The U.S. Senate and House of Representatives have passed the Inflation Reduction Act (IRA). President Biden is expected to sign the bill into law shortly. The IRA includes significant provisions related to climate change, health care, and, of course, taxes. The IRA also addresses the federal budget deficit. According to the Congressional Budget Office (CBO), the IRA is projected to reduce the deficit by around $90 billion over the next 10 years.

Although the IRA falls far short of Biden’s originally proposed $2 trillion Build Back Better Act, the $430 billion package nonetheless is a sprawling piece of legislation bound to affect most Americans over time. Here’s an overview of some of what the bill includes.

Significant tax provisions

For starters, how is the federal government going to pay for all of it? Not surprisingly, new taxes are part of the equation (along with savings from, for example, lower drug prices). But the bill is designed to not raise taxes on small businesses or taxpayers earning less than $400,000 per year. Rather, wealthier targets are in the crosshairs.

The first target is U.S. corporations (other than S corporations) that have more than $1 billion in annual earnings over the previous three years. While the current corporate tax rate is 21%, it’s been well documented that many such companies pay little to no federal income tax, due in part to deductions and credits. The IRA imposes a corporate alternative minimum tax of 15% of financial statement income (also known as book income, as opposed to tax income) reduced by, among other things, depreciation and net operating losses. The new minimum tax is effective for tax years beginning after December 31, 2022.

As a result of last-minute negotiations, private equity firms and hedge funds are exempt from the minimum tax. They could have been covered by a provision that generally includes subsidiaries when determining annual earnings. The tradeoff is that the IRA now will extend the excess business loss limitation for certain businesses for two years.

Although the initial bill language also closed the so-called “carried interest” loophole that permits these interests to be taxed as long-term capital gains rather than ordinary income, the loophole ultimately survived. Democrats agreed to remove the provision closing it to secure the vote of Sen. Kyrsten Sinema (D-AZ) — but they added another tax to make up for the lost revenue. The IRA will now impose a 1% excise tax on the fair market value when corporations buy back their stock.

In a statement, Sinema said she would work with Sen. Mark Warner (D-VA) on separate legislation to enact carried interest tax reform. To do so outside of the budget reconciliation process, however, would require 60 votes in the Senate in addition to a majority of the House. With midterm elections in the fall, and control of both houses of Congress hanging in the balance, imminent action on that front seems unlikely.

The IRA also provides about $80 billion over 10 years to fund the IRS and improve its “tax enforcement activities” and technology. Notably, the IRS budget has been dramatically slashed in recent years, dropping by 20% in 2020, compared to 2010. The CBO estimates that the infusion of funds will allow the IRS to collect $203 billion over the next decade from corporations and wealthy individuals.

Climate and energy provisions

The IRA dedicates about $370 billion to combating climate change and boosting domestic energy production. It aims to reduce the country’s carbon emissions by 40% by 2030.

The legislation includes new, extended and increased tax credits intended to incentivize both businesses and individuals to boost their use of renewable energy. For example, the bill provides tax credits to private companies and public utilities to produce renewable energy or manufacture parts used in renewable projects, such as wind turbines and solar panels. Clean energy producers that pay a prevailing wage also may qualify for tax credits.

Clean vehicle credit

The current tax credit for qualified plug-in electric vehicles has been significantly revised in the IRA. Currently, a taxpayer can claim a credit for each new qualified plug-in electric drive motor vehicle placed in service during the tax year. The maximum credit amount is $7,500. Certain vehicle requirements must be met.

The credit phases out beginning in the second calendar quarter after a manufacturer sells more than 200,000 plug-in electric drive motor vehicles for use in the U.S. after 2009. Under the IRA, the plug-in vehicle credit has been renamed the clean vehicle credit and the manufacturer limitation on the number of vehicles eligible for the credit has been eliminated after December 31, 2022.

The bill changes how the clean vehicle credit is calculated. Specifically, a vehicle must meet critical mineral and battery component requirements. There are also price and income limitations. The clean vehicle credit isn’t allowed for a vehicle with a manufacturer’s suggested retail price above $80,000 for vans, sport utility vehicles and pickups, and above $55,000 for other vehicles.

The clean vehicle credit isn’t allowed if a taxpayer’s modified adjusted gross income (MAGI) for the current or preceding tax year exceeds $150,000 for single filers, $300,000 for married couples filing jointly and $225,000 for heads of household.

The IRA also contains a tax credit for a used plug-in electric drive vehicle purchased after 2022. The tax credit is $4,000 or 30% of the vehicle’s sale price, whichever is less. There are also price and income limitations.

Home energy improvements

Individual taxpayers can also receive tax breaks for home energy efficiency improvements, such as installing solar panels, energy-efficient water heaters, heat pumps and HVAC systems. And a “Clean Energy and Sustainability Accelerator” will use public and private funds to invest in clean energy technologies and infrastructure.

Health care provisions

The IRA allows Medicare to negotiate the price of prescription drugs and prohibits future administrations from refusing to negotiate. It also caps Medicare enrollees’ annual out-of-pocket drug costs at $2,000 and monthly insulin costs at $35 and provides them free vaccines. Additional provisions to rein in drug costs include a requirement that pharmaceutical companies that raise the prices on drugs purchased by Medicare faster than the rate of inflation rebate the difference back to the program.

The IRA also should reduce health care costs for Americans of all ages who obtain health insurance coverage from the federal Health Insurance Marketplace. It extends the expansion of subsidies — in the form of refundable premium tax credits — under the America Rescue Plan Act through 2025. These subsidies had been scheduled to expire at the end of 2022.

Much more to come

The IRA is a sweeping piece of legislation that affects many sectors of U.S. business, as well as most citizens. Additional information, guidance and regulations related to its numerous, far-reaching provisions are inevitable. We’ll keep you up to date on the developments that could affect your finances and federal tax liability.

© 2022

Sometimes, bigger isn’t better: Your small- or medium-sized business may be eligible for some tax breaks that aren’t available to larger businesses. Here are some examples.

