taxeaseed.com · 2020-07-01 · i 2020 taxease, llc 20 hour continuing education 2020 taxease 20...

I

2020 TaxEase, LLC

20 HOUR CONTINUING EDUCATION

2020 TAXEASE 20 HOUR BUNDLE CTEC BUNDLE COURSE NUMBER -3064-CE-0059

2020 TAX UPDATE COURSE

IRS COURSE NUMBER: B8FQK-U-00036-20-S CTEC COURSE NUMBER: 3064-CE-0060

2020 TAX LAW COURSE

IRS COURSE NUMBER: B8FQK-T-00035-20-S CTEC COURSE NUMBER: 3064-CE-0063

2020 ETHICS COURSE

IRS COURSE NUMBER: B8FQK-E-00033-20-S CTEC COURSE NUMBER: 3064-CE-0062

2020 CALIFORNIA TAX COURSE CTEC COURSE NUMBER: 3064-CE-0061

See Page II for “Online” exam instructions

See Page III for “Fax or Email” exam instructions

PHONE NUMBER: 512-256-5812 WEBSITE: www.taxeaseed.com

FAX NUMBER: 510 779-5251 EMAIL: [email protected]

http://www.taxeaseed.com/

II

Online Instructions

The "Online Exam" allows you to add one more choice to how you complete your annual

continuing education. If you use the online system, each section will be graded immediately.

When you pass the exam with 70% or better any incorrect questions will be displayed. Please

read the following instructions before clicking on the link.

To access your exam go to www.taxeaseed.com and click on “Access Online Exams” on the

home page.

Returning Students: Enter your Login and Password you created in a prior year. You must have

your 2020 Order Number* to complete the login. Use either the Login you created last year or

your email address as your Login. You must enter your Order Number to continue.

*The 2020 Order Number is found on your Confirmation Email.

New Students: Setup your account by clicking Register on the login screen and following the

prompts. You must have your TaxEase 2020 Order Number and PTIN Number to complete the

login process. If you are a CTEC Registered Tax Preparer, you must also have your CTEC

number, for TaxEase to report your continuing education.

Click on the “Choose Program” button then click on the exam that you wish to take

2020 UPDATE COURSE (3-Hours CE)

2020 TAX LAW COURSE (10-Hours CE)

2020 ETHICS COURSE (2-Hours CE)

2020 CA TAX LAW COURSE (5-Hours CE)

You are allowed to stop, restart and resume the exams. You are allowed to login and logout. Be

sure to logout and close your browser, you must enter through our website www.taxeaseed.com

and select “Access Online Exams” from the home page to return to your exam.

A copy of the exam questions is found in the back of the syllabus. You do not have to take the

exams in order. You can print your Certificate after successfully completing each of the exams

within the bundle. All students taking the 20 Hour bundle online will receive your score at the

end of each exam. You may retake any of the exams you do not pass. Once the exam is passed,

you cannot retake.

TaxEase will notify CTEC and the IRS of your successful completion of each exam within 10

days. You must successfully pass all four exams before registering with CTEC.

Your feedback is very important to our development of our courses. We would greatly appreciate

if you would take a few moments and complete our TaxEase Course Evaluation.



III

Fax or Email Instructions

1. The Final Exam Questions, Final Exam Answer Sheet, Personal Information Form and

Evaluation Sheet are found at the back of this syllabus. The exam is open book; all the

answers are included in the text.

2. There is only one correct answer per question. Mark an “X” in the correct answer box on the

Final Exam Answer Sheet provided. All questions in all sections of the Final Exam must be

completed before submitting the answer sheet to TaxEase. Only TaxEase answer sheet will

be accepted.

3. Email or fax the following items: Answer Sheet, Personal Information Form and the Course

Evaluation. TaxEase no longer accepts mailed answer sheets.

Fax: 510-779-5251

Scan and email: [email protected]

4. TaxEase will grade the final exam. A score of 70% or better in each part is passing. Submit

ONLY the Answer Sheet, Personal Information Form and Evaluation Page.

5. If you do not pass the test the first time, you may retake the test at no additional charge.

6. Paper certificates are available instead of email certificates for $15 each. Paper certificates

are ordered on the Personal Information Form at the time the exam is submitted.

7. Students must provide TaxEase with their current CTEC number. No tests will be reported to

CTEC unless the CTEC number is on the TaxEase Personal Information Form. If your

registration is not current with CTEC, do not complete this course for CTEC continuing

education. TaxEase will report your 20 hours of continuing education to CTEC within 10

days of successful passage of this course.

8. TaxEase will report 15 hours of continuing education to your PTIN account upon successful

passage of this course if a valid PTIN is entered on TaxEase Personal Information Form.

TaxEase reports continuing education to the IRS within the required timeframes.

9. TaxEase provides the answers to the incorrect questions upon successful passage of the

exam, if the exam is taken “Online”. Incorrect answers will not be provided on exams

submitted by fax or email.

Advantages to Taking Your Exam Online Instant Grading

After You Pass the Exam - Know the Questions You Missed

Instant Printed Certificate

Retake the Test Without Waiting for Manual Grading

IV

TaxEase “20 Hour CTEC CE Bundle” Designed to meet the requirements for California Registered Tax Preparers (CRTP)

This is an intermediate course, designed for seasoned tax preparers, who have the basic

knowledge of tax. TaxEase objective is to:

Provide continuing education for seasoned tax preparers

Provide the student with comprehensive learning material, including examples and

interactive questions and answers to assist in the learning process.

Give an update and review of current tax matters.

Supply material that will give a wealth of information for use as a reference.

Meet all the requirements for a CTEC registered tax preparer

Meet all IRS voluntary continuing education requirements to receive an IRS Record of

Completion.

Specific objectives are stated at the beginning of each chapter.

The authors of this publication are offering a continuing education program only. TaxEase LLC

and the authors are not rendering any legal, accounting or other professional advice whatsoever.

There is always the possibility of error in every publication, though we try to avoid it. If a

significant error comes to our attention, you will find a correction on our website

www.taxeaseed.com. Your own research is always recommended. All tax situations and facts

differ. We strongly recommend that you do additional research and refer to IRS code and

publications in all situations. We do not take responsibility for any professional advice given to

you or given by you to others.

Tax preparers can use this course to meet their 15-hour federal continuing education

requirement. TaxEase is required to report continuing education hours that a student successfully

completes to the IRS if a valid PTIN is provided on TaxEase Personal Information Form (paper

exam) or the User Information screen (online exams).

This Continuing Education class is a CTEC-approved course, which fulfills the 20-hour

“continuing education” requirements for tax preparers in California. A listing of additional

requirements to register as a CTEC tax preparer can be obtained by contacting CTEC at P.O.

Box 2890, Sacramento, CA, 95812-2890, by phone at (877) 851-2832, or on the Internet at

www.ctec.org. TaxEase, LLC is an approved education provider.


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2020 Tax Year

This text will be continually updated to put in the 2020 tax law changes as they become

effective. The references made to 2019 are for examples where information for 2020 is not

available.

Course Update Policy

Tax Law is always changing. TaxEase endeavors to keep up by updating the Update Section of

our syllabus. We will do this whenever there is a significant change. If you already purchased the

course, you will receive an email and all new information will be posted on the Update Page of

our website. www.taxeaseed.com

Assignments

This is an intermediate course, designed for seasoned tax preparers, who have the basic

knowledge of tax law. This course references the Internal Revenue Code, tax publications and

tax case law. TaxEase recommends that you use IRS publications available on the IRS website

for additional information, though they are not needed to complete this course.

Thorough reading of this syllabus is required. All courses include review questions which we

call “What Do You Think?” to help guide the student. This course contains all answers to the

final exam questions.

To receive Internal Revenue publications, forms or instructions call or visit their website:

IRS: (800) 829-3676 www.irs.gov

CTEC rules require all students to renew their CTEC registration by October 31, 2020 (CTEC

allows late registration between Nov. 1, 2020 and Jan 15, 2021).

Course Refund Policy

All continuing education must be paid for in advance. We offer a full money back guarantee, if

requested within thirty (30) days of date ordered and prior to submission of any answer sheet for

grading. TaxEase will not exchange any courses for the following year. NO REFUNDS FOR

THIS COURSE WILL BE ISSUED AFTER JANUARY 15, 2021.


http://www.irs.gov/

VI

About the Authors

Sue Tornberg, EA is one of the owners of TaxEase and the author of TaxEase courses. Sue has

over 30 years of tax experience.

She started her career working for a computerized tax company, in the capacity of Technical Tax

Manager. That company processed over half a million tax returns for accountants. At that time,

Sue was in charge of writing and speaking at workshops that were given to clients. These

workshops explained the bridge between tax law and the computer input forms.

In 1999, Sue became the co-owner and Chief Financial Officer of The Tax Company, which

processed tax returns for over 300 accountants. While at The Tax Company, Sue qualified as a

CTEC provider for qualifying and continuing education. As the course administrator, she was

responsible for the writing and implementation of all course material. Sue has been writing the

course material for Tax Company and TaxEase for over 20 years. Tax Company and TaxEase

have passed every 3-year review from CTEC during that time. TaxEase is very pleased to keep

many of the same students year after year.

Jan Cusumano has been a CTEC Registered Tax Preparer for 20 years. She is the co-founder of

TaxEase; not only is she active in the preparation of tax returns each year, but also is an expert in

payroll and withholding issues, which our tax clients rely on. Jan actively researches, reviews,

and edits these courses each year.

Sue and Jan founded TaxEase LLC in 2007. They also have a private tax practice in Northern

California where they prepare approximately 500 individual, estate and trust, and business

returns annually.

VII

Contents

Online Instructions .............................................................................................................................. II

Fax or Email Instructions ................................................................................................................... III

Advantages to Taking Your Exam Online ..................................................................................... III TaxEase “20 Hour CTEC CE Bundle” ............................................................................................. IV

Assignments ..................................................................................................................................... V About the Authors ........................................................................................................................... VI

Contents ............................................................................................................................................. VII 2020 TAX UPDATE ....................................................................................................................... I Chapter 1 - Covid-19 ............................................................................................................................ 1

Postponement of Interest, Penalties, and Additions to Tax ................................................. 1

IR Notice 2020-23 and IRS People First Initiative. ................................................................... 1

Extensions ......................................................................................................................................... 3

Legislation Overview....................................................................................................................... 3

Expanded Unemployment Benefits............................................................................................. 3 Families First Act - Employer Tax Credits ................................................................................ 4

Paid Family Leave Refundable Credit ........................................................................................ 6

Phase 3 - The Coronavirus Aid, Relief, and Economic Security Act (CARES Act) ........ 7

Penalty-free Retirement Distributions ........................................................................................ 9

Loans from Qualified Plans ........................................................................................................... 11

Partial Above-the-Line Charitable Contribution Deduction .................................................. 13

What Do You Think? ....................................................................................................................... 15

What Do You Think? Answers ...................................................................................................... 16 Chapter 2 – CARES Act Business Provisions .............................................................................. 18

Tax Provisions to Assist Businesses and Roll Backs of TCJA Provisions ..................... 18

Modifications of Limits on Deduction of Business Interest ................................................. 19

Amendment to Depreciation Rules for Businesses ............................................................... 19 Excise Tax Exception for Alcohol Used to Produce Hand Sanitizer .................................. 19

A Look at the CARES Act's Paycheck Protection Program (PPP) ...................................... 19 PPP Flexibility Act 6/5/2020 ........................................................................................................... 21

Employer Credits ............................................................................................................................. 29

Employee Retention Credit ........................................................................................................... 29

What are the Paid Sick Leave and Family Leave Credits? ................................................... 30

How do businesses get the Employee Retention Credit? .................................................... 31 Form 7200- Advance Payment of Employer Credits Due to Covid-19 ............................... 32

What Do You Think? ....................................................................................................................... 33 What Do You Think? – Answers .................................................................................................. 34

Chapter 3- Amounts, Limits and Rates .......................................................................................... 36

Single Individuals............................................................................................................................. 36 2019 Tax Rates for Single Individuals ........................................................................................ Error! Bookmark not defined.

Head of Household .......................................................................................................................... 37 2019 Tax Rates for Heads of Household ................................................................................... 39

Married Filing Joint and Surviving Spouses ............................................................................ 39 2019 Tax Rates for Married Filing Jointly and Surviving Spouses .................................... 40 Married Filing Separately ............................................................................................................... 40

2019 Tax Rates for Married Individuals Filing Separately .................................................... 41

VIII

Tax Brackets Thresholds ............................................................................................................... 42

Gross Income Threshold For Filing Form 1040 ....................................................................... 43

Standard Deduction......................................................................................................................... 44 Child Tax Credit:............................................................................................................................... 44

Earned Income Credit ..................................................................................................................... 45 What Do You Think? ...................................................................................................................... 48

What Do You Think? – Answers .................................................................................................. 49 Chapter 4 – SECURE Act and COLA Adjustments ..................................................................... 50

HR 1865 ............................................................................................................................................... 50

Title 1 – Setting Every Community Up for Retirement Savings (SECURE Act) .............. 50 COLA Adjustments on Benefits and Contributions ............................................................... 52

IRA Recharacterizations ................................................................................................................ 54 Extended Rollover Period for the Rollover of Plan Loan Offset Amounts in Certain Cases .................................................................................................................................... 54

Flexible Spending Arrangements ................................................................................................ 55 Use-it-or-Lose-it Rule ...................................................................................................................... 55

Uniform Coverage Rules for Health FSAs ................................................................................. 55

Health Savings Account ................................................................................................................. 56

Medical Savings Account (MSAs) ............................................................................................... 57

What Do You Think .......................................................................................................................... 59

What Do You Think? - Answers ................................................................................................... 60

The Tuition and Fees Deduction .................................................................................................. 61

American Opportunity Tax Credit ................................................................................................ 61 Earned Income Tax Credit ............................................................................................................. 64

EITC can be disallowed .................................................................................................................. 66

Savers Credit for 2019 .................................................................................................................... 69

Savers Credit for 2020 .................................................................................................................... 69 Adoption Expense Credit for 2019 .............................................................................................. 69

Adoption Expense Credit for 2020 .............................................................................................. 69 Limits on Income Subject to Social Security Tax ................................................................... 70

2020 Form W-4 .................................................................................................................................. 71

2020 Form 1099-MISC and Form 1099-NEC .............................................................................. 74

What Do You Think? ....................................................................................................................... 76

What Do You Think? - Answers ................................................................................................... 77 2020 TAX LAW .............................................................................................................................. 1

Chapter 1 – Filing ................................................................................................................................. 2 2020 Economic Impact Payment .................................................................................................. 2 Filing Season Statistics Cumulative Statistics Comparing 4/20/18 and 4/19/2019 ........ 3

Tax Brackets Thresholds ............................................................................................................... 4 Gross Income Threshold For Filing Form 1040 ....................................................................... 5

Exemptions Repealed by TCJA .................................................................................................... 5 Maximum Rates on Capital Gains and Qualified Dividends ................................................. 6

Amended Returns ............................................................................................................................ 7 What Do You Think? ....................................................................................................................... 8 What Do You Think? - Answers ................................................................................................... 9

Net Investment Income Tax ........................................................................................................... 11

IX

TCJA Changes to Adjustments to Income ................................................................................ 13

Repeal of Deduction for Moving Expenses .............................................................................. 13

Student Loans ................................................................................................................................... 13 Recharacterization of an IRA ........................................................................................................ 15

Child Tax Credit 2020:..................................................................................................................... 15 “Earned Income” Formula for Computing the Additional Child Tax Credit ..................... 16


Chapter 2 – Itemized Deductions ..................................................................................................... 20

Standard Deductions versus Itemized Deductions ................................................................ 20 Medical Expenses ............................................................................................................................ 21

Capital Expenses Deductible as Medical Expenses ............................................................... 26 What Do You Think? ....................................................................................................................... 27

What Do You Think - Answers ...................................................................................................... 28 Schedule A Taxes ............................................................................................................................ 29 Real Estate Taxes ............................................................................................................................ 30

Personal Property Tax .................................................................................................................... 30 Mortgage Payment Forbearance .................................................................................................. 30

Home Mortgage Interest ................................................................................................................. 31 Mortgage Interest Statement......................................................................................................... 33

Loan Origination Fees - Points..................................................................................................... 35 What Do You Think? ....................................................................................................................... 37

What Do You Think? – Answers .................................................................................................. 38

Charitable Contributions ................................................................................................................ 39 Partial Above-the-Line Charitable Contribution Deduction .................................................. 39

Temporary Suspension of Contribution Limitations .............................................................. 39

TCJA Increase of Cash contributions ........................................................................................ 42

Noncash Contributions .................................................................................................................. 43

Donated Goods Valuation Chart .................................................................................................. 46 Contribution Carryovers ................................................................................................................ 47

TCJA Casualties and Theft ............................................................................................................ 48 Casualty Losses ............................................................................................................................... 49

Miscellaneous Itemized Deductions ........................................................................................... 49 Gambling Winnings and Losses .................................................................................................. 50

What Do You Think? ....................................................................................................................... 52

What Do You Think? – Answer..................................................................................................... 53 Chapter 3 – Education and Related Issues ................................................................................... 54

American Opportunity Credit ........................................................................................................ 54

American Opportunity Credit or Lifetime Learning Credit (2020) ....................................... 56

Form 8863........................................................................................................................................... 57 Fees, Books Supplies and Equipment ....................................................................................... 57

What Do You Think? ....................................................................................................................... 59

What Do You Think?-Answers ..................................................................................................... 60 Qualified Tuition Plan or §529 Plan ............................................................................................. 61

Allowing 529 plans to be used for K-12 tuition ........................................................................ 61 Recapture of Education Credit ..................................................................................................... 62

X

QTP and Coverdell ESA ................................................................................................................. 64

ABLE Accounts ................................................................................................................................ 65

U.S. Savings Bonds Interest Exclusion ..................................................................................... 66 Student Loan Interest ..................................................................................................................... 68

Student Loans Discharged on Account of Death or Disability ............................................ 69 MAGI when using Form 1040. ....................................................................................................... 69

What Do You Think? ....................................................................................................................... 70 What Do You Think? - Answers ................................................................................................... 71

Chapter 4 –Relevant Pass-through Entities (RPE), Rental Activities and Qualified Business Income (QBI) ....................................................................................................................... 73

Regulations Regarding Section 199A......................................................................................... 74

Form 1040........................................................................................................................................... 79

Schedule C and QBI Worksheet ................................................................................................... 83

Form 8995........................................................................................................................................... 88

What Do You Think? ...................................................................................................................... 88 What Do You Think? _Answers ................................................................................................... 90

Calculating the Qualified Business Income Deduction below the Threshold ................ 90

Trade or Business Requirement for QBI; Rental Real Estate Activities ........................... 91

QBI Rental Example – Form 8995 ................................................................................................ 94

Rental Activity Defined ................................................................................................................... 95

Different Rules Apply at Different Levels of Taxable Income .............................................. 97

Reasonable Compensation and Guaranteed Payments Are Not QBI ................................ 97

Determining the Final Amount of the QBI Deduction............................................................. 101 Calculating W-2 Wage Limitation................................................................................................. 103

Unmodified Box Method................................................................................................................. 105

Modified Box 1 Method ................................................................................................................... 105

Tracking Wages Method................................................................................................................. 105 Form 8995-A, Qualified Business Income Deduction ............................................................ 106

Overall limitation applied after combined QBI is calculated ................................................ 107 QBI Deduction – Specified Service Trade or Business ......................................................... 115

Estates and Trusts ........................................................................................................................... 119

What Do You Think? ....................................................................................................................... 121


Unmodified Box Method................................................................................................................. 124 Modified Box 1 Method ................................................................................................................... 124

