Category: Tax

If you become an executor of your loved one’s estate, you may have some important tax decisions to make. Here are some quick thoughts.

The decedent’s medical expenses provide you with planning opportunities to

• deduct as itemized deductions (subject to the 7.5 percent floor) not only the medical expenses incurred during the taxable year of death, but also those unpaid at the date of death but paid within one year of death; or
• deduct in full (no floor) the medical expenses paid after the date of death against the federal estate tax.

You, as the executor, may need to file

• the decedent’s final Form 1040,
• the estate’s Form 1041 income tax return, and
• the estate’s Form 706.

You won’t need to file Form 1041 when all the decedent’s income-producing assets bypass probate and go straight to the surviving spouse or other heirs by contract or by operation of law—assets such as

• real property that is owned by joint tenants with right of survivorship,
• qualified retirement plan accounts and IRAs that have designated account beneficiaries, and
• life insurance death benefits that are paid directly to designated policy beneficiaries.

If the estate is valued at $11.58 million or less and the decedent did not make any sizable gifts before death, you don’t have to file Form 706. But even if you don’t have to file Form 706, you may want to file it anyway to preserve the portability election.

If you’re considering moving to a different state, taxes in the new state may be the deciding factor—especially if you expect them to be lower.

Consider All Applicable State and Local Taxes

If your objective is to move to a lower-tax state, it may seem like a no-brainer to move to one that has no personal income tax. But that’s not a no-brainer!

You must consider all the taxes that can potentially apply to local residents—including property taxes and death taxes.

One Case Study

Texas is “famous” for having no personal state income tax, while Colorado has a flat 4.63 percent personal state income tax rate. So, you might reasonably think it would be much cheaper taxwise to live in Texas than Colorado if you have a healthy income. Not necessarily! Here’s why.

The property tax rate on a home in some Colorado Springs locales is about 0.49 percent of the property’s actual value, as determined by the county assessor. Say you move to one of these areas and buy a $500,000 home. Your annual property tax bill would be about $2,450.

Say your taxable income is $200,000. Your Colorado state income tax bill would be $9,260. Your combined property tax bill and state income tax bill would be about $11,710 ($2,450 + $9,260).

According to the Dallas Central Appraisal District’s online property tax estimator, the annual property tax bill on a $500,000 home in some Dallas locales would be about $21,200, or about $17,800 if you’re over 65 or a surviving spouse. You would have no state income tax bill.

In most areas within both Colorado Springs and Dallas, the combined state and local sales tax rate is 8.25 percent, so no difference there.

So the relevant comparison for property and income taxes is $11,710 in Colorado Springs and about $21,200 (or $17,800 if you’re over 65 or a surviving spouse) in Dallas.

But if your income is really high, it could be the other way around—assuming you don’t buy a really expensive home in Dallas.

Finally, it’s important to know that the restaurants are better in Dallas. True!

Defang the State Tax Domicile Issue

If you decide to make a permanent move to a lower-tax state, it’s important to establish legal domicile there in order to decouple yourself from taxes in the state you came from.

The exact definition of “legal domicile” varies from state to state.

In general, your domicile is your fixed and permanent home location and the place where you plan to return, even after periods of residing elsewhere.

Because each state has its own rules regarding your domicile, you could wind up in the worst-case scenario—with two states claiming that you owe state taxes because you established domicile in the new state but did not successfully terminate domicile in the old state.

Finally, if you die without clearly establishing domicile in just one state, both the old and new states may claim that state death taxes are owed. Not good!

If the federal tax you pay is dependent on where you are physically located, then COVID-19 likely has thrown a wrench in your physical tax location (and tax situation).

If you were living abroad and had to return to the U.S. because of COVID-19, you may wonder if you’ll have a big tax bill for failing to meet the foreign earned income exclusion requirements.

If you are a non-resident alien who got stuck in the U.S. because of COVID-19, you may be worried that the IRS will consider you a U.S. resident for tax purposes—thereby allowing Uncle Sam to tax your worldwide income.

Here’s good news. The IRS has provided relief in both circumstances if you qualify.

Foreign Earned Income Exclusion

The tax law gives you a huge tax benefit if you live or work abroad, which allows you to exclude a significant amount of your income from federal tax. In 2020, the maximum exclusion is $107,600 per person plus an additional amount for foreign housing costs.

