IRA

Article Dean Dorton

Yesterday afternoon, President Biden signed into law the Inflation Reduction Act of 2022 (“IRA”). The IRA includes provisions intended to combat climate change, promote clean energy, and lower prescription drug and health care costs. To pay for its spending, the IRA contains several tax changes, although the tax provisions are much narrower than those proposed in the Build Back Better Act that failed to progress in Congress last fall.

Notably, the IRA extends, through 2028, the limit on excess business losses (“EBL”) that can be deducted by noncorporate taxpayers. It also appropriates $80 billion to the Internal Revenue Service for enforcement, taxpayer services, operations support, and modernization, which could lead to increased audit activity. On a positive note, the IRA contains several tax incentives for individuals and businesses related to clean energy. Other tax provisions include a new corporate alternative minimum tax, an excise tax on the repurchase of corporate stock by publicly-traded companies, an increase in the research credit against payroll taxes for small businesses, and changes to the premium tax credit.

Extension of Limit on Excess Business Losses

The Tax Cuts and Jobs Act (“TCJA”), enacted at the end of 2017, introduced a limit on business losses deductible by individuals and other noncorporate taxpayers (trusts and estates) against non-business income. Specifically, the TCJA disallowed 2018 net tax losses from active businesses in excess of $250,000 (for individual taxpayers) and $500,000 (for joint filers), adjusted annually for inflation. Disallowed losses are converted into a net operating loss (“NOL”) and carried over to the following tax year. Under the TCJA, the EBL limit was effective for tax years 2018 through 2025.

In March of 2020, the CARES Act retroactively postponed the effective date of the EBL limit until tax years beginning in 2021. The American Rescue Plan Act of 2021 (“ARP”) later extended the EBL limit for one year, through 2026.

The IRA provides for a two-year extension of the EBL limit, through 2028. To illustrate the impact of this limitation, consider the following example:

H and W are married taxpayers filing a joint return. In 2022, H generates a net tax loss from his business of $600,000 and W generates a net tax loss from her business of $240,000. Both H and W actively participate in their businesses. Their aggregated net tax loss from trades or businesses is $840,000. For tax year 2022, the EBL limit is $540,000 for joint filers. Thus, their EBL for 2022 is $300,000 ($840,000 – $540,000).

How does this limitation impact the taxable income of H and W?

Let’s assume that, in addition to the losses generated from their businesses, H and W have other investment income totaling $1,000,000. The following table illustrates how taxable income is calculated before and after the EBL limit:

<table style="border-collapse:collapse;border:none;">
    <tbody>
        <tr>
            <td style="width: 197.75pt;border: 1pt solid windowtext;padding: 0in 5.4pt;vertical-align: top;">
                <p style='margin-top:0in;margin-right:0in;margin-bottom:.0001pt;margin-left:0in;text-align:  justify;font-size:15px;font-family:"Arial",sans-serif;'>&nbsp;</p>
            </td>
            <td style="width: 134.85pt;border-top: 1pt solid windowtext;border-right: 1pt solid windowtext;border-bottom: 1pt solid windowtext;border-image: initial;border-left: none;padding: 0in 5.4pt;vertical-align: top;">
                <p style='margin-top:0in;margin-right:0in;margin-bottom:.0001pt;margin-left:0in;text-align:center;font-size:15px;font-family:"Arial",sans-serif;'><strong>Before EBL limit</strong></p>
            </td>
            <td style="width: 134.9pt;border-top: 1pt solid windowtext;border-right: 1pt solid windowtext;border-bottom: 1pt solid windowtext;border-image: initial;border-left: none;padding: 0in 5.4pt;vertical-align: top;">
                <p style='margin-top:0in;margin-right:0in;margin-bottom:.0001pt;margin-left:0in;text-align:center;font-size:15px;font-family:"Arial",sans-serif;'><strong>After EBL limit</strong></p>
            </td>
        </tr>
        <tr>
            <td style="width: 197.75pt;border-right: 1pt solid windowtext;border-bottom: 1pt solid windowtext;border-left: 1pt solid windowtext;border-image: initial;border-top: none;padding: 0in 5.4pt;vertical-align: top;">
                <p style='margin-top:0in;margin-right:0in;margin-bottom:.0001pt;margin-left:0in;text-align:  justify;font-size:15px;font-family:"Arial",sans-serif;'>Investment income</p>
            </td>
            <td style="width: 134.85pt;border-top: none;border-left: none;border-bottom: 1pt solid windowtext;border-right: 1pt solid windowtext;padding: 0in 5.4pt;vertical-align: top;">
                <p style='margin-top:0in;margin-right:0in;margin-bottom:.0001pt;margin-left:0in;text-align:center;font-size:15px;font-family:"Arial",sans-serif;'><span style="color:black;">$1,000,000</span></p>
            </td>
            <td style="width: 134.9pt;border-top: none;border-left: none;border-bottom: 1pt solid windowtext;border-right: 1pt solid windowtext;padding: 0in 5.4pt;vertical-align: top;">
                <p style='margin-top:0in;margin-right:0in;margin-bottom:.0001pt;margin-left:0in;text-align:center;font-size:15px;font-family:"Arial",sans-serif;'><span style="color:black;">$1,000,000</span></p>
            </td>
        </tr>
        <tr>
            <td style="width: 197.75pt;border-right: 1pt solid windowtext;border-bottom: 1pt solid windowtext;border-left: 1pt solid windowtext;border-image: initial;border-top: none;padding: 0in 5.4pt;vertical-align: top;">
                <p style='margin-top:0in;margin-right:0in;margin-bottom:.0001pt;margin-left:0in;text-align:  justify;font-size:15px;font-family:"Arial",sans-serif;'>H&rsquo;s active business loss</p>
            </td>
            <td style="width: 134.85pt;border-top: none;border-left: none;border-bottom: 1pt solid windowtext;border-right: 1pt solid windowtext;padding: 0in 5.4pt;vertical-align: top;">
                <p style='margin-top:0in;margin-right:0in;margin-bottom:.0001pt;margin-left:0in;text-align:center;font-size:15px;font-family:"Arial",sans-serif;'>($600,000)</p>
            </td>
            <td style="width: 134.9pt;border-top: none;border-left: none;border-bottom: 1pt solid windowtext;border-right: 1pt solid windowtext;padding: 0in 5.4pt;vertical-align: top;">
                <p style='margin-top:0in;margin-right:0in;margin-bottom:.0001pt;margin-left:0in;text-align:center;font-size:15px;font-family:"Arial",sans-serif;'>($600,000)</p>
