In recent weeks, some Americans have been victimized by hurricanes, severe storms, flooding, wildfires and other disasters. No matter where you live, unexpected disasters may cause damage to your home or personal property. Before the Tax Cuts and Jobs Act (TCJA), eligible casualty loss victims could claim a deduction on their tax returns. But there are now restrictions that make these deductions harder to take.

What’s considered a casualty for tax purposes? It’s a sudden, unexpected or unusual event, such as a hurricane, tornado, flood, earthquake, fire, act of vandalism or a terrorist attack.

More difficult to qualify 

For losses incurred through 2025, the TCJA generally eliminates deductions for personal casualty losses, except for losses due to federally declared disasters. For example, during the summer of 2021, there have been presidential declarations of major disasters in parts of Tennessee, New York state, Florida and California after severe storms, flooding and wildfires. So victims in affected areas would be eligible for casualty loss deductions.

Note: There’s an exception to the general rule of allowing casualty loss deductions only in federally declared disaster areas. If you have personal casualty gains because your insurance proceeds exceed the tax basis of the damaged or destroyed property, you can deduct personal casualty losses that aren’t due to a federally declared disaster up to the amount of your personal casualty gains.

Special election to claim a refund

If your casualty loss is due to a federally declared disaster, a special election allows you to deduct the loss on your tax return for the preceding year and claim a refund. If you’ve already filed your return for the preceding year, you can file an amended return to make the election and claim the deduction in the earlier year. This can potentially help you get extra cash when you need it.

This election must be made by no later than six months after the due date (without considering extensions) for filing your tax return for the year in which the disaster occurs. However, the election itself must be made on an original or amended return for the preceding year.

How to calculate the deduction

You must take the following three steps to calculate the casualty loss deduction for personal-use property in an area declared a federal disaster:

1. Subtract any insurance proceeds.
2. Subtract $100 per casualty event.
3. Combine the results from the first two steps and then subtract 10% of your adjusted gross income (AGI) for the year you claim the loss deduction.

Important: Another factor that now makes it harder to claim a casualty loss than it used to be years ago is that you must itemize deductions to claim one. Through 2025, fewer people will itemize, because the TCJA significantly increased the standard deduction amounts. For 2021, they’re $12,550 for single filers, $18,800 for heads of households, and $25,100 for married joint-filing couples.

So even if you qualify for a casualty deduction, you might not get any tax benefit, because you don’t have enough itemized deductions.

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These are the rules for personal property. Keep in mind that the rules for business or income-producing property are different. (It’s easier to get a deduction for business property casualty losses.) If you are a victim of a disaster, we can help you understand the complex rules.

If you’re a business owner and you’re getting a divorce, tax issues can complicate matters. Your business ownership interest is one of your biggest personal assets and in many cases, your marital property will include all or part of it.

Tax-free property transfers

You can generally divide most assets, including cash and business ownership interests, between you and your soon-to-be ex-spouse without any federal income or gift tax consequences. When an asset falls under this tax-free transfer rule, the spouse who receives the asset takes over its existing tax basis (for tax gain or loss purposes) and its existing holding period (for short-term or long-term holding period purposes).

Let’s say that under the terms of your divorce agreement, you give your house to your spouse in exchange for keeping 100% of the stock in your business. That asset swap would be tax-free. And the existing basis and holding periods for the home and the stock would carry over to the person who receives them.

Tax-free transfers can occur before a divorce or at the time it becomes final. Tax-free treatment also applies to post-divorce transfers as long as they’re made “incident to divorce.” This means transfers that occur within:

1. A year after the date the marriage ends, or
2. Six years after the date the marriage ends if the transfers are made pursuant to your divorce agreement.

More tax issues

Later on, there will be tax implications for assets received tax-free in a divorce settlement. The ex-spouse who winds up owning an appreciated asset — when the fair market value exceeds the tax basis — generally must recognize taxable gain when it’s sold (unless an exception applies).

What if your ex-spouse receives 49% of your highly appreciated small business stock? Thanks to the tax-free transfer rule, there’s no tax impact when the shares are transferred. Your ex will continue to apply the same tax rules as if you had continued to own the shares, including carryover basis and carryover holding period. When your ex-spouse ultimately sells the shares, he or she will owe any capital gains taxes. You will owe nothing.