1. QBI deduction

For 2018 through 2025, the qualified business income (QBI) deduction is available to eligible individuals, trusts and estates. But it’s not available to C corporations or their shareholders.

The QBI deduction can be up to 20% of:

• QBI earned from a sole proprietorship or single-member limited liability company (LLC) that’s treated as a sole proprietorship for federal income tax purposes, plus
• QBI passed through from a pass-through business entity, meaning a partnership, LLC classified as a partnership for federal income tax purposes or S corporation.

Pass-through business entities report tax items to their owners, who then take them into account on their owner-level returns. The QBI deduction rules are complicated, and the deduction can be phased out at higher income levels.

2. Eligibility for cash-method accounting

Businesses that are eligible to use the cash method of accounting for tax purposes have the ability to fine-tune annual taxable income. This is accomplished by timing the year in which you recognize taxable income and claim deductions.

Under the cash method, you generally don’t have to recognize taxable income until you’re paid in cash. And you can generally write off deductible expenses when you pay them in cash or with a credit card.

Only “small” businesses are potentially eligible for the cash method. For this purpose under current law, a small business includes one that has no more than $25 million of average annual gross receipts, based on the preceding three tax years. This limit is adjusted annually for inflation. For tax years beginning in 2022, the limit is $27 million.

3. Section 179 deduction

The Sec. 179 first-year depreciation deduction potentially allows you to write off some (or all) of your qualified asset additions in the first year they’re placed in service. It’s available for both new and used property.

For qualified property placed in service in tax years 2018 and beyond, the deduction rules are much more favorable than under prior law. Enhancements include:

Higher deduction. The Sec. 179 deduction has been permanently increased to $1 million with annual inflation adjustments. For qualified assets placed in service in 2022, the maximum is $1.08 million.

Liberalized phase-out. The threshold above which the maximum Sec. 179 deduction begins to be phased out is $2.5 million with annual inflation adjustments. For qualified assets placed in service in 2022, the phase-out begins at $2.7 million.

The phase-out rule kicks in only if your additions of assets that are eligible for the deduction for the year exceed the threshold for that year. If they exceed the threshold, your maximum deduction is reduced dollar-for-dollar by the excess. Sec. 179 deductions are also subject to other limitations.

Bonus depreciation

While Sec. 179 deductions may be limited, those limitations don’t apply to first-year bonus depreciation deductions. For qualified assets placed in service in 2022, 100% first-year bonus depreciation is available. After this year, the first-year bonus depreciation percentages are scheduled to start going down to 80% for qualified assets placed in service in 2023. They will continue to be reduced until they reach 0% for 2028 and later years.

Contact us to determine if you’re taking advantage of all available tax breaks, including those that are available to small and large businesses alike.

© 2022

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

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

The impetus

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

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

The new tax credit

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

Qualified property is tangible property that:

• Qualifies for depreciation or amortization,
• Is constructed, reconstructed or erected by the taxpayer or acquired by the taxpayer if the original use of the property begins with the taxpayer, and
• Is integral to the operation of the advanced manufacturing facility.

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

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

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

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

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

Additional provisions

The CHIPS Act also provides:

• $39 billion in subsidies to build, expand or modernize domestic facilities and equipment for semiconductor fabrication, assembly, testing, advanced packaging or research, and development,
• $200 million for workforce development and training, and
• $1.5 billion to spur wireless supply chain innovation.

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

Stay tuned

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

© 2022

The Tax Cuts and Jobs Act (TCJA) significantly boosted the potential value of bonus depreciation for taxpayers — but only for a limited duration. The amount of first-year depreciation available as a so-called bonus will begin to drop from 100% after 2022, and businesses should plan accordingly.

Bonus depreciation in a nutshell

Bonus depreciation has been available in varying amounts for some time. Immediately prior to the passage of the TCJA, for example, taxpayers generally could claim a depreciation deduction for 50% of the purchase price of qualified property in the first year — as opposed to deducting smaller amounts over the useful life of the property under the modified accelerated cost recovery system (MACRS).

The TCJA expanded the deduction to 100% in the year qualified property is placed in service through 2022, with the amount dropping each subsequent year by 20%, until bonus depreciation sunsets in 2027, unless Congress acts to extend it. Special rules apply to property with longer recovery periods.

Businesses can take advantage of the deduction by purchasing, among other things, property with a useful life of 20 years or less. That includes computer systems, software, certain vehicles, machinery, equipment and office furniture.

Both new and used property can qualify. Used property generally qualifies if it wasn’t:

• Used by the taxpayer or a predecessor before acquiring it,
• Acquired from a related party, and
• Acquired as part of a tax-free transaction.

Qualified improvement property (generally, interior improvements to nonresidential property, excluding elevators, escalators, interior structural framework and building expansion) also qualify for bonus depreciation. A drafting error in the TCJA indicated otherwise, but the CARES Act, enacted in 2020, retroactively made such property eligible for bonus depreciation. Taxpayers that placed qualified improvement property in service in 2018, 2019 or 2020 may, generally, now claim any related deductions not claimed then — subject to certain restrictions.

Buildings themselves aren’t eligible for bonus depreciation, with their useful life of 27.5 (residential) or 39 (commercial) years — but cost segregation studies can help businesses identify components that might be. These studies identify parts of real property that are actually tangible personal property. Such property has shorter depreciation recovery periods and therefore qualifies for bonus depreciation in the year placed in service.

The placed-in-service requirement is particularly critical for those wishing to claim 100% bonus depreciation before the maximum deduction amount falls to 80% in 2023. With the continuing shipping delays and shortages in labor, materials and supplies, taxpayers should place their orders promptly to increase the odds of being able to deploy qualifying property in their businesses before year-end.

Note, too, that bonus depreciation is automatically applied by the IRS unless a taxpayer opts out. Elections apply to all qualified property in the same class of property that is placed in service in the same tax year (for example, all five-year MACRS property).

Bonus depreciation vs. Section 179 expensing

Taxpayers sometimes confuse bonus depreciation with Sec. 179 expensing. The two tax breaks are similar, but distinct.

