Court of Appeals found that the Tax Court did not err in rejecting innocent spouse equitable relief for a former wife on a single highly weighted factor – that she had knowledge of the excessive spending and unpaid tax liability; in Spitulnik v. Commissioner, TC Memo Bench Opinion (2021), the Tax Court denied innocent spouse treatment to a teacher, married to a law firm partner, where only one of seven factors, her health, favored relief and she remained married to her husband, was aware of the liability and benefitted beyond support needs.

In In Re:  Ransdell, 127 AFTR2d 2021-________, a Florida Bankruptcy Court permitted a divorcee to discharge income taxes in bankruptcy where she and her former husband filed three years of returns without payment; the Court noted that this was a “close” case but noted that excessive personal spending including private schools and an expensive pony for her daughter is insufficient to show an attempt to evade taxes.

In In Re:  Szczyporski, 127 AFTR2d 2021-________, a Pennsylvania Federal District Court reversed a bankruptcy court’s decision and found that the shared responsibility payment in the Affordable Care Act was a tax and not a penalty, preventing discharge in bankruptcy until the statutory passage of time.

In Announcement 2021-59, IRS extended the individual income tax filing deadline until May 17, 2021; the extension does not apply to first quarter 2021 estimates.

Federal Tax Update – February 2021

INDIVIDUALS

In Anikeev v. Commissioner, TC Memo 2021-23, the Tax Court considered the case of a couple who profited  by using their credit cards for rewards in the form of gift certificates but then acquired money orders and debit cards with the gift cards; the Court found an accretion to wealth on the conversion to money orders and gift cards not exempt by the IRS policy on credit card rewards.

In Stassi v. Commissioner, TC Summary Opinion 2021-5, the Tax Court determined that an $80,000 settlement for wrongful discharge after filing complaints was fully taxable despite the settlement agreement stating that payment was in “consideration for physical manifestations of emotional distress claims” as all prior documents failed to mention any physical injury – an allegation was first made at trial that the stress brought on shingles.

In Blum v. Commissioner, TC Memo 2021-18, the Tax Court held that a malpractice settlement payment by attorneys who represented the taxpayer in an unsuccessful personal injury case was taxable as no physical injury was caused by the defendant.

RETIREMENT AND ESTATE PLANNING

In Estate of Warne v. Commissioner, TC Memo 2021-17, the Tax Court stated that the proper valuation of charitable bequests of an entire LLC to two different charitable organizations is computed based on the value of what the organizations received, thus the estate must include 100 percent of the value of the LLC but it may deduct only the sum of the discounted values received by the charities.

BUSINESS

In San Jose Wellness v. Commissioner, 156 TC No. 4, the Tax Court concluded that a legal medical marijuana dispensery could not deduct depreciation or charitable contributions consistent with its prior decisions of only allowing a deduction for cost of goods sold; in Desert Organic Solutions v. Commissioner, TC Memo 2021-22, the Tax Court once again found that sales of non-marijuana products were so minimal that all expenses other than for cost of goods sold should be denied.

In Information Letter 2021-0031, IRS announced that employees cannot receive cash refunds for unused amounts remaining on transit passes.

PROCEDURE

In Bedrosian v. United States, 127 AFTR2d 2021-771, a Pennsylvania Federal District Court found that the imposition of a 50 percent of account balance penalty by IRS in the case of a willful FBAR violation was not an abuse of discretion.

In United States v. Weber, 127 AFTR2d 2021-793, the Second Circuit Court of Appeals upheld a New York Federal District Court jury verdict convicting an individual of willfully filing a false return as a nonresident alien because he claimed to be a citizen of New York and not of the United States.

In BM Construction v. Commissioner, TC Memo 2021-13, the Tax Court concluded that receipt of a 30-day letter gives a taxpayer the opportunity to present substantive issues, precluding these issues from being raised at a CDP hearing; the Court had previously ruled similarly in the case of receipt of a 90-day letter.

In In Re:  Candy, 127 AFTR2d 2021-816, a Tennessee bankruptcy court refused to discharge an attorney’s income tax liability in bankruptcy, finding a conduct of late filing and titling properties in his wife’s name.

In Rogers v. Commissioner, TC Memo 2021-20, the Tax Court rejected innocent spouse status in the case of a divorcee who maintained her husband’s books and records and should have had knowledge of the understatement of income.

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Feeling Blue: What to Expect in 2021

Here’s what CPAs and financial planners should keep in mind as we head into 2021 with Democratic majorities in the House and Senate and a new president in the White House.

So far, 2021 continues the 2020 theme of “expect the unexpected.” The election cycle of 2020 finally ended on January 5 with the Georgia runoff elections where Democrats won both Senate seats. As a result, President Joe Biden enters his first term with small Democratic majorities in both the House and the Senate. While not exactly the blue tsunami Democrats were hoping for, Democratic control opens the door for significant tax and regulatory policy changes in 2021 and beyond. Here are the major changes to watch and plan for this year.

The American Rescue Plan

On January 14, President Biden outlined his American Rescue Plan, offering the first glimpse of what 2021 legislation would look like. The $1.9 trillion economic relief plan is the first step in a two-part plan that is needed immediately and will be followed by an economic recovery plan in February. The American Rescue Plan would bring the total amount of COVID-19 relief to upwards of $5 trillion. Here are the most important proposals included in the bill.

The American Rescue Plan would send $1,400 in direct payments to most Americans. It would also allow residents who are married to undocumented residents—who were barred in prior rounds—to receive stimulus payments.

Biden’s plan includes $20 billion to create a national vaccine distribution program that would offer free shots to all U.S. residents regardless of immigration status. The plan calls for creating community vaccination centers and deploying mobile units in hard-to-reach areas. Biden is also calling for $50 billion to ramp up testing efforts, including purchasing rapid-result tests, expanding lab capacity, and helping local jurisdictions implement testing regimens.

The plan would expand tax credits for low- and middle-income families and make them refundable for 2021, expanding the child tax credit to $3,000 from $2,000 for each child 17 and younger. Children under age six would be eligible for $3,600. Biden is also requesting $25 billion for a stabilization fund to open childcare centers and $15 billion in grants to help essential workers meet childcare costs.

The plan also calls for $170 billion to help schools open. About $130 billion would go to K-12 schools to help them hire additional staff to reduce class sizes, modify spaces, and obtain resources to help meet students’ academic and mental health needs. The plan would also direct $35 billion to colleges and universities and create a $5 billion fund for governors to direct help to schools hit hardest by the pandemic.

The proposal would extend the eviction and foreclosure moratorium through September and provide $30 billion to help low-income households who have lost jobs to pay rent and utility bills. The plan would also provide $5 billion to states and localities to offer emergency housing for families facing homelessness.

The Biden plan would require all employers, regardless of size, to offer paid sick leave to workers during the pandemic, impacting a projected 106 million workers. Parents and family members caring for sick relatives or out-of-school children could receive more than 14 weeks of paid sick and family leave. The plan would provide benefits of up to $1,400 per week and tax credits for employers with fewer than 500 employees to reimburse them for the cost of the leave. Biden’s plan would also extend and expand unemployment benefits that are scheduled to run out mid-March. The proposal increases a weekly federal benefit from $300 to $400 and extends it through the end of September.