            </td>
        </tr>
        <tr>
            <td style="width: 197.75pt;border-right: 1pt solid windowtext;border-bottom: 1pt solid windowtext;border-left: 1pt solid windowtext;border-image: initial;border-top: none;padding: 0in 5.4pt;vertical-align: top;">
                <p style='margin-top:0in;margin-right:0in;margin-bottom:.0001pt;margin-left:0in;text-align:  justify;font-size:15px;font-family:"Arial",sans-serif;'>W&rsquo;s active business loss</p>
            </td>
            <td style="width: 134.85pt;border-top: none;border-left: none;border-bottom: 1pt solid windowtext;border-right: 1pt solid windowtext;padding: 0in 5.4pt;vertical-align: top;">
                <p style='margin-top:0in;margin-right:0in;margin-bottom:.0001pt;margin-left:0in;text-align:center;font-size:15px;font-family:"Arial",sans-serif;'>($240,000)</p>
            </td>
            <td style="width: 134.9pt;border-top: none;border-left: none;border-bottom: 1pt solid windowtext;border-right: 1pt solid windowtext;padding: 0in 5.4pt;vertical-align: top;">
                <p style='margin-top:0in;margin-right:0in;margin-bottom:.0001pt;margin-left:0in;text-align:center;font-size:15px;font-family:"Arial",sans-serif;'>($240,000)</p>
            </td>
        </tr>
        <tr>
            <td style="width: 197.75pt;border-right: 1pt solid windowtext;border-bottom: 1pt solid windowtext;border-left: 1pt solid windowtext;border-image: initial;border-top: none;padding: 0in 5.4pt;vertical-align: top;">
                <p style='margin-top:0in;margin-right:0in;margin-bottom:.0001pt;margin-left:0in;text-align:  justify;font-size:15px;font-family:"Arial",sans-serif;'>Excess business loss (see above)</p>
            </td>
            <td style="width: 134.85pt;border-top: none;border-left: none;border-bottom: 1pt solid windowtext;border-right: 1pt solid windowtext;padding: 0in 5.4pt;vertical-align: top;">
                <p style='margin-top:0in;margin-right:0in;margin-bottom:.0001pt;margin-left:0in;text-align:center;font-size:15px;font-family:"Arial",sans-serif;'>$0</p>
            </td>
            <td style="width: 134.9pt;border-top: none;border-left: none;border-bottom: 1pt solid windowtext;border-right: 1pt solid windowtext;padding: 0in 5.4pt;vertical-align: top;">
                <p style='margin-top:0in;margin-right:0in;margin-bottom:.0001pt;margin-left:0in;text-align:center;font-size:15px;font-family:"Arial",sans-serif;'>$300,000</p>
            </td>
        </tr>
        <tr>
            <td style="width: 197.75pt;border-right: 1pt solid windowtext;border-bottom: 1pt solid windowtext;border-left: 1pt solid windowtext;border-image: initial;border-top: none;padding: 0in 5.4pt;vertical-align: top;">
                <p style='margin-top:0in;margin-right:0in;margin-bottom:.0001pt;margin-left:0in;text-align:  justify;font-size:15px;font-family:"Arial",sans-serif;'><strong>Net taxable income</strong></p>
            </td>
            <td style="width: 134.85pt;border-top: none;border-left: none;border-bottom: 1pt solid windowtext;border-right: 1pt solid windowtext;padding: 0in 5.4pt;vertical-align: top;">
                <p style='margin-top:0in;margin-right:0in;margin-bottom:.0001pt;margin-left:0in;text-align:center;font-size:15px;font-family:"Arial",sans-serif;'><strong>$160,000</strong></p>
            </td>
            <td style="width: 134.9pt;border-top: none;border-left: none;border-bottom: 1pt solid windowtext;border-right: 1pt solid windowtext;padding: 0in 5.4pt;vertical-align: top;">
                <p style='margin-top:0in;margin-right:0in;margin-bottom:.0001pt;margin-left:0in;text-align:center;font-size:15px;font-family:"Arial",sans-serif;'><strong>$460,000</strong></p>
            </td>
        </tr>
    </tbody>
</table>