Note that the person who winds up owning appreciated assets must pay the built-in tax liability that comes with them. From a net-of-tax perspective, appreciated assets are worth less than an equal amount of cash or other assets that haven’t appreciated. That’s why you should always take taxes into account when negotiating your divorce agreement.

In addition, the beneficial tax-free transfer rule is now extended to ordinary-income assets, not just to capital-gains assets. For example, if you transfer business receivables or inventory to your ex-spouse in a divorce, these types of ordinary-income assets can also be transferred tax-free. When the asset is later sold, converted to cash or exercised (in the case of nonqualified stock options), the person who owns the asset at that time must recognize the income and pay the tax liability.

Plan ahead to avoid surprises

Like many major life events, divorce can have major tax implications. For example, you may receive an unexpected tax bill if you don’t carefully handle the splitting up of qualified retirement plan accounts (such as a 401(k) plan) and IRAs. And if you own a business, the stakes are higher. We can help you minimize the adverse tax consequences of settling your divorce.

There may be a tax-advantaged way for people to save for the needs of family members with disabilities — without having them lose eligibility for government benefits to which they’re entitled. It can be done though an Achieving a Better Life Experience (ABLE) account, which is a tax-free account that can be used for disability-related expenses.

Who is eligible?

ABLE accounts can be created by eligible individuals to support themselves, by family members to support their dependents, or by guardians for the benefit of the individuals for whom they’re responsible. Anyone can contribute to an ABLE account. While contributions aren’t tax-deductible, the funds in the account are invested and grow free of tax.

Eligible individuals must be blind or disabled — and must have become so before turning age 26. They also must be entitled to benefits under the Supplemental Security Income (SSI) or Social Security Disability Insurance (SSDI) programs. Alternatively, an individual can become eligible if a disability certificate is filed with the IRS for him or her.

Distributions from an ABLE account are tax-free if used to pay for expenses that maintain or improve the beneficiary’s health, independence or quality of life. These expenses include education, housing, transportation, employment support, health and wellness costs, assistive technology, personal support services, and other IRS-approved expenses.

If distributions are used for nonqualified expenses, the portion of the distribution that represents earnings on the account is subject to income tax — plus a 10% penalty.

More details

Here are some other key factors:

• An eligible individual can have only one ABLE account. Contributions up to the annual gift-tax exclusion amount, currently $15,000, may be made to an ABLE account each year for the benefit of an eligible person. If the beneficiary works, the beneficiary can also contribute part, or all, of their income to their account. (This additional contribution is limited to the poverty-line amount for a one-person household.)
• There’s also a limit on the total account balance. This limit, which varies from state to state, is equal to the limit imposed by that state on qualified tuition (Section 529) plans.
• ABLE accounts have no impact on an individual’s Medicaid eligibility. However, ABLE account balances in excess of $100,000 are counted toward the SSI program’s $2,000 individual resource limit. Therefore, an individual’s SSI benefits are suspended, but not terminated, when his or her ABLE account balance exceeds $102,000 (assuming the individual has no other assets). In addition, distributions from an ABLE account to pay housing expenses count toward the SSI income limit.
• For contributions made before 2026, the designated beneficiary can claim the saver’s credit for contributions made to his or her ABLE account.

States establish programs

There are many choices. ABLE accounts are established under state programs. An account may be opened under any state’s program (if the state allows out-of-state participants). The funds in an account can be invested in a variety of options and the account’s investment directions can be changed up to twice a year. Contact us if you’d like more details about setting up or maintaining an ABLE account.

If you have a parent entering a nursing home, you may not be thinking about taxes. But there are a number of possible tax implications. Here are five.

1. Long-term medical care

The costs of qualified long-term care, including nursing home care, are deductible as medical expenses to the extent they, along with other medical expenses, exceed 7.5% of adjusted gross income (AGI).

Qualified long-term care services are necessary diagnostic, preventive, therapeutic, curing, treating, mitigating and rehabilitative services, and maintenance or personal-care services required by a chronically ill individual that is provided under care administered by a licensed healthcare practitioner.