The proposal would increase the federal minimum wage from $7.25 to $15 an hour and would end the tipped minimum wage widely used by restaurants and the hospitality industry.

Biden is proposing to leverage $35 billion in government funds into $175 billion in low-interest loans to finance small businesses. He is also calling for $15 billion in grants for small business employers.

Finally, the proposal includes $350 billion in funding assistance for state, local, and territorial governments plus $20 billion for public transit systems.

The Build Back Better Recovery Plan

President Biden has said his American Rescue Plan will be followed by a second economic recovery plan, the Build Back Better Recovery Plan, targeted toward recovery, infrastructure, green energy, health care, and education initiatives. It will focus on the longer-term recovery and will be outlined in more detail in February.

Biden’s Campaign Tax Platform

From a tax policy perspective, 2021 could be a year of significant legislative tax change as well. Biden’s American Rescue Plan did not include any tax increases, and with stimulus plans taking priority, it may be mid-year or later before a Biden tax package is put forth. Biden’s campaign plan included increased income tax rates on taxpayers with income greater than $400,000, increased social security taxes on income above $400,000, and increased capital gains rates on income above $1 million. Many other tax cuts in the Tax Cuts and Jobs Act (TCJA) could be rolled back as well, including the 21 percent corporate tax rate.

Some fear that these tax increases will be retroactive to Jan. 1, 2021, which is certainly possible. The last time a significant tax increase was enacted retroactively was in August of 1993, when the Omnibus Budget Reconciliation Act included an increase in the top estate tax rate from 50 percent to 55 percent, retroactive to January 1, 1993. However, most feel that retroactive tax increases are unlikely since unemployment is still high and the economic recovery from COVID-19 has been slow. It seems more likely that the expected tax increases would be effective later in 2021 or on Jan. 1, 2022, giving investors more time to plan.

While Democrats seem united in rolling back the tax cuts in the TCJA for high-income households, there are party differences on the finer points of how to raise taxes. The 50-50 split in the Senate means that to pass a tax bill, every Democratic senator will need to support it if no Republicans do, setting the stage for extensive negotiations on any potential legislation.  Some moderate Democrats have already expressed concern over the size of President Biden’s proposals, and he will need their full support to pass any bill.  In addition, because Democrats have slim hope of securing the 10 Republican votes necessary to avoid a filibuster, they will likely need to use the budget reconciliation process to advance any legislation, forcing more targeted and revenue neutral proposals.

Securing a Strong Retirement Act

In October 2020, the Securing a Strong Retirement Act was introduced in the House. If passed, this bill would significantly impact 401(k)s, 403(b)s, and IRAs, helping employers improve the strength of their retirement offerings by expanding coverage and increasing retirement savings. Here are the key proposals in the bill.

The bill would raise the age to begin mandatory distributions. While 2019’s Setting Every Community Up for Retirement Enhancement (SECURE) Act generally increased the required minimum distribution (RMD) age to 72, the proposed legislation would bump it up again to 75.

The bill would exempt individuals with low account balances from RMD rules, no longer requiring participants to take a RMD if the balance in their retirement plans and IRAs (excluding defined benefit plans) is not more than $100,000 indexed on December 31 of the year before they turn 75.

The proposal would also reduce the excise tax on certain accumulations in qualified retirement plans, such as reducing the penalty for failure to take a RMD from 50 percent to 25 percent. If a failure to take a RMD is corrected in a timely manner (as defined by the bill), the excise tax on the failure is reduced again from 25 percent to 10 percent.

The legislation would allow a higher catch-up contribution after age 60. Currently, employees who are ages 50 and older can make catch-up contributions to retirement plans that exceed overall applicable limits. For 2021, the catch-up contribution limit is $6,500, and the proposed legislation would increase this limit to $10,000 for individuals over age 60. It would also allow employers to offer small immediate financial incentives, like gift cards, to employees for contributing to a retirement plan.

It would also build on the SECURE Act by expanding automatic enrollment in retirement plans. Employers offering 401(k), 403(b), and SIMPLE plans would be required to automatically enroll eligible participants unless employees opt out. The initial automatic enrollment deferral would be at a minimum of 3 percent but no more than 10 percent. Each year, the amount would increase by 1 percent until it reaches the maximum 10 percent.

The proposal would amend the Saver’s Credit to create a single 50 percent rate, increase the maximum credit amount from $1,000 to $1,500 per person, and raise the maximum income eligibility amount. The legislation would index the credit to inflation. It would also index IRA catch-up limit contributions beginning in 2022. Under current law, the limit on IRA contributions is increased by $1,000 (not indexed) for individuals who have reached age 50.

Finally, the bill would modify the credit for small employer pension plan startup costs. The proposed credit would be increased from 50 percent of administrative costs to 100 percent for employers with up to 50 employees. The applicable percentage would be 100 percent in the first and second years, 75 percent in the third year, 50 percent in the fourth year, and 25 percent in the fifth year.

2021 is shaping up to be another year of significant new legislation in the wake of the blue wave, leading to many tax and financial planning opportunities for CPAs, financial planners, and investors to navigate. With the potential of retroactive tax legislation unlikely, we can start planning now for these upcoming changes.

Illinois CPA Society member Daniel F. Rahill, CPA, JD, LL.M., CGMA, is a managing director at Wintrust Wealth Management. He is also a former chair of the Illinois CPA Society Board of Directors.

This information may answer some questions, but is not intended to be a com­prehensive analysis of the topic. In addition, such information should not be relied upon as the only source of information; professional tax and legal advice should always be obtained. Securities, insurance products, financial planning, and investment management services are offered through Wintrust Investments, LLC (Member FINRA/SIPC), founded in 1931. Trust and asset management services offered by The Chicago Trust Company, N.A. and Great Lakes Advisors, LLC, respectively. © 2020 Wintrust Wealth Management Investment products such as stocks, bonds, and mutual funds are: NOT FDIC INSURED | NOT BANK GUARANTEED | MAY LOSE VALUE | NOT A DEPOSIT | NOT INSURED BY ANY FEDERAL GOVERNMENT AGENCY

Federal Tax Update – January 2021

INDIVIDUALS

In Hairston v. Commissioner, TC Summary Opinion 2021-2, the Tax Court determined that social security benefits are fully taxable in the year received despite a subsequent obligation to repay a portion.

In Kelley v. Commissioner, TC Memo 2021-2, the Tax Court determined that taxation of a portion of social security benefits at zero taxable income for married individuals filing separately is constitutional.

In Brown v. Commissioner, TC Summary Opinion 2021-4, the Tax Court disallowed expenses of an individual on schedules A, C and E because he provided no substantiation and no credible estimates and, in any event, failed to establish that he was a real estate professional as his three rental properties showed no income. 