Like bonus deprecation, Sec. 179 allows a taxpayer to deduct 100% of the purchase price of new and used eligible assets. Eligible assets include software, computer and office equipment, certain vehicles and machinery, as well as qualified improvement property.

But Sec. 179 is subject to some limits that don’t apply to bonus depreciation. For example, the maximum allowable deduction for 2022 is $1.08 million.

In addition, the deduction is intended to benefit small- and medium-sized businesses so it begins phasing out on a dollar-for-dollar basis when qualifying property purchases exceed $2.7 million. In other words, the deduction isn’t available if the cost of Sec. 179 property placed in service this year is $3.78 million or more.

The Sec. 179 deduction also is limited by the amount of a business’s taxable income; applying the deduction can’t create a loss for the business. Any cost not deductible in the first year can be carried over to the next year for an unlimited number of years. Such carried-over costs must be deducted according to age — for example, costs carried over from 2019 must be deducted before those carried over from 2020.

Alternatively, the business can claim the excess as bonus depreciation in the first year. For example, say you purchase machinery that costs $20,000 but, exclusive of that amount, have only $15,000 in income for the year it’s placed in service. Presuming you’re otherwise eligible, you can deduct $15,000 under Sec. 179 and the remaining $5,000 as bonus depreciation.

Also in contrast to bonus depreciation, the Sec. 179 deduction isn’t automatic. You must claim it on a property-by-property basis.

Some caveats

At first glance, bonus depreciation can seem like a no-brainer. However, it’s not necessarily advisable in every situation.

For example, taxpayers who claim the qualified business income (QBI) deduction for pass-through businesses could find that bonus depreciation backfires. The amount of your QBI deduction is limited by your taxable income, and bonus depreciation will reduce this income. Like bonus depreciation, the QBI deduction is scheduled to expire in 2026, so you might want to maximize it before then.

The QBI deduction isn’t the only tax break that depends on taxable income. Increasing your depreciation deduction also could affect the value of expiring net operating losses and charitable contribution and credit carryforwards.

And deduction acceleration strategies always should take into account tax bracket expectations going forward. The value of any deduction is higher when you’re subject to higher tax rates. Newer businesses that currently have relatively low incomes might prefer to spread out depreciation, for example. With bonus depreciation, though, you’ll also need to account for the coming declines in the maximum deduction amounts.

Buy now, decide later

If you plan on purchasing bonus depreciation qualifying property, it may be wise to do so and place it in service before year end to maximize your options. We can help you chart the most advantageous course of action based on your specific circumstances and the upcoming changes in tax law.

© 2022

The IRS recently announced that it’ll increase the standard mileage rate for qualified business driving for the second half of 2022. The adjustment reflects the soaring cost of gasoline this year. In fact, as of June 13, the nationwide average price of regular unleaded gas was $5.01 a gallon, according to the AAA Gas Prices website. This is compared with $3.08 a gallon a year ago.

Beginning July 1, 2022, the standard mileage rate for business travel will be 62.5 cents per mile, up 4 cents from the 58.5 cents-per-mile rate effective for the first six months of the year. The IRS also announced an increased standard mileage rate for medical driving and moving for members of the military.

“The IRS is adjusting the standard mileage rates to better reflect the recent increase in fuel prices,” said IRS Commissioner Charles Rettig. “We are aware a number of unusual factors have come into play involving fuel costs, and we are taking this special step to help taxpayers, businesses and others who use this rate.”

Basic business driving deduction rules

There are two options for deducting business driving expenses. If you use a vehicle for business driving, you generally have the option to deduct the actual expenses attributable to your business use. This includes expenses such as gas, oil, tires, insurance, repairs, licenses and vehicle registration fees. In addition, you may claim a depreciation allowance for the vehicle, based on the percentage of business use. Note that your deduction may be subject to so-called “luxury car” limits, indexed annually.

But many taxpayers don’t want to keep track of all their vehicle-related expenses. Instead of deducting your actual expenses, you may be able to use a standard cents-per-mile rate. With the standard mileage deduction, you don’t have to account for all your actual expenses, although you still must record certain information such as the mileage for each business trip, the dates you drove and the business purpose of the travel.

The cents-per-mile rate is adjusted annually by the IRS. Initially, the agency established a rate of 58.5 cents per business mile for 2022 (up from 56 cents per mile in 2021). But higher gas prices spurred calls for a mid-year adjustment. There’s some precedent for this action: The standard mileage rate was increased for the last six months of 2011 and 2008 after gas prices soared.

With the IRS announcement that the standard business rate will increase to 62.5 cents per mile for the last half of this year, taxpayers who use it will have to use a “blended rate” for 2022 to figure their deductions.

For example, let’s assume that you drive 10,000 miles every six months on business. You also incur $1,100 in related tolls and parking fees during the year. Based on the initial IRS rate, your deduction for business driving for the first six months of 2022 is $5,850 (10,000 miles × 58.5 cents). However, you can deduct $6,250 (10,000 miles × 62.5 cents) for business auto trips during the last six months of 2022. Thus, your total deduction is $13,200 ($5,850 + $6,250 + $1,100 tolls and parking fees).

There are additional rules that may prevent a taxpayer from using the standard cents-per-mile rate or the actual expenses method. For example, leased vehicles must use the standard mileage rate method for the entire lease period (including renewals) if the standard mileage rate is chosen for the first year.

Medical and moving driving

In addition to business driving, you can use the standard mileage rate if you use your vehicle for medical reasons and you deduct medical expenses on your tax return. For example, you can include in medical expenses the amounts paid when you use a car to travel to doctors’ appointments. The new rate for deductible medical expenses will be 22 cents per mile beginning July 1, up from 18 cents per mile for the first six months of 2022.

And the rate for moving-expense driving (currently available only for active-duty members of the military) will also increase to 22 cents per mile beginning July 1, up from 18 cents per mile. The rate for charitable driving, which can be amended only by Congress, remains unchanged at 14 cents per mile for the entire year.

What’s the right option for you?

Keep in mind that you still may fare better from a tax standpoint using the actual expense method than you would with the standard mileage rate, even after the latest rate increases. Contact us to discuss your particular circumstances.