Tracking Wages Method................................................................................................................. 124 Rental Income ................................................................................................................................... 125 Rental Expenses............................................................................................................................... 126

Material Participation ...................................................................................................................... 129 Passive Activity Rules .................................................................................................................... 129

Rental Activity Treated as a Business ....................................................................................... 133 What Do You Think? ....................................................................................................................... 135

What Do You Think? - Answers ................................................................................................... 136 Chapter 5 –Depreciation and Cost Basis....................................................................................... 137

Bonus Depreciation for Qualified Improvement Property .................................................... 137

Listed Property ................................................................................................................................. 142

XI

Original Use Requirement for Bonus Depreciation and IRC §179 ...................................... 142

IRC §179 .............................................................................................................................................. 142

Section 179 at a Glance for 2020 ................................................................................................. 144 Luxury Autos ..................................................................................................................................... 145


Cost Basis .......................................................................................................................................... 150 Purchase of a Trade or Business ................................................................................................ 151 Adjusted Basis .................................................................................................................................. 152

Basis Other Than Cost ................................................................................................................... 153 Inheritance ......................................................................................................................................... 154

Dividend Reinvestment .................................................................................................................. 155 Basis of Bonds ................................................................................................................................. 157

Sales and Other Dispositions ....................................................................................................... 159 Involuntary Conversion .................................................................................................................. 161 Like-Kind Exchange ........................................................................................................................ 162

What Do You Think? ....................................................................................................................... 164 What Do You Think? – Answer..................................................................................................... 165

Chapter 6 – Clergy Tax ....................................................................................................................... 187 Definition of Minister under the Regulations ........................................................................... 187

IRS and Judicial Determinations ................................................................................................. 189 Employees of Churches ................................................................................................................. 189

Employees of Church-Affiliated Organizations ....................................................................... 190

Housing Allowance/Parsonage .................................................................................................... 192 Classification as Employees or Independent Contractors ................................................... 195

What Do You Think? ....................................................................................................................... 196

What Do Your Think – Answers ................................................................................................... 197

Chapter 7– Miscellaneous Items ...................................................................................................... 199

Digital Signatures............................................................................................................................. 199 Virtual Currency ............................................................................................................................... 199

Gamers ................................................................................................................................................ 200 Insolvency .......................................................................................................................................... 201

Estate and Trust Tax Rates and Brackets ................................................................................. 208 Increase in Estate and Gift Tax Exclusion ................................................................................ 208

What Do You Think? ....................................................................................................................... 209

What Do You Think? – Answers .................................................................................................. 210 Alternative Minimum Tax ............................................................................................................... 211

AMT risk factors ............................................................................................................................... 211

Kiddie Tax. ......................................................................................................................................... 212

The Kiddie Tax Before 2018 and After 2025 .............................................................................. 213 The Kiddie Tax 2018 through 2025 .............................................................................................. 213

Final Regulations Expand Use of Health Reimbursement Arrangements ....................... 214

Foreign Earned Income and Housing Exclusion ..................................................................... 217 FinCen ................................................................................................................................................. 219

Foreign Account and Asset Reporting....................................................................................... 219 FinCEN Form 114 ............................................................................................................................. 220

XII

Due Date for FinCEN ....................................................................................................................... 222

FinCEN Form 114 Penalties .......................................................................................................... 222

What Do You Think? ....................................................................................................................... 223 What Do You Think? -Answers .................................................................................................... 224

Chapter 8 - Business Related Changes ......................................................................................... 225 Paycheck Protection Program ...................................................................................................... 225

Paycheck Protection Loan Forgiveness Application - EZ .................................................... 225 PPP Flexibility ................................................................................................................................... 226 Excess Business Losses -TCJA .................................................................................................. 227

Excess Business Losses – The CARES Act ............................................................................. 228 Net Operating Loss -TCJA ............................................................................................................. 230

Net Operating Loss – CARES Act ................................................................................................ 231 Extended Time Limit for IRS Levy ............................................................................................... 233

Applying for an EIN ......................................................................................................................... 233 What Do You Think? ....................................................................................................................... 235 What Do You Think? – Answers .................................................................................................. 236

Chapter 9– Affordable Care Act ....................................................................................................... 237 Requirement to Have Health Insurance ..................................................................................... 237

Health care penalty eliminated ..................................................................................................... 238 Premium Tax Credit Eligibility ...................................................................................................... 239

Poverty Thresholds ......................................................................................................................... 240 Shared Policy Allocations ............................................................................................................. 242

Coverage Reporting Requirements ............................................................................................ 242

Form 1095-B ...................................................................................................................................... 243 1095-C ................................................................................................................................................. 243

Form 1095-A ...................................................................................................................................... 243

Self-Employed Health Insurance Deduction ............................................................................. 245

What Do You Think? ....................................................................................................................... 247

What Do You Think? – Answers .................................................................................................. 248 2020 ETHICS – DUE DILIGENCE .............................................................................................. 1

Chapter One – Circular 230 ............................................................................................................... 2 PTIN ..................................................................................................................................................... 2

Internal Revenue Code ................................................................................................................... 2 Circular 230 ........................................................................................................................................ 3

Office of Professional Responsibility ......................................................................................... 4

Annual Filing Season Program (AFSP) ...................................................................................... 4 Record of Completion ..................................................................................................................... 5

Rules for Individuals Within A Firm ............................................................................................ 8

What Do You Think? ....................................................................................................................... 10

What Do You Think? – Answers .................................................................................................. 11 Chapter Two – Due Diligence ........................................................................................................... 12

Paid Preparer Due Diligence Requirement – Form 8867 ....................................................... 12

Requirement for Child Tax Credit ................................................................................................ 13 Paid preparer due diligence requirement for Head of Household status ......................... 13

Form 8867 – Due Diligence Checklist ......................................................................................... 19 Conflict of Interest ........................................................................................................................... 21

XIII

What Do You Think? ....................................................................................................................... 23


Chapter Three – Disclosure, Document Protection and Rules ................................................ 25 Internal Revenue Code §7216 ....................................................................................................... 25

IRC § 7216 – Related to the Affordable Care Act ..................................................................... 26 Revenue Procedure 2013-14 ......................................................................................................... 27

Federally Authorized Tax Practitioner-Client Privilege ......................................................... 31 What Do You Think? ....................................................................................................................... 34 What Do You Think? – Answers .................................................................................................. 35

Chapter Four – Sanctions for the Violation of Regulations ..................................................... 36 Circular 230 §10.50 Sanctions ...................................................................................................... 36

Circular 230, Subchapter C §10.51- Incompetence and disreputable conduct. .............. 36 Trade or Business Expenses Under IRC §162 and Related Sections ................................ 37

Damage Awards ............................................................................................................................... 40 What Do You Think? ....................................................................................................................... 42 What Do You Think? – Answers .................................................................................................. 43

Chapter Five – Identity Theft –Taxpayer First Act ...................................................................... 44 HR 3151 ............................................................................................................................................... 44

Establishment of IRS Independent Office of Appeals ............................................................ 44 Comprehensive Customer Service Strategy ............................................................................ 44

Relief from Joint Liability ............................................................................................................... 45 Private Debt Collection ................................................................................................................... 45

Modernization of IRS Organizational Structure ....................................................................... 45

Closure of Taxpayer Assistance Centers .................................................................................. 46 Whistleblower Reforms .................................................................................................................. 46

Cyber Security and Identity Protection ...................................................................................... 47

Information Sharing......................................................................................................................... 48

Identity Protection Personal Identification Numbers (IP PIN) .............................................. 48

Uniform Standards for the Use of Electronic Signatures ..................................................... 50 Increased Penalty for Failure to File ........................................................................................... 50


2020 CALIFORNIA TAX COURSE ................................................................................................ 1

Chapter 1 – CA Update ....................................................................................................................... 2

Covid 19 –........................................................................................................................................... 2 California’s conformity with Federal CARES Act .................................................................... 2

Small Business Payment Plan for Sales and Use Tax ........................................................... 3 Health Care Mandate ....................................................................................................................... 3

Extension for Filing Business/Personal Property Tax Statements .................................... 6

What Do You Think? ....................................................................................................................... 7 What Do You Think - Answers ...................................................................................................... 8

Chapter 2 - Rates, Exemptions and Deductions ........................................................................ 9 California Personal Income Tax ................................................................................................... 11

Other Filing Situations .................................................................................................................... 11 California Residency ....................................................................................................................... 12 Safe Harbor ........................................................................................................................................ 12

XIV

Individual Tax Rates ........................................................................................................................ 13

Mental Health Tax............................................................................................................................. 14

Personal and Dependent Exemptions ........................................................................................ 15 Reduction in itemized deductions ............................................................................................... 16


Chapter 3 – California Conformity and Nonconformity ............................................................. 21 Common Income Adjustments for California ........................................................................... 21 Interest Reminder............................................................................................................................. 21

50-Percent Rule ................................................................................................................................ 21 Retirement Plans .............................................................................................................................. 21

Schedule C, Schedule E and Schedule F .................................................................................. 22 AB91 .................................................................................................................................................... 22

Qualified Business Income (QBI)................................................................................................. 24 Alimony ............................................................................................................................................... 25 Moving Expense and Exclusion ................................................................................................... 25

Standard Deduction......................................................................................................................... 25 Itemized Deductions ........................................................................................................................ 26

Medical Expenses ............................................................................................................................ 26 State and Local Taxes .................................................................................................................... 26

Mortgage Interest – Personal Residence .................................................................................. 26 Federal Repeal of 2% Miscellaneous Deductions ................................................................... 27

Itemized Deductions Limitation Amounts ................................................................................. 27

What Do You Think? ....................................................................................................................... 29 What Do You Think? Answers ...................................................................................................... 30

A is the correct answer. ................................................................................................................. 30

Chapter 4 – Filing Status and Related Item................................................................................... 31

Filing Status....................................................................................................................................... 31

Filing Requirements for RDP Residents, Nonresidents, and Part-Year Residents ........ 31 Same-Sex Married Couples ........................................................................................................... 32

California Adjustments for Registered Domestic Partners .................................................. 33 Health coverage for spouse .......................................................................................................... 33

Tax Law Cases .................................................................................................................................. 37 Head of Household .......................................................................................................................... 39

NPA vs. NTRC ................................................................................................................................... 39

Examples of Head of Household Qualifications for California ............................................ 40 What Do You Think? ....................................................................................................................... 44


Chapter 5 – Miscellaneous Items ..................................................................................................... 46

California Real Estate Withholding ............................................................................................. 46 2020 Form 593 – Real Estate Withholding Statement ............................................................ 48

Like-kind Exchange ......................................................................................................................... 49

Native Americans ............................................................................................................................. 53 What Do You Think? ....................................................................................................................... 55

What Do You Think? – Answers .................................................................................................. 56 Chapter 6 - California NOL, Disaster Loss, California Estimates ........................................... 58

XV

Claiming the NOL Carryback ........................................................................................................ 58

California Disasters ......................................................................................................................... 59

California Estimated Tax Requirements .................................................................................... 59 Payment methods for ES Vouchers ............................................................................................ 61

Mandatory e-Pay Requirements for Individual Taxpayers .................................................... 62 Underpayment of Estimated Tax ................................................................................................. 63


Chapter 7 – Alternative Minimum Tax and Stock Options ........................................................ 66

California Alternative Minimum Tax – Schedule P .................................................................. 66 Credit for Prior Year Minimum Tax .............................................................................................. 68

Stock Options ................................................................................................................................... 68 Nonstatutory Stock Options ......................................................................................................... 70

Incentive Stock Options ................................................................................................................. 71 Incentive Stock Option Tax Treatment ....................................................................................... 72 What Do You Think? ....................................................................................................................... 73

What Do You Think? –Answers ................................................................................................... 74 Chapter 8 – Power of Attorney, MyFTB, Identity Theft .............................................................. 75

Form FTB 3520, Power of Attorney (POA) ................................................................................ 75 MyFTB ................................................................................................................................................. 75

e-file for Fiduciary Returns ............................................................................................................ 79 MyFTB Account for Individuals .................................................................................................... 80

Differences between the IRS and FTB electronic file Programs ......................................... 81

The ERO PIN ...................................................................................................................................... 86 Treasury Offset Program ............................................................................................................... 87

Phishing .............................................................................................................................................. 90

California Registered Tax Preparers .......................................................................................... 90

CTEC Registration ........................................................................................................................... 91

Late Fees and Registrations ......................................................................................................... 92 Failure to Register .......................................................................................................................... 92


Chapter 9 – Nonresident Returns .................................................................................................... 97 Determining California Tax as a Nonresident .......................................................................... 99

Schedule CA (540NR), California Adjustments –Nonresidents ........................................... 100

IRA Deductions When a Nonresident Working in California ................................................ 105 Stock Options ................................................................................................................................... 106

California Property Exchange for Property Out of State ....................................................... 107

CA Group Nonresident Tax Return ............................................................................................. 108

Election to File a Group Nonresident Return ........................................................................... 108 What Do You Think? ....................................................................................................................... 109


Chapter 10 – California Credits ........................................................................................................ 111 Ordering of Credits .......................................................................................................................... 111

California Competes Credit ........................................................................................................... 112 College Access Credit .................................................................................................................... 112

XVI

Child and Dependent Care Credit - Form 3506 ........................................................................ 113

Other State Tax Credit .................................................................................................................... 114

Joint Custody Head of Household Credit/Dependent Parent Credit .................................. 116 Dependent Parent Credit .............................................................................................................. 117

Credit for Senior Head of Household ........................................................................................ 117 Credit for Child Adoption Costs ................................................................................................. 117

Credit for Prior Year Alternative Minimum Tax ........................................................................ 118 New Young Child Tax Credit ......................................................................................................... 119 California Earned Income Tax Credit .......................................................................................... 119

Paid Preparer’s CA Earned Income Tax Credit Checklist ..................................................... 120 What Do You Think? ....................................................................................................................... 123

What Do You Think? – Answers .................................................................................................. 124 California Appendix ............................................................................................................................. 125

Preparer Code of Conduct ............................................................................................................. 125 Final Exam – Tax Update ............................................................................................................... 3 Final Exam – Tax Law ..................................................................................................................... 7

Final Exam - Ethics .......................................................................................................................... 29 Final Exam - California ................................................................................................................... 33

2020 Answer Sheet .......................................................................................................................... 38 2020 PERSONAL INFORMATION FORM .................................................................................... 39

2020 TaxEase Course Evaluation ................................................................................................ 40

2020

TaxEase, LLC


2020 TAX UPDATE IRS COURSE NUMBER: B8FQK-U-00036-20-S CTEC COURSE NUMBER 3064-CE-0060




mailto:[email protected]

1

Update

Chapter 1 - Covid-19

The Treasury Department and the Internal Revenue Service are providing special tax filing and

payment relief to individuals and businesses in response to the COVID-19 Outbreak. The filing

deadline for tax returns has been extended from April 15 to July 15, 2020. The IRS urges

taxpayers who are owed a refund to file as quickly as possible. For those who cannot file by the

July 15, 2020 deadline, the IRS reminds individual taxpayers that everyone is eligible to request

an extension to file their return.

As a result, of the COVID-19 pandemic, the IRS issued Notice 2020-23. This notice provides

that any person with a federal tax payment obligation, a federal tax return, or other form of

obligation which is due to be filed on or after April 1, 2020, and before July 15, 2020, is

automatically granted an extension. The extension is until July 15, 2020, to either file the return

and/or make the payment that would otherwise be due. This relief is automatic no extension

forms are required. This relief also includes estimated tax payments for tax year 2020 that are

due on April 15, 2020 and June 15, 2020. Penalties and interest will begin to accrue on any

remaining unpaid balances as of July 16, 2020. You will automatically avoid interest and

penalties on the taxes paid by July 15.

Postponement of Interest, Penalties, and Additions to Tax

IR Notice 2020-23 provides that, because of the postponement of the due dates for the period

beginning on April 1, 2020, and ending on July 15, 2020, the calculation of any interest, penalty

will be disregarded, or addition to tax for failure to file the forms listed above or to make the

payments postponed by Notice 2020-23. Interest, penalties, and additions to tax will begin to

accrue on July 16, 2020. Refer to list below regarding which forms are extended until July 15.

IR Notice 2020-23 and IRS People First Initiative.

Below is a list of provisions outlined in these initiatives and notices designed to extend deadlines

and ease the burden of people facing tax issues:

• Individual income tax payments and return filings on Form 1040, U.S. Individual Income

Tax Return and related forms. All schedules and other forms that are filed as attachments

to Form 1040 and related forms or are required to be filed by the due date of such forms,

including, for example, Schedule H and Schedule SE.

• Corporate income tax payments and return filings on Form 1120, U.S. Corporation

Income Tax Return and related forms, all schedules and other forms that are filed as

attachments to Form 1120 and related forms are required to be filed by July 15. Calendar

year S-Corporation returns that were due prior to April 1 are not automatically extended.

• Partnership return filings on Form 1065, U.S. Return of Partnership Income, and Form

1066, U.S. Real Estate Mortgage Investment Conduit (REMIC) Income Tax Return; all

schedules and other forms that are filed as attachments to Form 1065 and related forms

are required to be filed by the due date. Calendar year Partnership returns that were due

prior to April 1 are not automatically extended.

Objective:

Explain the legislative changes regarding Covid 19.

Examples and explanation of the CARES Act and

resulting stimulus checks.

Objective:

Explain the legislative changes regarding Covid 19.

Examples and explanation of the CARES Act and

Economic Impact Payments

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Update

• Estate and trust income tax payments and return filings on Form 1041, U.S. Income Tax

Return for Estates and Trusts, all schedules and other forms that are filed as attachments

to Form 1041 and related forms are required to be filed by the due date.

• Estate and generation-skipping transfer tax payments and return filings on Form 706,

Form 8971, Information Regarding Beneficiaries Acquiring Property from a Decedent,

Gift and generation-skipping transfer tax payments and return filings on Form 709, are

extended until July 15.

• The contribution to an Individual Retirement Account (IRA), a Health Savings Account

(HSA) and an Archer Medical Savings Account (MSA) are all extended to July 15. The

taxpayer may also withdraw any excess contributions until July 15.

• The due date for filing the FBAR remains April 15, but pursuant to previously issued

guidance, an automatic extension is granted until October 15. Form 8938 is filed with

Form the individual income tax return on or before July 15 (or as extended by a timely

requested filing extension).

• 2020 estimated tax payments due on or after April 15, 2020, and June 15, 2020 are due

July 15.

• Any installment payments due on or after April 1, 2020, and before July 15, 2020 are due

July 15.

• Elections that are made or required to be made on a timely filed form listed above (or

attachment to such form) will be timely made if filed on the form or attachment, as

appropriate, on or before July 15, 2020.

• For taxpayers under an existing Installment Agreement, payments due between April 1

and July 15, 2020 are suspended. Taxpayers who are currently unable to comply with the

terms of an Installment Payment Agreement, including a Direct Debit Installment

Agreement, may suspend payments during this period if they prefer. The IRS will not

default any Installment Agreements during this period. By law, interest will continue to

accrue on any unpaid balances.

Offers in Compromise

• Pending OIC applications – The IRS will allow taxpayers until July 15 to provide

requested additional information to support a pending OIC. In addition, the IRS will

not close any pending OIC request before July 15, 2020, without the taxpayer's

consent.

• OIC Payments – Taxpayers have the option of suspending all payments on accepted

OICs until July 15, 2020, although by law interest will continue to accrue on any

unpaid balances.