While H and W cannot reduce their 2022 taxable income by the $300,000 EBL, this loss is converted to a NOL and carried over to the following year. H and W can use the NOL in 2023 to offset up to 80% of their taxable income. To illustrate, let’s assume that H and W have the exact same facts as above for 2023. Their 2023 taxable income would be calculated as follows:

<table style="border-collapse:collapse;border:none;">
    <tbody>
        <tr>
            <td style="width: 332.75pt;border: 1pt solid windowtext;padding: 0in 5.4pt;vertical-align: top;">
                <p style='margin-top:0in;margin-right:0in;margin-bottom:.0001pt;margin-left:0in;text-align:  justify;font-size:15px;font-family:"Arial",sans-serif;'>&nbsp;</p>
            </td>
            <td style="width: 134.75pt;border-top: 1pt solid windowtext;border-right: 1pt solid windowtext;border-bottom: 1pt solid windowtext;border-image: initial;border-left: none;padding: 0in 5.4pt;vertical-align: top;">
                <p style='margin-top:0in;margin-right:0in;margin-bottom:.0001pt;margin-left:0in;text-align:center;font-size:15px;font-family:"Arial",sans-serif;'><strong>2023</strong></p>
            </td>
        </tr>
        <tr>
            <td style="width: 332.75pt;border-right: 1pt solid windowtext;border-bottom: 1pt solid windowtext;border-left: 1pt solid windowtext;border-image: initial;border-top: none;padding: 0in 5.4pt;vertical-align: top;">
                <p style='margin-top:0in;margin-right:0in;margin-bottom:.0001pt;margin-left:0in;text-align:  justify;font-size:15px;font-family:"Arial",sans-serif;'>Investment income</p>
            </td>
            <td style="width: 134.75pt;border-top: none;border-left: none;border-bottom: 1pt solid windowtext;border-right: 1pt solid windowtext;padding: 0in 5.4pt;vertical-align: top;">
                <p style='margin-top:0in;margin-right:0in;margin-bottom:.0001pt;margin-left:0in;text-align:center;font-size:15px;font-family:"Arial",sans-serif;'>$1,000,000</p>
            </td>
        </tr>
        <tr>
            <td style="width: 332.75pt;border-right: 1pt solid windowtext;border-bottom: 1pt solid windowtext;border-left: 1pt solid windowtext;border-image: initial;border-top: none;padding: 0in 5.4pt;vertical-align: top;">
                <p style='margin-top:0in;margin-right:0in;margin-bottom:.0001pt;margin-left:0in;text-align:  justify;font-size:15px;font-family:"Arial",sans-serif;'>H&rsquo;s active business loss</p>
            </td>
            <td style="width: 134.75pt;border-top: none;border-left: none;border-bottom: 1pt solid windowtext;border-right: 1pt solid windowtext;padding: 0in 5.4pt;vertical-align: top;">
                <p style='margin-top:0in;margin-right:0in;margin-bottom:.0001pt;margin-left:0in;text-align:center;font-size:15px;font-family:"Arial",sans-serif;'>($600,000)</p>
            </td>
        </tr>
        <tr>
            <td style="width: 332.75pt;border-right: 1pt solid windowtext;border-bottom: 1pt solid windowtext;border-left: 1pt solid windowtext;border-image: initial;border-top: none;padding: 0in 5.4pt;vertical-align: top;">
                <p style='margin-top:0in;margin-right:0in;margin-bottom:.0001pt;margin-left:0in;text-align:  justify;font-size:15px;font-family:"Arial",sans-serif;'>W&rsquo;s active business loss</p>
            </td>
            <td style="width: 134.75pt;border-top: none;border-left: none;border-bottom: 1pt solid windowtext;border-right: 1pt solid windowtext;padding: 0in 5.4pt;vertical-align: top;">
                <p style='margin-top:0in;margin-right:0in;margin-bottom:.0001pt;margin-left:0in;text-align:center;font-size:15px;font-family:"Arial",sans-serif;'>($240,000)</p>
            </td>
        </tr>
        <tr>
            <td style="width: 332.75pt;border-right: 1pt solid windowtext;border-bottom: 1pt solid windowtext;border-left: 1pt solid windowtext;border-image: initial;border-top: none;padding: 0in 5.4pt;vertical-align: top;">
                <p style='margin-top:0in;margin-right:0in;margin-bottom:.0001pt;margin-left:0in;text-align:  justify;font-size:15px;font-family:"Arial",sans-serif;'>Excess business loss (see above)</p>
            </td>
            <td style="width: 134.75pt;border-top: none;border-left: none;border-bottom: 1pt solid windowtext;border-right: 1pt solid windowtext;padding: 0in 5.4pt;vertical-align: top;">
                <p style='margin-top:0in;margin-right:0in;margin-bottom:.0001pt;margin-left:0in;text-align:center;font-size:15px;font-family:"Arial",sans-serif;'>$300,000</p>
            </td>
        </tr>
        <tr>
            <td style="width: 332.75pt;border-right: 1pt solid windowtext;border-bottom: 1pt solid windowtext;border-left: 1pt solid windowtext;border-image: initial;border-top: none;padding: 0in 5.4pt;vertical-align: top;">
                <p style='margin-top:0in;margin-right:0in;margin-bottom:.0001pt;margin-left:0in;text-align:  justify;font-size:15px;font-family:"Arial",sans-serif;'>Net taxable income before NOL carryover</p>
            </td>
            <td style="width: 134.75pt;border-top: none;border-left: none;border-bottom: 1pt solid windowtext;border-right: 1pt solid windowtext;padding: 0in 5.4pt;vertical-align: top;">
                <p style='margin-top:0in;margin-right:0in;margin-bottom:.0001pt;margin-left:0in;text-align:center;font-size:15px;font-family:"Arial",sans-serif;'>$460,000</p>
            </td>
        </tr>
        <tr>
            <td style="width: 332.75pt;border-right: 1pt solid windowtext;border-bottom: 1pt solid windowtext;border-left: 1pt solid windowtext;border-image: initial;border-top: none;padding: 0in 5.4pt;vertical-align: top;">
                <p style='margin-top:0in;margin-right:0in;margin-bottom:.0001pt;margin-left:0in;text-align:  justify;font-size:15px;font-family:"Arial",sans-serif;'>NOL carryover from 2022 (lesser of NOL of $300,000 or 80% of taxable income before NOL ($368,000))</p>
            </td>
            <td style="width: 134.75pt;border-top: none;border-left: none;border-bottom: 1pt solid windowtext;border-right: 1pt solid windowtext;padding: 0in 5.4pt;vertical-align: top;">
                <p style='margin-top:0in;margin-right:0in;margin-bottom:.0001pt;margin-left:0in;text-align:center;font-size:15px;font-family:"Arial",sans-serif;'>($300,000)</p>
            </td>
        </tr>
        <tr>
            <td style="width: 332.75pt;border-right: 1pt solid windowtext;border-bottom: 1pt solid windowtext;border-left: 1pt solid windowtext;border-image: initial;border-top: none;padding: 0in 5.4pt;vertical-align: top;">
                <p style='margin-top:0in;margin-right:0in;margin-bottom:.0001pt;margin-left:0in;text-align:  justify;font-size:15px;font-family:"Arial",sans-serif;'><strong>Net taxable income after NOL</strong></p>
            </td>
            <td style="width: 134.75pt;border-top: none;border-left: none;border-bottom: 1pt solid windowtext;border-right: 1pt solid windowtext;padding: 0in 5.4pt;vertical-align: top;">
                <p style='margin-top:0in;margin-right:0in;margin-bottom:.0001pt;margin-left:0in;text-align:center;font-size:15px;font-family:"Arial",sans-serif;'><strong>$160,000</strong></p>
            </td>
        </tr>
    </tbody>
</table>