In Mann v. United States, 127 AFTR2d 2021-447, the Fourth Circuit Court of Appeals agreed with a Maryland Federal District Court that taxpayers could not take a charitable deduction of $675,000 representing the appraised value of the structure razed by a charity which previously disassembled some of the house and salvaged useful components with the remainder left for demolition; the Court reasoned that the taxpayers did not convey their entire interest in the house, failed to record that the house was transferred (though the land was not) and did not provide an accurate appraisal of what was actually donated.

In Soboyede v. Commissioner, TC Summary Opinion 2021-3, the Tax Court found that a lawyer who divided time between Washington, DC and Minnesota had his “tax home” in the District of Columbia where he had greater wages and taxable income, disallowing expenses claimed in nearby Maryland for apartment rent at his tax home.

RETIREMENT AND ESTATE PLANNING

In United States v. Abell, 127 AFTR2d 2021-________, the First Circuit Court of Appeals agreed with a Massachusetts Federal District Court that a married person does not have a vested interest in a spouse’s retirement plan prior to divorce such that the spouse could preclude an otherwise lawful seizure for satisfaction of a restitution award for embezzlement.

BUSINESS

In Bruneau v. Commissioner, TC Summary Opinion 2021-1, the Tax Court accepted an IRS analysis of bank deposits and determined the underreporting of gross receipts, the Court also denying various deductions including depreciation of improvements for lack of adequate books and records.

In Aspro Inc. v. Commissioner, TC Memo 2021-8, the Tax Court ruled that a C corporation could not deduct “management fees” paid to three shareholders who collectively owned 100 percent of the company, two being individuals and one being a C corporation; the payor did not enter into any written agreement with its shareholders and almost all of the tentative profits were taken out, the Court finding that the evidence indicated disguised distributions. 

In Costello v. Commissioner, TC Memo 2021-9, the Tax Court decided that an individual who attempted to raise cattle and then sought to grow different crops on 6,000 acres in Mexico was still in a startup phase and had not commenced any active business allowing a current deduction; in Whatley v. Commissioner, TC Memo 2021-11, the Tax Court found that a cattle farm (which had no cattle until the IRS audit) which was converted to a tree farm was operated as a hobby by its banker owner.

In Notice 2021-7, IRS granted permission for employers using “annual lease value” to value personal use of a vehicle by an employee to switch to cents per mile for use after March 12, 2020 in the case of vehicles costing no more than $50,400; if cents per mile is continued for 2021, it must be used for all subsequent years.

In Letter Rulings 202103001-202103007, IRS granted relief to preserve an S election where a single owner LLC owned by an individual issued membership interests to nonqualifying trusts but subsequently corrected.

PROCEDURE

In United States v. Kaufman, 127 AFTR2d 2021-342, a Connecticut Federal District Court concluded that the $10,000 nonwillful FBAR penalty applies per form and not per bank account; the courts are divided on the issue.

In Grajales v. Commissioner, 156 TC No. 3, the Tax Court concluded that the “penalty for early withdrawal” from a retirement plan is not a penalty for purpose of requiring written supervisory approval on a timely basis during the administrative process, the Court noting that an “exaction” may be a tax for one purpose and a penalty for another.

In Ramey v. Commissioner, 156 TC No. 1, the Tax Court determined that a CDP appeal was late when it was timely received at the last known address shared by multiple businesses and taken in by an individual not authorized to accept mail on the taxpayer’s behalf.

In United States v. Henco Holding Corporation, 127 AFTR2d 2021-________, the Eleventh Circuit Court of Appeals agreed with a Georgia Federal District Court that IRS was not required to separately assess shareholders for transferee liability and that the state statute of limitations was not applicable against IRS. 

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Post-Election 2021 Planning: Surfing the Blue Wave

The year 2020 was one like no other, and thus far into 2021, the 2020 mantra “expect the unexpected” has continued.   The election cycle of 2020 finally ended on January 5, 2021 with the Georgia runoff elections with Democrats wining both Senate seats.  As a result, President Biden will have slight Democratic majorities in both the House and the Senate (with the Vice President’s tie breaking vote).  It was not the tsunami “Blue Wave” Democrats had been hoping for, but Democratic control nonetheless, opening the door to potentially significant tax and regulatory policy changes in 2021. 

EXECUTIVE SUMMARY

On January 14, we received our first indication of what 2021 legislation will look like, when President Joe Biden outlined his American Rescue Plan.  The $1.9 trillion economic relief plan includes additional $1,400 direct stimulus checks for qualifying Americans, raises the federal minimum wage to $15 per hour, and includes $350 billion in emergency funding for state and local governments. Biden said the proposal is the first step in a two-part plan that is needed immediately and will be followed by an economic recovery plan — the Build Back Better Recovery Plan — that he will outline in February.  The American Rescue Plan will bring the total amount of Covid-19 relief to exceed $5 trillion.

From a tax policy perspective, 2021 could be a year of significant legislative tax change as well.  Under the Biden plan, the top income tax rate on taxpayers with income greater than $400,000 will most likely revert back to 39.6 percent, the top rate prior to the Tax Cuts and Jobs Act (TCJA) passed in 2017.  Many of the other TCJA tax cuts could be rolled back as well, including the 21 percent corporate tax rate.  A new corporate alternative minimum tax could also be introduced.   Other tax increases are expected as well, including increased social security taxes and capital gains rates on income above $400,000 and $1 million, respectively.  

The most significant proposed tax policy changes, could be in the area of estate and gift, where Biden’s proposals have included eliminating the step-up in basis at death for inherited assets, and reducing the estate tax exemption from the current $11.7 million amount to pre-TCJA levels of $5 million (indexed for inflation), or possibly even lower, to $3.5 million. 

Some fear that these tax increases will be retroactive to January 1, 2021, which is certainly possible.  The last time a significant tax increase was enacted retroactively was in August 1993, when the Omnibus Budget Reconciliation Act included an increase in the top estate tax rate from 50 percent to 55 percent, retroactive to January 1, 1993. 

Many feel, however, that retroactive tax increases are unlikely in 2021, because unemployment is still high, and given the slow economic recovery from COVID-19, it’s not an ideal time for significant tax increases.  It seems more likely that the expected tax increases would be effective later in 2021 or on January 1, 2022, giving investors more time to plan. 

THE CONSOLIDATED APPROPRIATIONS ACT, 2021

The bipartisan Consolidated Appropriations Act, 2021 (CAA) was signed into law on December 27, 2020, providing $2.3 trillion of federal funding and COVID-19 relief. The law includes refundable tax credits, new Paycheck Protection Program (PPP) and Economic Injury Disaster Loans (EIDL) programs, and numerous extenders from the 2020 Coronavirus Aid, Relief, and Economic Security (CARES) Act.  The 5,593 page CAA also adds numerous new tax, payroll and retirement provisions.  