• Delinquent Return Filings - The IRS will not default an OIC for those taxpayers who

are delinquent in filing their tax return for tax year 2018. However, taxpayers should

file any delinquent 2018 return (and their 2019 return) on or before July 15, 2020

3

Update

Extensions

Affected taxpayers who need additional time beyond July 15, 2020, to file a return should file the

appropriate extension form by July 15, 2020, to obtain an extension. The extension date may not

go beyond the original statutory or regulatory extension date. For example, a Form 4868,

Application for Automatic Extension of Time to File U.S. Individual Income Tax Return, may be

filed by July 15, 2020, to extend the time to file an individual income tax return, but that

extension will only be to October 15, 2020. That extension does not extend the time to pay

federal income tax beyond July 15, 2020.

Legislation Overview

Phase 1. The Coronavirus Preparedness and Response Supplemental Appropriations Act,

20201, was Washington’s initial response to the virus, an $8.3 billion emergency funding bill

designed to treat and prevent the spread of COVID-19. Significant portions of the funding went

to the Department of Health and Human Services (HHS) to develop vaccines and testing kits for

local communities, to state and local health departments to be used for staffing increases and

additional laboratory equipment and to the federal government to aid in the international

containment of the virus.

Phase 2 - Families First Coronavirus Response Act2 (Families First Act), which responds to

the Coronavirus outbreak by providing paid sick leave and free Coronavirus testing, expanding

food assistance and unemployment benefits, and requiring employers to provide additional

protections for health care workers. The law also provides four types of tax credits that are

available to employers and self-employed individuals. The package includes two weeks of

qualified sick leave wages for those employees who must self-quarantine or seek treatment due

to the virus, employer tax credits for paid sick and paid family and medical leave, guaranteed

coverage of testing by public and private payers and additional health provisions regarding

Medicare and Medicaid.

Expanded Unemployment Benefits

The size and scope of unemployment benefits is expanded under this bill. It includes relief for

workers who are self-employed, as well as independent contractors. These changes are

temporary.

Provides $250 billion to expand unemployment benefits.

Makes sure self-employed and independent contractors, like Uber drivers and gig

workers, can receive unemployment during the public health emergency. The bill also

includes support to state and local governments and nonprofits so they can pay

unemployment to their employees.

Makes benefits more generous by adding a $600/week across-the-board payment increase

through the end of July. In addition, for those who need it, the bill provides an additional

13 weeks of benefits beyond what states typically allow.

1 H.R 6074, March 5, 2020 2 H.R 6201, March 17 2020

4

Update

Unemployment insurance eligibility is expanded to those who are not eligible for regular

compensation or extended benefits under state or federal law, or previously passed

pandemic emergency unemployment compensation.

To qualify, an individual must self-certify that he or she is otherwise able and available to work

but cannot for one of the following reasons:

Diagnosis of COVID-19 or is experiencing the systems and seeking a medical diagnosis.

Member of household has COVID-19.

Individual is providing care for a family member or member of household who has been

diagnosed with COVID-19.

Child or other person in household for whom the individual is the primary caregiver is

unable to attend school or other facility because of COVID-19 and such attendance is

necessary for that individual to attend work.

Individual is unable to reach place of employment because of mandatory quarantine,

Individual has been advised by a medical professional to self-quarantine due to COVID-

19 concerns.

Individual was scheduled to start a job and doesn’t have a job or unable to reach job due

to COVID-19,

Individual has become the primary source of income or major support for household due

to head of household dying due to COVID-19.

Individual has quit job as a direct result of COVID-19.

Place of business is closed due to COVID-19.

Individual is self-employed, is seeking part-time employment, does not have sufficient

work history, or otherwise does not qualify for regular unemployment or extended

benefits.

This does not include individuals who can telework with pay or who are receiving paid

sick leave or other leave benefits due to other provisions in COVID-19 relief.

This assistance is available beginning Jan. 27, 2020 and goes until Dec. 31, 2020 with a 39-week

maximum for an individual receiving assistance.

The bill also allows states to waive their one week waiting period for unemployment benefits and

the federal government will reimburse them for that week, thus incentivizing states to provide an

immediate benefit.

Families First Act - Employer Tax Credits

Paid Sick Leave Credit: For an employee who is unable to work because of Coronavirus

quarantine or self-quarantine or has Coronavirus symptoms seeking a medical diagnosis, eligible

employers may receive a refundable sick leave credit. For sick leave at the employee's regular,

rate of pay, up to $511 per day and $5,110 taken together, for a total of 10 days. For an employee

who is caring for someone with Coronavirus; or is caring for a child because the child's school or

child care is closed; or the child care provider is closed due to the Coronavirus, eligible

employers may claim a credit for two-thirds of the employee's regular rate of pay, up to $200 per

day and $2,000 in total up to 10 days. Eligible employers are entitled to an additional tax credit

determined based on costs to maintain health insurance coverage for the eligible employee

during the leave period. A similar credit is available for self-employed individuals.

5

Update

Child Care Leave Credit: In addition to the sick leave credit, for an employee who is unable to

work because of a need to care for a child whose school or child-care facility is closed or whose

childcare provider is unavailable due to the Coronavirus, eligible employers may receive a

refundable childcare leave credit. This credit is equal to two-thirds of the employee's regular pay,

capped at $200 per day or $10,000 in the total. Up to 10 weeks of qualifying leave can be

counted towards the child-care leave credit. Eligible employers are entitled to an additional tax

credit determined based on costs to maintain health insurance coverage for the eligible employee

during the leave period. A similar credit is available for self-employed individuals.

Eligible employers who pay qualifying sick or child-care leave can retain an amount of the

payroll taxes equal to the amount of qualifying sick and childcare leave that they paid, rather

than deposit them with the IRS. The payroll taxes that are available for retention include

withheld federal income taxes, the employee share of social security and Medicare taxes, and the

employer share of social security and Medicare taxes with respect to all employees. If there are

not sufficient, payroll taxes to cover the cost of qualified sick and childcare leave paid,

employers will be able file a request for an accelerated payment from the IRS.

Eligible employers are businesses and tax-exempt organizations with fewer than 500 employees

that are required to provide emergency paid sick leave and emergency paid family and medical

leave under the Families First Act. Eligible employers can claim these credits based on

qualifying leave they provide between the effective date (which is defined as not later than 15

days after the date the Act was signed on March 18) and December 31, 2020.

Under the Family First Act, certain employers are eligible for a payroll tax credit for required

paid sick leave because of the Emergency Paid Sick Leave Act (EPSLA) enacted as part of the

Family First Act. In addition, a credit for sick leave for certain self-employed individuals is also

available under EPSLA.

The EPSLA requires certain employers to provide an employee with paid sick time to the extent

that the employee is unable to work or telework due to a need for leave because3:

(1) The employee is subject to a federal, state, or local quarantine or isolation order

related to the Coronavirus (COVID-19) pandemic;

(2) The employee has been advised by a health care provider to self-quarantine due to

concerns related to COVID-19;

(3) The employee is experiencing symptoms of COVID-19 and seeking a medical

diagnosis;

(4) The employee is caring for an individual who is subject to an order described in

clause (1) or has been advised as described in clause (2);

(5) The employee is caring for the employee's son or daughter if the school or place of

care of the son or daughter has been closed, or the child care provider of such son or

daughter is unavailable due to COVID-19 precautions; or

3 §5102(a)(1)(2)(3)(4)(5)(6)

6

Update

(6) The employee is experiencing any other substantially similar condition specified by

the Secretary of Health and Human Services Treasury and Labor.

Under EPSLA, an employee is entitled to paid sick time as follows:

(1) For full-time employees, 80 hours.

(2) For part-time employees, a number of hours equal to the number of hours that such

employee works, on average, over a two-week period.

Paid sick time under EPSLA does not carryover from one year to the next.

The paid sick time paid under EPSLA is terminated upon the termination of the need for such

paid sick time. An employer cannot require, as a condition of providing paid sick time under

EPSLA, that the employee search for or find a replacement employee to cover the hours during

which the employee is using paid sick time. In general, the paid sick time must be available for

immediate use by employees, regardless of how long the employee has been employed by an

employer.

An employee may first use the paid sick time under EPSLA and the employer may not require an

employee to use other paid leave provided by the employer to the employee before the employee

uses the paid sick time under EPSLA.

Paid Family Leave Refundable Credit

In addition to the paid sick leave credit, under the expanded FMLA, an employee who is unable

to work (including telework) because of a need to care for a child whose school or place of care

is closed or whose child care provider is unavailable due to COVID-19, is entitled to paid family

and medical leave equal to two-thirds of the employee’s regular pay, up to $200 per day and

$10,000 in total. Up to ten weeks of qualifying leave can be counted towards the family leave

credit.

Payment of the Sick and Family Leave Credit

Eligible Employers are entitled to receive a credit in the full amount of the qualified sick leave

wages and qualified family leave wages, plus allocable qualified health plan expenses and the

employer’s share of Medicare tax, paid for leave during the period beginning April 1, 2020, and

ending December 31, 2020. Employers are not subject to taxes on qualified sick leave wages and

qualified family leave wages.

Eligible Employers that pay qualified leave wages will be able to retain an amount of all federal

employment taxes equal to the amount of the qualified leave wages paid, plus the allocable

qualified health plan expenses and the amount of the employer’s share of Medicare tax imposed

on those wages, rather than depositing them with the IRS. The federal employment taxes that are

available for retention by Eligible Employers include federal income taxes withheld from

employees, the employees’ share of social security and Medicare taxes, and the employer’s share

of social security and Medicare taxes with respect to all employees.

7

Update

If the federal employment taxes yet to be deposited are not sufficient to cover the Eligible

Employer’s cost of qualified leave wages, plus the allocable qualified health plan expenses and

the amount of the employer’s share of Medicare tax imposed on those wages, the employer will

be able file a request for an advance payment from the IRS. The IRS expects to begin processing

these requests in April 2020.

Eligible employers claiming the credits for qualified leave wages, plus allocable qualified health

plan expenses and the eligible employer’s share of Medicare taxes, must retain records,

documentation related to and supporting each employee’s leave. These records are to

substantiate the claim for the credits, as well retaining the Forms 941, Employer's Quarterly

Federal Tax Return, and 7200, Advance of Employer Credits Due To COVID-19, and any other

applicable filings made to the IRS requesting the credit.

Phase 3 - The Coronavirus Aid, Relief, and Economic Security Act (CARES Act)

Economic Impact Payment The Act repurposes a section of the Internal Revenue Code that was used for rebates in 2001 and

again in 2008. Section 6428 is newly named “2020 Recovery Rebates for Individuals”. The Act

creates a tax credit for individual taxpayers against taxes generated in 2020 and authorizes an

advance payment (Economic Impact Payment) of the credit to taxpayers. The CARES Act

provides that individuals are entitled to a “Economic Impact Payment " (EIP) against their

income tax for the first tax year beginning in 2020 equal to -

(1) $1,200 ($2,400 in the case of a joint return); plus

(2) An amount equal to the product of $500 multiplied by the number of qualifying

children.

A qualifying child is defined as one who meets the "qualifying child" definition for the child tax

credit. A qualifying child must be under the age of 17 at the end of the tax year. The IRS

clarified4 that, because it lacked dependent information for recipients of social security, railroad

retirement, social security income and veteran affairs benefits, the 2020 Economic Impact

Payment under the CARES Act did not include the additional $500 per eligible child amount

unless the IRS had received dependent information from non-filers before May 6, 2020. The IRS

said that eligible recipients of the $500 per eligible child amount, who did not receive that

benefit, can expect such amounts after filing a 2020 tax return.

AGI Phaseout. The amount of the EIP is reduced (but not below zero) by 5 percent of the

amount by which the taxpayer's adjusted gross income exceeds:

(1) $150,000 in the case of a joint return,

(2) $112,500 in the case of a head of household, and

(3) $75,000 in the case of a taxpayer not described in (1) or (2).

4 IR2020-86

8

Update

Example: Bill, a single taxpayer with no qualifying children, has adjusted gross income

of $85,000. Bill's Economic Impact Payment is $700 [$1,200 - $500 (($85,000 - $75,000)

x 5%))].

An eligible individual is defined as any individual other than

(1) Any nonresident alien individual,

(2) Any individual with respect to whom a dependency deduction5 is allowable to another

taxpayer for a tax year beginning in the calendar year in which the individual's tax year

begins, and

(3) An estate or trust.

The CARES Act provides that no Economic Impact Payments will be issued after December 31,

2020.

In the case of an EIP issued or allowed with respect to a joint return, half of the amount is treated

as having been made or allowed to each individual filing the return.

If an individual has not filed a tax return for 2019, the Treasury Secretary may instead use the

individual's 2018-tax year information in determining the amount of the advance refund. If the

individual has not filed a tax return for 2018, the Treasury Secretary may use information with

respect to such individual for calendar year 2019 provided in Form SSA-1099, Social Security

Benefit Statement, or Form RRB-1099, Social Security Equivalent Benefit Statement.

NOTE: Economic Impact Payments 6 are calculated on a taxpayer's 2020 tax return,

based on a taxpayer's 2020 AGI and filing status, and the stimulus check received by

taxpayers are based on either 2018 or 2019 tax information; there may be situations in

which the amounts will differ.

The actual credit will be calculated on the taxpayer’s 2020 Form 1040. Any Economic Impact

Payment paid to the taxpayer will reduce the amount of credit in 2020, but not below -0-. In a

win-win for taxpayers, the law is written to provide for a payment to taxpayers if the 2020 credit

calculation exceeds the payment received already received by the taxpayer. If the actual 2020

credit is less than the rebate, the taxpayer is not required to pay back any of the excess cash

received.

Example: Janice has one qualifying child and files as a head of household, receives an

Economic Impact Payment of $1,700 ($1,200 + $500) based on her 2018 income tax

return on which she reported AGI of $100,000 (an amount below the $112,500 phaseout

threshold for heads of household). On her 2020 return, Janice reports AGI of $125,000,

resulting in a tentative credit of $1,075 [$1,700 - ($125,000 - $112,500) x 5%]. Janice's

recovery rebate credit on her 2020 return is reduced to zero to reflect her Economic

Impact Payment

5 IRC §151 6 IRC §6428(a)(f)

9

Update

Because the EIP cannot be reduced below zero.7 She is not required to pay back the $625

($1,700 - $1,075) difference between the Economic Impact Payment received and the amount

calculated using her 2020 AGI and filing status.

Example: Assume the same facts as the previous example, except that the AGI amounts

are reversed ($125,000 in 2018 and $100,000 in 2020). In this scenario, Janice’s

Economic Impact Payment was $1,075 [$1,700 - ($125,000 - $112,500) x 5%] and her

credit (before being reduced by the payment received) is $1,700. Janice will claim a

credit of $625 on her 2020 return ($1,700 - $1,075 Economic Impact Payment).

Penalty-free Retirement Distributions

Certain taxpayers are permitted to withdraw up to $100,000 from a retirement plan or IRA for

“Coronavirus related distributions” without incurring the 10% premature distribution penalty

under §72(t). Distributions are not tax-free.

A Coronavirus-related distribution includes a distribution:

• Made after Jan. 1, 2020 and before Dec. 31, 2020.

• To an individual who is diagnosed with the virus SARS-CoV-2 or COVID-19 by a

test approved by the Centers for Disease Control and Prevention.

• To a spouse or dependent of a person diagnosed with such virus by such a test.

• To persons who experience adverse financial consequences as a result of being

quarantined, furloughed or laid off; or having work hours reduced due to the virus or

disease; being unable to work due to lack of child care due to the virus or disease;

closing or reducing hours of a business owned or operated by the individual due to

the virus or disease, or other factors as determined by the Secretary of the Treasury.

If the taxpayer chooses, they may, at any time during the 3-year period beginning on the day

after the date such distribution from a qualified retirement plan was received, make one or more

contributions in an aggregate amount. This contribution may not exceed the amount of the

distribution to an eligible retirement plan and treat the contribution as a trustee-to-trustee transfer

contribution. Distributions from an IRA are treated similarly.

Example: John, age 45, is a single father of a four year old. Due to the Coviid-19 virus,

John is unable to take his son to his daycare and as such cannot work. John took $60,000

from his 401K on June 1, 2020.

Due to the CARES Act, the 10% penalty that John would be subject to since he is under

59 1/2 is waived. The tax on the distribution can be paid ratably over a three-year period

as follows:

• 2020 - $20,000

• 2021 - $20,000

• 2022 - $20,000

7 IRC§6428(e)(1)

10

Update

The taxpayer may repay all or part of the amount of a Coronavirus-related distribution to an

eligible retirement plan, if he or she completes the repayment within three years after the date

that the distribution was received. If the taxpayer repays a Coronavirus-related distribution, the

distribution will be treated as though it were repaid in a direct trustee-to-trustee transfer so that

they do not owe federal income tax on the distribution.

Example: Larry receive a Coronavirus-related distribution in 2020, he choose to include

the distribution amount in income over a 3-year period (2020, 2021, and 2022). In 2022

Larry chose to repay the full amount to an eligible retirement plan, he may file amended

federal income tax returns for 2020 and 2021 to claim a refund of the tax attributable to

the amount of the distribution for those years. Larry will not be required to include any

amount in income in 20228.

The administrator of an eligible retirement plan may rely on an individual's certification that the

individual satisfies the conditions to be a qualified individual in determining whether a

distribution is a Coronavirus-related distribution, unless the administrator has actual knowledge

to the contrary. Although an administrator may rely on an individual's certification in making

and reporting a distribution, the individual is entitled to treat the distribution as a Coronavirus-

related distribution for purposes of the individual's federal income tax return only if the

individual actually meets the eligibility requirements.

In general, it is anticipated that eligible retirement plans will accept repayments of Coronavirus-

related distributions, which are to be treated as rollover contributions. However, eligible

retirement plans generally are not required to accept rollover contributions. For example, if a

plan does not accept any rollover contributions, the plan is not required to change its terms or

procedures to accept repayments.

If the taxpayer is a qualified individual, he or she may designate any eligible distribution as a

Coronavirus-related distribution as long as the total amount that is designated as Coronavirus-

related distributions is not more than $100,000. As noted earlier, a qualified individual may treat

a distribution that meets the requirements to be a Coronavirus-related distribution as such a

distribution, regardless of whether the eligible retirement plan treats the distribution as a

Coronavirus-related distribution. A Coronavirus-related distribution should be reported on Form

1040 individual federal income tax return for 2020. He or she must include the taxable portion of

the distribution in income ratably over the 3-year period – 2020, 2021, and 2022 – unless he or

she elect to include the entire amount in income in 2020. Whether or not he or she are required to

file a federal income tax return, they would use Form 8915-E (which is expected to be available

before the end of 2020) to report any repayment of a Coronavirus-related distribution and to

determine the amount of any Coronavirus-related distribution includible in income for a year9.

8 Notice 2005-92,§§4D, 4E, 4F 9 Notice 2005-92, §4

11

Update

The payment of a Coronavirus-related distribution to a qualified individual must be reported by

the eligible retirement plan on Form 1099-R, Distributions from Pensions, Annuities, Retirement

or Profit-Sharing Plans, IRAs, Insurance Contracts, etc. This reporting is required even if the

qualified individual repays the Coronavirus-related distribution in the same year. The IRS

expects to provide more information on how to report these distributions later this year.10

Loans from Qualified Plans

Prior Rules: IRS Rules permit, but do not require, plan sponsors (typically employers) to

include loan provisions in their qualified employee benefit plans. Those plans include profit

sharing, 401(k), 403(b), and 457(b) plans. IRAs, including SEPs and Simple IRAs, do not offer

loans. If a plan allows loans to be made, the maximum amount of the loan is;

1) The greater of $10,000 or 50% of the vested account balance or

2) $50,000, whichever is less.