To qualify as chronically ill, a physician or other licensed healthcare practitioner must certify an individual as unable to perform at least two activities of daily living (eating, toileting, transferring, bathing, dressing, and continence) for at least 90 days due to a loss of functional capacity or severe cognitive impairment.

2. Long-term care insurance

Premiums paid for a qualified long-term care insurance contract are deductible as medical expenses (subject to limitations explained below) to the extent they, along with other medical expenses, exceed the percentage-of-AGI threshold. A qualified long-term care insurance contract covers only qualified long-term care services, doesn’t pay costs covered by Medicare, is guaranteed renewable and doesn’t have a cash surrender value.

Qualified long-term care premiums are includible as medical expenses up to certain amounts. For individuals over 60 but not over 70 years old, the 2021 limit on deductible long-term care insurance premiums is $4,520, and for those over 70, the 2021 limit is $5,640.

3. Nursing home payments

Amounts paid to a nursing home are deductible as a medical expense if a person is staying at the facility principally for medical, rather than custodial care. If a person isn’t in the nursing home principally to receive medical care, only the portion of the fee that’s allocable to actual medical care qualifies as a deductible expense. But if the individual is chronically ill, all qualified long-term care services, including maintenance or personal care services, are deductible.

If your parent qualifies as your dependent, you can include any medical expenses you incur for your parent along with your own when determining your medical deduction.

4. Head-of-household filing status 

If you aren’t married and you meet certain dependency tests for your parent, you may qualify for head-of-household filing status, which has a higher standard deduction and lower tax rates than single filing status. You may be eligible to file as head of household even if the parent for whom you claim an exemption doesn’t live with you.

5. The sale of your parent’s home. 

If your parent sells his or her home, up to $250,000 of the gain from the sale may be tax-free. In order to qualify for the $250,000 exclusion, the seller must generally have owned the home for at least two years out of the five years before the sale, and used the home as a principal residence for at least two years out of the five years before the sale. However, there’s an exception to the two-out-of-five-year use test if the seller becomes physically or mentally unable to care for him or herself during the five-year period.

These are only some of the tax issues you may deal with when your parent moves into a nursing home. Contact us if you need more information or assistance.

Do you play a major role in a closely held corporation and sometimes spend money on corporate expenses personally? These costs may wind up being nondeductible both by an officer and the corporation unless proper steps are taken. This issue is more likely to arise in connection with a financially troubled corporation.

Deductible vs. nondeductible expenses

In general, you can’t deduct an expense you incur on behalf of your corporation, even if it’s a legitimate “trade or business” expense and even if the corporation is financially troubled. This is because a taxpayer can only deduct expenses that are his own. And since your corporation’s legal existence as a separate entity must be respected, the corporation’s costs aren’t yours and thus can’t be deducted even if you pay them.

What’s more, the corporation won’t generally be able to deduct them either because it didn’t pay them itself. Accordingly, be advised that it shouldn’t be a practice of your corporation’s officers or major shareholders to cover corporate costs.

When expenses may be deductible

On the other hand, if a corporate executive incurs costs that relate to an essential part of his or her duties as an executive, they may be deductible as ordinary and necessary expenses related to his or her “trade or business” of being an executive. If you wish to set up an arrangement providing for payments to you and safeguarding their deductibility, a provision should be included in your employment contract with the corporation stating the types of expenses which are part of your duties and authorizing you to incur them. For example, you may be authorized to attend out-of-town business conferences on the corporation’s behalf at your personal expense.

Alternatively, to avoid the complete loss of any deductions by both yourself and the corporation, an arrangement should be in place under which the corporation reimburses you for the expenses you incur. Turn the receipts over to the corporation and use an expense reimbursement claim form or system. This will at least allow the corporation to deduct the amount of the reimbursement.

Contact us if you’d like assistance or would like to discuss these issues further.

If you’re planning your estate, or you’ve recently inherited assets, you may be unsure of the “cost” (or “basis”) for tax purposes.