Recovery Rebates and Unemployment Benefits

The CAA provides a refundable tax credit in the amount of $600 per taxpayer ($1,200 for married taxpayers filing jointly), in addition to $600 per qualifying child. The credit phases out starting at $75,000 of modified adjusted gross income ($112,500 for heads of household and $150,000 for married taxpayers filing jointly). The rebates are based on 2019 tax returns, and therefore a taxpayer could receive a payment that is less than they are entitled to. These taxpayers would be able to claim an additional credit for the shortfall on their 2020 tax return. Conversely, if a taxpayer receives too high a payment, they won’t have to repay the difference.

For the 14 million Americans collecting unemployment, the Act provides an addition $300 per week from December 26, 2020 through March 14, 2021.  The law also provides an extra benefit of $100 per week for certain workers who have both wage and self-employment income but whose base unemployment benefit calculation doesn’t take their self-employment into account.

Deductibility of PPP-Funded Expenses

The CAA relief package provides $284 billion to reinstate the CARES Act PPP loan program through March 31, 2021; $15 billion for live venues, independent movie theaters, and cultural institutions; and $20 billion for EIDL grants to businesses in low-income communities.  The Act makes numerous modifications to the CARES Act PPP and EIDL programs, generally making them simpler and more favorable for borrowers.  

In a welcome provision, the Act clarifies that gross income does not include any amount that would otherwise arise from the forgiveness of a PPP loan. This addresses a controversial issue where the IRS had taken the position that no deduction would be allowed for an expense if the payment of the expense results in forgiveness of a PPP loan.  The IRS position had effectively negated Congressional intent that the PPP forgiveness be tax-free.  The Act corrects that. 

The deductibility provision is retroactive back to the date of enactment of the CARES Act. The Act provides similar treatment for Second Draw PPP loans, effective for tax years ending after the date of enactment of the provision.  The Act also clarifies that gross income does not include forgiveness of certain loans, emergency EIDL grants, and certain loan repayment assistance, also provided by the CARES Act.

CAA CARES Act Pandemic Provisions

Employee retention tax credit: The Act extends the CARES Act Employee Retention Tax Credit (ERTC) through June 30, 2021, expanding the ERTC and making necessary technical corrections. The expansions of the credit include:

  • An increase in the credit rate from 50 percent to 70 percent of qualified wages;
  • An increase in the limit on per employee creditable wages from $10,000 for the year to $10,000 each quarter;
  • A reduction in the required year-over-year gross receipts decline from 50 percent to 20 percent;
  • A safe harbor allowing employers to use prior-quarter gross receipts to determine eligibility;
  • A provision to allow certain governmental employers to claim the credit;
  • An increase from 100 to 500 in the number of employees counted when determining the relevant qualified wage base; and
  • Rules allowing new employers who were not in existence for all or part of 2019 to be able to claim the credit.

The Act also makes the following changes retroactive to the effective date of the CARES Act:

  • Provides that employers who receive PPP loans may still qualify for the ERTC with respect to wages that are not paid with forgiven PPP proceeds;
  • Clarifies the determination of gross receipts for certain tax-exempt organizations; and
  • Clarifies that group health plan expenses can be considered qualified wages even when no other wages are paid to the employee, consistent with IRS guidance.

Payroll tax credits: The CAA extends the refundable payroll tax credits for paid sick and family leave enacted in the Families First Coronavirus Response Act through the end of March 2021. It also modifies the payroll tax credits so that they apply as if the corresponding employer mandates were extended through March 31, 2021. The CAA also allows individuals to elect to use their average daily self-employment income from 2019 rather than 2020 to compute the credit.

Deferral of employees’ portion of payroll tax: In August, President Trump issued a memorandum allowing employers to defer the withholding, deposit, and payment of the employee portion of the Old-Age, Survivors, and Disability Insurance (OASDI) tax for any employee whose pretax wages or compensation during any biweekly pay period generally is less than $4,000.

Trump’s deferral applies to payroll taxes on wages paid from Sept. 1 through Dec. 31, 2020. Under the memorandum, employers are required to increase withholding and pay the deferred amounts ratably from wages and compensation paid between Jan. 1, 2021, and April 30, 2021. The CAA extends the repayment period through Dec. 31, 2021.

Educator expenses for protective equipment: The CAA requires Treasury to issue regulations or other guidance providing that the cost of personal protective equipment and other supplies used for the prevention of the spread of COVID-19 is treated as an eligible expense for the educator expense deduction. The regulations or guidance will apply retroactively to March 12, 2020.

Retirement Plan Relief: The CARES Act temporarily allows individuals to make penalty-free withdrawals from certain retirement plans for coronavirus-related expenses, permits taxpayers to pay the associated tax over three years, allows taxpayers to recontribute withdrawn funds, and increases the allowed limits on retirement plan loans. The CAA adds money purchase pension plans to the retirement plans qualifying for these temporary rules. The provision applies retroactively to the effective date of the CARES Act.  

Be aware that the CAA doesn’t extend the CARES Act’s temporary waiver of required minimum distributions. Affected taxpayers should plan on resuming those distributions for 2021.

CAA Tax Provisions

Temporary allowance of full deduction for business meals: The Act temporarily allows a 100 percent business expense deduction for meals (rather than the current 50 percent) as long as the expense is for food or beverages provided by a restaurant. This provision is effective for expenses incurred after Dec. 31, 2020, and expires at the end of 2022.

Certain charitable contributions deductible by nonitemizers:  Under the CARES Act, taxpayers who don’t itemize their deductions on their tax returns can nonetheless claim a $300 “above-the-line” deduction for cash contributions to qualified charitable organizations in 2020. The CAA extends that deduction through 2021 and doubles the deduction for married filers to $600. Contributions to donor-advised funds and supporting organizations don’t qualify for the deduction. The penalty is increased from 20 percent to 50 percent of the underpayment for taxpayers who overstate this deduction.

Modification of limitations on charitable contribution: The CARES Act increased the limitations on charitable deductions for cash contributions made in 2020, boosting it from 50 percent to 100 percent of Adjusted Gross Income (AGI).  The CAA carries that over for 2021 more tax planning flexibility.  Any excess cash contributions are carried forward to later years.

Education expenses: The Act repeals the deduction for qualified tuition and related expenses and in its place increases the phase out limits on the lifetime learning credit (so they match the phase-out limits for the American opportunity credit), effective for tax years beginning after Dec. 31, 2020.

Earned Income Tax Credits: The CAA includes a temporary change that could result in larger Earned Income Tax Credits (EITCs) and Child Tax Credits (CTCs). It allows lower-income individuals to use their earned income from the 2019 tax year to determine their EITC and the refundable portion of their CTC for the 2020 tax year. This could produce larger credits for eligible taxpayers who earned lower wages in 2020 due to the pandemic.

Temporary special rules for health and dependent care flexible spending arrangements: The CAA allows taxpayers to roll over unused amounts in their health and dependent care flexible spending arrangements from 2020 to 2021 and from 2021 to 2022. This provision also permits employers to allow employees to make a 2021 midyear prospective change in contribution amounts.

Depreciation of certain residential rental property over 30-year period: TheCAA provides that the recovery period for residential rental property placed in service before January 1, 2018, and held by an electing real property trade or business, is 30 years.