CARES Act: For those same individuals to whom the changes in the early withdrawal rules

apply (see discussion above), the CARES Act offers several advantageous provisions regarding

loans from qualified retirement plans:

The maximum amount that can be borrowed is increased from $50,000 to $100,000 and the

percentage test limit also increases, from half the present value of the participant’s account

balance to the entire value at the time of the loan; and

If a plan participant has an existing loan and loan repayment is due between the date of the

CARE Act’s enactment and the end of the year, the Act allows the repayment to be delayed

for one year from the original due date, with subsequent loan repayments adjusted to reflect

the delay in the 2020 repayment.

Note: Unlike the changes to the early withdrawal rules, the COVID-19-related changes to the

loan rules do not expand the availability of loans from IRAs; and whether loans are permitted

from qualified employee retirement plans remains subject to the terms of the plan.

Temporary Waiver of Required Minimum Distributions (RMDs)

Prior Rules: Historically, the law required owners of retirement accounts (including IRAs,

SEPs, Simple IRAs, 401(k)s, 403(b)s, profit-sharing, and other defined benefit plans) to start

taking withdrawals by April 1 of the year after they turned 70½.

The SECURE Act, signed on December 20, 2019, allows RMDs by individuals whose birthday

is July 1, 2019 or later to begin by April 1 of the year after they turn 72. The amount of the RMD

for any year is the account balance as of the end of the preceding calendar year divided by a

distribution period derived from the IRS’s “Uniform Lifetime Table.” RMDs do not apply to

Roth IRAs.

10 Notice 2005-92, §3

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The CARES Act includes a provision permitting a one-year delay in RMDs11. The suspension of

RMDs applies to all IRA accounts (including SEP and SIMPLE IRAs) and defined contribution

plan accounts, such as those under 403(a), 403(b), 401(a), and 401(k) plans, as well as the

Federal Thrift Savings Plan (TSP). RMDs from 457(b) plans are also suspended, but only from

plans offered by government employers.

Not only can individuals who have RMDs for 2020 suspend their distributions, but individuals

who either turned 70 ½ in 2019 or who were older but had retired in 201912 the “Still-Working

Exception” can avoid any 2019 RMDs that were delayed to 2020. Beneficiaries of retirement

accounts are also eligible to suspend their 2020 RMDs. On the other hand, accounts that are not

eligible for suspended RMDs include defined benefit plans, non-governmental 457(b) plans,

annuitized annuities held in an otherwise eligible plan, and 72(t) Distributions. Qualified

Charitable Distributions (QCDs) are also not impacted by the CARES Act’s suspension of

RMDs (and can still be made normally in 2020 for those who were otherwise QCD eligible).

Taxpayers who took RMDs for 2020 from their retirement accounts (or who have postponed

RMDs for 2019 in 2020, as noted above) but who could benefit from suspending the distribution,

there are a few ways to address the unwanted RMDs. Individuals can return the funds to the

original account or rollover the funds to another retirement account. This rollover can be done

either through the 60-day-rollover window, or the extended rollover deadline offered through

IRS Notice 2020-23, or for individuals directly affected by the COVID-19 virus using the

Coronavirus-Related Distribution Provision of the CARES Act13.

NOTE: Qualifying individuals of the Coronavirus-Related Distribution Provision of the CARES

Act are persons whose health or finances have been impacted by the coronavirus. More

specifically, individuals (or their spouses or dependents) who have been diagnosed with COVID-

19 by a test approved by the Centers for Disease Control and Prevention are eligible, as well as

individuals who have been financially impacted by COVID-19. These individuals have been

quarantined, furloughed, laid off, or have had to reduce their work hours; unable to work due to

lack of childcare; or are business owners who have had to close their business or reduce the

number of business hours they can remain open.

In the case of IRA owners who are considering rolling over their distribution, it is important to

be mindful of the once-per-year IRA-rollover rule. Effectively, the rule prevents an unwanted

RMD (or any other IRA distribution) from being rolled back into another IRA, if another IRA-

to-IRA or Roth IRA-to-Roth IRA 60-day rollover has been completed during the past 365 days.

Ultimately, the key point is that taxpayers who are retirement account owners can use relief

offered through the CARES Act by suspending 2020 RMDs that are not immediately needed.

For retirees who may already have taken their RMDs for 2020 (or for certain individuals who

took 2019 RMDs timely in 2020), there are strategies for them to return these unwanted

distributions. The taxpayer can use the 60-day-rollover rule, the relief provided by IRS Notice

11 CARES Act §2203 12 IRC §401(a)(9)(C)(i)(II) 13 CARES Act §2202(a)

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2020-23 (which pushes back the deadline to rollover distributions taken on or after February 1,

2020, to July 15, 2020), or a Coronavirus-Related Distribution for individuals directly affected

by the COVID-19 virus.

NOTE: The distributions, which are being rolled over, are being handled by taxpayers; the

taxpayer should be reminded to retain the paperwork showing the date the rollover was

completed. Furthermore, if there was withholding attached to the distribution that withholding

must be recovered on the 2020 Form 1040.

Partial Above-the-Line Charitable Contribution Deduction

Due to the significant increase of the standard deduction for individuals after the enactment of

the 2017 Tax Cut and Jobs Act, it is estimated that more than 85 percent of taxpayers will not

claim itemized deductions on their federal income tax returns for tax year 2019. As a result,

many people have learned they did not or will not receive any direct tax benefit for their 2019

charitable contributions and may not receive tax benefits for future years.

To encourage charitable giving among this group of taxpayers, Congress included a provision in

the CARES Act that creates a new partial above-the-line deduction, for cash contributions up to

$300, to certain charitable organizations14 for taxpayers that elect not to itemize deductions.

Qualifying donations do not include contributions to a supporting organization or to a sponsoring

organization for the establishment of a new donor advised fund or to be added to an existing

donor advised fund.

It remains uncertain whether Congress intended to allow this new charitable deduction for non-

itemizers in future years, or if this is a one-time incentive as part of the COVID-19 disaster

response. For now, the hope is that this change will benefit those nonprofits that traditionally rely

upon a volume of smaller-level contributions, including those charities that provide direct

services to the needy, healthcare organizations such as nonprofit hospitals, and religious

organizations.

Raising the Limits on Deductions for Cash Charitable Contributions During 2020 The CARES Act temporarily modified the percentage limitations on the income tax charitable

deduction for cash contributions to certain charities available to individuals who are itemizers

and corporations if these taxpayers elect to have these provisions apply for the 2020 tax year. For

2020, individuals may deduct qualified contributions to the extent of their contribution base (i.e.,

the individual's 2020 adjusted gross income without regard to any net operating loss carryback to

2020). This provision is very favorable to those donors who wish to make large cash

contributions in 2020, the deductibility of which might otherwise have been curbed due to the

percentage limitations. The election would allow much more to be deducted in 2020 and less

carried forward for deduction in future years.

14 IRC §170(b)(1)(A)

https://taxfoundation.org/standard-deduction-itemized-deductions-current-law-2019/

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For corporations, the percentage limitation on the corporate income tax charitable deduction

increased from 10 to 25 percent of the corporation's taxable income for 2020. In the case of

charitable contributions by partnerships or S corporations, each partner or shareholder must

separately elect to use the modified percentage limitations.

Any charitable contribution exceeding the limits discussed above may be carried forward and

used in later years subject to certain limits.

Charitable contributions carried over from a prior tax year (before 2020) are excluded from this

temporary relief and are subject to previous limitations in the tax code. Charitable contributions

to private non-operating foundations, supporting organizations and sponsoring organizations to

fund donor advised funds do not qualify for the modified percentage limitations for 2020.

Food Donations: Finally, the CARES Act raises the applicable limits on the amount of the

allowed deduction for food inventory from 15 percent to 25 percent for the taxable year, thereby

encouraging donations of food to organizations that provide for those in need.

15

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What Do You Think?

Q1. John and Joan are a married couple with two children under 17. They

receive a stimulus check for $1,000 on May 2, 2020. John and Joan’s adjusted

gross income in 2020 went down to $175,000. What is the additional amount of

Recovery Rebate Credit that John and Joan will receive on their 2020 return?

A. $2,400

B. $ 250

C. $ 750

D. $1,500

Q2. Ethan, age 40, took a distribution of $30,000 from his IRA in June 2020 because he had to

stay home with his 7-year old son who was not going to school because the schools were closed

due to the Coronavirus. How much is the penalty on this distribution?

A. $3,000

B. $300

C. $0

D. $1000

Q3. Which of the following is correct regarding loans made from a qualified employee benefit

plan due to Coronavirus?

A. The taxpayer can borrow up to $100,000 from their 457 plan.

B. The loan can be made from an IRA

C. The maximum amount of the loan allowed is greater of $10,000 or 50% of the vested

account balance

D. The plan sponsors must include loan provisions to allow the loan

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What Do You Think? Answers

A1. John and Joan are a married couple with two children under 17. They receive a

stimulus check for $1,000 on May 2, 2020. John and Joan’s adjusted gross income in

2020 went down to $175,000. What is the additional amount of Recovery Rebate Credit

that John and Joan will receive on their 2020 return?

A. $2,400

B. $ 250

C. $ 1150 is the additional credit computed on tax return and is refunded

D. $1,500

The actual payment will be calculated on the taxpayer’s 2020 Form 1040. Any advance rebate

paid (stimulus check) to the taxpayer will reduce the amount of credit in 2020, but not below -0-.

John and Joan are a married couple with two children; they had an AGI of $175,000 on their

2020 tax return. Actual credit = $2,150 less advance rebate credit received $1,000 = $1,150.

$175,000 minus $150,000 (phaseout for AGI) = $25,000 x 5% = $1,250 John and Joan’s rebate

if they were under the phaseout amount would have been $2,400. This amount $2,400 is reduced

by $1,250 =$1,150 plus $500 for each child equals $2,150 minus the stimulus check received of

$1000, John and Joan will get an additional credit of $1,150.

A2. Ethan, age 40, took a distribution of $30,000 from his IRA in June, 2020, because he had to

stay home with his 7-year old son who was not going to school because the schools were closed

due to the Coronavirus. How much is the penalty on this distribution?

A. $3,000

B. $300

C. $0 – Ethan is under 59 ½, the distribution meets the requirements excluding the

10% penalty

D. $1000

Certain taxpayers are permitted to withdraw up to $100,000 from a retirement plan or IRA for

“Coronavirus related distributions” without incurring the 10% premature distribution penalty

under §72(t). Distributions are not tax-free.

A Coronavirus-related distribution includes a distribution:

• Made after Jan. 1, 2020 and before Dec. 31, 2020.

• To an individual who is diagnosed with the virus SARS-CoV-2 or COVID-19 by a

test approved by the Centers for Disease Control and Prevention.

• To a spouse or dependent of a person diagnosed with such virus by such a test.

• To persons who experience adverse financial consequences as a result of being

quarantined, furloughed or laid off or having work hours reduced due to such virus or

disease, being unable to work due to lack of child care due to such virus or disease,

closing or reducing hours of a business owned or operated by the individual due to

such virus or disease, or other factors as determined by the Secretary of the Treasury.

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A3. Which of the following is correct regarding loans made from a qualified employee benefit

plan due to Coronavirus?

A. The taxpayer can borrow up to $100,000 from their 457 plan.

B. The A loan can be made from an IRA

C. The maximum amount of the loan allowed is greater of $10,000 or 50% of the vested

account balance

D. The plan sponsors must include loan provisions to allow the loan

CARES Act: For those same individuals to whom the changes in the early withdrawal rules

apply (see discussion above), the CARES Act offers several advantageous provisions regarding

loans from qualified retirement plans:

The maximum amount that can be borrowed is increased from $50,000 to $100,000 and the

percentage test limit also increases, from half the present value of the participant’s account

balance to the entire value at the time of the loan; and

If a plan participant has an existing loan and loan repayment is due between the date of the

CARE Act’s enactment and the end of the year, the Act allows the repayment to be delayed

for one year from the original due date, with subsequent loan repayments adjusted to reflect

the delay in the 2020 repayment

Note: Unlike the changes to the early withdrawal rules, the COVID-19-related changes to the

loan rules do not expand the availability of loans from IRAs; and, whether loans are permitted

from qualified employee retirement plans remains subject to the terms of the plan.

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Chapter 2 – CARES Act Business Provisions

Tax Provisions to Assist Businesses and Roll Backs of TCJA Provisions

The CARES Act contains numerous tax provisions that were drafted to assist businesses in

dealing with the economic effects of COVID-19. It rolls back some of the provisions of the Tax

Cuts and Jobs Act of 2017 (TCJA) including, among others, loosening restrictions on deducting

net operating losses and interest expenses.

Changes to Use of Net Operating Losses (NOL)

The CARES Act changes limitations on a company’s use of NOLs imposed by the TCJA. Under

the TCJA provisions, NOLs could not be carried back to reduce income in prior years and could

only be used to offset 80 percent of taxable income.

The CARES Act now allows for NOL carrybacks for losses arising in any taxable year beginning

after December 31, 2017 and before January 1, 2021. Such losses can be carried back for five

years. The CARES Act also provides for a temporary removal of the 80 percent taxable income

limitation to allow NOLs to fully offset income for years beginning before January 1, 2021. The

80 percent taxable income limitation is modified slightly for years beginning after December 31,

2020.

Changes to Limitation on Excess Business Losses of Non-Corporate Taxpayers

The CARES Act changes the years in which excess business loss will be disallowed for non-

corporate taxpayers. Instead of excess business losses being disallowed in tax years beginning

after December 31, 2017 and before January 1, 2026, as per TCJA provisions, the limitation will

apply to tax years beginning after December 31, 2020 and before January 1, 2026. (See Tax

Law)

Modification of Credit for Prior Year Minimum Tax Liability of Corporations

After the TCJA repealed the corporate alternative minimum tax (AMT), AMT credit refunds

were payable incrementally each year through 2021. As part of the CARES Act, payments of

AMT credit refunds are accelerated through 2019.

A specific election may be made to take the entire refundable credit for the 2018 tax year.

Applications to do so must be filed prior to December 31, 2020 and must set forth the amount of

the credit claimed for the taxable year, set forth the amount of the refundable credit claimed

under the section for any previously filed return for such taxable year and show the amount of

the refund claimed. The Secretary must, within 90 days, review the application and apply or

refund the amount.

Objective: Review roll backs of TCJA

Review provisions of the Paycheck Protection

Program and Employer Credits

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Modifications of Limits on Deduction of Business Interest

One of the most significant changes to the Internal Revenue Code made under the TCJA was

the limitation of interest expense deductions to 30 percent of adjusted taxable income. The

CARES Act increases the current 30 percent limitation to 50 percent for tax years beginning

in 2019 and 2020. Furthermore, taxpayers may elect to use 2019 adjusted taxable income in

lieu of current year adjusted taxable income for taxable years beginning in 2020.

The 50 percent threshold does not apply to partnerships for any taxable year beginning in

2019. Instead, unless they elect otherwise, 50 percent of a partner’s allocated share of the

partnership’s 2019 excess business interest will be treated as paid or accrued by a partner in

the partner’s first taxable year beginning in 2020 and will not be subject to Code Section

163(j).

A taxpayer may elect not to have the 50 percent limit apply to any taxable year. However,

once the election is made, it may only be revoked with consent from the Secretary.

Partnerships making the election may only do so for taxable years beginning in 2020.

Amendment to Depreciation Rules for Businesses

The CARES Act makes a technical correction to TCJA for the depreciation of qualified

improvement property (QIP). The CARES Act now includes any QIP within the definition of 15-

year MACRS property. Accordingly, QIP is now eligible for bonus depreciation such that

businesses may now immediately write off costs associated with improvements of facilities

meeting the definition of QIP. The amendments shall take retroactive effect to the 2018 year.

Excise Tax Exception for Alcohol Used to Produce Hand Sanitizer

For businesses normally subject to excise tax resulting from distilling spirits, the CARES Act

waives certain Federal excise tax on distilled spirits used in the production of hand sanitizer after

December 31, 2019 and before January 1, 2021. The hand sanitizer must be produced and

distributed in a manner consistent with FDA guidance related to the outbreak of COVID-19.

A Look at the CARES Act's Paycheck Protection Program (PPP)

Several taxpayer’s have taken advantage of the Paycheck Protection Program due to the

unprecedented economic disruptions due to the Coronavirus (COVID-19) outbreak. The

Paycheck Protection Program was authorized as part of the CARES Act that was signed into law

on March 27, 2020. This new loan program authorizes the Small Business Administration to

guarantee $349 billion in new loans to eligible businesses and nonprofits and, if certain criteria

are met, the loan may qualify for tax-free loan forgiveness. On Thursday, April 16, 2020, the

SBA announced it is no longer accepting applications because it had already approved the $349

billion allotted for the program. Congress has added another $310 billion to the PPP in April

The Paycheck Protection Program provides small businesses with funds to pay up to 8 weeks of

payroll costs including benefits. Funds can also be used to pay interest on mortgages, rent, and

utilities. The PPP Flexibility Act of 2020 extends the 8 weeks to 24 weeks after the origination

date, or December 31, 2020.

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Maximum PPP Loan Amount

The formula used to determine a loan applicant's maximum loan amount depends on whether or

not the applicant's business is seasonal and whether the applicant was in business during a

specified reference period. In all scenarios, the maximum loan amount is determined by the

applicant's payroll costs, but cannot be more than $10 million.

Fully Forgiven Funds are provided in the form of loans that will be fully forgiven when used for payroll costs,

interest on mortgages, rent, and utilities. The purpose of the program is to inject money quickly

into the economy primarily by paying employees of small businesses; the PPP provides the

opportunity for complete forgiveness of the PPP loan. Those portions of the loan that are not

spent quickly enough or for the right purposes must be repaid over two years, but the idea is that

these amounts should be small. Qualifying businesses will be eligible for loan forgiveness when

PPP loan proceeds are spent on qualified expenses within the eight week Covered Period and at

least 75% (the “75/25 Rule”) of qualified expenses were payroll costs. The forgiven amount

cannot exceed the principal amount of the PPP loan15.

Under the loan program, banks, savings and loans, credit unions, and other specialized lenders

participate with the SBA on a deferred basis to provide structured small business loans. If a

borrower defaults on an SBA-guaranteed loan, the lender may ask the SBA to purchase the

guaranteed portion.

To participate in the SBA 7(a) loan program, a lender must meet the following requirements:

(1) Have a continuing ability to evaluate, process, close, disburse, service, and liquidate

small business loans.

(2) Be open to the public to issue loans (and not be a financing subsidiary, engaged

primarily in financing the operations of an affiliate)

(3) Have continuing good character and reputation, and otherwise meet and maintain

certain ethical requirements

(4) Be supervised and examined by a state or federal regulatory authority, satisfactory to

the SBA

Loan payments will also be deferred for six months. No collateral or personal guarantees are

required. Neither the government nor lenders will charge small businesses any fees.

Must Keep Employees on the Payroll—or Rehire Quickly

Forgiveness is based on the employer maintaining or quickly rehiring employees and

maintaining salary levels. Forgiveness will be reduced if full-time headcount declines, or if

salaries and wages decrease.

15 CARES Act §1106(d)(1)

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All Small Businesses Eligible Small businesses with 500 or fewer employees—including nonprofits, veterans organizations,

tribal concerns, self-employed individuals, sole proprietorships, and independent contractors—

are eligible. Businesses with more than 500 employees are eligible in certain industries. Starting

April 3, 2020, small businesses and sole proprietorships can apply. Starting April 10, 2020,

independent contractors and self-employed individuals can apply.