© 2022

The IRS recently announced that it’ll increase the standard mileage rate for qualified business driving for the second half of 2022. The adjustment reflects the soaring cost of gasoline this year. In fact, as of June 13, the nationwide average price of regular unleaded gas was $5.01 a gallon, according to the AAA Gas Prices website. This is compared with $3.08 a gallon a year ago.

Beginning July 1, 2022, the standard mileage rate for business travel will be 62.5 cents per mile, up 4 cents from the 58.5 cents-per-mile rate effective for the first six months of the year. The IRS also announced an increased standard mileage rate for medical driving and moving for members of the military.

“The IRS is adjusting the standard mileage rates to better reflect the recent increase in fuel prices,” said IRS Commissioner Charles Rettig. “We are aware a number of unusual factors have come into play involving fuel costs, and we are taking this special step to help taxpayers, businesses and others who use this rate.”

Basic business driving deduction rules

There are two options for deducting business driving expenses. If you use a vehicle for business driving, you generally have the option to deduct the actual expenses attributable to your business use. This includes expenses such as gas, oil, tires, insurance, repairs, licenses and vehicle registration fees. In addition, you may claim a depreciation allowance for the vehicle, based on the percentage of business use. Note that your deduction may be subject to so-called “luxury car” limits, indexed annually.

But many taxpayers don’t want to keep track of all their vehicle-related expenses. Instead of deducting your actual expenses, you may be able to use a standard cents-per-mile rate. With the standard mileage deduction, you don’t have to account for all your actual expenses, although you still must record certain information such as the mileage for each business trip, the dates you drove and the business purpose of the travel.

The cents-per-mile rate is adjusted annually by the IRS. Initially, the agency established a rate of 58.5 cents per business mile for 2022 (up from 56 cents per mile in 2021). But higher gas prices spurred calls for a mid-year adjustment. There’s some precedent for this action: The standard mileage rate was increased for the last six months of 2011 and 2008 after gas prices soared.

With the IRS announcement that the standard business rate will increase to 62.5 cents per mile for the last half of this year, taxpayers who use it will have to use a “blended rate” for 2022 to figure their deductions.

For example, let’s assume that you drive 10,000 miles every six months on business. You also incur $1,100 in related tolls and parking fees during the year. Based on the initial IRS rate, your deduction for business driving for the first six months of 2022 is $5,850 (10,000 miles × 58.5 cents). However, you can deduct $6,250 (10,000 miles × 62.5 cents) for business auto trips during the last six months of 2022. Thus, your total deduction is $13,200 ($5,850 + $6,250 + $1,100 tolls and parking fees).

There are additional rules that may prevent a taxpayer from using the standard cents-per-mile rate or the actual expenses method. For example, leased vehicles must use the standard mileage rate method for the entire lease period (including renewals) if the standard mileage rate is chosen for the first year.

Medical and moving driving

In addition to business driving, you can use the standard mileage rate if you use your vehicle for medical reasons and you deduct medical expenses on your tax return. For example, you can include in medical expenses the amounts paid when you use a car to travel to doctors’ appointments. The new rate for deductible medical expenses will be 22 cents per mile beginning July 1, up from 18 cents per mile for the first six months of 2022.

And the rate for moving-expense driving (currently available only for active-duty members of the military) will also increase to 22 cents per mile beginning July 1, up from 18 cents per mile. The rate for charitable driving, which can be amended only by Congress, remains unchanged at 14 cents per mile for the entire year.

What’s the right option for you?

Keep in mind that you still may fare better from a tax standpoint using the actual expense method than you would with the standard mileage rate, even after the latest rate increases. Contact us to discuss your particular circumstances.

© 2022

Back in late 2019, the first significant legislation addressing retirement savings since 2006 became law. The Setting Every Community Up for Retirement Enhancement (SECURE) Act has resulted in many changes to retirement and estate planning strategies, but it also raised some questions. The IRS has been left to fill the gaps, most recently with the February 2022 release of proposed regulations that have left many taxpayers confused and unsure of how to proceed.

The proposed regs cover numerous topics, but one of the most noteworthy is an unexpected interpretation of the so-called “10-year rule” for inherited IRAs and other defined contribution plans. If finalized, this interpretation — which contradicts earlier IRS guidance — could lead to larger tax bills for certain beneficiaries.

Birth of the 10-year rule

Before the SECURE Act was enacted, beneficiaries of inherited IRAs could “stretch” the required minimum distributions (RMDs) on such accounts over their entire life expectancies. The stretch period could be decades for younger heirs, meaning they could take smaller distributions and defer taxes while the accounts grew.

In an effort to accelerate tax collection, the SECURE Act eliminated the rules that allowed stretch IRAs for many heirs. For IRA owners or defined contribution plan participants who die in 2020 or later, the law generally requires that the entire balance of the account be distributed within 10 years of death. This rule applies regardless of whether the deceased died before, on or after the required beginning date (RBD) for RMDs. Under the SECURE Act, the RBD is age 72.

The SECURE Act recognizes exceptions for the following types of “eligible designated beneficiaries” (EDBs):

• Surviving spouses,
• Children younger than “the age of majority,”
• Individuals with disabilities,
• Chronically ill individuals, and
• Individuals who are no more than 10 years younger than the account owner.

EDBs may continue to stretch payments over their life expectancies (or, if the deceased died before the RBD, they may elect the 10-year rule treatment). The 10-year rule will apply to the remaining amounts when an EDB dies.

The 10-year rule also applies to trusts, including see-through or conduit trusts that use the age of the oldest beneficiary to stretch RMDs and prevent young or spendthrift beneficiaries from rapidly draining inherited accounts.

Prior to the release of the proposed regs, the expectation was that non-EDBs could wait until the end of the 10-year period and take the entire account as a lump-sum distribution, rather than taking annual taxable RMDs. This distribution approach generally would be preferable, especially if an heir is working during the 10 years and in a higher tax bracket. Such heirs could end up on the hook for greater taxes than anticipated if they must take annual RMDs.