As illustrated above, the EBL limit is merely a timing issue. Fortunately, the IRA only extends the limit for two more years and does not make further changes to current law, such as the conversion of disallowed losses into a NOL.

Increased IRS Funding

As noted above, the IRA appropriates $80 billion to the IRS for enforcement and other activities. The $80 billion is appropriated over a ten-year period and approximately broken down as follows:

  • $3.2 billion for taxpayer services;
  • $45.6 billion for enforcement;
  • $25.3 billion for operations support; and
  • $4.8 billion for business systems modernization.

An additional $15 million is appropriated to the IRS with a directive to report to Congress on the potential development of an IRS-run e-file system.

The IRA does not instruct the IRS on how to spend this additional funding with respect to enforcement activities. However, in a letter Congress on August 4, the IRS Commissioner stated that the agency’s investment of these additional resources would follow the Department of Treasury’s directive that audit rates will not rise relative to recent years for households making less than $400,000. Instead, the letter stated that the IRS would “pursue meaningful, impactful examinations of large corporate and high-net-worth taxpayers to ensure they are paying their fair share.”

Clean Energy Incentives

Investment in clean energy is a focal point of the IRA, and the law contains several tax incentives for both businesses and individuals. Notable clean energy incentives include, but are not limited to, the following:

  • Modification and extension of the credit for nonbusiness energy property – This credit, which applies to energy-efficient windows and doors, in addition to certain HVAC systems and heat pumps, is extended through 2032. The $500 lifetime limit for the credit is replaced with an annual limit of $1,200.
  • Modification and extension of the credit for residential energy-efficient property – This credit is renamed the “residential clean energy credit” and extended through 2034. It applies to residential energy-efficient property installed in a dwelling unit used as a residence by the taxpayer, such as qualified solar electric property, solar water heating property, fuel cell property, small wind energy property, and geothermal heat pump property.
  • Modification and extension of the clean vehicle credit – The credit for the purchase of clean vehicles, such as plug-in electric vehicles, is extended through 2032. The IRA eliminates the current cap on the number of credit-eligible vehicles produced by a specific manufacturer. However, it also imposes sourcing requirements on a vehicle’s critical components and battery systems. For example, electric vehicles made with any battery components manufactured by “foreign entities of concern” would be ineligible to receive the credit after 2023. The IRA also imposes a new credit limit based on the taxpayer’s income. The credit is not allowed if a taxpayer’s modified adjusted gross income exceeds $150,000 (for individual taxpayers) or $300,000 (for joint filers). The maximum credit per vehicle remains at $7,500.
  • Credit for previously-owned clean vehicles – A new credit of up to $4,000 is created for the purchase of a previously-owned clean vehicle. The credit applies only to taxpayers whose modified adjusted gross income does not exceed $75,000 (for individual taxpayers) or $150,000 (for joint filers). The credit applies to vehicles acquired after 2022 and before 2033.
  • Credit for commercial clean vehicles – The IRA creates a new business credit for qualified commercial clean vehicles acquired after 2022 and before 2033. The maximum credit per vehicle is $7,500, or $40,000 for a vehicle with a gross vehicle weight rating of at least 14,000 pounds.

The IRA also appropriates funds for the establishment of state rebate programs geared towards low- and middle-income households that purchase energy-efficient appliances.