The taxpayer can apply through any existing SBA 7(a) lender or through any federally insured

depository institution, federally insured credit union, and Farm Credit System institution that is

participating. An SBA 7(a) lender has been previously granted authority to make credit decisions

without contacting the SBA. Other regulated lenders will be available to make these loans once

they are approved and enrolled in the program. All loans will have the same terms regardless of

lender or borrower. A list of participating lenders as well as additional information and full terms

can be found at www.sba.gov.

Many small businesses quickly saw the advantage of the generous terms of PPP capital not

requiring collateral, personal guarantees, or SBA fees and providing a six-month deferment

period at a fixed interest rate of 1%. Approved borrowers have started to receive the proceeds of

the loans, beginning the eight week Covered Period within which to spend the proceeds in order

to qualify for loan forgiveness. As we enter the disbursement phase, borrowers need to focus on

how to properly spend the money to maximize forgiveness and avoid potential problems in the

future, when the government reviews the disbursements under the program. The SBA is required

by the CARES Act to provide guidance on the implementation of the loan forgiveness feature.

PPP Flexibility Act 6/5/2020

Part of the loan forgiveness calculation involves a reduction in the amount that may be forgiven

if an employer reduces employee head counts or wages. The PPP Flexibility Act 16adds a new

loan forgiveness exemption based on employee availability.

Under this exemption, during the period beginning on February 15, 2020, and ending on

December 31, 2020, the amount of loan forgiveness is determined without regard to a

proportional reduction in the number of full-time equivalent (FTE) employees if an eligible

recipient, in good faith is able to document either –

(1) An inability to rehire individuals who were employees of the eligible recipient on

February 15, 2020, and an inability to hire similarly qualified employees for unfilled

positions on or before December 31, 2020; or

16 HR 7010

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(2) An inability to return to the same level of business activity as before February 15,

2020, due to compliance with requirements established during the period beginning on

March 1, 2020, and ending December 31, 2020, related to the maintenance of standards

for sanitation, social distancing, or any other worker or customer safety requirement

related to COVID - 19.

NOTE: The PPP Flexibility Act does not define the term "inability to return to the same level of

business activity." Watch for additional guidance from the IRS or SBA the exact meaning.

Borrowers Can Spend More of the Loan Proceeds on Nonpayroll Costs

Pursuant to an interim final rule issued by the SBA after the passage of the CARES Act, PPP

borrowers had to use 75 percent of the total loan proceeds on payroll costs.

The PPP Flexibility Act reduces the amount that must be spent on payroll to 60 percent. Thus,

40 percent of a PPP loan can be used for nonpayroll costs.

NOTE: As the law is written, if less than 60 percent is spent on payroll, no loan forgiveness will

be granted. The change effectively creates a cliff that did not exist with respect to the SBA's 75

percent rule.

Loan Maturity Date Extended

Under the PPP, borrowers that did not qualify for loan forgiveness generally were required to

repay the loan over a two-year period.

The PPP Flexibility Act extends this period to five years.

More Borrowers Now Eligible for Payroll Tax Deferment

One of the provisions in the CARES Act allows the deferment of an employer's share of social

security tax. However, the provision did not apply to employers that had their PPP loan forgiven.

The PPP Flexibility Act now allows employers who have their PPP loan forgiven to also delay

paying 50 percent of the their share of social security tax due until December 31, 2021, and delay

paying the remaining 50 percent due until December 31, 2022.

Extension of Loan Payment Deferral Period

Under the CARES Act, PPP loan payments are deferred for six months. Thus, borrowers were

not required to make any payments of principal and interest for six months following receipt of

the loan, although interest continues to accrue on the loan during this deferment period.

The PPP Flexibility Act extends the existing six-month loan deferral period until the date on

which the amount of forgiveness determined is sent to the lender. If a borrower fails to apply for

forgiveness within 10 months after the last day of the covered period, payments of principal,

interest, and fees on such loans begin on the day that is not earlier than the date that is 10 months

after the last day of such covered period.

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Under the CARES Act, PPP loan proceeds can lawfully be used for the various purposes of a

normal SBA 7(a) loan, such as to provide working capital as well as to cover:

(1) Payroll costs (as defined by the Act);

(2) Costs related to continuation of group health care benefits during periods of paid sick,

medical or family leave, as well as insurance premiums;

(3) Mortgage interest payments;

(4) Rent payments;

(5) Utility payments;

(6) Interest payments on other debt obligations incurred before February 15, 2020; and

(7) Refinancing an SBA Economic Injury Disaster Loan made between January 31, 2020,

and April 3, 2020.17 The SBA has declared in its Interim Final Rule that 75% of the PPP

loan proceeds must be spent on payroll costs.

If a borrower uses PPP funds for unauthorized purposes, the SBA will direct the borrower to

repay those amounts. If a borrower knowingly uses the funds for unauthorized purposes, the

borrower will be subject to additional liability charges for fraud. If a borrower uses funds for

unauthorized purposes, the SBA will have recourse against the borrower’s shareholders,

members, or partner(s) for the unauthorized use.

Payroll Costs. The CARES Act defines payroll costs as Qualified Expenses. CARES Act §

1106(b)(1). For a business (as opposed to an independent contractor or sole proprietor), payroll

costs are payments to employees that are

(i) Salary, wages, commissions, or similar compensation (up to an annualized $100,000);

(ii) Cash tips or equivalent;

(iii) Vacation, parental, family medical, or sick leave (excluding payments for emergency

paid sick leave or expanded family and medical leaves);

(iv) Separation or dismissal pay;

(v) Group health insurance;

(vi) Retirement benefits; or

(vii) State or local payroll tax (but not federal payroll tax).

Working partners and members of an LLC are treated as employees for the purpose of the PPP.

Under most traditional definitions of “employee,” owners of a business such as partners and

members of an LLC are not considered “employees.” Nor, if there are several owners, are they

“sole proprietors” or “independent contractors,” which are separately addressed under the

program. The question arises, therefore, whether payments to such owners who perform work for

a small business are payroll costs under the PPP for which the borrower may seek forgiveness.

The Treasury Department, in consultation with the SBA, issued guidance on April 6, 2020, that

indicated that payments to such individuals might be included in payroll costs. Pre-PPP cases

under the SBA have indicated that owners who work at least 40 hours per month on the business

may be considered employees for SBA purposes.

17 CARES Act § 1102(f).

https://www.mccarter.com/insights/your-small-business-may-be-eligible-to-supplement-its-paycheck-protection-loan-with-an-sba-economic-injury-disaster-loan/

https://fridayfirm.com/docs/default-source/blogs/faq---ppp-4-6-2020.pdf?sfvrsn=d7e5d76b_2

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Compensation with respect to employees includes:

(1) Salary, wage, commission, or similar compensation;

(2) Payment of cash tip or equivalent;

(3) Payment for vacation, parental, family, medical, or sick leave;

(4) Allowance for dismissal or separation;

(5) Payment required for the provisions of group health care benefits, including insurance

premiums;

(6) Payment of any retirement benefit; and

(7) Payment of state or local tax assessed on the compensation of employees.

Compensation with respect to employees excludes18:

(1) The compensation of an individual employee in excess of an annual salary of

$100,000, as prorated for the covered period;

(2) Taxes imposed or withheld under Internal Revenue Code chapters 21, 22, or 24

(employment taxes) during the covered period;

(3) Any compensation of an employee whose principal place of residence is outside of

the United States;

(4) Qualified sick leave wages for which a credit is allowed

(5) Qualified family leave wages for which a credit is allowed; and

(6) Payments to independent contractors.

PPP loans may be used for the following expenses if these expenses were incurred in the

ordinary course of doing business before February 15, 2020:

(1) Payroll costs;

(2) Costs related to the continuation of group health care benefits during periods of paid

sick, medical, or family leave, and insurance premiums;

(3) Utility payments;

(4) Rent payments;

(5) Mortgage interest payments (but not mortgage prepayments or principal payments);

(6) Interest payments on any other debt obligations.

Reduction in Forgiveness. PPP loan forgiveness will be reduced

(a) in proportion to the decrease in the average monthly full-time-equivalent employees

(“FTEE”) during the Covered Period as compared to a reference period and

(b) dollar for dollar for the amount of reduction in excess of 25% of the total salary and

wages of any employee during the Covered Period as compared to a reference period.19

Employee Reductions. The biggest driver of forgiveness of PPP loans is maintaining or

restoring the borrower’s workforce to pre-pandemic levels. The PPP compares the average

number of FTEEs that the borrower has each month during the Covered Period to the average

number of monthly FTEEs the borrower employed during one of two base periods.

18 Pub.L 116-127,15 USC (636(a)(36),SBA 2020 19 CARES Act §§ 1106(d)(2) and (d)(3).

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The borrower may choose either

(i) The period from February 15, 2019, to June 30, 2019, or

(ii) The period from January 1, 2020, until February 29, 2020.

As a practical matter, the borrower should calculate the number of FTEEs it had during both

these periods and choose the period with the lower number of FTEEs. Because the PPP deals

with FTEEs rather than specific individuals, whether people are hired or fired or replaced is

irrelevant to the calculation. The easiest way to satisfy the 75/25 Rule is to bring the workforce

back to base period levels as quickly as possible.

Rehiring Employees. The CARES Act has a limited exception to the forgiveness reduction that

accompanies a reduction in the workforce from pre-pandemic base levels. To the extent that all

or part of the reduction in FTEEs occurred between February 15, 2020, and April 26, 2020, and

the borrower “eliminates the reduction in the number of” FTEEs by June 30, then the amount of

loan forgiveness shall be determined without regard to the reduction in FTEEs that occurred

between February 15, 2020, and April 26, 2020. This may end up being all or a substantial

portion of the FTEE reduction, which would result in an increase in the forgiveness amount.

Satisfying the 75/25 Rule, however, will require that a lot of the workforce be active during the

eight week Covered Period.

Salary Reductions. Forgiveness is reduced by the amount of any reduction in total salary or

wages of any employee (except employees who made more than $100,000 in 2019) during the

Covered Period that is in excess of 25% of the total salary or wages of the employee during the

most recent quarter that the employee was employed before the Covered Period. Unlike the total

number of employees, which is based on FTEEs, this reduction looks at individual employees for

whom the borrower has reduced pay. This section of the CARES Act makes it possible for

businesses to reduce wages without having to report a salary reduction, but reducing salary

wages would make it harder for businesses to meet the 75/25 Rule required for loan forgiveness.

Salary reductions can also be eliminated by June 30, 2020, which then eliminates this reduction.

Processing the Loan As soon as practical after the Covered Period, a borrower must submit to

the lender that is servicing the PPP SBA Form 3508 for loan forgiveness, which will include

(a) Documentation verifying the number of FTEEs on payroll and pay rates for the Covered

Period and the applicable reference period, including

(i) Payroll tax filings reported to the IRS and

(ii)State income, payroll, and unemployment insurance filings;

(b) Documentation, including canceled checks, payment receipts, transcripts of accounts, or

other documents verifying payments on covered mortgage obligations, payments on covered

lease obligations, and covered utility payments;

(c) A certification from the borrower that

(i) The documentation presented is true and correct; and

(ii)The amount for which forgiveness is requested was used to retain employees, make

interest payments on a covered mortgage obligation, make payments on a covered rent

obligation, or make covered utility payments; and

(d) Any other documentation the SBA determines necessary.

26

Update

Any portion of the loan forgiveness denied is due two years after maturity of the loan. The lender

will have up to 60 days to issue a decision on the loan forgiveness application. 20

Guidance on these loans are ongoing by the IRS and SBA. We expect further guidance from the

SBA on this process. CARES Act §1106(e) and (g).

The CARES Act "Paycheck Protection Program" (PPP). The program authorizes the Small

Business Administration (SBA) to guarantee new loans to eligible businesses and nonprofits

affected by coronavirus/COVID-19. Such loans may also qualify for tax-free loan forgiveness.

Maximum loan amounts, subject to a $10 million limit, are set at 2.5 times the borrower's

average monthly payroll costs. Loan proceeds can be used for payroll costs, utility payments,

rent, and interest on certain mortgages.

In addition to the potential for tax-free forgiveness, PPP loans offer the following benefits:

(1) Interest rates set at 1 percent for all borrowers.

(2) No personal guarantee is required.

(3) No collateral is required.

(4) Loans are nonrecourse with respect to shareholders, members, and partners as long as

proceeds are used in accordance with the loan terms.

(5) No fees for borrowers.

(6) All loan payments are deferred for six months (however, interest still accrues).

(7) To the extent balances are not forgiven, loans mature in two years.

(8) Fully guaranteed by the SBA.

(9) Not contingent on the borrower's creditworthiness (but delinquency on other open

SBA loans and past defaults can be disqualifying).

The main downside of the loans is that they are heavily based on borrowers maintaining the

employee headcounts that they had going into the COVID-19 crisis, and keeping any reductions

in wages and salaries within specified limits - actions that may not be feasible for some

businesses in a highly uncertain business environment.

The PPP launched on April 3, 2020 and exhausted its original $349 billion in funding after just

two weeks, thus preventing many businesses from taking advantage of the program. Congress

has now passed, and the President has signed, the Paycheck Protection Program and Health Care

Enhancement Act (PPP Enhancement Act), adding another $310 billion in funds to the program

In order to receive a PPP loan, an authorized representative of the borrower needs to complete

SBA Form 2483, Paycheck Protection Program Borrower Application Form, and submit it to the

borrower's SBA participating lender.

20 CARES Act § 1106(e) and (g)

https://www.parkertaxpublishing.com/PDFs_Citable/CARES%20Act.pdf

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The CARES Act prohibits CPAs and accounting firms from collecting fees from small business

clients they help apply for PPP loans. The restrictions apply to CPAs and firms that act as official

application agents as defined in the CARES Act. CPAs who serve as agents should receive

compensation for their work, but the Treasury Department has designated that lenders pay agents

out of their fee. In its statement, the AICPA said that its understanding is that the limitation on

fees applies to fees for assistance in the preparation of a loan application for a loan available

under the PPP. If an accounting firm charges fees for providing a small business with advice on

deciding which loan program and tax relief program would be best for their business, the

statement says that the AICPA thinks it is "reasonable that those fees would fall outside this

provision of the CARES Act." Many volunteer organizations offer assistance at no charge.

Applicants must apply for the loans by June 30, 2020, because that is when the PPP expires.

However, loans are available only as long as the cash lasts. The loans are geared towards

borrowers that have an existing relationship with an SBA participating lender.

The IRS addressed the deductibility for federal income tax purposes of certain otherwise

deductible expenses incurred in a taxpayer's trade or business when the taxpayer receives a loan

(covered loan) pursuant to the Paycheck Protection Program, which was enacted as part of the

CARES Act. The IRS concluded that no deduction is allowed for an expense that is otherwise

deductible if the payment of the expense results in forgiveness of a covered loan21 and the

income associated with the forgiveness is excluded from gross income.22

The following definitions are integral to applying the various provisions of the CARE Act's

Paycheck Protection Program (PPP)23.

The "covered period" is the period beginning on February 15, 2020, and ending on June

30, 2020.

A "covered loan" is a loan meeting the requirements of the PPP that is made during the

covered period. Covered loans are also referred to a "PPP loans

The term "payroll costs" is discussed in detail below and refers to outlays for

compensation and benefits.

PPP loans may only be made to "eligible recipients." An "eligible recipient" means an

individual or entity that is eligible to receive a covered loan.

Subject to limits based on number of employees, eligible recipients may include:

(1) Any business;

(2) Nonprofit organizations exempt from tax; 24

(3) Veterans organizations;25

(4) Tribal business concerns.

21 CARES Act §1103(b) 22 CARES Act §1106(i), Notice 2020-32 23 15 U.S.C. 636(a)(36). 24 IRC§501(c)(3) 25 IRC§501(c)(19) IRC§501(a)

https://www.parkertaxpublishing.com/PDFs_Citable/15%20U.S.C.%20636(a)(36).pdf

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Update

The following categories of individuals, businesses, and organizations are specifically listed as

ineligible for PPP loans by the SBA's interim final rules:

(1) Household employers (i.e., individuals who employ household employees such as

nannies or housekeepers);

(2) Those engaged in any activity that is illegal under federal, state, or local law;

(3) A business with a 20-percent-or-more owner who is incarcerated, on probation, on

parole; presently subject to an indictment, criminal information, arraignment, or other

means by which formal criminal charges are brought in any jurisdiction; or has been

convicted of a felony within the last five years; or

(4) Any individual, organization, business, or business with any owner who/that has ever

obtained a direct or guaranteed loan from SBA or any other federal agency that is

currently delinquent or has defaulted within the last seven years and caused a loss to the

government.

Sole proprietors, independent contractors, and "eligible self-employed individuals" may be

eligible to receive PPP loans, but are required to submit documentation to establish themselves

as eligible, including payroll processor records, payroll tax filings, Forms 1099 - MISC, or

income and expenses from the sole proprietorship.

Eligible recipients must have been in operation on February 15, 2020, and either paid

salaries/wages to employees (with respect to which payroll taxes were paid) or paid independent

contractors, as reported on a Form 1099-MISC.

There is an eligible recipient employee limit. Eligible recipients must either have 500 or fewer

employees whose principal place of residence is in the United States, or be a business that

operates in a certain industry and meets the applicable SBA employee-based size standards for

that industryAs a key component in determining both the maximum PPP loan amount and the

amount that can be forgiven, "payroll costs" are central to the loan program. The term is defined

to mean the sum of:

(1) Payments of any compensation with respect to employees; and

(2) Payments of any compensation to or income of a sole proprietor or independent

contractor that is a wage, commission, income, net earnings from self-employment, or

similar compensation and that is in an amount that is not more than $100,000 in one year,

as prorated for the covered period.

General Rule. Subject to a $10 million limit, the maximum amount of a covered loan under the

CARES Act's Paycheck Protection Program is determined by multiplying:

(1) The average total monthly payments by the applicant for payroll costs incurred during

the one-year period before the date on which the loan is made; by

(2) 2.526

The interim final rules issued by the SBA require that 75 percent of the proceeds of covered

loans must be used for payroll costs.

26 15 U.S.C. 636(a)(36)(E)(i)(I)(aa)

https://www.parkertaxpublishing.com/PDFs_Citable/CARES%20Act.pdf

https://www.parkertaxpublishing.com/PDFs_Citable/15%20U.S.C.%20636(a)(36).pdf

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Update

An employer may not receive the Employee Retention Credit if the employer receives a PPP

loan that is authorized under the CARES Act. An Eligible Employer that receives a PPP loan,

regardless of the date of the loan, cannot claim the Employee Retention Credit.

NOTE: An employer that applied for a PPP loan, received payment, and repaid the loan by May

14, 2020 will be treated as though the employer had not received a covered loan under the PPP

for purposes of the Employee Retention Credit. Therefore, the employer will be eligible for the

credit if the employer is otherwise an Eligible Employer. An employer that receives a PPP loan

may not receive an Employee Retention Credit, regardless of whether and when the loan is

forgiven.

Employers cannot receive both the Paid Family and Medical Leave Credit (Section 45S of the

Internal Revenue Code) and the Employee Retention Credit, for the same wages. The employer

may be able to claim the credit for any additional wages paid.

Employer Credits

The first of these, the Employee Retention Credit, is intended to encourage businesses to keep

employees on the payroll. The ERC is a refundable tax credit of 50% up to $10,000 in wages

paid by an eligible employer whose business has been financially affected by COVID-19.

The credit is available to all employers, regardless of size, and includes tax-exempt

organizations. The IRS says there are only two exceptions to this credit: State and local

governments and their instrumentalities, and small businesses who take small-business loans.