The IRS has now muddied the waters with conflicting guidance. In March 2021, it published an updated Publication 590-B, “Distributions from Individual Retirement Arrangements (IRAs),” which suggested that annual RMDs would indeed be required for years one through nine post-death. But, just a few months later, it again revised the publication to specify that “the beneficiary is allowed, but not required, to take distributions prior to” the 10-year deadline.

That position didn’t last long. The proposed regs issued in February call for annual RMDs in certain circumstances.

Proposed regs regarding the 10-year rule

According to the proposed regs, as of January 1, 2022, non-EDBs who inherit an IRA or defined contribution plan before the deceased’s RBD satisfy the 10-year rule simply by taking the entire sum before the end of the calendar year that includes the 10th anniversary of the death. The regs take a different tack when the deceased passed on or after the RBD.

In that case, non-EDBs must take annual RMDs (based on their life expectancies) in year one through nine, receiving the remaining balance in year 10. The annual RMD rule gives beneficiaries less flexibility and could push them into higher tax brackets during those years. (Note that Roth IRAs don’t have RMDs, so beneficiaries need only empty the accounts by the end of 10 years.)

Aside from those tax implications, this stance creates a conundrum for non-EDBs who inherited an IRA or defined contribution plan in 2020. Under the proposed regs, they should have taken an annual RMD for 2021, seemingly subjecting them to a penalty for failure to do so, equal to 50% of the RMD they were required to take. But the proposed regs didn’t come out until February of 2022.

What about non-EDBs who are minors when they inherit the account but reach the “age of majority” during the 10-year post-death period? Those beneficiaries can use the stretch rule while minors, but the annual RMD will apply after the age of majority (assuming the deceased died on or after the RBD).

If the IRS’s most recent interpretation of the 10-year rule sticks, non-EDBs will need to engage in tax planning much sooner than they otherwise would. For example, it could be wise to take more than the annual RMD amount to more evenly spread out the tax burden over the 10 years. They also might want to adjust annual distribution amounts based on factors such as other income or deductions for a particular tax year.

Clarifications of the exceptions

The proposed regs clarify some of the terms relevant to determining whether an heir is an EDB. For example, they define the “age of majority” as age 21 — regardless of how the term is defined under the applicable state law.

The definition of “disability” turns on the beneficiary’s age. If under age 18 at the time of the deceased’s death, the beneficiary must have a medically determinable physical or mental impairment that 1) results in marked and severe functional limitations, and 2) can be expected to result in death or be of long-continued and indefinite duration. Beneficiaries age 18 or older are evaluated under a provision of the tax code that considers whether the individual is “unable to engage in substantial gainful activity.”

Wait and see?

The U.S. Treasury Department is accepting comments on the proposed regs through May 25, 2022, and will hold a public hearing on June 15, 2022. Non-EDBs who missed 2021 RMDs may want to delay action to see if more definitive guidance comes out before year-end, including, ideally, relief for those who relied on the version of Publication 590-B that indicated RMDs weren’t necessary. As always, though, contact us to determine the best course for you in light of new developments.

© 2022

Back in late 2019, the first significant legislation addressing retirement savings since 2006 became law. The Setting Every Community Up for Retirement Enhancement (SECURE) Act has resulted in many changes to retirement and estate planning strategies, but it also raised some questions. The IRS has been left to fill the gaps, most recently with the February 2022 release of proposed regulations that have left many taxpayers confused and unsure of how to proceed.

The proposed regs cover numerous topics, but one of the most noteworthy is an unexpected interpretation of the so-called “10-year rule” for inherited IRAs and other defined contribution plans. If finalized, this interpretation — which contradicts earlier IRS guidance — could lead to larger tax bills for certain beneficiaries.

Birth of the 10-year rule

Before the SECURE Act was enacted, beneficiaries of inherited IRAs could “stretch” the required minimum distributions (RMDs) on such accounts over their entire life expectancies. The stretch period could be decades for younger heirs, meaning they could take smaller distributions and defer taxes while the accounts grew.

In an effort to accelerate tax collection, the SECURE Act eliminated the rules that allowed stretch IRAs for many heirs. For IRA owners or defined contribution plan participants who die in 2020 or later, the law generally requires that the entire balance of the account be distributed within 10 years of death. This rule applies regardless of whether the deceased died before, on or after the required beginning date (RBD) for RMDs. Under the SECURE Act, the RBD is age 72.

The SECURE Act recognizes exceptions for the following types of “eligible designated beneficiaries” (EDBs):

• Surviving spouses,
• Children younger than “the age of majority,”
• Individuals with disabilities,
• Chronically ill individuals, and
• Individuals who are no more than 10 years younger than the account owner.

EDBs may continue to stretch payments over their life expectancies (or, if the deceased died before the RBD, they may elect the 10-year rule treatment). The 10-year rule will apply to the remaining amounts when an EDB dies.

The 10-year rule also applies to trusts, including see-through or conduit trusts that use the age of the oldest beneficiary to stretch RMDs and prevent young or spendthrift beneficiaries from rapidly draining inherited accounts.

Prior to the release of the proposed regs, the expectation was that non-EDBs could wait until the end of the 10-year period and take the entire account as a lump-sum distribution, rather than taking annual taxable RMDs. This distribution approach generally would be preferable, especially if an heir is working during the 10 years and in a higher tax bracket. Such heirs could end up on the hook for greater taxes than anticipated if they must take annual RMDs.

The IRS has now muddied the waters with conflicting guidance. In March 2021, it published an updated Publication 590-B, “Distributions from Individual Retirement Arrangements (IRAs),” which suggested that annual RMDs would indeed be required for years one through nine post-death. But, just a few months later, it again revised the publication to specify that “the beneficiary is allowed, but not required, to take distributions prior to” the 10-year deadline.

That position didn’t last long. The proposed regs issued in February call for annual RMDs in certain circumstances.

Proposed regs regarding the 10-year rule

According to the proposed regs, as of January 1, 2022, non-EDBs who inherit an IRA or defined contribution plan before the deceased’s RBD satisfy the 10-year rule simply by taking the entire sum before the end of the calendar year that includes the 10th anniversary of the death. The regs take a different tack when the deceased passed on or after the RBD.