Other Provisions

  • Corporate Alternative Minimum Tax – Effective for taxable years beginning after 2022, the IRA imposes a new, 15% corporate alternative minimum tax on the adjusted financial statement income (“AFSI”) of large corporations. The minimum tax applies to C corporations which, for a three taxable year period, have average annual AFSI greater than $1 billion. A lower threshold applies to foreign-parented corporations that are members of an international financial reporting group. S corporations are not subject to the minimum tax.
  • Excise Tax on Repurchase of Corporate Stock – The IRA also establishes a new excise tax on the repurchase of certain corporate stock. An excise tax of 1% is imposed on the fair market value of stock repurchased by a publicly-traded U.S. corporation during the taxable year. Several exceptions apply, including an exception in any case in which the total value of the stock repurchased during the taxable year does not exceed $1 million. The excise tax applies to repurchases of stock after 2022.
  • Increase in Research Credit Against Payroll Taxes for Small Businesses – Under current law, taxpayers engaged in research and development activities may be eligible for a research credit against their income tax liability. Small businesses that meet certain requirements may elect to apply the credit against their payroll tax liability. The amount of the credit that can offset a taxpayer’s payroll tax liability currently is limited to $250,000. The IRA increases this amount to $500,000 for taxable years beginning after 2022.
  • Changes to Premium Tax Credit – Taxpayers who purchase health insurance through the Health Insurance Marketplace may be eligible for a premium tax credit under current law. Eligibility for the credit depends on various factors, including a taxpayer’s household income, family size, and the federal poverty line. For 2021 and 2022, the ARP expanded eligibility for the credit to individuals with household income in excess of 400% of the poverty line and increased the credit amount for qualifying taxpayers. The IRA extends these enhancements to the credit through 2025.

Article Dean Dorton

By: Matt Smith, CPA | msmith@deandortonstg.wpenginepowered.com

Tax planning for 2020 is considerably more complicated for many taxpayers due to the following major factors:

  • The impact on business profits or compensation income of the COVID-19 pandemic, including uncertainty about the ultimate tax treatment of expenses paid by PPP loan funds when the loan qualifies to be forgiven, and
  • The current uncertainty about future tax law changes after the recent federal elections.

Discussions of all the “what ifs” are beyond this article’s scope, and the planning ideas that follow focus on the short-term—reducing 2020 taxes. We recommend you consult your tax advisor if you believe your situation is particularly impacted by unusual circumstances.

Maximize pre-tax deductions. Determine if you are on track to have 2020 maximum amounts withheld from your paycheck for your retirement plan contributions, HSA contributions, dependent care benefits, and other available pre-tax options. If you are not going to maximize these, consider having additional amounts withheld from year-end bonuses, if possible, and consider increasing these amounts for 2021.

Capital gains and losses. If you have realized net capital gains during 2020, consider realizing capital losses before the end of the year to offset the gains. Remember that net long-term losses can be used to offset net short-term capital gains which otherwise would be taxed as ordinary income. Also, be aware of the “wash sale” rules if you are inclined to reinvest in a security you sell at a loss.

Bonus depreciation & Section 179. Businesses should consider these tax breaks related to fixed asset acquisitions:

  • Special “bonus depreciation” allowance. For 2020, 100% of the cost of qualifying property (including used assets) is deductible if the property is placed in service by year-end. This deduction can create or increase an existing business loss. Note: Because its requirements are much less restrictive, 100% bonus depreciation usually makes Section 179 not applicable.
  • Section 179 depreciation deduction. In 2020, individuals and business entities can elect to deduct up to $1,040,000 of qualifying business property cost in the year the property is placed in service. The deduction is reduced dollar-for-dollar for qualifying property cost greater than $2,590,000. This deduction is available only to the extent of positive business taxable income.

Self-employed retirement plans. If you have self-employment income and don’t have a retirement plan in place to shelter any of it, you may qualify to use a Self-Employed Plan (SEP). A SEP contribution deduction is allowed for 2020, even if the SEP is created and funded at any time up to the due date, including extensions, of your 2020 income tax return in 2021. Depending on the amount of self-employment income, you could fund (and deduct) up to $57,000 for 2020.

Required minimum distributions (RMDs). The CARES Act waives required minimum distributions during 2020 for IRAs and retirement plans. Individuals with traditional IRAs and most individuals with employer-sponsored qualified retirement plan accounts must take minimum annual distributions from the account upon reaching a certain age, most recently changed to 72.

Charitable contributions. Depending on your situation, it may be beneficial to accelerate planned 2021 charitable contributions into 2020 or to defer 2020 contributions into 2021 to bunch them into the same year for greater tax savings.