Employee Retention Credit

Under the CARES Act, eligible employers can take a credit against applicable employment taxes

for each calendar quarter equal to 50 percent of the qualified wages with respect to each

employee of the employer for the calendar quarter.27 The employee retention credit applies to

wages paid after March 12, 2020, and before January 1, 2021. The amount of qualified wages

with respect to any employee, which may be taken into account for purposes of determining the

credit for all calendar quarters, is limited to $10,000.

There are only two qualifications and employers have to meet one or the other:

The employer's business is fully or partially suspended by government order due to

COVID-19 during the calendar quarter.

The employer's gross receipts are below 50% of the comparable quarter in 2019. Once

the employer's gross receipts go above 80% of a comparable quarter in 2019, they no

longer qualify after the end of that quarter.

Employers will calculate these measures each calendar quarter.

27 Pub. L. 116-136, Sec. 2301(a)

https://www.parkertaxpublishing.com/PDFs_Citable_ForAnalysis/CARES%20Act.pdf

https://www.parkertaxpublishing.com/PDFs_Citable_ForAnalysis/Pub.%20L.%20116-136.pdf

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Update

The credit amount is reduced by the amount of any of the following credits

Credit for employment of qualified veterans28

Credit for research expenditures of qualified small business,29 as well as

The payroll tax credits for paid sick leave and paid family and medical leave30

What are the Paid Sick Leave and Family Leave Credits?

The paid sick leave credit is aimed at giving businesses a tax credit for an employee who is

unable to work (including working from home) because of Coronavirus quarantine or self-

quarantine. It also applies if the employee has Coronavirus symptoms and is seeking a medical

diagnosis.

Qualified sick leave wages are wages that requires an employer to pay to an employee who is

unable to work or telework because of the employee’s health status, quarantine or self-quarantine

or has COVID-19 symptoms, or the employee needs to care for children or other family

members.

Qualified sick leave wages are wages that Eligible Employers must pay eligible employees for

periods of leave during which they are unable to work or telework because the employee:

1. Is subject to a Federal, State, or local quarantine or isolation order related to COVID-19;

2. Has been advised by a health care provider to self-quarantine due to concerns related to

COVID-19;

3. Is experiencing symptoms of COVID-19 and seeking a medical diagnosis;

4. Is caring for an individual who is subject to a Federal, State, or local quarantine or

isolation order related to COVID-19, or has been advised by a health care provider to

self-quarantine due to concerns related to COVID-19;

5. Is caring for a child of such employee if the school or place of care of the child has been

closed, or the child care provider of such child is unavailable due to COVID-19

precautions; or

6. Is experiencing any other substantially similar condition specified by the Secretary of

Health and Human Services in consultation with the Secretary of the Treasury and the

Secretary of Labor

28 IRC §3111(e) 29 IRC §3111(f) 30 Pub. L. 116-136, Sec. 2301(b)(2)).

https://www.parkertaxpublishing.com/PDFs_Citable_ForAnalysis/Pub.%20L.%20116-136.pdf

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Update

Qualified family leave wages are wages31 that requires an employer to pay to an employee who

is unable to work or telework because of the employee’s health status, quarantine or self-

quarantine or has COVID-19 symptoms, or the employee needs to care for children or other

family members. The first ten days for which an employee takes leave for this reason may be

unpaid. However, during that 10-day period, an employee may be entitled to receive qualified

sick leave wages as provided under the ESPLA or may receive other forms of paid leave, such as

accrued sick leave, annual leave, or other paid time off under the Eligible Employer’s policy.

After an employee takes leave for ten days, the Eligible Employer must provide the employee

with qualified family leave wages for up to ten weeks.

Employees are entitled to paid sick leave for up to 10 days (up to 80 hours) at the employee’s

regular rate of pay up to $511 per day and $5,110 in total. Employees are also entitled to paid

family leave amounting to two-thirds of the employee’s regular pay, up to $200 per day and

$10,000 in total. Up to 10 weeks of qualifying leave can be counted toward the family leave

credit.

Businesses can be reimbursed immediately for the credit by reducing their required deposits of

payroll taxes that have been withheld by the amount of the credit. Eligible employers can

immediately get a credit in the full amount of the required sick leave and family leave—plus

related health plan expenses and the employer’s share of Medicare tax on the leave—for the

period of April 1, 2020, through Dec. 31, 2020. The refundable credit is applied against

employment taxes on wages paid to all employees.

How do businesses get the Employee Retention Credit?

The employment taxes that are available for the credits include withheld federal income tax, the

employee share of social security and Medicare taxes, and the employer share of social security

and Medicare taxes with respect to all employees.

If there are not sufficient employment taxes to cover the cost of qualified sick and family leave

wages (plus the qualified health expenses and the employer share of Medicare tax on the

qualified leave wages) and the employee retention credit, employers can file Form 7200 to

request an advance payment from the IRS. Do not reduce the employer deposits and request

advance credit payments for the same expected credit. The advanced credit payments will need

to be reconciles on the employment tax return.

The IRS says getting the credit is as simple as reducing the required deposits of payroll taxes that

have been withheld from workers’ wages. The reduction is made by the amount of the credit.

Eligible employers will report their total qualified wages and the related health insurance costs

for each quarter on their quarterly employment tax returns or Form 941 beginning with the

second quarter. If the employer's employment tax deposits are not sufficient to cover the credit,

the employer may receive an advance payment from the IRS by filing Form 7200, Advance

Payment of Employer Credits Due to COVID-19.

31 IRC §3121(a)

32

Update

Form 7200- Advance Payment of Employer Credits Due to Covid-19

33

Update

What Do You Think?

Q1. Which of the following is not one of the qualifications for the Employer Retention

Credit? A. The employer's business is fully or partially suspended by government order due

to COVID-19 during the calendar quarter.

B. The employer's gross receipts are below 50% of the comparable quarter in 2019.

C. The employer's gross receipts are below 80% of a comparable quarter in 2019. D. Employers will calculate the gross receipts each calendar quarter.

Q2. Which of the following is correct regarding the technical correction made to depreciation

rules for businesses in the CARES Act?

A. The CARES Act includes any Qualified Improvement Property within the definition of

15-year MACRS property.

B. The change in depreciation made in the CARES Act allows qualified improvement

property to be eligible for bonus depreciation.

C. Businesses can amend 2018 and 2019 tax returns for the qualified improvement

property.

D. All of the above.

Q3.Which of the following qualified expenses is a business required to spend 75% of the loan

funds received on to be eligible for loan forgiveness under the PPP rules?

A. Payroll costs

B. Interest on mortgages

C. Rent

D. Utilities

34

Update

What Do You Think? – Answers

A1.Which of the following is not one of the qualifications for the Employer

Retention Credit

A. The employer's business is fully or partially suspended by government

order due to COVID-19 during the calendar quarter.

B. The employer's gross receipts are below 50% of the comparable quarter in 2019.

C. The employer's gross receipts are below 80% of a comparable quarter in 2019. D. Employers will calculate the gross receipts each calendar quarter.

There are only two qualifications and employers have to meet one or the other:

The employer's business is fully or partially suspended by government order due to

COVID-19 during the calendar quarter.

The employer's gross receipts are below 50% of the comparable quarter in 2019. Once

the employer's gross receipts go above 80% of a comparable quarter in 2019, they no

longer qualify after the end of that quarter.

Employers will calculate these measures each calendar quarter.

A2. Which of the following is correct regarding the technical correction made to depreciation

rules for businesses in the CARES Act?

A. The CARES Act includes any Qualified Improvement Property within the definition of

15-year MACRS property.

B. The change in depreciation made in the CARES Act allows qualified improvement

property to be eligible for bonus depreciation.

C. Businesses can amend 2018 and 2019 tax returns for the qualified improvement

property.


The CARES Act makes a technical correction to TCJA for the depreciation of qualified

improvement property (QIP). The CARES Act now includes any QIP within the definition of 15-

year MACRS property. Accordingly, QIP is now eligible for bonus depreciation such that

businesses may now immediately write off costs associated with improvements of facilities

meeting the definition of QIP. The amendments shall take retroactive effect to the 2018 year.

35

Update

A3.Which of the following qualified expenses is a business required to spend 75% of the loan

funds received on to be eligible for loan forgiveness under the PPP rules?

A. Payroll costs

B. Interest on mortgages

C. Rent

D. Utilities

Funds are provided in the form of loans that will be fully forgiven when used for payroll costs,

interest on mortgages, rent, and utilities. The purpose of the program is to inject money quickly

into the economy primarily by paying employees of small businesses; the PPP provides the

opportunity for complete forgiveness of the PPP loan. Those portions of the loan that are not

spent quickly enough or for the right purposes must be repaid over two years, but the idea is

that these amounts should be small. Qualifying businesses will be eligible for loan forgiveness

when PPP loan proceeds are spent on qualified expenses within the eight week Covered Period

and at least 75% (the “75/25 Rule”) of qualified expenses were payroll costs. The forgiven

amount cannot exceed the principal amount of the PPP loan.

36

Update

Chapter 3- Amounts, Limits and Rates

This section will be updated with the release of

additional information from the taxing authorities

Each bracket saw an increase in the range tied to inflation. The IRS Published the rates in

Revenue Procedure 2019-44. Tax rate tables changes to IRC §1 are as follows:

Single Individuals

A taxpayers’ filing status is single if, on the last day of the year, the taxpayer is unmarried or

legally separated from a spouse under a divorce or separate maintenance decree, and the taxpayer

does not qualify for another filing status.32

32 IRC § 7703

Objective Provide the student with awareness and

understanding regarding:

Rates, and Limitations for 2019/2020 Tax

Season

TCJA changes to existing provisions

TCJA Exemption Repeal

37

Update

Head of Household

A taxpayer may choose Head of Household filing status if the taxpayer lived apart from his or

her spouse, meets certain tests, and is considered unmarried on the last day of the year.33 A

taxpayer can elect Head of Household filing status even if the taxpayer is not divorced or legally

separated. If a taxpayer qualifies as Head of Household (rather than as Married Filing

Separately), the taxpayers’ tax may be lower, the earned income credit and certain other credits

may be available, and the standard deduction is higher. In addition, when filing as Head of

Household, the taxpayer can choose the standard deduction even if the taxpayers’ spouse

itemizes deductions.

If the taxpayer is a nonresident alien during any part of the tax year, the taxpayer cannot qualify

as head of a household even though he or she complies with the other provisions for claiming

Head of Household filing status.

A taxpayer qualifies for Head of Household filing status if all the following requirements are

met:

(1) The taxpayer is unmarried or "considered unmarried" on the last day of the year.

(2) The taxpayer paid more than half the cost of keeping up a home for the year.

(3) A "qualifying person" lived with the taxpayer in the home for more than half the year

(except for temporary absences, such as school). However, if the "qualifying person" is a

dependent parent, he or she does not have to live with the taxpayer

For purposes of qualifying for Head of Household filing status, a taxpayer is considered

unmarried on the last day of the tax year if the taxpayer meets all of the following tests:

(1) The taxpayer files a separate return and maintains as his home which constitutes for

more than one-half of the tax year the principal place of abode of a child (within the

meaning of IRC § 152(f)(1)) with respect to whom such taxpayer is entitled to a

dependency exemption deduction for the tax year under Code Sec. 151.

(2) The taxpayer furnishes over one-half of the cost of maintaining such household

during the tax year; and

(3) During the last six months of the tax year, such individual's spouse is not a member of

such household.

Qualifying child for Head of Household filing status purposes is an individual:

Younger than the taxpayer and under age 19 or under age 24 and a full-time student, or

any age and permanently and totally disabled, and

Who lived with the taxpayer for more than half of the year, and

Who did not provide over half of his or her own support, and

Who is the taxpayers’ son, daughter, stepchild, foster child, brother, sister, stepbrother,

stepsister, grandchild, niece or nephew.

33 IRC§2(b)

http://www.parkertaxpublishing.com/LinkDirector.aspx/C%5E~DataLocal~_Frequent~irc~HTML~0101_0199~390-4999834_0152%5E%5E152(f)(1)

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Qualifying relative for Head of Household filing status purposes is an individual:

Who is not a qualifying child of the taxpayer or any other taxpayer, and

Who lived with the taxpayer for more than half of the year (except a parent), and

Whom the taxpayer can claim as a dependent, and

Who is the taxpayers’ son, daughter, stepchild, foster child, grandchild, brother, sister,

niece, nephew, father, mother, grandfather, grandmother, aunt, uncle, stepbrother,

stepsister, stepfather, stepmother, son-in-law, daughter-in-law, father-in-law, mother-in-

law, brother-in-law or sister-in-law.

A person other than the relationships listed above, who lived with the taxpayer all year as a

member of the taxpayers’ household, can qualify to be claimed as a dependent by the taxpayer,

but such person who is a dependent only because they lived with the taxpayer all year does not

qualify for Head of Household filing status.

The gross income limitation for a qualifying relative is $4,300, which is the 2020 exemption

amount.34

Unmarried individuals who can file using the Head of Household filing status if he or she was

unmarried or legally separated according to state law under a decree of divorce or separate

maintenance at the end of 2020.

An individual is considered unmarried if he or she meets all the following requirements:

Files a separate return

Pays more than half of the cost of keeping up the home for the year

The spouse did not live in that home during the last six months of the year

The home was the main home of the taxpayers’ child stepchild or eligible foster child for

more than half the year.

The taxpayer must be able to claim an exemption for the child. The release of the

exemption allowing the noncustodial parent to claim the exemption for a child does not

violate the requirement.

34 IRC §152(d)(1)(B)

2020 Tax Rates for Heads of Household

If Taxable Income Is:

Over But Not Over The Tax Is:

$0 $14,100 10% of the taxable income

$14,101 $53,700 $1,410.00 plus 12% of the excess over $14,100





$518,400 --- $154,793.50 plus 37% of the excess over $518,400

39

Update

Married Filing Joint and Surviving Spouses

Spouses may file a joint return, except in the following situations:

(1) No joint return can be filed if either spouse at any time during the tax year is a

nonresident alien.35

(2) No joint return can be filed if a couple has different tax years; except that if such tax

years begin on the same day and end on different days because of the death of either or

both, then a joint return may be prepared with respect to the tax year of each. This

exception does not apply if the surviving spouse remarries before the close of his or her

tax year, or if the tax year of either spouse is a fractional part of a year

(3) In the case of the death of one spouse or both spouses, the joint return with respect to

the decedent may be made only by his executor or administrator; except that in the case

of the death of one spouse, the joint return may be filed by the surviving spouse with

respect to both the surviving spouse and the decedent if no return for the tax year has

been filed by the decedent, no executor or administrator has been appointed, and no

executor or administrator is appointed before the last day prescribed by law for filing the

return of the surviving spouse.

If a spouse dies during the tax year, the taxpayer can use Married Filing Jointly as the filing

status for that year if the taxpayer otherwise qualifies to use that status. The year of death is the

last year for which the taxpayer can file jointly with the deceased spouse."

A surviving spouse is a taxpayer:

(1) Whose spouse died during either of the two tax years immediately preceding the tax

year; and

(2) Who maintains as a home a household for a dependent who is a son, stepson,

daughter, or stepdaughter of the taxpayer.36

35 IRC§6013(a)(1) 36 IRC §2(a)

2019 Tax Rates for Heads of Household










40

Update

2019 Tax Rates for Married Filing Jointly and Surviving Spouses




$19,401 $78,950 $1,940 plus 12% of the excess over $19,400

$78,951 $168,400 $9,086 plus 22% of the ecess over $78,950





The taxpayer is considered as maintaining a household only if over half of the cost of

maintaining the household during the tax year is furnished by the taxpayer.

Married Filing Separately

A legally married couple may choose Married Filing Separately as their filing status. This filing

status may either be beneficial if a spouse only wants to be responsible for his or her own tax or

if it results in less tax than filing a joint return. If the couple does not agree to file a joint return,

they must to use this filing status.

When the Married Filing Separately filing status is chosen, each spouse generally reports only

his or her own income, credits, and deductions on his or her individual return.

2020 Tax Rates for Married Filing Jointly and Surviving Spouses










41

Update

2019 Tax Rates for Married Individuals Filing Separately




$9,701 $39,475 $970.00 plus 12% of the excess over $9,700






If either spouse files separately, the other spouse is required to file a return, without exception.

Special rules, some of which are distinctly disadvantageous, apply when the Married Filing

Separately filing status is used, including the following:

The exemption amount for calculating the alternative minimum tax is half that

allowed to a joint return filer;

In most cases, the credit for child and dependent care expenses is not allowed, and the

amount that is excludible from income under an employer's dependent care assistance

program is limited to $2,500 (instead of $5,000 for a joint return);

No earned income credit is allowed;

In most cases, the exclusion or credit for adoption expenses is not allowed;

None of the education credits (the American opportunity credit and lifetime learning

credit) are allowed;

There is no deduction for student loan interest ;

The exclusion for interest income from qualified U.S. savings bonds used for higher

education expenses does not apply;

Contributions to Roth IRAs are phased out for modified AGI of $10,000; and

The capital loss deduction is limited to $1,500 (instead of $3,000 for a joint return).

2020 Tax Rates for Married Individuals Filing Separately










42

Update

Further, if the taxpayer lived with his or her spouse at any time during the tax year for which the

taxpayer files as Married Filing Separately:

The elderly or disabled credit cannot be claimed; and

The taxpayer will have to include in income more (up to 85 percent) of any social

security or equivalent railroad retirement benefits received.

In addition, the following credits and deductions are reduced at income levels that are half of

those for a joint return:

The child tax credit;

The Savers Credit;

Itemized deductions; and

The deduction for personal exemptions, which are not available for (2018-

2025).

Caution: One of the more important rules for taxpayers using the Married Filing Separately

filing status is that, if the taxpayers’ spouse itemizes deductions, the taxpayer cannot claim the

standard deduction and instead must itemize deductions. If the taxpayer can claim the standard

deduction, the taxpayers’ basic standard deduction is half the amount allowed on a joint return.

Marriage Penalty: The 2020 tax brackets have a marriage penalty for upper income individuals,

by making the top 37% tax bracket kick in at $500,000 for individuals. The 37% tax bracket

starts at $600,000 for married couples. (Example using 2020 Tax Rates)

Example. Brad and Ann each expect to have $500,000 of income (after all deductions) in

2020, and are planning to get married. As individuals, neither of them would be in the top

37% tax bracket (which begins at $518,400), and instead would have their income taxed

at a blend of 10%, 12%, 22%, 24%, 32%, and slightly over half at 35%, producing a tax

liability of $144,795 each (or $289,590 in taxes for their combined $1,000,000 of

income). As a married couple, their joint income of $1,000,000 is subject to the married

filing joint tax brackets, where everything above $622,050 is subject to 37% tax rate,

producing a tax liability of $307,149, or $17,559 higher than what the couple would have

paid as two single filers.

Tax Brackets Thresholds

The income tax bracket thresholds are all adjusted for inflation, and then rounded to the next

lowest multiple of $100 in future years. Unlike tax brackets prior to TCJA (which uses a measure

of the consumer price index (CPI) for all-urban consumers), the inflation adjustment uses the

chained consumer price index37 for all-urban consumers (C-CPI-U). The chained consumer price

index results in lower inflation adjustments, which means smaller annual increases than with the

current tax.

37 TCJA §11002

43

Update

Chained CPI is a variant of the traditional CPI. Both are reported monthly by the U.S. Labor

Department’s Bureau of Labor Statistics, and both track the prices of a "basket" of 80,000 goods

and services bought by consumers in urban areas. Chained CPI adjusts for substitution bias by

recognizing that consumers tend to shift their purchasing behavior as the relative prices of things

change.

For example, when the price of Granny Smith apples increases, people may buy Gala apples

instead. As a result, chained CPI shows a slower pace of price gains, or inflation, than traditional

CPI. The gauge’s official name is the Chained Consumer Price Index for All Urban Consumers,

or C-CPI-U. Using chained CPI will decrease the rate of inflation.