The current rules

Under the current fair market value basis rules (also known as the “step-up and step-down” rules), an heir receives a basis in inherited property equal to its date-of-death value. So, for example, if your grandmother bought stock in 1935 for $500 and it’s worth $1 million at her death, the basis is stepped up to $1 million in the hands of your grandmother’s heirs — and all of that gain escapes federal income tax.

The fair market value basis rules apply to inherited property that’s includible in the deceased’s gross estate, and those rules also apply to property inherited from foreign persons who aren’t subject to U.S. estate tax. It doesn’t matter if a federal estate tax return is filed. The rules apply to the inherited portion of property owned by the inheriting taxpayer jointly with the deceased, but not the portion of jointly held property that the inheriting taxpayer owned before his or her inheritance. The fair market value basis rules also don’t apply to reinvestments of estate assets by fiduciaries.

Gifting before death

It’s crucial to understand the current fair market value basis rules so that you don’t pay more tax than you’re legally required to.

For example, in the above example, if your grandmother decides to make a gift of the stock during her lifetime (rather than passing it on when she dies), the “step-up” in basis (from $500 to $1 million) would be lost. Property that has gone up in value acquired by gift is subject to the “carryover” basis rules. That means the person receiving the gift takes the same basis the donor had in it ($500 in this example), plus a portion of any gift tax the donor pays on the gift.

A “step-down” occurs if someone dies owning property that has declined in value. In that case, the basis is lowered to the date-of-death value. Proper planning calls for seeking to avoid this loss of basis. Giving the property away before death won’t preserve the basis. That’s because when property that has gone down in value is the subject of a gift, the person receiving the gift must take the date of gift value as his basis (for purposes of determining his or her loss on a later sale). Therefore, a good strategy for property that has declined in value is for the owner to sell it before death so he or she can enjoy the tax benefits of the loss.

Change on the horizon?

Be aware that President Biden has proposed ending the ability to step-up the basis for gains in excess of $1 million. There would be exemptions for family-owned businesses and farms. Of course, any proposal must be approved by Congress in order to be enacted.

These are the basic rules. Other rules and limits may apply. For example, in some cases, a deceased person’s executor may be able to make an alternate valuation election. Contact us for tax assistance when estate planning or after receiving an inheritance. We’ll keep you up to date on any tax law changes.

Do you have significant investment-related expenses, including the cost of subscriptions to financial services, home office expenses and clerical costs? Under current tax law, these expenses aren’t deductible through 2025 if they’re considered investment expenses for the production of income. But they’re deductible if they’re considered trade or business expenses.

For years before 2018, production-of-income expenses were deductible, but they were included in miscellaneous itemized deductions, which were subject to a 2%-of-adjusted-gross-income floor. (These rules are scheduled to return after 2025.) If you do a significant amount of trading, you should know which category your investment expenses fall into, because qualifying for trade or business expense treatment is more advantageous now.

In order to deduct your investment-related expenses as business expenses, you must be engaged in a trade or business. The U.S. Supreme Court held many years ago that an individual taxpayer isn’t engaged in a trade or business merely because the individual manages his or her own securities investments — regardless of the amount or the extent of the work required.

A trader vs. an investor

However, if you can show that your investment activities rise to the level of carrying on a trade or business, you may be considered a trader, who is engaged in a trade or business, rather than an investor, who isn’t. As a trader, you’re entitled to deduct your investment-related expenses as business expenses. A trader is also entitled to deduct home office expenses if the home office is used exclusively on a regular basis as the trader’s principal place of business. An investor, on the other hand, isn’t entitled to home office deductions since the investment activities aren’t a trade or business.

Since the Supreme Court decision, there has been extensive litigation on the issue of whether a taxpayer is a trader or investor. The U.S. Tax Court has developed a two-part test that must be satisfied in order for a taxpayer to be a trader. Under this test, a taxpayer’s investment activities are considered a trade or business only where both of the following are true:

1. The taxpayer’s trading is substantial (in other words, sporadic trading isn’t considered a trade or business), and
2. The taxpayer seeks to profit from short-term market swings, rather than from long-term holding of investments.