In that case, non-EDBs must take annual RMDs (based on their life expectancies) in year one through nine, receiving the remaining balance in year 10. The annual RMD rule gives beneficiaries less flexibility and could push them into higher tax brackets during those years. (Note that Roth IRAs don’t have RMDs, so beneficiaries need only empty the accounts by the end of 10 years.)

Aside from those tax implications, this stance creates a conundrum for non-EDBs who inherited an IRA or defined contribution plan in 2020. Under the proposed regs, they should have taken an annual RMD for 2021, seemingly subjecting them to a penalty for failure to do so, equal to 50% of the RMD they were required to take. But the proposed regs didn’t come out until February of 2022.

What about non-EDBs who are minors when they inherit the account but reach the “age of majority” during the 10-year post-death period? Those beneficiaries can use the stretch rule while minors, but the annual RMD will apply after the age of majority (assuming the deceased died on or after the RBD).

If the IRS’s most recent interpretation of the 10-year rule sticks, non-EDBs will need to engage in tax planning much sooner than they otherwise would. For example, it could be wise to take more than the annual RMD amount to more evenly spread out the tax burden over the 10 years. They also might want to adjust annual distribution amounts based on factors such as other income or deductions for a particular tax year.

Clarifications of the exceptions

The proposed regs clarify some of the terms relevant to determining whether an heir is an EDB. For example, they define the “age of majority” as age 21 — regardless of how the term is defined under the applicable state law.

The definition of “disability” turns on the beneficiary’s age. If under age 18 at the time of the deceased’s death, the beneficiary must have a medically determinable physical or mental impairment that 1) results in marked and severe functional limitations, and 2) can be expected to result in death or be of long-continued and indefinite duration. Beneficiaries age 18 or older are evaluated under a provision of the tax code that considers whether the individual is “unable to engage in substantial gainful activity.”

Wait and see?

The U.S. Treasury Department is accepting comments on the proposed regs through May 25, 2022, and will hold a public hearing on June 15, 2022. Non-EDBs who missed 2021 RMDs may want to delay action to see if more definitive guidance comes out before year-end, including, ideally, relief for those who relied on the version of Publication 590-B that indicated RMDs weren’t necessary. As always, though, contact us to determine the best course for you in light of new developments.

© 2022

The April tax filing deadline has passed, but that doesn’t mean you should push your taxes out of your mind until next year. Here are three tax-related actions that you should consider taking in the near term (if you filed on time and didn’t file for an extension).

Retain the requisite records

Depending on the specific issue, the IRS has years to audit your tax return so it’s critical to maintain the records you may need to defend yourself. You generally need to keep the documents that support your income, deductions and credits for at least three years after the tax-filing deadline. (Note that no time limit applies to how long the IRS has to pursue taxpayers who don’t file or file fraudulent returns.)

Essential documentation to retain may include:

• Form W-2, “Wage and Tax Statement,”
• Form 1099-NEC, “Nonemployee Compensation,” 1099-MISC, “Miscellaneous Income,” and 1099-G, “Certain Government Payments,”
• Form 1098, “Mortgage Interest Statement,”
• Property tax payments,
• Charitable donation receipts,
• Records related to contributions to and withdrawals from Section 529 plans and Health Savings Accounts, and
• Records related to deductible retirement plan contributions.

Hold on to records relating to property (including improvements to property) until the period of limitations expires for the year in which you dispose of the property. You’ll need those records to calculate your gain or loss.

Plan for your 2022 taxes

You should be collecting the documentation you’ll need for next year’s tax filing deadline on an ongoing basis. Keep up-to-date records of items such as charitable donations and mileage expenses.

In addition, this is a good time to reassess your current tax withholding to determine if you need to update your Form W-4, “Employee’s Withholding Certificate.” You may want to increase withholding if you owed taxes this year. Conversely, you might want to reduce it if you received a hefty refund. Changes also might be in order if you expect to experience certain major life changes, such as marriage, divorce, childbirth or adoption this year.

If you make estimated tax payments throughout the year, consider reevaluating the amounts you pay. You might want to increase or reduce the payments on account of changes in self-employment income, investment income, Social Security benefits and other types of nonwage income. To preempt the risk of a penalty for underpayment of estimated tax, consider paying at least 90% of the tax for the current year or 100% of the tax shown on your prior year’s tax return, whichever amount is less.

When it comes to strategies to reduce your 2022 tax bill, recent downturns in the stock market may have some upside. If you have substantial funds in a traditional IRA, this could be a ripe time to convert them to a Roth IRA. Roth IRAs have no required mandatory distributions, and distributions are tax-free. You must pay income tax on the fair market value of the converted assets, but, if you convert securities that have fallen in value or you’re in a lower tax bracket in 2022, you could pay less in taxes now than you would in the future. Moreover, any subsequent appreciation will be tax-free.

The market downturn could provide loss-harvesting opportunities, too. By selling poorly performing investments before year end, you can offset realized taxable gains on a dollar-for-dollar basis. If you end up with excess losses, you generally can apply up to $3,000 against your ordinary income and carry forward the balance to future tax years.

If you itemize deductions on your tax return, you also might consider “bunching” expected medical expenses into 2022 to increase the odds that you can claim the medical and dental expense deduction. You’re allowed to deduct unreimbursed expenses that exceed 7.5% of your adjusted gross income. If you expect to have, for example, a knee replacement surgery next winter, accelerating it (and all of the follow-up appointments and physical therapy) into this year could put you over the 7.5% threshold.

Respond to an IRS question or audit

You might have no choice but to continue thinking about your taxes if you receive a tax return question or audit letter from the IRS (and you would be notified only by a letter — the IRS doesn’t initiate inquiries or audits by telephone, text or email). Such letters can be alarming, but don’t assume the worst.

It’s important to remember that receiving a question or being selected for an audit doesn’t always mean you’ve tripped up somehow. For example, your tax return could have been flagged based on a statistical formula that compares similar returns for deviations from “norms.”

