W-2

Article Dean Dorton

By: Matt Smith, CPA | msmith@deandorton.com and Jon Tennent, CPA | jtennent@deandorton.com

2019 federal and most state individual income tax returns are due to be filed by Wednesday, April 15, 2020.

Individuals who need additional time to file 2019 income tax returns may file for an automatic extension of time to file until October 15, 2020. The extension of time to file is not an extension of time to pay. Failure to pay tax shown on your return is subject to interest and to a 0.5% per month failure-to-pay penalty. You should make a good-faith effort to estimate the amount of tax due and report that amount on your extension form. Failure to do so may invalidate your extension and result in imposition of the failure-to-file penalty—a steep 5% per month of the balance due. You can underestimate the tax by up to 10% on the extension form without incurring penalties, but interest still applies.

As you’re compiling your 2019 tax information, give some thought to what information you would need if your return is selected for audit and how you would access that information. Most of us are aware that expense documentation is important, but many do not realize we must be prepared to identify and substantiate every deposit appearing on our bank statements.

You should also consider the format of your records. Many of us rely upon web-based programs or software to house financial records electronically, but these records may only be available for a few years. We need to think proactively about how we’ll retrieve information, if needed, from our electronic information sources.

Remember that the standard deduction remains large in 2019 (up to $12,200 for a single filer and $24,400 for married filing jointly). Some common itemized deductions are state and local taxes paid, large medical expenses, certain interest paid, and gifts to charity—all of which have certain limitations. It is more beneficial to claim the standard deduction if all of these items together don’t reach the threshold. However, many states (including Kentucky) have much smaller standard deduction amounts. For itemized deductions, Kentucky allows only charitable contributions, mortgage interest, investment interest, and gambling losses to the extent of winnings.

Substantiating records are required for charitable donations of any amount to be deductible on your tax return, but charitable gifts of $250 or more also require a timely written gift acknowledgment containing certain information. The charitable organization’s letter must state the gift’s date and amount and either (1) affirm that no goods or services were provided in connection with the gift, or (2) if such goods or services were provided, identify what they were and their value, and include a statement that the amount deductible is limited to the excess of the amount given over the value received. The deduction also is contingent on the contributor having the acknowledgement letter by the earlier of the filing date or due date (including an extension) of the return.

IRA and HSA contributions, if any, for 2019 must be made by April 15, 2020.

An impact of globalization is a greater incidence of U.S. persons having financial accounts or owning other property outside the U.S. Additional reporting requirements are imposed on certain owners of such assets. These reporting requirements may apply if:

  • You have a beneficial interest in or signature authority over a foreign bank or investment account.
  • You own an interest in a foreign corporation, partnership, or other business entity (not held in an investment account), a note, or other receivable due from a foreign borrower, or any other interest in any foreign financial asset.
  • You have an interest in a foreign trust or estate, have ever created a foreign trust, or received a gift or bequest from a foreign person during the year.

If you pay no or minimal state income tax, please note that you can choose to deduct state sales tax instead of state income tax as an itemized deduction. Consider whether you made any large purchases, such as vehicles, during 2019.

The Kentucky individual income tax return includes a line to report use tax on purchases from out-of-state retailers. If you purchased items online or from a catalog and did not pay sales tax on those items, you would report the use tax on this line. Kentucky ensures that out-of-state purchases are subject to at least Kentucky’s sales and use tax rate. For example, if you purchased clothes out of state, paid 5% sales tax, and brought or had the clothes shipped into Kentucky (where the rate is 6%), you would owe Kentucky the extra 1% use tax.

You can check the status of your 2019 tax refund, if you are due one, at www.irs.gov/refunds. You will need your tax identification number, filing status, and refund amount from your return. For Kentucky refunds, visit refund.ky.gov. Please note that due to rising rates of identity theft, refunds may be delayed.

If you are a W-2 employee who either has a large overpayment or owes a large amount on your 2019 tax return, consider adjusting your 2020 withholding by updating your Form W-4 with your employer. The IRS has revised the W-4 significantly from the previous version to factor in the tax law changes of late 2017. Because the form can be complex, the IRS also provides an interactive calculator to help you determine the ideal withholding amount for your situation. It is available at www.irs.gov/W4App.

Article Dean Dorton

The Tax Cuts and Jobs Act includes a new deduction for individual business owners who conduct their activities through a sole proprietorship, partnership, or S corporation. Trusts and estates are also eligible to claim the deduction. The deduction is effective for taxable years beginning after December 31, 2017, but continues only through taxable years beginning prior to December 31, 2025. In a series of three articles, we will discuss the new deduction, its complexities, and its uncertainties. (Please note that the discussion below is based on the statute and committee explanations and is subject to change with additional guidance.)

The qualified business income (QBI) deduction is a 20% deduction from the net taxable business income of each separate qualified trade or business of the taxpayer, regardless of whether the business is conducted as a sole proprietorship or through a pass-through entity, such as a partnership or S corporation. The deduction is applicable regardless of whether the taxpayer has an active or passive role (for example, as a limited partner) in the operation of the business. Additionally, the new law provides for a 20% deduction with respect to certain qualified income from real estate investment trusts (REITs) and publicly-traded partnerships (PTPs).

The 20% deduction for each separate trade or business is subject to certain limitations related to wages paid and depreciable property owned and used by the business. There is an additional limitation for the combined business income deduction for each separate trade or business and the deductions related to REIT and PTP income based on the taxable income of the individual taxpayer. After this limitation is applied, the deduction is increased if the taxpayer has qualified cooperative dividends.