Profit in the short term

So, the fact that a taxpayer’s investment activities are regular, extensive and continuous isn’t in itself sufficient for determining that a taxpayer is a trader. In order to be considered a trader, you must show that you buy and sell securities with reasonable frequency in an effort to profit on a short-term basis. In one case, a taxpayer who made more than 1,000 trades a year with trading activities averaging about $16 million annually was held to be an investor rather than a trader because the holding periods for stocks sold averaged about one year.

Contact us if you have questions or would like to figure out whether you’re an investor or a trader for tax purposes.

The IRS just released its audit statistics for the 2020 fiscal year and fewer taxpayers had their returns examined as compared with prior years. But even though a small percentage of returns are being chosen for audit these days, that will be little consolation if yours is one of them.

Latest statistics

Overall, just 0.5% of individual tax returns were audited in 2020. However, as in the past, those with higher incomes were audited at higher rates. For example, in 2020, 2.2% of taxpayers with adjusted gross incomes (AGIs) of between $1 million and $5 million were audited. Among the richest taxpayers, those with AGIs of $10 million and more, 7% of returns were audited in 2020.

These are among the lowest percentages of audits conducted in recent years. However, the Biden administration has announced it would like to raise revenue by increasing tax compliance and enforcement. In other words, audits may be on the rise in coming years.

Prepare in advance 

Even though fewer audits were performed in 2020, the IRS will still examine thousands of returns this year. With proper planning, you may fare well even if you’re one of the unlucky ones.

The easiest way to survive an IRS examination is to prepare in advance. On a regular basis, you should systematically maintain documentation — invoices, bills, canceled checks, receipts, or other proof — for all items reported on your tax returns.

It’s possible you didn’t do anything wrong. Just because a return is selected for audit doesn’t mean that an error was made. Some returns are randomly selected based on statistical formulas. For example, IRS computers compare income and deductions on returns with what other taxpayers report. If an individual deducts a charitable contribution that’s significantly higher than what others with similar incomes report, the IRS may want to know why.

Returns can also be selected if they involve issues or transactions with other taxpayers who were previously selected for audit, such as business partners or investors.

The government generally has three years within which to conduct an audit, and often the exam won’t begin until a year or more after you file your return.

Complex vs. simple returns

The scope of an audit depends on the tax return’s complexity. A return reflecting business or real estate income and expenses will obviously take longer to examine than a return with only salary income.

An audit may be conducted by mail or through an in-person interview and review of records. The interview may be conducted at an IRS office or may be a “field audit” at the taxpayer’s home, business, or accountant’s office.

Important: Even if your chosen for audit, an IRS examination may be nothing to lose sleep over. In many cases, the IRS asks for proof of certain items and routinely “closes” the audit after the documentation is presented.

Don’t go it alone

It’s advisable to have a tax professional represent you at an audit. A tax pro knows the issues that the IRS is likely to scrutinize and can prepare accordingly. In addition, a professional knows that in many instances IRS auditors will take a position (for example, to disallow certain deductions) even though courts and other guidance have expressed contrary opinions on the issues. Because pros can point to the proper authority, the IRS may be forced to concede on certain issues.

If you receive an IRS audit letter or simply want to improve your recordkeeping, we’re here to help. Contact us to discuss this or any other aspect of your taxes.

The Employee Retention Tax Credit (ERTC) is a valuable tax break that was extended and modified by the American Rescue Plan Act (ARPA), enacted in March of 2021. Here’s a rundown of the rules.

Background

Back in March of 2020, Congress originally enacted the ERTC in the CARES Act to encourage employers to hire and retain employees during the pandemic. At that time, the ERTC applied to wages paid after March 12, 2020, and before January 1, 2021. However, Congress later modified and extended the ERTC to apply to wages paid before July 1, 2021.

The ARPA again extended and modified the ERTC to apply to wages paid after June 30, 2021, and before January 1, 2022. Thus, an eligible employer can claim the refundable ERTC against “applicable employment taxes” equal to 70% of the qualified wages it pays to employees in the third and fourth quarters of 2021. Except as discussed below, qualified wages are generally limited to $10,000 per employee per 2021 calendar quarter. Thus, the maximum ERTC amount available is generally $7,000 per employee per calendar quarter or $28,000 per employee in 2021.