Annual gifting. You may give your children and others up to $15,000 each in 2020 without any gift tax consequences. This annual exclusion is calculated on a per donee basis and no carryover is allowed for the unused exclusion. Consider making year-end gifts to fully utilize this year’s annual exclusion.

Roth IRAs. With individual tax rates at the lowest levels in recent memory, consider converting traditional IRAs to Roth IRAs. The current tax cost from a conversion done now may turn out to be a relatively small price to pay for completely avoiding potentially higher future tax rates on the account’s earnings. Also consider making a backdoor Roth IRA contribution, if your current income level is too high to make a direct Roth IRA contribution. A backdoor Roth IRA contribution consists of making a nondeductible IRA contribution followed by converting the contributed funds to a Roth IRA. The rules regarding this are very particular, so please consult with your tax advisor regarding this strategy.

HSAs & FSAs. Health Savings Accounts (HSAs) and Flexible Savings Accounts (FSAs) are two separate tools to convert your dollars spent on medical expenses from post-tax into pre-tax, potentially saving you up to 42% of the cost.  An HSA is a bank account set up to pay for medical expenses and must be paired with a high-deductible health plan. FSAs allow you to direct some of your wages into a pre-tax account, and your employer will reimburse you from the account for your documented medical expenses.  Specific funding rules and limits apply to these accounts.

S Corporation and partnership losses. If your S Corporation will generate a tax loss this year, consider whether you have enough basis in the stock (or in loans you’ve made to the corporation) to take the full loss. If you don’t, additional investments should be considered. Similar considerations can arise in some situations with partnerships expecting tax losses.

Excess Business Loss. The Tax Cuts and Jobs Act (TCJA), passed in late 2017, introduced a limitation on business losses deductible by individuals and other non-corporate taxpayers (trusts and estates) against non-business income.  Specifically, the TCJA disallowed net tax losses from active businesses over $250,000 ($500,000 for joint filers), adjusted annually for inflation. For pass-through entities, this is calculated at the owner level, as tax-paying persons combine all business activities when determining overall net business income or loss. Disallowed losses are treated as net operating loss carryforwards to the following year. Under the TCJA, the excess business loss (EBL) limitation was effective for 2018 through 2025. The CARES Act retroactively postponed implementation of the EBL limitation until 2021. This postponement and other available income tax incentives—such as 100% bonus depreciation and net operating loss carrybacks—mean 2020 could be the optimal year to accelerate deductions in your business.

This article was originally published in News & Views (Dean Dorton’s quarterly newsletter).

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Article Dean Dorton

Yes, there’s still time to make 2016 contributions to your IRA. The deadline for such contributions is April 18, 2017. If the contribution is deductible, it will lower your 2016 tax bill. But even if it isn’t, making a 2016 contribution is likely a good idea.

Benefits beyond a deduction

Tax-advantaged retirement plans like IRAs allow your money to grow tax-deferred — or, in the case of Roth accounts, tax-free. But annual contributions are limited by tax law, and any unused limit can’t be carried forward to make larger contributions in future years.

This means that, once the contribution deadline has passed, the tax-advantaged savings opportunity is lost forever. So it’s a good idea to use up as much of your annual limit as possible.

Contribution options

The 2016 limit for total contributions to all IRAs generally is $5,500 ($6,500 if you were age 50 or older on December 31, 2016). If you haven’t already maxed out your 2016 limit, consider making one of these types of contributions by April 18:

  1. Deductible traditional. If you and your spouse don’t participate in an employer-sponsored plan such as a 401(k) — or you do but your income doesn’t exceed certain limits — the contribution is fully deductible on your 2016 tax return. Account growth is tax-deferred; distributions are subject to income tax.
  2. Roth. The contribution isn’t deductible, but qualified distributions — including growth — are tax-free. Income-based limits, however, may reduce or eliminate your ability to contribute.
  3. Nondeductible traditional. If your income is too high for you to fully benefit from a deductible traditional or a Roth contribution, you may benefit from a nondeductible contribution to a traditional IRA. The account can still grow tax-deferred, and when you take qualified distributions you’ll be taxed only on the growth. Alternatively, shortly after contributing, you may be able to convert the account to a Roth IRA with minimal tax liability.

Want to know which option best fits your situation? Contact us.

Article Dean Dorton

Retirement plan contribution limits are indexed for inflation, but with inflation remaining low, most of the limits remain unchanged for 2017. The only limit that has increased from the 2016 level is for contributions to defined contribution plans, which has gone up by $1,000.