Waste energy recovery property eligible for energy credit: The CAA makes waste energy recovery property eligible for the energy investment tax credit, effective for 2021 through 2023. Waste energy recovery property generates electricity from the heat from buildings or equipment.

Minimum age for distributions during working retirement: The CAA will allow certain qualified pensions to make distributions to workers who are 59½ or older and who are still working. For certain construction and building trades workers, the age is lowered to 55.

Temporary rule preventing partial plan termination: The CAA provides that qualified plans will not be treated as having a partial termination during any plan year that includes the period March 13, 2020, through March 31, 2021, as long as the number of active participants covered by the plan on March 31, 2021, is at least 80 percent of the number covered on March 13, 2020.

CAA Disaster Tax Relief

The CAA provides disaster tax relief for individuals and businesses in presidentially declared disaster areas for major disasters (other than COVID-19) declared after Dec. 31, 2019, through 60 days after the date of enactment.

Use of retirement funds for disaster mitigation: The CAA allows residents of qualified disaster areas (as defined in the Act) to take a qualified distribution of up to $100,000 from a retirement plan or individual retirement account (IRA) without penalty. Amounts withdrawn are included in income over three years or may be recontributed to the plan.

Employee retention credit for disaster zones: The CAA allows a tax credit of 40 percent of wages (up to $6,000 per employee) to employers who conducted an active trade or business in a qualified disaster zone (as defined in the Act). The credit applies to wages paid without regard to whether the employee performed any services associated with those wages.

Qualified disaster relief contributions: The CAA modifies the CARES Act’s modification of the charitable contribution limits for 2020 to allow corporations to make qualified disaster relief contributions of up to 100 percent of their taxable income.

Qualified disaster-related personal casualty losses: The CAA permits individuals who have a net disaster loss (as modified by the Act) to increase their standard deduction amount by the amount of the net disaster loss.

CAA Tax Extenders

Medical Expense Deductions:  For tax years beginning before January 1, 2021, an itemized deduction is allowed for unreimbursed medical expenses that exceeded 7.5 percent of adjusted gross income (AGI). The threshold was scheduled to jump to 10 percent of AGI for 2021. The CAA permanently sets the threshold at 7.5 percent of AGI for tax years beginning after December 31, 2020.

Five-Year Tax Extenders:  The CAA includes five-year extensions to the following provisions:

  • New markets tax credit.
  • Employer credit for paid family and medical leave, which is in addition to the payroll tax credits for paid sick and family leave.
  • Work opportunity credit.
  • Gross income exclusion for discharge of indebtedness on a principal residence, although the amount of exclusion is lowered to $750,000 from $2 million.
  • Tax-free exclusion for certain $5,250 employer payments of student loans through 2025.  The payment can be made to the employee or the lender.
  • Empowerment zone designation.

Two-Year Tax Extenders:  The Act provides two-year extensions to the following provisions:

  • Residential energy-efficient property credit.  The bill also makes qualified biomass fuel property expenditures eligible for the credit.
  • Carbon oxide sequestration credit (through 2025).
  • Energy investment tax credit for solar and residential energy-efficient property.

One-Year Tax Extenders:  The Act provides one-year extensions to the following provisions:

  • 10 percent credit for qualified non-business energy property.
  • Credit for qualified fuel cell motor vehicles.
  • 30 percent credit for the cost of alternative fuel vehicle refueling property.
  • 10 percent credit for plug-in electric motorcycles and two-wheeled vehicles.
  • Health coverage tax credit.
  • Credit for electricity produced from certain renewable resources.
  • Energy-efficient homes credit.
  • Treatment of qualified mortgage insurance premiums as qualified residence interest.
  • Three-year recovery period for racehorses two years old or younger.
  • Excise tax credits for alternative fuels.
  • The American Samoa economic development credit

LOOKING AHEAD: THE BLUE WAVE LEGISLATIVE AGENDA

Biden’s American Rescue Plan

President Biden’s American Rescue Plan builds on previous relief to individuals, households and small businesses.  It would include funding for vaccine distribution and aid to state and local governments. 

Stimulus Checks: The Biden plan would boost direct payments to individuals to $2,000 for most Americans, on top of the $600 that the CAA provided in December.  The plan would also allow residents who are married to undocumented residents, who were barred in prior rounds, to receive stimulus payments.

Tax credits, childcare: Biden would expand tax credits for low- and middle- income families and make them refundable for 2021. He is proposing to expand the child tax credit to $3,000 from $2,000 for each child 17 and younger. Children under age six would be eligible for $3,600.  Biden is also requesting $25 billion for a stabilization fund to help open child-care centers and $15 billion in grants to support essential workers in meeting childcare costs.

Paid leave:  The Biden plan would create a requirement for employers, regardless of size, to offer paid sick leave during the pandemic to workers, extending the benefit to a projected 106 million workers. Parents and family members caring for sick relatives or out-of-school children could receive more than 14 weeks of paid sick and family leave.  The plan would provide benefits of up to $1,400 per week and tax credits for employers with fewer than 500 employees to reimburse them for the cost of the leave.

Vaccinations, testing:  Biden’s plan includes $20 billion to create a national vaccine distribution program that would offer free shots to all U.S. residents regardless of immigration status.  The plan calls for creating community vaccination centers and deploying mobile units in hard-to-reach areas. Biden is also calling for $50 billion to ramp up testing efforts, including purchasing rapid-result tests, expanding lab capacity and helping local jurisdictions implement testing regimens.

State aid:  Biden is pushing for $350 billion in funding assistance for state, local and territorial governments plus $20 billion for public transit systems.

Unemployment insurance:  Biden’s plan would extend and expand unemployment benefits that are scheduled to run out in mid-March. The proposal increases a weekly federal benefit to $400 from $300 and extends it through the end of September.

Minimum wage:  Biden would increase the federal minimum wage to $15 an hour from $7.25, and would end the tipped minimum wage used widely by restaurants and the hospitality industry.

Schools:  The plan is also calling for $170 billion to help schools to open.  About $130 billion would go to K-12 schools to help them hire additional staff to reduce class size, modify spaces and purchase resources to help meet students’ academic and mental health needs. The plan would also direct $35 billion to colleges and universities and create a $5 billion fund for governors to direct help to schools most hard-hit by the virus.

Rental assistance:  The proposal would extend the eviction and foreclosure moratorium through September. It would also provide $30 billion to help low-income households who have lost jobs to pay rent and utility bills. The plan would also provide $5 billion to states and localities to offer emergency housing for families facing homelessness.

Small businesses: Biden is proposing to leverage $35 billion in government funds into $175 billion in low-interest loans to finance small businesses. He is also calling for $15 billion in grants for such employers.

PRESIDENT BIDEN’S RESCUE PLAN PART II: THE BUILD BACK BETTER RECOVERY PLAN

President Biden has said his American Rescue Plan will be followed by a second economic recovery plan, the Build Back Better Recovery Plan, targeted toward recovery, infrastructure, green energy, health care, and education initiatives. It will focus on the longer-term recovery and will be outlined in more detail in February.