For purposes of the ERTC, a qualified employer is eligible if it experiences a significant decline in gross receipts or a full or partial suspension of business due to a government order. Employers with up to 500 full-time employees can claim the credit without regard to whether the employees for whom the credit is claimed actually perform services. But, except as explained below, employers with more than 500 full-time employees can only claim the ERTC with respect to employees that don’t perform services.

Employers who got a Payroll Protection Program loan in 2020 can still claim the ERTC. But the same wages can’t be used both for seeking loan forgiveness or satisfying conditions of other COVID relief programs (such as the Restaurant Revitalization Fund program) in calculating the ERTC.

Modifications

Beginning in the third quarter of 2021, the following modifications apply to the ERTC:

• Applicable employment taxes are the Medicare hospital taxes (1.45% of the wages) and the Railroad Retirement payroll tax that’s attributable to the Medicare hospital tax rate. For the first and second quarters of 2021, “applicable employment taxes” were defined as the employer’s share of Social Security or FICA tax (6.2% of the wages) and the Railroad Retirement Tax Act payroll tax that was attributable to the Social Security tax rate.
• Recovery startup businesses are qualified employers. These are generally defined as businesses that began operating after February 15, 2020, and that meet certain gross receipts requirements. These recovery startup businesses will be eligible for an increased maximum credit of $50,000 per quarter, even if they haven’t experienced a significant decline in gross receipts or been subject to a full or partial suspension under a government order.
• A “severely financially distressed” employer that has suffered a decline in quarterly gross receipts of 90% or more compared to the same quarter in 2019 can treat wages (up to $10,000) paid during those quarters as qualified wages. This allows an employer with over 500 employees under severe financial distress to treat those wages as qualified wages whether or not employees actually provide services.
• The statute of limitations for assessments relating to the ERTC won’t expire until five years after the date the original return claiming the credit is filed (or treated as filed).

Contact us if you have any questions related to your business claiming the ERTC.

Are you age 65 and older and have basic Medicare insurance? You may need to pay additional premiums to get the level of coverage you want. The premiums can be expensive, especially if you’re married and both you and your spouse are paying them. But there may be a bright side: You may qualify for a tax break for paying the premiums.

Medicare premiums are medical expenses

You can combine premiums for Medicare health insurance with other qualifying medical expenses for purposes of claiming an itemized deduction for medical expenses on your tax return. This includes amounts for “Medigap” insurance and Medicare Advantage plans. Some people buy Medigap policies because Medicare Parts A and B don’t cover all their health care expenses. Coverage gaps include co-payments, coinsurance, deductibles and other costs. Medigap is private supplemental insurance that’s intended to cover some or all gaps.

Itemizing versus the standard deduction

Qualifying for a medical expense deduction is hard for many people for a couple of reasons. For 2021, you can deduct medical expenses only if you itemize deductions and only to the extent that total qualifying expenses exceeded 7.5% of AGI.

The Tax Cuts and Jobs Act nearly doubled the standard deduction amounts for 2018 through 2025. As a result, fewer individuals are claiming itemized deductions. For 2021, the standard deduction amounts are $12,550 for single filers, $25,100 for married couples filing jointly and $18,800 for heads of household. (For 2020, these amounts were $12,400, $24,800 and $18,650, respectively.)

However, if you have significant medical expenses, including Medicare health insurance premiums, you may itemize and collect some tax savings.

Note: Self-employed people and shareholder-employees of S corporations can generally claim an above-the-line deduction for their health insurance premiums, including Medicare premiums. So, they don’t need to itemize to get the tax savings from their premiums.

Medical expense deduction basics

In addition to Medicare premiums, you can deduct various medical expenses, including those for dental treatment, ambulance services, dentures, eyeglasses and contacts, hospital services, lab tests, qualified long-term care services, prescription medicines and others.

There are also many items that Medicare doesn’t cover that can be deducted for tax purposes, if you qualify. In addition, you can deduct transportation expenses to get to medical appointments. If you go by car, you can deduct a flat 16-cents-per-mile rate for 2021 (down from 17 cents for 2020), or you can keep track of your actual out-of-pocket expenses for gas, oil and repairs.

Claim all eligible deductions

Contact us if you have additional questions about claiming medical expense deductions on your tax return.