Further, if selected, you’re most likely going to undergo a correspondence audit; these audits account for more than 70% of IRS audits. They’re conducted by mail for a single tax year and involve only a few issues that the IRS anticipates it can resolve by reviewing relevant documents. According to the IRS, most audits involve returns filed within the last two years.

If you receive notification of a correspondence audit, you and your tax advisor should closely follow the instructions. You can request additional time if you can’t submit all documentation requested by the specified deadline. It’s advisable to submit copies instead of original documents, and each page of documentation should be marked with your name, Social Security number and the tax year under scrutiny.

Don’t ignore the letter. Doing so will eventually lead to the IRS disallowing the item(s) claimed and issuing a Notice of Deficiency (that is, a notice that a balance is due). You’ll then have 90 days to petition the U.S. Tax Court for review.

While correspondence audits are by far the most common, you could be selected for an office audit (in an IRS office) or field audit (at the taxpayer’s place of business). These are more intensive, and you should consult a tax professional with expertise in handling these types of exams.

Stay ahead of the game

Tax planning is an ongoing challenge. We can help you take the necessary steps to minimize your filing burden, your tax liability and the risk of bad results if you’re ever flagged for an audit.

© 2022

In 2019, the bipartisan Setting Every Community Up for Retirement Enhancement Act (SECURE Act) — the first significant legislation related to retirement savings since 2006 — became law. Now Congress appears ready to build on that law to further increase Americans’ retirement security.

The U.S. House of Representatives passed the Securing a Strong Retirement Act by a 414-5 vote. Also known as SECURE 2.0, the bill contains numerous provisions that — if enacted — would affect both individuals and employers, including in the following areas.

Catch-up contributions

Currently, qualified individuals age 50 or older can make catch-up contributions, on top of the standard contribution limits, to certain retirement accounts — an extra $6,500 for 401(k) plan accounts and $3,000 for SIMPLE plans. Beginning in 2024, SECURE 2.0 would boost those figures for individuals age 62 to 64 to $10,000 for 401(k)s and $5,000 for SIMPLE plans (indexed for inflation). In addition, the $1,000 annual catch-up for IRAs, which hasn’t changed in years, would be indexed going forward.

The bill also would change the taxation of catch-up contributions, reducing the upfront tax savings for those who max out their annual contributions. Such contributions would be treated as post-tax Roth contributions starting in 2023. Under existing law, you can choose whether to make catch-up contributions on a pre- or post-tax basis. SECURE 2.0 would also allow you to determine whether your employer’s matching contributions should be treated as pre- or post-tax. Currently, these contributions can be pre-tax only.

RMDs

The SECURE Act eased the rules for required minimum distributions (RMDs) from traditional IRAs and other qualified plans. It generally raised the age at which you must begin to take your RMDs — and pay taxes on them — from 70½ to 72.

SECURE 2.0 would increase the age over the course of a decade. As of 2023, RMDs wouldn’t be mandated until age 73, going up to age 74 in 2030 and age 75 in 2033. This would give you more time to grow your retirement savings tax-free, bearing in mind that delayed RMDs may translate to larger withdrawal requirements down the road.

The bill would relax the penalty for failing to take full RMDs, too. Currently, the failure results in a 50% excise tax of the amount that should have been withdrawn. SECURE 2.0 would reduce the tax to 25% beginning in 2023. If corrected in a “timely” manner, the penalty would further drop to 10%.

QCDs

Some taxpayers use qualified charitable distributions (QCDs) to satisfy both their RMD requirements and their philanthropic inclinations. With a QCD, you can distribute up to $100,000 per year directly to a 501(c)(3) charity after age 70½. You can’t claim a charitable deduction for this donation, but the distribution is removed from taxable income.

The bill would make this option more attractive. It would annually index the $100,000 limit for inflation. It also would allow you to make a one-time QCD transfer of up to $50,000 through a charitable gift annuity or charitable remainder trust (as opposed to directly to the charity). Both provisions would take effect in the taxable year following enactment of the law.

Automatic enrollment

The House bill would require employers to automatically enroll all newly eligible employees in their 401(k) plans at a deduction rate of at least 3% (but no more than 10%) of the employee’s pay, increasing it by 1% each year until the employee is contributing 10%. Employees could opt out or change their contribution rates.

Annuities

Annuities can help reduce the risk that retirees run out of money during their lifetimes. The SECURE Act encouraged reluctant employers to offer annuities by immunizing them from breach of fiduciary duty liability if they choose an annuity provider that meets certain requirements.

But an actuarial test in the regulations for RMDs has interfered with the availability of annuities. For example, the test commonly prohibits annuities with guaranteed annual increases of only 1% to 2%, return of premium death benefits and period-certain guarantees. Without such guarantees, though, many individuals are hesitant to choose an annuity option in a defined contribution plan or IRA. SECURE 2.0 would specify that these guarantees are allowed. The changes would take effect upon enactment of the law.

Matching contributions on student loan payments

SECURE 2.0 recognizes that many employees are unable to contribute to their retirement accounts because of student loan payment responsibilities. Such employees miss out on matching contributions from their employers.

The bill would allow employers to contribute to certain retirement plans for employees who are making qualified student loan payments. If enacted, this would take effect for contributions made for plan years beginning after 2022.

Part-time employee eligibility

The SECURE Act generally requires employers to allow part-time employees who work at least 500 hours for three consecutive years to participate in their 401(k) plans. Under SECURE 2.0, part-time employees would need to work at least 500 hours for only two consecutive years to be eligible for their employer’s 401(k) plan. The provision would be effective for plan years beginning after 2022.

Small business tax credits

SECURE 2.0 would create or enhance some tax credits for small businesses for tax years after 2022. For example, the SECURE Act increased the potential amount of the credit for retirement plan startup costs by capping it at $5,000 (up from $500). The three-year credit currently is available for 50% of “qualified startup costs” for employers with no more than 100 employees.