BIDEN CAMPAIGN TAX PLATFORM

Biden’s American Rescue Plan did not include any tax increases, and with stimulus plans taking priority, it may be mid-year or later before a Biden tax package is put forth.   But while there are some differences among Democrats about how best to raise taxes, the party was united in rolling back Trump’s TCJA tax cuts for high-income households during the campaign.  The 50-50 split in the Senate means every Democratic senator would need to support a tax-increase bill for it to pass if no Republicans support it.

If Biden is successful in building on this narrow Blue Wave of Democratic control, his tax increases could be retroactive to January 1, 2021 as noted above.  While retroactivity is possible, the later in the year that the legislation enacted the more likely that most provisions will be prospectively effective on January 1, 2022.   Some provisions, however, could become law on an earlier date, such as the date the legislation is introduced or the date it is signed into law.

Higher Income Tax Rates

During the election campaign, Democrats proposed to raise taxes on earners with more than $400,000 of annual income, cut them for others, and raise benefits for the lowest earners. Assuming these income tax hikes will be effective in 2022, those affected would want to deploy basic tax bracket management strategies for times of rising tax rates, such as accelerating income into 2021, making Roth IRA conversions, exercising stock options and taking bonuses in 2021, if possible.

From a corporate rate perspective, Biden’s proposal is to increase the corporate tax rate, bumping it from 21 percent to 28 percent.   Since the campaign, some speculate that the rate will only increase to 24 or 25 percent given the fragile economy and the narrow Democratic majority.   The Biden plan would also create a new alternative minimum tax of 15 percent on corporations with over $100 million in book net income, a plan which may get some bipartisan support among Republicans in an effort to reduce the deficit.    

Limits on Itemized Deductions

A Biden administration would limit the value of itemized deductions by limiting a taxpayer with more than $400,000 of income to a 28 percent tax bracket benefit. Itemized deductions would be further limited at that income level by restoring the pre-2018 Pease Limitation, which would reduce itemized deductions by 3 percent of AGI up to 80 percent of itemized deductions.   Also proposed is the elimination of the TCJA $10,000 state and local tax (SALT) deduction cap.  Itemizers should plan to defer SALT payments until 2022 when possible.

Retirement Plan Contributions

The Biden administration proposes to convert currently deductible retirement plan contributions into a refundable 26 percent tax credit for each $1 contributed.  Roth tax treatment would be unaffected and therefore, higher income taxpayers would likely benefit from a shift to more Roth-style plans after this law change.  

Increased Payroll Taxes

The Biden payroll tax proposal would subject wage and self-employment income in excess of $400,000 to the Social Security payroll tax. Currently, the 6.2 percent tax is on the first $142,800 of wage income, so wages and earnings between $137,700 and $400,000 would not be taxed, creating a donut-hole structure. For those self-employed individuals who pay both the employee and the employer halves, the tax is 12.4 percent.  Someone who is self-employed making $1 million a year would see their self-employment (SE) tax increase by $74,400, mitigated slightly by the fact that the 50 percent employer-equivalent portion would be deductible in calculating AGI.

Should this tax be expanded, business owners might consider converting to an S corporation structure, as S corporation dividends are not subject to employment taxes, assuming reasonable compensation rules are met. As for executive compensation, incentive stock options would likely become more popular because there is no Social Security tax on the option spread.

Higher Capital Gains and Investment Income Taxes

Under the Biden plan, individuals earning over $1 million would be subject to ordinary income tax rates on their long-term capital gains and qualified dividends. Investors with incomes over $1 million should consider selling appreciated assets in 2021, prior to elimination of the 20 percent preferential rate for long-term capital gains and qualified dividends in 2022.

Other options to consider include investment in opportunity zone funds, gifting of appreciated assets (also to utilize the current estate and gift tax exemption), and charitable contributions of appreciated assets to qualified charities, including donor-advised funds and private foundations.

Limits on the 199A Pass-Through Deduction and 1031 Like-Kind Exchanges

The Biden platform would phase-out the TCJA’s Code Section 199A 20 percent deduction for pass-through business income for those with income exceeding $400,000.  It would also modify or eliminate the tax-fee treatment of like-kind exchanges of real estate at that same level. Affected taxpayers are encouraged to consider accelerating income and completing 1031 transactions into 2021, prior to the effective date of any law change.

Estate and Gift Tax Changes

The 2021 estate tax exemption threshold is $11.7 million per individual (indexed for inflation) with a top tax rate of 40 percent. After 2025, this amount is scheduled to revert to the pre-TCJA exemption, which is an indexed amount that would equate to approximately $5.8 million. The Biden plan would accelerate the reduction of the exemption now, either to the pre-TCJA level of $5 million (indexed for inflation), or as low as $3.5 million as proposed by the Obama administration. The top tax rate would increase to 45 percent or possibly higher.

Also proposed is the elimination of the “basis step-up” at death.  Currently, a future capital gains tax upon disposition of an inherited asset is based on its value at the time of death or six months later, referred to as the basis step-up. The Biden plan is unclear as to how this change would be implemented, but there are two options. The first is to tax unrealized gains of the decedent, whereby the decedent’s estate would pay the tax at death based on its fair market value, and presumably the heirs would take the assets at a basis stepped-up to that value.   Alternatively, the heirs would receive carryover basis at death, and would pay capital gains tax on the sale of the asset based on that basis.  Either option would lead to a significant tax on appreciated assets.

It is also possible that certain estate planning trust structures such as Grantor Retained Annuity Trusts (GRATs), Spousal Lifetime Access Trusts (SLATs) or Dynasty trusts could be modified or eliminated.   Anticipating that the estate tax exemption could be cut in half or more, taxpayers with estates as low as $3.5 million should seriously consider a wealth-transfer plan in 2021.

SECURING A STRONG RETIREMENT ACT OF 2020

Proposed retirement legislation, Securing a Strong Retirement Act of 2020, was introduced in the House in October.  If enacted, this would significantly impact 401(k)s, 403(b)s, and IRAs, helping employers improve the strength of their retirement plan by expanding coverage and increasing retirement savings. Here’s a list of key proposals that are in the proposed legislation:

Raise the age to begin mandatory distributions: while 2019’s Setting Every Community Up for Retirement Enhancement (SECURE) Act generally increased the required minimum distribution (RMD) age to 72, the proposed legislation would increase the required minimum distribution age to 75.

Expand automatic enrollment in retirement plans: 401(k), 403(b) and SIMPLE plans would be required to automatically enroll eligible participants unless employees opt out. The initial automatic enrollment deferral would be at a minimum of 3 percent but no more than 10 percent. Each year, the amount would increase by 1 percent until it reaches the maximum 10 percent.

Simplify and increase in Saver’s Credit: The proposal would amend the Saver’s Credit to create a single 50 percent rate, increase the maximum credit amount from $1,000 to $1,500 per person, and raise the maximum income eligibility amount. The legislation would index the credit to inflation.

Index the IRA catch-up limit: Under current law, the limit on IRA contributions is increased by $1,000 (not indexed) for individuals who have attained age 50. The legislation would index IRA catch-up limit contributions beginning in 2022.