Type of Limit 2017 Limit
Elective deferrals to 401(k), 403(b), 457(b)(2), and 457(c)(1) plans $18,000
Contributions to defined contribution plans $54,000
Contributions to SIMPLE IRAs $12,500
Contributions to IRAs $5,500
Catch-up contributions to 401(k), 403(b), 457(b)(2), and 457(c)(1) plans $6,000
Catch-up contributions to SIMPLE IRAs $3,000
Catch-up contributions to IRAs $1,000

Nevertheless, if you’re not already maxing out your contributions, you still have an opportunity to save more in 2017. And if you turn age 50 in 2017, you can begin to take advantage of catch-up contributions.

However, keep in mind that additional factors may affect how much you’re allowed to contribute (or how much your employer can contribute on your behalf). For example, income-based limits may reduce or eliminate your ability to make Roth IRA contributions or to make deductible traditional IRA contributions. If you have questions about how much you can contribute to tax-advantaged retirement plans in 2017, check with us.

Article Dean Dorton

There’s a lot to think about when you change jobs, and it’s easy for a 401(k) or other employer-sponsored retirement plan to get lost in the shuffle. But to keep building tax-deferred savings, it’s important to make an informed decision about your old plan. First and foremost, don’t take a lump-sum distribution from your old employer’s retirement plan. It generally will be taxable and, if you’re under age 59½, subject to a 10% early-withdrawal penalty. Here are three tax-smart alternatives:

  1. Stay put. You may be able to leave your money in your old plan. But if you’ll be participating in your new employer’s plan or you already have an IRA, keeping track of multiple plans can make managing your retirement assets more difficult. Also consider how well the old plan’s investment options meet your needs.
  2. Roll over to your new employer’s plan. This may be beneficial if it leaves you with only one retirement plan to keep track of. But evaluate the new plan’s investment options.
  3. Roll over to an IRA. If you participate in your new employer’s plan, this will require keeping track of two plans. But it may be the best alternative because IRAs offer nearly unlimited investment choices.

If you choose a rollover, request a direct rollover from your old plan to your new plan or IRA. If instead the funds are sent to you by check, you’ll need to make an indirect rollover (that is, deposit the funds into an IRA) within 60 days to avoid tax and potential penalties.

Also, be aware that the check you receive from your old plan will, unless an exception applies, be net of 20% federal income tax withholding. If you don’t roll over the gross amount (making up for the withheld amount with other funds), you’ll be subject to income tax — and potentially the 10% penalty — on the difference.

There are additional issues to consider when deciding what to do with your old retirement plan. We can help you make an informed decision — and avoid potential tax traps.

Article Dean Dorton

Last year a break valued by many charitably inclined retirees was made permanent: the charitable IRA rollover. If you’re age 70½ or older, you can make direct contributions — up to $100,000 annually — from your IRA to qualified charitable organizations without owing any income tax on the distributions.

Satisfy your RMD

A charitable IRA rollover can be used to satisfy required minimum distributions (RMDs). You must begin to take annual RMDs from your traditional IRAs in the year in which you reach age 70½. If you don’t comply, you can owe a penalty equal to 50% of the amount you should have withdrawn but didn’t. (An RMD deferral is allowed for the initial year, but you’ll have to take two RMDs the next year.)

So if you don’t need the RMD for your living expenses, a charitable IRA rollover can be a great way to comply with the RMD requirement without triggering the tax liability that would occur if the RMD were paid out to you.

Additional benefits

You might be able to achieve a similar tax result from taking the RMD payout and then contributing that amount to charity. But it’s more complex because you must report the RMD as income and then take an itemized deduction for the donation. This has two more possible downsides:

  • The reported RMD income might increase your income to the point that you’re pushed into a higher tax bracket, certain additional taxes are triggered and/or the benefits of certain tax breaks are reduced or eliminated. It could even cause Social Security payments to become taxable or increase income-based Medicare premiums and prescription drug charges.
  • If your donation would equal a large portion of your income for the year, your deduction might be reduced due to the percentage-of-income limit. You generally can’t deduct cash donations that exceed 50% of your adjusted gross income for the year. (Lower limits apply to donations of long-term appreciated securities or made to private foundations.) You can carry forward the excess up to five years, but if you make large donations every year, that won’t help you.

A charitable IRA rollover avoids these potential negative tax consequences.

Have questions about charitable IRA rollovers or other giving strategies? Please contact us. We can help you create a giving plan that will meet your charitable goals and maximize your tax savings