Gross Income Threshold For Filing Form 1040

Gross Income Threshold38 2020 2019

Single and under 65

Single and 65 or older

Married Filing Jointly, under 65 (both spouses)

Married Filing Jointly, 65 or older (one spouse)

Married Filing Jointly, 65 or older (both spouses)

Married Filing Separately, any age*

Head of Household, under 65

Head of Household, 65 or older

Surviving spouse with dependent child, under 65

Surviving spouse with dependent child, 65 or older

$12,400

14,050

24,800

26,100

27,400

5

18,650

20,300

12,400

14,050

$12,200

13,850

24,400

25,700

27,000

5

18,350

20,000

12,200

13,850

* If either spouse files separately, the other spouse is required to file a return, without exception.

Gross income39 means all income received in the form of money, goods, property, and services

that is not exempt from tax, including any income from sources outside the United States or from

the sale of the taxpayers main home (even if an exclusion applies on part or all of it). Taxable

portion of Social Security Benefits are included. Gross income includes gains, but not losses,

reported on Form 8949 or Schedule D. Gross income from a businesses, farms, or rentals means

income prior to expenses, for example, the amount on Schedule C, line 7.

38 TCJA 39 IRS Pub 501

http://www.frbsf.org/economic-research/publications/economic-letter/1997/may/bias-in-the-cpi-roughly-right-or-precisely-wrong/#subs

https://www.bls.gov/news.release/cpi.t05.htm

44

Update

Standard Deduction40

Child Tax Credit: The Child Tax Credit for 2019 and 2020 is expanded from $1,000 per

qualifying child under the age of 17 up to a Child Tax Credit of $2,00041 per qualifying child (of

which $1,400 is a refundable credit) for those whose net tax liabilities may be less than zero after

the application of the credit. To get a CTC refund, the taxpayer must earn more than $2,500.

Schedule 8812: The maximum refundable child tax credit of $1,400 per child for 2019 and 2020

is limited to the greater of:

15% of earned income above $2,500, or

The excess of the taxpayers’ social security taxes for the year over the earned income

credit for the year for taxpayers with three or more children.

An additional nonrefundable credit of $500 for qualifying dependent that is not a qualifying child

is also available. This would apply to children over the age of 17 or dependent parents. The

qualifying individual must meet the dependent rules from prior years.

2019 and 2020 Child and Other Dependent Credit

Credit Amount per qualifying

child/dependent

Phase-out Range

Child Tax Credit $2,000 MFJ: $400,000-$440,000

Others: $200,000-$240,000

Dependent Credit $500 MFJ: $400,000-$410,000

Others: $200,000-$210,000

NOTE: There is no personal exemption deduction or credit for the taxpayer or spouse

40 IRC§1(j)(2)(A-D) 41 TCJA §11022

Standard Deduction Amounts 2020 2019

Filing Status

Single $12,400 $12,200

Head of Household $18,650 $18,350

Married Filing Jointly $24,800 $24,400

Surviving Spouse $24,400 $24,400

Married Filing Separately $12,400 $12,200

Additional Amount for Aged or Blind* $1,300-$1,600 $1,300-1,650

__________

* The additional standard deduction for a spouse age 65 or older, or blind is

$1,300. These amounts are increased to $1,650 if the taxpayer is also unmarried

and not a surviving spouse

45

Update

Eligibility for the CTC hinges on a few factors. The child the taxpayer claims, as his or her

dependent has to meet IRS tests:

1. Age Test: The child was under age 17 (age 16 or younger) at the end of the tax year.

2. Relationship Test: The child is the taxpayers’ daughter, son, stepchild, foster child,

adopted child, brother, sister, stepbrother, stepsister, half-sister or half-brother. The child

can also be the direct descendant of any of those listed above. (Example: grandchild,

niece or nephew).

3. Support Test: The child did not provide more than half of their own “support.”

4. The child also cannot file a joint return that year.

5. Dependent Test: The child must be claimed as a dependent on the federal tax return of the

taxpayer.

6. Citizenship Test: The child must be a U.S. citizen, a U.S. national or a U.S. resident alien.

The child must also have a Social Security Number.

7. Resident Test: The child must have lived with the taxpayer for more than half of the tax

year.

8. The child must be younger than the taxpayer or the spouse.

TCJA caps the refundable portion of the CTC to 15% of the taxpayer’s earned income that

exceeds $2,500. The CTC is first used to offset income taxes owed. If the credit exceeds taxes

owed – which it often will for low-income families, taxpayers can receive up to $1,400 of the

balance as a refund, known as the additional child tax credit (ACTC) or refundable CTC. The

ACTC is limited to 15 percent of earnings above $2,500. Accordingly, low-income families that

do not earn at least $11,830 of earned income will get less refundable credit. ($11,830 - $2,500 X

15% = $1,400)

The expanded Child Tax Credit, along with the new $500 qualifying dependent credit, will

sunset after 2025.

Earned Income Credit

For taxable years beginning in 2020, the following amounts are used to determine the earned

income credit under Sec. 32(b). The "earned income amount" is the amount of earned income at

or above which the maximum amount of the earned income credit is allowed. The "threshold

phase-out amount" is the amount of adjusted gross income (or, if greater, earned income) above

which the maximum amount of the credit begins to phase-out. The "completed phase-out

amount" is the amount of adjusted gross income (or, if greater, earned income) at or above which

no credit is allowed. The threshold phase-out amounts and the completed phase-out amounts

shown in the table below for married taxpayers filing a joint return include the increase provided

in Sec. 32(b)(3)(B)(i), as adjusted for inflation for taxable years beginning in 2020.

46

Update

The earned income credit is a refundable tax credit for certain lower-income working taxpayers

who meet income, filing status and other requirements. Eligibility to claim the credit requires,

among other things, that the taxpayer have an earned income and also have an adjusted gross

income (AGI) that is below a specified level, have no excluded foreign income, and not have

investment income exceeding $3,650 (2020). The applicable AGI level generally changes

annually. The rules that apply to claiming the earned income credit fall into three categories: a)

rules that apply to everyone, b) rules that apply if the taxpayer has a qualifying child, and c) rules

that apply if the taxpayer does not have a qualifying child.

If the taxpayer meets all the rules applicable to his or her claiming the EITC, the amount of the

EITC for which the taxpayer is eligible is determined using EITC Worksheet A—for taxpayers

who were not self-employed, not a member of the clergy, not a church employee who files

Schedule SE, nor a statutory employee filing Schedule C—or EITC Worksheet B for those

taxpayers who can be included in one of those categories (EITC Worksheets are found in the

EITC Instructions).

Adjusted Gross Income Limits

To meet the rule concerning adjusted gross income limits, a taxpayer must have an AGI that is

less than the maximum amount for his or her filing status and number of qualifying children. The

applicable AGI limits generally change each year and, for 2018 and 2019, are as shown in the

following chart:

Number of Qualifying Children

Item One Two Three or More None

Earned Income Amount $10,540 $14,800 $14,800 $7,030

Maximum Amount

of Credit $3,584 $5,920 $6,660 $538

Threshold Phase-out $19,330 $19,330 $19,330 $8,780

Amount (Single, Surviving Spouse,

Or Head of Household)

Completed Phase-out $41,756 $47,440 $50,954 $15,820

Amount (Single,

Surviving Spouse, or

Head of Household)

Threshold Phase-out $25,220 $25,220 $25,220 $14,680

Amount (Married Filing

Jointly)

Completed Phase-out $47,646 $53,330 $56,844 $21,710

Amount (Married Filing

Jointly)

47

Update

Excessive investment income for taxable years beginning in 2020, the earned income tax credit

is not allowed under Sec. 32(i)(1) if the aggregate amount of certain investment income exceeds

$3,650. Increased by $50 from 2019 tax year.

Valid Social Security Number Required

In order to claim the EITC, the taxpayer—and spouse, if filing a joint return—must also have a

valid social security number issued by the Social Security Administration. In addition, if a

qualifying child is listed on Schedule EITC, the child must also have a valid social security

number. A social security card stating “Not valid for employment” is not sufficient for purposes

of the EITC.

(Note: If a child was born and died during the year, no social security number is required for the

child. In such a case, a tax preparer should attach a copy of the child’s birth certificate, death

certificate, or hospital records showing a live birth to the taxpayer’s return.)

Residence and Joint Return Tests

A taxpayer’s child is a qualifying child for purposes of the EITC if the child meets four tests and,

unless the child was born and died in the year, has a valid social security number. The four tests

the child must meet are:

The relationship test;

The age test;

The residency test; and

The joint return test.

All four tests must be met. If the taxpayer does not meet all four tests, the child is not a

qualifying child for purposes of the EITC.

Earned Income Tax Credit and Wage Verification Reviews – Taxpayers have until July 15,

2020, to respond to the IRS to verify that they qualify for the Earned Income Tax Credit or to

verify their income. These taxpayers are encouraged to exercise their best efforts to obtain and

submit all requested information, and if unable to do so, please reach out to the IRS indicating

the reason such information is not available. Until July 15, 2020, the IRS will not deny these

credits for a failure to provide requested information.

48

Update

What Do You Think?

Q1. Mara, age 18 is the daughter of Paula’s friend. Paula is unmarried and lives in a

location where Mara will attend college. To help make college affordable, Paula made a

room in her home available to Mara, rent-free. Which of the following is a correct

statement?

A. Mara can be the qualifying person for Head of Household for Paula.

B. Paula can take the dependent credit since Mara lived with Paula all year.

C. Both A and B are correct.

D. Neither A nor B are correct.

Q2. Which of the following is a not true statement regarding the nonrefundable and refundable

Child Tax Credit?

A. The qualifying child must be under age 17.

B. In 2019, the qualifying child must meet the same tests as in 2018.

C. Tax preparers must complete Form 8867 and submit it with Form 1040 when preparing a

return with the Child Tax Credit.

D. Individuals can file an amended return to claim the Child Tax Credit when a qualifying

child did not have a required identification number in a prior year.

49

Update


Answer A1. Mara, age 18 is the daughter of Paula’s friend. Paula is unmarried and

lives in a location where Mara will attend college. To help make college affordable,

Paula made a room in her home available to Mara, rent-free. Which of the

following is a correct statement?

A. Mara can be the qualifying person for Head of Household for Paula. No Mara cannot be

the qualifying person, since she is not a relative.

B. Paula can take the dependent credit since Mara lived with Paula all year. No Mara does

not qualify for the dependent credit since she is not a relative.

C. Both A and B are correct. No

D. Neither A nor B is correct. This is the correct answer Mara does not meet the

requirements to be a dependent.

Answer A2. Which of the following is a not true statement regarding the nonrefundable and

refundable Child Tax Credit?

A. The qualifying child must be under age 17, is a true statement

B. In 2019, the qualifying child must meet the same tests as in previous years before TCJA.

This is a true statement

C. Tax preparers must complete Form 8867 and submit it with Form 1040 when preparing a

return with the Child Tax Credit, is a true statement

D. Is the correct answer - Individuals cannot file an amended return to claim the Child

Tax Credit for prior years that a qualifying child did not have an ITIN or SSN.

50

Update

Chapter 4 – SECURE Act and COLA Adjustments

HR 1865

On Dec. 20, 2019, the President signed the Further Consolidated Appropriations Act,

202042, a $428 billion tax-cut plan that would restore a mixed bag of benefits. These

benefits are known as extenders, modify rules for retirement plans, rescind several

Obamacare taxes, offer breaks to victims of natural disasters and keep the federal

government funded for the rest of the fiscal year.

The spending bill consists of two separate pieces of legislation most notable to taxpayers – the

Setting Every Community Up for Retirement Enhancement (SECURE) Act and the Taxpayer

Certainty and Disaster Tax Relief Act of 2019.

Title 1 – Setting Every Community Up for Retirement Savings (SECURE Act)43

• Certain taxable non-tuition fellowship and stipend payments treated are as compensation

for IRA purposes. The term “compensation” shall include any amount that is included in

the individual’s gross income and paid to the individual to aid in the pursuit of graduate

or postdoctoral study. Effective for tax years beginning after Dec. 31, 2019.

• Repeal of maximum age for traditional IRA contributions. Contributions to a traditional

IRA are now permitted for eligible taxpayers of any age. Effective for contributions made

tax years beginning after Dec. 31, 2019.

• Qualified charitable distributions (QCDs) from an IRA can only be made after the

taxpayer reaches age 70½. The amount of a taxpayer’s QCDs that are not includible in

gross income for a tax year is reduced (but not below zero) by the excess of:

1. The total amount of IRA deductions allowed to the taxpayer for all tax years ending

on or after the date the taxpayer attains age 70½, over

2. The total amount of reductions for all tax years preceding the current tax year.

42 43 HR 1865 PL116-94

Objective:

Review and Update the changes brought

about for 2019/2020. Discuss the items

from prior years affected by inflation and

COLA adjustments.

51

Update

Effective for distributions made for tax years beginning after Dec. 31, 2019.

• Qualified cash or deferred arrangements must allow long-term employees working more

than 500 but less than 1,000 hours per year to participate. Generally applies to plan years

beginning after Dec. 31, 2020.

• Penalty-free withdrawals from retirement plans for individuals in case of birth or

adoption of child under the age of 18, or is physically or mentally incapable of self-

support. Distributions shall not exceed $5,000. Effective for distributions made after Dec.

31, 2019.

• Increase in age for required minimum distributions from 70½ to 72. Effective for

distributions required to be made after Dec. 31, 2019, with respect to individuals who

attain age 70½ after that date.

• Taxpayers can elect to treat excluded difficulty of care payments as compensation for

determining retirement contribution limitations. Apply to contributions after Dec. 20,

2019.

52

Update

Section 415 of the Internal Revenue Code provides for dollar limitations on benefits and

contributions under qualified retirement plans. Section 415(d) requires that the Secretary of the

Treasury annually adjust these limits for cost-of-living increases. Other limitations applicable to

deferred compensation plans are also affected by these adjustment procedures similar to those

used to adjust benefit amounts under Sec. 215(i)(2)(A) of the Social Security Act.

COLA Adjustments on Benefits and Contributions

2020 2019

IRAs

IRA Contribution Limit $6,500 $6,000

IRA Contribution Catch Up $1,000 $1,000

IRA AGI Deduction Phase-out (If Participating in a Retirement Plan)

Joint Return/QW $104,000 to $124,000 $103,000 - $123,000

Single or Head of Household $65,000 to $75,000 $64,000 - $74,000

MFS 0 0

Spouse not, PL in active plan -$196,000 to $206,000 $193,000 – 203,000

SEP

SEP Contribution $57000 $56,000

SIMPLE Plans

SIMPLE Maximum Contributions $13,500 $13,000

Catch-up Contributions $3,000 $3,000

401(k), 403(b), Profit-Sharing Plans, etc.

Elective Deferrals $19,500 $19,000

Catch-up Contributions $6,500 $6,000

Defined Contribution Limits 25%/$57,000 25%/$56,000

Other

457 Elective Deferrals $19,500 $19,000

Taxable Wage Base (FICA) $137,700 $132,900

Roth IRA Phase-out

MFJ/QW $196,000-$206,000 $193,000 - $203,000

Single, Head of Household $124000-$139,000 $122,000 - $137,000

MFS 0-$10,000

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Update

Qualified distributions from a Roth IRA are excluded from the IRA owner's gross income.44

Because they are excluded from income, they are not subject to the 10 percent penalty tax on

early distributions. The penalty applies to distribution of earnings only. Contributions can be

withdrawn anytime without penalty. To be a qualified distribution, a payment or distribution

from a Roth IRA must be:

(1) Made after a five-year waiting period; and

(2) Made for any of four qualifying reasons ("qualifying distribution events"):

(a) The owner has reached age 59 1/2;

(b) The owner is disabled;

(c) The owner has died; or

(d) The owner uses the funds for a qualified home purchase (subject to a $10,000

lifetime limit).

The five-year waiting period ("non-exclusion period") is the five-tax-year period beginning with

the earlier of:

(1) The first day of tax year for which the first regular contribution was made to any Roth

IRA set up for the owner's benefit; or

(2) The first day of the tax year in which the first conversion contribution is made to any

Roth IRA of the individual.

The five-year period ends on the last day of the individual's fifth consecutive tax year beginning

with the tax year described above

Example: Sally makes a first-time regular Roth IRA contribution in February 2016 for

her 2015 tax year. Her five-year period begins on January 1, 2015, and ends on December

31, 2019. Sally can begin taking qualified distributions from her Roth IRA as early as

January 1, 2020, as long as the distributions are made after or because of one of the

qualifying distribution events.

Each Roth IRA owner has only one five-year period for all the Roth IRAs he or she owns. By

setting up and making even a small contribution to his or her first Roth IRA, a client can get the

clock running on the five-year waiting period to the benefit of any future Roth IRAs the client

later establishes.

The beginning of the five-year period is not reset because of the owner’s date of death. Thus, in

determining whether the five-year period has expired, the period a Roth IRA is held in the name

of a beneficiary, or in the name of a surviving spouse who treats the decedent's Roth IRA as his

or her own, includes the period it was held by the deceased owner.

44 IRC §408(d)(1)

54

Update

A beneficiary of a Roth IRA determines the five-year period independently of the five-tax-year

waiting period for the beneficiary's own Roth IRA. However, if a surviving spouse treats the

Roth IRA as his or her own, the five-year period for any of the surviving spouse's Roth IRAs

(including the one he or she treats as his or her own) ends at the earlier of the end of either:

The five-tax-year period for the decedent, or

The five-tax-year period applicable to the spouse's own Roth IRAs.

Example: John made a first-time regular Roth IRA contribution in March 2014 for his

2013 tax year. His five-year period begins on January 1, 2013, and ended on December

31, 2017. Wendy, John's wife, makes a first-time regular Roth IRA contribution in July

2015 for her 2015 tax year. Her five-year period begins on January 1, 2015, and ends on

December 31, 2019.

Upon John's death in 2018, Wendy inherits his Roth IRA and chooses to treat it as her

own. Wendy's five-year period for any of her Roth IRAs (including the one she inherited

from John) ends on December 31, 2017, the earlier of the end of either John's five-year

period or her own five-year period.

IRA Recharacterizations

The special rule allowing a contribution to one type of IRA to be recharacterized to the other

type of IRA no longer applies to a conversion contribution to a Roth IRA.

The recharacterization cannot be used to unwind a Roth conversion. However, recharacteization

is still permitted with respect to other contributions. For example, an individual may contribute

for a year to the Roth IRA and before the due date for the individual’s income tax return for that

year, recharacterize it as a contribution to a traditional IRA.

An individual may still make a contribution to a traditional IRA and convert the traditional IRA

to a Roth IRA, but the provision precludes the individual from later unwinding the conversion

through a recharacterization

Extended Rollover Period for the Rollover of Plan Loan Offset Amounts in Certain Cases

Under law prior to TCJA (prior to January 1, 2018), if a plan terminates or an employee’s

employment terminates while a plan loan is outstanding, the employee has 60 days to contribute

the loan balance to an individual retirement account (IRA), or the loan is treated as a distribution.

Under TCJA, employees whose plan terminates or who separate from employment while they

have plan loans outstanding would have until the due date for filing their tax return for that year

to contribute the loan balance to an IRA in order to avoid the loan being taxed as a distribution.

Qualified plan loan offset amount is a plan loan offset amount that is treated as distributed from a

qualified retirement plan, a section 403(b) plan or a governmental section 457(b) plan solely by

reason of the termination of the plan or the failure to meet the repayment terms of the loan

because of the employee’s severance from employment.