Allow higher catch-up contribution after age 60: Currently, employees who are 50 and older can make catch-up contributions to retirement plans that exceed overall applicable limits. For 2021, the catch-up contribution is $6,500. The legislation would increase these limits to $10,000 and $5,000 (both indexed), respectively, for individuals 60 and older.

Allow small immediate financial incentives for contributing: To motivate participants to contribute to a 401(k) plan, the bill would allow small immediate incentives such as gift cards.

Reduce the excise tax on certain accumulations in qualified retirement plans: The Act would reduce the penalty for failure to take a RMD from 50 percent to 25 percent. If a failure to take a RMD is corrected in a timely manner (as defined under the bill), the excise tax on the failure is reduced from 25 percent to 10 percent.

Exempt individuals with low account balances from RMD rules: The proposed legislation would not require participants to take a RMD if the balance in their retirement plans and IRAs (excluding defined benefit plans) is not more than $100,000 (indexed) on December 31 of the year before they attain 75.

Modify the credit for small employer pension plan startup costs: The proposed start-up credit would be increased from 50 percent of administrative costs to 100 percent, for employers with up to 50 employees.  The applicable percentage would be 100 percent in the first and second years, 75 percent in the third year, 50 percent in the fourth year, and 25 percent in the fifth year.

This retirement legislation could be attached to and pass as part of other legislation in 2021. 

SUMMARY

2021 is shaping up to be another year of significant new legislation after the Democrat’s Blue Wave, leading to many tax and financial planning opportunities for investors to surf.   With the potential of retroactive tax legislation unlikely, investors should be planning now for these upcoming law changes.  Your Wintrust advisor is here to guide you on your financial planning, the PPP loan application process, or other investment or financial needs you may have. 

Federal Tax Update – December 2020

INDIVIDUALS

Taxpayer Certainty & Disaster Tax Relief Act of 2020, part of PL 116-________, the Consolidated Appropriations Act, 2021:

●          Extends through 2025 the exclusion on employer payment of student loans up to $5,250 per year as part of an educational benefit plan

●          Makes financial aid grants under the CARES Act excludable from the income of university students and provides that receipt does not affect eligibility for either the American Opportunity or Lifetime Learning tax credit

●          Extends through 2025 the exclusion from gross income on discharge of acquisition indebtedness on a principal residence irrespective of insolvency but reduces the maximum exclusion effective 2021 from $2 million to $750,000

●          Repeals the above the line deduction for qualified education expenses and replaces it after 2020 with higher phaseout limits on the lifetime learning credit of $58,000-$80,000 (double for joint filers)

●          Makes personal protective equipment and other supplies for the prevention of COVID after March 11, 2020 eligible for the above the line deduction for educator expenses

●          Makes permanent the exclusions of up to $50 per month for reimbursement payments to volunteer first responders and for any state or local tax benefit

●          Makes permanent a restoration of the 7½ percent floor on medical expenses as an itemized deduction

●          Allows plans to permit flexible spending arrangements to carryover unused 2020 and 2021 amounts to the succeeding year, allows raising the maximum age for eligible dependents from 12 to 13 for 2020 and allows midyear prospective changes in elections during 2021

●          Extends through 2021 the treatment of mortgage insurance premiums (PMI) as home mortgage interest phasing out for those with adjusted gross income greater than $100,000

●          Extends the 100 percent of adjusted gross income limitation on charitable contributions by itemizers through 2021 and doubles the $300 limit for married itemizers for 2021 and restructures that deduction so as not to reduce AGI

●          Creates a new $600 per person refundable tax credit per family member phased out at $5 per additional $100 of income over a $75,000 modified adjusted gross income level for singles, $112,500 for heads of household and $150,000 on joint returns with advance payments generally based on 2019 MAGI; nonfilers with social security or disability income will also receive advance payments

●          Extends through 2021 the lifetime credit of $500 for the purchase of nonbusiness qualified energy improvements to a principal residence.

In Lakner v. Commissioner, 126 AFTR2d 2020-________, the DC Circuit Court of Appeals agreed with the Tax Court that a settlement with the Veterans Administration constituted taxable income as the settlement agreement addressed only a claim for discrimination and did not deal with later-arising physical injuries. 

RETIREMENT AND ESTATE PLANNING

Taxpayer Certainty & Disaster Tax Relief Act of 2020, part of PL 116-________, the Consolidated Appropriations Act, 2021:

●          Clarifies that the penalty-free withdrawals through 2020 from certain retirement plans with recontribution possible through 2022 applies to money purchase pension plans as well as profit sharing plans

●          Precludes deemed plan terminations if the number of active participants on March 31, 2021 is at least 80 percent of the number as of March 13, 2020.

Proposed Regulations under Part 300 would impose a user fee of $67 on estate tax closing letters effective 30 days after Final Regulations.

In Chief Counsel Advice 202045011, IRS stated that a qualified disclaimer cannot exist if the original beneficiary directs the transfer of funds even to an account in which the original beneficiary had no ownership or control; such direction is treated as receipt of the funds followed by a gift.

BUSINESS

Taxpayer Certainty & Disaster Tax Relief Act of 2020, part of PL 116-________, the Consolidated Appropriations Act, 2021:

●          Clarifies that expenses paid with forgiven PPP loans and EIDL loans are deductible and that tax basis in the assets of a business is unaffected by forgiveness

●          Restores the 100 percent deduction for business meals “provided by a restaurant” and paid or incurred in 2021 and 2022

●          Allows C corporations to deduct charitable contributions up to 25 percent of tentative taxable income for 2021 as in 2020

●          Allows farmers to elect a two-year net operating loss carryback instead of the five-year carryback of the CARES Act and, accordingly, allows revocation of an election to waive the carryback

●          Creates a floating interest rate for determining whether a life insurance policy qualifies as a “life insurance contract” effective for contracts lifted entered into after 2020

●          Extends the empowerment zone tax incentives through 2025 but eliminates increased expensing and capital gains tax deferrals after 2020

●          Extends the employee retention tax credit through June 30, 2021, increasing the credit rate from 50 to 70 percent, allowing advance payments, reducing the required gross receipts decline from 50 to 20 percent, increasing creditable wages from $10,000 per year to $10,000 per quarter and changing from 100 to 500 the maximum number of employees a business can have and still claim the credit for workers still on the job

●          Clarifies retroactively that employers who receive PPP loans remain eligible for the employee retention tax credit as to wages not paid for with forgiven PPP money and that group health benefits are considered wages even when no other compensation is paid to an employee

●          Extends the refundable payroll tax credit for paid sick and family leave, originally in the Families First Coronavirus Response Act, for an additional calendar quarter through March 2021

●          Extends the 12½ to 25 percent credit for paid family and medical leave through 2025

●          Extends the Work Opportunity Credit through 2025

●          Spreads out the repayment period on deferred employee portions of social security through December 31, 2021 with penalties and interest accruing thereafter.