The new bill hikes the credit to 100% of qualified costs for employers with up to 50 employees. It provides an additional credit, too, except for defined benefit plans. The additional amount generally is a percentage of the amount the employer contributes on behalf of employees, up to $1,000 per employee. The full additional credit is limited to employers with 50 or fewer employees, gradually phasing out for employers with 51 to 100 employees.

Next steps

While the odds for passage of some form of retirement savings reform seem high in light of the bipartisan support for the SECURE Act and the new House bill, it remains to be seen what form it’ll take. The Senate is working its own bill, and the two would need to be reconciled before it reaches President Biden’s desk. The final legislation could add to, revise or remove the provisions described above. We’ll keep you up to date.

© 2022

The IRS has announced additional relief for pass-through entities required to file two new tax forms — Schedules K-2 and K-3 — for the 2021 tax year. Certain domestic partnerships and S corporations won’t be required to file the schedules, which are intended to make it easier for partners and shareholders to find information related to “items of international tax relevance” that they need to file their own returns.

In 2021, the IRS released guidance providing penalty relief for filers who made “good faith efforts” to adopt the new schedules. The IRS has indicated that its latest, more sweeping move comes in response to continued concern and feedback from the tax community and other stakeholders.

A tough tax season for the IRS

The announcement of additional relief comes as IRS Commissioner Charles Rettig has acknowledged that the agency faces “enormous challenges” this tax season. For example, millions of taxpayers are still waiting for prior years’ returns to be processed.

To address such issues, he says, the IRS has taken “extraordinary measures,” including mandatory overtime for IRS employees, the creation and assignment of “surge teams,” and the temporary suspension of the mailing of certain automated compliance notices to taxpayers. In addition, the partial suspension of the Schedules K-2 and K-3 filing requirements might ease the burden for both affected taxpayers and the IRS.

K-2 and K-3 filing requirements

Provisions of the Tax Cuts and Jobs Act, which was enacted in 2017, require taxpayers to provide significantly more information to calculate their U.S. tax liability for items of international tax relevance. The Schedule K-2 reports such items, and the Schedule K-3 reports a partner’s distributive share of those items. These schedules replace portions of Schedule K and numerous unformatted statements attached to earlier versions of Schedule K-1.

Schedules K-2 and K-3 generally must be filed with a partnership’s Form 1065, “U.S. Return of Partnership Income,” or an S corporation’s Form 1120-S, “U.S. Income Tax Return for an S Corporation.” Previously, partners and S corporation shareholders could obtain the information that’s included on the schedules through various statements or schedules the respective entity opted to provide, if any. The new schedules require more detailed and complete reporting than the entities may have provided in the past.

In January of 2022, the IRS surprised many in the tax community when it posted changes to the instructions for the schedules. Under the revised instructions, an entity may need to report information on the schedules even if it had no foreign partners, foreign source income, assets generating such income, or foreign taxes paid or accrued.

For example, if a partner claims a credit for foreign taxes paid, the partner might need certain information from the partnership to file his or her own tax return. Although some narrow exceptions apply, this change substantially expanded the pool of taxpayers required to file the schedules.

Good faith exception

IRS Notice 2021-39 exempted affected taxpayers from penalties for the 2021 tax year if they made a good faith effort to comply with the filing requirements for Schedules K-2 and K-3. When determining whether a filer has established such an effort, the IRS considers, among other things:

• The extent to which the filer has made changes to its systems, processes and procedures for collecting and processing the information required to file the schedules,
• The extent the filer has obtained information from partners, shareholders or a controlled foreign partnership or, if not obtained, applied reasonable assumptions, and
• The steps taken by the filer to modify the partnership or S corporation agreement or governing instrument to facilitate the sharing of information with partners and shareholders that’s relevant to determining whether and how to file the schedules.

The IRS won’t impose the relevant penalties for any incorrect or incomplete reporting on the schedules if it determines the taxpayer exercised the requisite good faith efforts.

Latest exception

Under the latest guidance, announced in early February, partnerships and S corporations need not file the schedules if they satisfy all of the following requirements:

• For the 2021 tax year:
  • The direct partners in the domestic partnership aren’t foreign partnerships, corporations, individuals, estates or trusts, and
  • The domestic partnership or S corporation has no foreign activity, including 1) foreign taxes paid or accrued, or 2) ownership of assets that generate, have generated or may reasonably be expected to generate foreign-source income.
• For the 2020 tax year, the domestic partnership or S corporation didn’t provide its partners or shareholders — nor did they request — information regarding any foreign transactions.
• The domestic partnership or S corporation has no knowledge that partners or shareholders are requesting such information for the 2021 tax year.

Entities that meet these criteria generally aren’t required to file Schedules K-2 and K-3. But there’s an important caveat. If such a partnership or S corporation is notified by a partner or shareholder that it needs all or part of the information included on Schedule K-3 to complete its tax return, the entity must provide that information.

Moreover, if the partner or shareholder notifies the entity of this need before the entity files its own return, the entity no longer satisfies the criteria for the exception. As a result, it must provide Schedule K-3 to the partner or shareholder and file the schedules with the IRS.

Temporary reprieves

The IRS guidance on the exceptions to the Schedules K-2 and K-3 filing requirement explicitly refers to 2021 tax year filings. In the absence of additional or updated guidance, partnerships and S corporations should expect and prepare to file the schedules for current and future tax years. We can help ensure you have the necessary information on hand.

© 2022

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

Form 1099-K primer

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

• From payment card transactions (for example, debit, credit or stored-value cards), and
• In settlement of third-party network transactions, when above a certain minimum threshold amount.

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

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

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

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

Understanding the new rules

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

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

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

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

Taking steps toward accurate reporting

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

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

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

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

Other potential landmines include:

• Incorrect amounts due to mid-tax year changes in entity type (for example, from a sole proprietorship to a partnership),
• Forms issued to you as an individual, with your Social Security number, rather than to your C corporation, S corporation or partnership, with its taxpayer identification number,
• Incorrect amounts due to a mid-tax year sale or purchase of a business, and
• Duplicate payments that appear on both a Form 1099-K and either a Form 1099-MISC or a Form 1099-NEC, “Nonemployee Compensation.”

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

Don’t dawdle

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

© 2022