To claim the exclusion, you need

• foreign-sourced earned income,
• a foreign tax home, and
• to meet either the physical presence or the bona fide residence test.

You’ll still be a qualified individual for the foreign earned income exclusion if you had to leave the foreign country because of war, civil unrest, or similar adverse conditions that precluded the normal conduct of business.

Exclusion Relief

The IRS has ruled that COVID-19 is an adverse condition that precluded the normal conduct of business

• in the People’s Republic of China, excluding the Special Administrative Regions of Hong Kong and Macau (China), as of December 1, 2019, and
• globally, as of February 1, 2020.

To use this relief procedure, you had to

• establish residency, or be physically present, in the foreign country on or before the applicable date above, and
• reasonably expect to meet the foreign earned income exclusion requirements but for the COVID-19 pandemic.

The period covered by this relief ends on July 15, 2020.

Exclusion Relief Example

Joe is present in the United Kingdom from January 1, 2020, through March 1, 2020, and expected to work in London for all of calendar year 2020.

Due to COVID-19, Joe leaves the United Kingdom on March 2, 2020, then returns on August 24, 2020, and stays for the remainder of 2020.

Joe is a qualified individual for the foreign earned income exclusion for the following periods:

• January 1, 2020, through March 1, 2020, and
• August 25, 2020, through December 31, 2020.

Because Joe has 188 qualifying days in the calendar year period, his maximum foreign earned income exclusion in 2020 is $55,270.

U.S. Residency

If you are a citizen or resident of the United States, then you pay federal tax on your worldwide income.

If you are a non-resident alien, then you pay tax only on your U.S. source income. Therefore, if you aren’t a U.S. citizen or resident, but work occasionally in the U.S., you don’t want to become a U.S. resident for tax purposes.

If you are neither a U.S. citizen nor a lawful permanent resident, then you become a U.S. resident for tax purposes for a calendar year if you meet the substantial presence test in that calendar year.

To meet the substantial presence test for a calendar year, you would be present in the U.S. for at least

• 31 days in the current year, and
• 183 days over a three-year period, using the sum of days present in the current year, one-third of the days present in the first preceding year, and one-sixth of the days present in the second preceding year.

Therefore, if you work in the U.S., and couldn’t leave due to COVID-19, your worldwide income could be subject to U.S. tax.

You don’t count certain days toward the substantial presence test, including medical condition exception days, which are days in which you intended to leave the U.S. but were unable to do so because of a medical condition that arose while you were present in the U.S.

Residency Relief

If you intended to leave the U.S. during your COVID-19 emergency period, but you were unable to do so due to COVID-19 emergency travel disruptions, you can exclude the COVID-19 emergency period days from the substantial presence test.

Your COVID-19 emergency period is a single period of up to 60 consecutive calendar days that you select, starting on or after February 1, 2020, and on or before April 1, 2020, during which you were physically present in the United States for each day.

You qualify for this relief if

• you were not a U.S. resident at the close of the 2019 tax year;
• you are not a lawful permanent resident at any point in the 2020 tax year;
• you are physically present in the U.S. during your COVID-19 emergency period; and
• you don’t become a U.S. resident in 2020 due to days of your presence outside of your COVID-19 emergency period.

To claim your relief, you will either

• have to file a Form 1040-NR and complete a Form 8843 according to Revenue Procedure 2020-20, or
• not have to file a Form 1040-NR and simply retain appropriate records in case the IRS inquires.

Residency Relief Example

Martha arrived in the United States on August 14, 2019, and anticipated staying for work through March 31, 2020. With this schedule, she would not have met the substantial presence test in either 2019 or 2020.

But due to COVID-19, Martha did not leave the U.S. until May 26, 2020. Without relief, Martha would be a U.S. resident in calendar year 2020 with 192 days of presence:

• 146 days in 2020, and
• 46 days in 2019 (one-third of 139 days).

If Martha selects April 1, 2020, as the start of her COVID-19 emergency period, then she is not a U.S. resident in calendar year 2020 because she’ll have only 136 days of presence:

• 90 days in 2020, and
• 46 days in 2019 (one-third of 139 days).

The IRS recently issued new cryptocurrency guidance and is hot on your trail if you bought and sold cryptocurrency and didn’t report it on your tax return.

Here are the tax basics. You’ll treat cryptocurrency as property for tax purposes.