In Chief Counsel Advice 202050015, IRS stated that a partnership cannot deduct the cost of premiums on a policy intended to reimburse partners for extra personal tax liability resulting from disallowed deductions at the partnership level. 

In Letter Ruling 202050017, IRS denied status as an educational organization to a group formed to promote the education and history of golf, to support youth golf programs and to provide a forum for golf memorabilia collectors to meet each other as the organization was considered primarily for the pleasure and recreation of members as a social organization.

In Letter Ruling 202053019, IRS rejected 501(c)(3) status for a spiritual group which uses cannabis in its sacraments in light of its promotion of a controlled substance.

PROCEDURE

In Gregory v. Commissioner, 126 AFTR2d 2020-________, the Third Circuit Court of Appeals reversed the Tax Court and threw out a Notice of Deficiency sent to an old address when the Revenue Agent had been verbally told of a new address and subsequent forms 2848 and 4868 had been filed with the new address after the last filed return.

In e-News for Tax Professionals 2020-48, IRS announced that it will be putting a focus on tax return preparers who have not filed their own returns, normally starting with a letter from the assigned Revenue Officer.

In Chief Counsel Advice 202053013, IRS cautioned that a claim for refund of individual taxes for 2019 must be filed by April 15, 2023 notwithstanding that an unextended 2019 return was actually due on July 15, 2020 as the result of COVID delays.

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Year-End Tax Planning With the Senate in the Balance

In the final days of 2020, here are some tips on planning for 2021 when control of the Senate is yet to be determined.

Year-end tax planning in an election year is often guided by the policies of the prevailing political party. This year, a Georgia Senate runoff race that will not take place until Jan. 5, 2021 may determine the likelihood of stimulus money, tax policy, and other actions. This race will decide control of the Senate—if the Republicans win one or both seats, they will maintain control. If the Democrats take both, they will have control of the House, Senate, and White House for the first time since 2010.

If the Democrats win, President-Elect Joe Biden’s progressive tax policies have a very good chance of making it into law. If the Republicans prevail, partisan gridlock will likely continue for another two years, hindering chances of broad stimulus programs or big tax changes.

Regardless of the outcome, here are a few tax planning issues investors should bear in mind as year-end approaches.

Planning for a Democratic-Controlled Congress

Higher Income Tax Rates

During the 2020 election campaign, Democrats proposed to raise taxes on earners with more than $400,000 of annual income, cut them for others, and raise benefits for the lowest earners. Those affected would want to deploy basic tax bracket management strategies for times of rising tax rates, such as accelerating income into 2020 by converting traditional IRAs to Roth IRAs, exercising stock options, and taking bonuses early if possible.

Limits on Itemized Deductions

Under Biden’s proposal, a itemized tax deductions would save a taxpayer with more than $400,000 of income no more than 28 cents on the dollar, even if that person’s top tax bracket is higher. In addition, itemized deductions for those with income over $400,000 would be reduced by 3 percent of adjusted gross income over a certain threshold—up to 80 percent of itemized deductions.

Affected taxpayers should consider accelerated deductions into 2020, especially large charitable donations, to take advantage of increased limits currently in place as part of the CARES Act. However, if Biden removes the $10,000 cap on state and local tax deductions, itemizers should plan to defer payments of these taxes until after the law change.

Higher Capital Gains and Investment Income Taxes

Per Biden’s proposal, individuals earning over $1 million would be subject to ordinary income tax rates on their long-term capital gains and qualified dividends. Investors with incomes over $1 million should seriously consider selling appreciated assets in 2020 as the 20 percent preferential rate for long-term capital gains and qualified dividends would very likely be eliminated. Conversely, any capital loss harvesting should be delayed until 2021 as capital gains rates would be expected to go up.

Estate and Gift Tax Changes

The current estate tax exemption threshold is $11.58 million per individual with a top tax rate of 40 percent. Biden’s plan reduces the lifetime exemption threshold by either $5 million (indexed for inflation) or as low as the 2009 level of $3.5 million per individual as proposed by the Obama administration. The tax on estates above this threshold would also increase to 45 percent.

Another significant change proposed by Biden is the elimination of the “basis step-up” at death. Currently, a future capital gains tax upon disposition of an inherited asset is based on its value at the time of inheritance, rather than the time of purchase—referred to as the “basis step-up.” Such a change would create significant practical problems with establishing the tax basis of long-held assets such as appreciated securities or a family business. Combined with the possibility that the estate tax exemption could be cut in half, taxpayers with estates worth in excess of several million dollars and with significantly appreciated assets should seriously consider a wealth transfer plan prior to year-end.

Planning for a Republican-Controlled Senate

If Republicans maintain Senate control, major tax legislation is doubtful. Among the more likely developments are an infrastructure bill and further relief packages. There are several year-end planning strategies to implement in this scenario.

Income Tax Planning

Traditional year-end tax planning would include postponing income into the following year combined with accelerating deductions into the current year. With the current itemized standard deduction amounts, a bunching strategy for itemized deductions may be effective. This strategy consists of taking the standard deduction every other year and bunching itemized deductions such as charitable contributions into the itemized year. This year may be a good year to bunch itemized deductions with higher limits on charitable contributions and a lower 7.5 percent threshold for medical expenses only available for 2020.

Health and Education Savings

Year-end planning for those with a high-deductible health plan should always include consideration for contributions to a health savings account (HSA). Taxpayers with self-only coverage can deduct up to $3,550 ($7,100 with family coverage) for 2020, and an additional $1,000 contribution is permitted if the eligible taxpayer is at least age 55. After age 65, withdrawals can be used for non-medical expenses as well. Consider an HSA as a form of long-term care insurance, which grows tax free for use during retirement. A 529 plan or Coverdell education savings account should also be considered to help ease the burden of future qualified higher education expenses. Any investment growth is federally income tax-free to the extent distributions do not exceed qualified expenses, and many states offer income tax benefits for qualifying contributions. Keep in mind, taxpayers also can use 529 plan distributions to pay up to $10,000 of elementary or secondary school expenses per student per year.

2020 has been a uniquely challenging year in many ways and facing year-end tax planning with important political questions still unanswered is just another challenge we will overcome.


AAA-CPA member Daniel F. Rahill, CPA, JD, LL.M., CGMA, is a managing director at Wintrust Wealth Services. He is also a former chair of the Illinois CPA Society Board of Directors.

This information may answer some questions, but is not intended to be a comprehensive analysis of the topic. In addition, such information should not be relied upon as the only source of information; professional tax and legal advice should always be obtained. Securities, insurance products, financial planning, and investment management services are offered through Wintrust Investments, LLC (Member FINRA/SIPC), founded in 1931. Trust and asset management services offered by The Chicago Trust Company, N.A. and Great Lakes Advisors, LLC, respectively. © 2020 Wintrust Wealth Management Investment products such as stocks, bonds, and mutual funds are: NOT FDIC INSURED | NOT BANK GUARANTEED | MAY LOSE VALUE | NOT A DEPOSIT | NOT INSURED BY ANY FEDERAL GOVERNMENT AGENCY