Although the next article will cover in more detail the definition of a qualified trade or business and type of business income that qualifies for the deduction, it should be noted that based on the statutory language, most retail, manufacturing, and real estate businesses, and many service businesses, should qualify. However, certain service businesses will not qualify for the deduction if the owner’s taxable income exceeds a certain amount.

As noted above, the qualified business income deduction is calculated separately for each qualified trade or business and then the combined amount is subject to the taxable income limitation. In determining the deduction for each separate business, the calculation begins with 20% of the net taxable business income of the business. This is the maximum deduction applicable to that business. There are special rules applicable to businesses with losses, which we will address later.

The next step is to determine the limitation based on the wages paid by the business and the depreciable property owned and used by the business. This limitation is only applicable if the owner’s taxable income for the year exceeds a certain “threshold amount” for the taxable year. The threshold amount for 2018 is $315,000 for taxpayers filing joint returns and $157,500 for all other taxpayers. These amounts will be adjusted for inflation. The limitation is “phased-in” after taxable income exceeds these amounts and is fully applicable when taxable income exceeds $415,000 and $207,500, respectively.

Generally, the deduction for each separate business is limited to the greater of two amounts.

The first amount is 50% of the “W-2 wages” of the business. W-2 wages include wages paid by the business that are subject to withholding plus certain deferred wages, such as Section 401(k) contributions. So, for example, if a business had $200,000 of wages paid including deferrals, this limitation amount would be $100,000.

The second limitation amount is the sum of 25% of W-2 wages plus 2.5% of qualifying depreciable property owned and used by the business. The property generally must be real property or personal property that was acquired within the last 10 years. The 2.5% is applied to the original cost or basis of the property, rather than the remaining undepreciated cost. Assuming the business in the above example had $1 million of qualifying property at the end of the tax year, this second limitation would be the sum of 25% of $200,000 for the wage component plus 2.5% of $1 million for the property component, or $50,000 + $25,000 = $75,000.

Accordingly, the higher of the two limitation amounts is $100,000, so the qualified business income deduction for this separate business would be limited to $100,000, regardless of the whether the 20% of business income was a higher amount. However, if the 20% amount is less than the limitation, say $50,000 in this example, then the deduction is limited to the 20%, or $50,000 in this example.

As noted above, the sum of the deductions for each separate trade or business, plus 20% of qualified REIT and PTP income, is limited by the taxable income of the owner (or owner and spouse if filing jointly). The combined deduction is limited to 20% of the taxable income in excess of capital gains and certain cooperative dividends. Although guidance has not been published, capital gains as defined in the legislation include capital gains from the sale of assets used in a business. The lower of these two amounts, plus 20% of certain cooperative income, is the final deductible amount on the tax return. The deduction cannot exceed taxable income for the year.

As noted above, there are special rules regarding losses at businesses that qualify for the new deduction. Generally, if a taxpayer has multiple businesses, a loss at one business will reduce the combined deduction for all other separate businesses with positive income for the tax year. Additionally, an overall loss for all businesses for the tax year will be carried over to the next tax year and reduce the deduction in the succeeding tax year.

In the next article, we will discuss the types of trades or businesses and the income that qualifies for the new deduction.

Read All Tax Cuts and Jobs Act Articles

Article Dean Dorton

The short answer is: none. You need to hold on to all of your 2015 tax records for now. But this is a great time to take a look at your records for previous tax years and determine what you can purge.

The 3-year rule

At minimum, keep tax records for as long as the IRS has the ability to audit your return or assess additional taxes, which generally is three years after you file your return. This means you likely can shred and toss most records related to tax returns for 2012 and earlier years.

What to keep longer

You’ll need to hang on to certain records beyond the statute of limitations:

  • Keep tax returns themselves forever, so you can prove to the IRS that you actually filed. (There’s no statute of limitations for an audit if you didn’t file a return.)
  • For W-2 forms, consider holding them until you begin receiving Social Security benefits. Why? In case a question arises regarding your work record or earnings for a particular year.
  • For records related to real estate or investments, keep documents as long as you own the asset, plus three years after you sell it and report the sale on your tax return.

Just a starting point

This is only a sampling of retention guidelines for tax-related documents. If you have questions about other documents, please contact us.

Article Dean Dorton

Penalties for failure to file correct information returns (W-2s, 1099s, 1098s, 1042s) have recently increased per new tax rules implemented effective for returns and statements to be filed after December 31, 2015. These penalties are based on the period of delinquency, the intent, and the size of the taxpayer. An unintentional delinquency per return has increased from $30 to $50 for a period of no more than 30 days. Beyond 30 days would be an additional penalty. The maximum for the calendar year increased from $75,000 to $175,000 for small taxpayers. The maximum penalty would increase from $1.5MM to $3MM for “other than small” taxpayers (i.e. those over $5MM of gross receipts).

With the increase in penalties, businesses will need to be more diligent in their collection of information and ensuring that they understand all reporting requirements. To avoid penalties for incorrect information or late filings:

  • Obtain a completed and signed W-9 from any vendor prior to payment.
  • Obtain employee social security numbers and home addresses prior to the first payroll.
  • Use the IRS TIN (tax identification number) matching system to avoid incorrect tax id numbers.
  • To ensure meeting all specified IRS deadlines, refer to the IRS website and form instructions or hire a qualified professional to generate the required forms.

For further information, please contact your Dean Dorton advisor or Gina Whitis at gwhitis@deandorton.com.