• If you receive bitcoin in exchange for your services, then your income is the fair market value of the bitcoin received. Your basis in the bitcoin received is its fair market value at the time of receipt plus any transaction fees incurred.
• If you receive bitcoin in exchange for your property, then your gain or loss is the fair market value of the bitcoin received less the adjusted basis of your property given up. Your basis in the bitcoin is its fair market value at the time of receipt plus any transaction fees incurred.
• If you give bitcoin in exchange for services, then the value of the expense is the fair market value of the bitcoin given. Also, the value of the services received less the adjusted basis of the bitcoin is a gain or loss to you.
• If you give bitcoin in exchange for someone’s property, then your gain or loss is the fair market value of the property you received less the adjusted basis of your bitcoin.

Cryptocurrency is a capital asset (provided you aren’t a trader). Therefore,

• you pay tax on any gain at reduced rates, and
• losses are subject to capital loss limitation rules.

Forks

In the cryptocurrency world, a fork occurs when the digital register that logs transactions of a particular cryptocurrency diverges into a new digital register. There are two types of forks:

• one in which you don’t get cryptocurrency, and
• one in which you get new cryptocurrency.

The IRS ruled that

• a fork in which you don’t get cryptocurrency is not a taxable event, and
• a fork in which you get new cryptocurrency is a taxable event and you’ll recognize ordinary income equal to the fair market value of the new cryptocurrency received.

Example. You own J, a cryptocurrency. A fork occurs and you receive three units of K, a new cryptocurrency. At the time of the fork, K has a value of $20 per unit. You’ll recognize $60 of ordinary income due to the fork.

Specific Identification

When selling property, you generally sell it on a first-in, first-out (FIFO) basis, unless you are eligible to use the specific identification method. You want to use the specific identification method if you can because you can select the amount of gain or loss your sale will create. With FIFO, you have no choice.

To use the specific identification method, you’ll have to either

• document the specific unit’s unique digital identifier, such as a private key, public key, and address, or
• keep records showing the transaction information for all units of a specific virtual currency, such as bitcoin, held in a single account, wallet, or address.

This information must show

• the date and time you acquired each unit;
• your basis and the fair market value of each unit at the time you acquired it;
• the date and time you sold, exchanged, or otherwise disposed of each unit;
• the fair market value of each unit when you sold, exchanged, or disposed of it; and
• the amount of money or the value of property received for each unit.

For most small businesses and the self-employed, the 20 percent tax deduction from new tax code Section 199A is the most valuable deduction to come out of the Tax Cuts and Jobs Act.

The Section 199A tax deduction is complicated, and many questions remain unanswered even after the IRS issued its proposed regulations on the provision. And to further complicate matters, there’s also a lot of misinformation out there about Section 199A.

Below are answers to six common questions about this new 199A tax deduction.

Question 1. Are real estate agents and brokers in an out-of-favor specified service trade or business for purposes of Section 199A?

Answer 1. No.

Question 2. Do my S corporation shareholder wages count as wages paid by the S corporation for purposes of the 50 percent Section 199A wage limitation?

Answer 2. Yes.

Question 3. Will my allowable SEP/SIMPLE/401(k) contribution as a Schedule C taxpayer be based only on Schedule C net earnings, or do I first subtract the Section 199A deduction?

Answer 3. You’ll continue to use Schedule C net earnings with no adjustment for Section 199A.

Question 4. Is my qualified business income for the Section 199A deduction reduced by either bonus depreciation or Section 179 expensing?

Answer 4. Yes, to both.

Question 5. I took out a loan to buy S corporation stock. The interest is deductible on my Schedule E. Does the interest reduce my Section 199A qualified business income?

Answer 5. Yes, in most circumstances.

Question 6. The out-of-favor specified service trade or business does not qualify for the Section 199A deduction, correct?

Answer 6. Incorrect.

Looking at your taxable income is the first step to see whether you qualify for the Section 199A tax deduction. If your taxable income on IRS Form 1040 is $157,500 or less (single) or $315,000 or less (married, filing jointly) and you have a pass-through business such as a proprietorship, partnership, or S corporation, you qualify for the Section 199A deduction.

With taxable income equal to or below the thresholds above, your type of pass-through business makes no difference. Retail store owners and medical doctors with income equal to or below the thresholds qualify in the same exact manner.