55

Update

Flexible Spending Arrangements

A flexible spending arrangement (FSA) generally is a benefit program designed to reimburse

employees specified, incurred expenses, subject to reimbursement maximums and any other

reasonable conditions. An expense for qualified benefits can be reimbursed from the FSA only if

the expense is incurred during a coverage period. After an expense for a qualified benefit has

been incurred, the expense must be substantiated before the expense can be reimbursed.

The inflation-adjusted amounts for 2019 is 2,700, and for 2020 is $2,75045

FSAs are generally offered under a cafeteria plan. Dependent care assistance46, adoption

assistance47 and a medical reimbursement arrangement48 may be offered through an FSA in a

cafeteria plan.

Use-it-or-Lose-it Rule

Absent a plan having a grace period provision, no contribution or benefit from an FSA could be

carried over to any subsequent plan year or period of coverage. Unused benefits or contributions

remaining at the end of the plan year (or at the end of a grace period, if applicable) were

forfeited. The rule is known as the "use-it-or-lose-it" rule.49 This rule permits Code Sec. 125

cafeteria plans to allow up to $500 of unused amounts remaining at the end of a plan year in a

health FSA to be paid or reimbursed to plan participants for qualified medical expenses incurred

during the following plan year, provided that the plan does not also incorporate the grace period

rule.

Uniform Coverage Rules for Health FSAs

The maximum amount of reimbursement from a health flexible spending arrangement (FSA)

must be available at all times during the coverage period (reduced for prior reimbursements for

the same coverage period). Thus, the maximum amount of reimbursement at any particular time

during the coverage period cannot relate to the amount that has been contributed to the FSA at

any particular time before the end of the plan year. Similarly, the payment schedule for the

required amount for coverage under a health FSA cannot be based on the rate or amount of

covered claims incurred during the coverage period. Employees' salary reduction payments must

not be accelerated based on employees' incurred claims and reimbursements.

Reimbursement is deemed to be available at all times if it is paid at least monthly or when the

total amount of the claims to be submitted is at least a specified, reasonable minimum amount.50

45 RP 2019-44 46 IRC §129 47 IRC §137 48 IRC §105(b) 49 Notice 2013-71 50 Prop. Reg. Sec. 1.125-5(d)(2)


http://www.parkertaxpublishing.com/LinkDirector.aspx/C%5E~DataLocal~_Frequent~propreg~HTML~0101_0199~370-4999930_0125~~0001-0005%5E%5E%5E1~~125-5%5E%5E1~~125-5(d)(2)

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Update

When an employee ceases to be a participant, the cafeteria plan must pay the former participant

any amount the former participant previously paid for coverage or benefits to the extent the

previously paid amount relates to the period from the date the employee ceases to be a

participant through the end of that plan year51. The uniform coverage rule applies only to health

FSAs - it does not apply to FSAs for dependent care assistance or adoption assistance.

Health Savings Account

Allowable Contributions

A taxpayer, who is age 55 or older at the end of the tax year, can make an additional

contribution of $1,000 to an HSA.

The maximum contribution is reduced by any employer contributions to the HSA, any

contributions made to the taxpayers’ Archer MSA, and any qualified HSA funding

distributions.

The taxpayer can make deductible contributions to the HSA even if the employer

contributed. Contributions in excess of the maximum (see below) can result in additional

tax.

The taxpayer cannot deduct any contributions for any month in which they were enrolled

in Medicare.

The taxpayer cannot deduct contributions if he or she is being claimed as a dependent on

someone else's tax return.

See the chart below for the amounts that can be contributed by a taxpayer to an HSA

HSA Inflation Adjusted Limitations

Annual contribution is limited to: 2021 2020 2019

Self-only coverage, under age 55 $3,600 $3,550 $3,500

Self-only coverage, age 55 or older $4,600 $4,550 $4,500

Family coverage, under age 55 $7,200 $7,100 $7,000

*Family coverage, age 55 or older $8,200 $8,100 $8,000

Minimum annual deductibles:

Self-only coverage $1,400 $1,400 $1,350

Family Coverage $2,800 $2,800 $2,700

Maximum annual deductible and out-of-pocket expense limits:

Self-only coverage $7,000 $6,900 $6,750

Family Coverage $14,000 $13,800 $13,500

51 IRC §1.125-5

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Update

Diagnosis, cure, mitigation, treatment, or prevention of disease and treatments affecting

any part or function of the body. It includes the costs of equipment, supplies and

diagnostic devices needed for these purposes. It also includes dental expenses. (Some

examples: body scan, crutches, hearing aids, medicines, dental treatment and

psychological treatment)

Premiums paid for insurance that cover the expenses of medical care and the amount paid

for transportation to get medical care

Healthcare coverage while the taxpayer is receiving Federal or state unemployment

compensation if the taxpayer is unemployed

Long-term care insurance

Certain qualified continuation-of-benefit coverage

Health insurance plans that qualify after age 65

NOTE: Violations – nonqualified uses of Health Savings Account funds are subject to taxation

and a 20% penalty. The 20% penalty does not apply if the Health Savings Account holder is age

65 or older, disabled or dies.

Medical Savings Account (MSAs)52

High Deductible Health Plans

2020 2019

Self Family Self Family

Annual Minimum

Deductible

$2,350 $4,750 $2,350 $4,650

Annual Maximum

Deductible

$3,550 $7,100 $3,500 $7,000

Out-of-pocket Expense $4,750 $8,650 $4,650 $8,550

Maximum Annual

Contribution

65% of

deductible

75% of

deductible

65% of

deductible

75% of

deductible

To start an HSA or a MSA, the taxpayer needs to have a high deductible health insurance plan

(HDHP).

Deposits can be made by the employer on a pretax basis, into the MSA or HSA.

If the deposits are not through the employer, then the collections will be post-tax.

There are limits to the amounts that can be deposited into each account, and these limits are

set by the IRS (and listed above).

Any amounts exceeding the limits are considered excessive, and are not tax-deductible.

However, once the money has been deposited, it remains in the taxpayers’ account, and even

if the taxpayer leaves the employment and drops the HDHP, the account will remain his or

hers.

52 IRC §220 (c )(2)(A), Rev. Proc. 2019-44

http://www.differencebetween.net/language/difference-between-been-and-being/

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Differences between, HSA, and MSA:

Both HSA and MSA need a HDHP in order to open such an account, but there are two further

particulars required for a MSA.

Only persons, or their spouses, in the employ of a company with 50 or less workers qualify

for a MSA. The taxpayer or spouse can be self-employed.

With a MSA, the employer and the taxpayer contribute to the MSA in the same year.

HSA limitations are set by the IRS at a fixed amount per year; while for the MSA, it is

determined by a percentage of the yearly income and annual deductibles. A MSA is limited by

the amount earned in that year.

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What Do You Think

Q1 – Which of the following are effective for distributions made for tax years

beginning after Dec. 31, 2019?

A. Qualified cash or deferred arrangements must allow long-term

employees working more than 500 but less than 1,000 hours per year to

participate. Generally applies to plan years beginning after Dec. 31,

2020.

B. Penalty-free withdrawals from retirement plans for individuals in case of birth or adoption of

child under the age of 18, or is physically or mentally incapable of self-support. Distributions

shall not exceed $5,000. Effective for distributions made after Dec. 31, 2019.

C. Increase in age for required minimum distributions from 70½ to 72. Effective for distributions

required to be made after Dec. 31, 2019, with respect to individuals who attain age 70½ after that

date.


60

Update

What Do You Think? - Answers

Answer Q1 Which of the following are effective for distributions made for tax

years beginning after Dec. 31, 2019?

A. Qualified cash or deferred arrangements must allow long-term employees working more

than 500 but less than 1,000 hours per year to participate. Generally applies to plan years

beginning after Dec. 31, 2020.

B. Penalty-free withdrawals from retirement plans for individuals in case of birth or


support. Distributions shall not exceed $5,000. Effective for distributions made after Dec.

31, 2019.

C. Increase in age for required minimum distributions from 70½ to 72. Effective for



D. All of the above. The items above are part of Title 1 of the SECURE Act.

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Update

The Tuition and Fees Deduction

The Tuition and Fees Deduction allows eligible taxpayers to deduct up to $4,000 in qualified

higher education expenses for themselves, a spouse and dependent children as an above-the-line

exclusion from income. Qualified expenses generally include tuition and fees, textbooks and

supplies that are required for enrollment or attendance at an eligible higher education institution.

The Tuition and Fees Deduction expired in 2017 but the Further Consolidated Appropriations

Act, 2020 extended the expiration date through the end of 2020.

Tuition and Fees Deduction cannot be claimed if American Opportunity Tax Credit (AOTC) or

Lifetime Learning Tax Credit are claimed for the same student during the same tax year. A

taxpayer may claim the Tuition and Fees Deduction and take a qualified 529-plan distribution

during the same tax year for the same student, but there is no double dipping.

Any amount of other tax-free educational assistance, such as scholarships, employer-provided

educational assistance and veteran’s educational assistance received during the current year must

be subtracted from the student’s qualified education expenses that are eligible for the Tuition and

Fees Deduction.

Eligible taxpayers who are claiming the Tuition and Fees Deduction must complete a separate

IRS Form 8917 with Form 1040 for tax years 2019 and 2020. A taxpayer may retroactively

claim the deduction for 2018 by filing an amended return with Form 1040X. Amended tax

returns may be filed up to three years after the original return was filed or up to two years after

taxes for the year were paid. Taxpayers should not claim the Tuition and Fees Deduction for tax

year 2021 unless the expiration date is extended again

American Opportunity Tax Credit

The American Opportunity Tax Credit53 phase-out is the same for 2019 is the same as it was for

the previous taxable year. Single, Head of Household or qualifying widow (er) is $80,000 –

90,000 ($160,000 - $180,000 MFJ), MFS is not applicable.

The maximum credit is $2,500 per student.

100% of the first $2,000 of qualified expenses

25% of the next $2,000 of qualified expenses

40% of the AOTC can be refundable.

Example: Rick, a 30-year old single taxpayer, is an eligible student and pays $5,000 of

qualified education expenses during the year for his tuition. He has little income for the

year and he does not have any tax liability. Rick claims a $2,500 American opportunity

tax credit for the qualified education expenses he paid during the year. Rick can get a

refund of $1,000 ($2,500 x 40%) for the American opportunity tax credit. The $1,500

balance of the credit is nonrefundable.

53 IRC§25A(b)(1)

https://www.savingforcollege.com/article/which-college-expenses-qualify-for-education-tax-benefits

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In order to claim an American Opportunity or Lifetime Learning credit or a deduction for

education-related tuition and fees, a student must receive a Form 1098-T. The form reports

qualified tuition and related expenses received by the educational institution. The information

reported on this form will be matched against the information reported to the IRS. Students

should receive Form 1098-T from the educational institution to which the taxpayer made

payments by January 31st.

Form 1098-T only reports qualified tuition and related expenses, students may see a discrepancy

between the amounts paid and the amounts reported. This is due to the fact that certain expenses,

such as fees for room, board, insurance, medical expenses, transportation, etc. are not considered

qualified tuition and related expenses and thus are not reported on Form 1098-T.

Generally, qualified education expenses may be claimed as an education credit only if they are

paid for an academic period that begins in the same year. However, qualified education expenses

paid for an academic period that begins during the first three months of the following tax year

can be claimed as an education credit in the tax year they are paid. Thus, for a calendar year

taxpayer, qualified education expenses paid for an academic period that begins in January,

February, or March of the following tax year are treated as qualified education expenses in the

year they are paid.54

In Ferm v. Comm'r,,55 the IRS disallowed taxpayers' claimed American Opportunity Tax Credit

for qualified tuition expenses paid on behalf of their daughter in December for her spring

semester the following year. The taxpayers claimed the credit for the year in which the tuition

applied, but as they had paid the expenses in the previous year, the tax court upheld the IRS's

disallowance. This provision, therefore, requires taxpayers to claim the credit with respect to the

taxable year that the expenses were paid when the academic period begins in January, February,

or March of the following year.

Eligible educational institution.

An eligible educational institution is any college, university, vocational school, or other

postsecondary educational institution eligible to participate in a student aid program

administered by the U.S. Department of Education. Eligible institutions include virtually all

accredited post-secondary schools in the United States and some schools outside the United

States.

Eligible Student

To be an eligible student, a student must carry at least half the normal full-time workload in a

program leading toward a degree, certificate, or other recognized educational credential at an

eligible educational institution for at least one academic period that begins during the tax year.

54 IRC §25A(g)(4) 55 T.C. Summary 2014-115

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Update

The standard for what is half the normal full-time workload is determined by each eligible

educational institution. However, that standard may not be lower than the applicable half-time

standard established by the Department of Education.56

A taxpayer cannot treat any portion of the American opportunity tax credit as refundable if:

At the end of the tax year, he was:

o under age 18,

o age 18 and his earned income was less than half his support, or

o a full-time student over age 18 but under age 24 and his earned income

was less than half his support;

At the end of the tax year, at least one of his parents was alive; and

He is not filing a joint return for the tax year

Example: In December 2019, Doug, who is not a dependent of another taxpayer,

receives a bill from XYZ University for $2,000 for qualified tuition and related expenses

to attend XYZ University as a full-time student for the 2020 spring semester, which

begins in January 2020. In December 2019, Doug pays $500 of qualified tuition and

related expenses for the 2020 spring semester. In January 2020, Doug pays an additional

$1,500 of qualified tuition and related expenses for the 2020 spring semester. Early in the

2020 spring semester, Doug withdraws from several courses and no longer qualifies as a

full-time student. As a result, of Doug's change in status from a full-time student to a

part-time student, Doug receives a $750 refund from XYZ University on February 16,

2020. Doug has no other qualified tuition and related expenses for 2020. Doug may

allocate all, or a portion, of the $750 refund to reduce the $1,500 of qualified tuition and

related expenses paid in 2020. Alternatively, Doug may also allocate a portion of the

$750 refund, up to $500, to reduce the qualified tuition and related expenses paid in

2019; and allocate the remainder of the refund to reduce the qualified tuition and related

expenses paid in 2020.

Expenses paid by parents and others.

Students who qualify to claim an education credit can use payments by their parents or third

parties to claim education credits. Payments are considered gifts to the student.

Expenses paid by a dependent.

Taxpayers can use payments made by their dependent to claim an education credit, including

payments by third parties treated as paid by the student.

Example: Jan’s aunt paid $4,000 tuition directly to Jan’s college. Jan also paid tuition of

$5,000 with proceeds from a student loan in her name. Jan’s parents claim her as a

dependent and can use the $9,000 paid by Jan and her grandmother to claim an education

credit.

56 IRC §25A(b)(2)(B)

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Earned Income Tax Credit

A taxpayer can claim the Earned Income Tax Credit57 only if all the following requirements are

met for the year:

(1) The taxpayer has earned income

(2) The taxpayers’ adjusted gross income does not exceed certain limits

(3) The taxpayer does not have more than a specified amount of investment income

(4) The taxpayer is a U.S. citizen or resident for the entire year

(5) The taxpayer uses a filing status other than Married Filing Separately

(6) The taxpayer has a valid social security number, and

(7) The taxpayer does not claim the foreign earned income exclusion or the foreign

housing exclusion or deduction.

A taxpayer must work and have earned income to claim the Earned Income Tax Credit. If a

taxpayer, is married and files a joint return, only one spouse needs to have earned income.

Wages, salaries, tips, and other employee compensation are treated as earned income only if they

are includible in the taxpayers’ gross income for the tax year.58

Earned income includes:

(1) Wages, salaries, tips, and other taxable employee compensation;

(2) Net earnings from self-employment;

(3) Gross income received as a statutory employee; and

(4) Taxable disability benefits received under an employer's disability retirement plan

before reaching minimum retirement age.59

Earned income does not include:

(1) Interest and dividends;

(2) Pensions and annuities;

(3) Social security and railroad retirement benefits (including disability benefits);

(4) Alimony and child support;

(5) Welfare benefits;

(6) Workers' compensation payments;

(7) Unemployment compensation;

(8) Nontaxable foster care payments;

(9) Veterans' benefits (including VA rehabilitation payments);

(10) Nontaxable workfare payments;

(11) Amounts received for work performed while an inmate in a penal institution

(including a halfway house or work release program);

(12) Amounts earned by a spouse and treated as belonging to the taxpayer under

community property laws; or

(13) Nontaxable military pay.

57 IRC §32 58 IRC §32(c)(2)(A)(i) 59 IRC §32(c)(2)(A), IRS Pub. 596

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Although nontaxable military pay generally is not included in earned income, a taxpayer can

elect to include nontaxable combat pay in earned income.60

Earned Income and AGI Limits for 2019 Earned Income Tax Credit

Earned income and adjusted gross income (AGI) must each be less than:

If filing... Qualifying Children Claimed

Zero One Two Three or more

Single, Head of

Household or

Widowed

$15,570 $41,094 $46,703 $50,162

Married Filing

Jointly $21,370 $46,884 $52,493 $55,952

Investment Income must be $3,600 or less for the year.

Maximum Earned Income Tax Credit Amounts for 2019

$6,557 with three or more qualifying children

$5,828 with two qualifying children

$3,526 with one qualifying child

$529 with no qualifying children

Earned Income and AGI Limits for 2020 Earned Income Tax Credit

Earned income and adjusted gross income (AGI) must each be less than:

If filing... Qualifying Children Claimed

Zero One Two Three or more

Single, Head of

Household or

Widowed

$15,820 $41,756 $47,440 $50,594

Married Filing

Jointly $21,710 $47,646 $53,330 $56,844

Investment Income must be $3,650 or less for the year.

Maximum Earned Income Tax Credit Amounts for 2020

$6,660 with three or more qualifying children

$5,920 with two qualifying children

$3,584 with one qualifying child

$538 with no qualifying children

60 IRC §32(c)(2)(B)(vi)

https://www.irs.gov/credits-deductions/individuals/earned-income-tax-credit/earned-income

https://www.irs.gov/credits-deductions/individuals/earned-income-tax-credit/earned-income

http://www.parkertaxpublishing.com/LinkDirector.aspx/C%5E~DataLocal~_Frequent~irc~HTML~0001_0090~390-4999975_0032%5E%5E32(c)(2)(B)(vi)

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EITC can be disallowed61

EITC May Be Banned for Taxpayer's Children after Taxpayer Improperly Claimed One Child.

The Office of Chief Counsel advised that, if a taxpayer claimed the earned income tax credit

(EITC) for three children and the credit was disallowed for one of those children; yet the

taxpayer continued to claim the credit for that one child in succeeding years, the taxpayer is

subject to the two-year ban62 on claiming the EITC; if this determination is made that the

taxpayer's claim for that one child was due to reckless or intentional disregard for the rules and

regulations. According to the Chief Counsel's Office, the two-year ban applies even though the

taxpayer otherwise would have been entitled to the EITC for her other two children.

61 CCA 201931008 62 IRC §32(k)(1),

https://www.parkertaxpublishing.com/LinkDirector.aspx/C%5E~DataLocal~_PLR~plr~HTML~2019~2019_Week_31~125-201931008

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Update

What Do You Think?

Q1. In 2020, which of the following is not correct regarding the

requirements for the Earned Income Tax Credit?

A. Self-employment income is considered earned income.

B. The taxpayer must not have more than $3,650 of investment income

C. The taxpayer must be U.S. citizen or resident for the entire year

D. The taxpayer must have a valid social security number.

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Update

What Do You Think? - Answer

Answer Q1. In 2020, which of the following is not correct regarding the requirements

for the Earned Income Tax Credit?

A. Is the correct answer. The self-employment income is included as part of

earned income.

B. The taxpayer must not have more than $3,650 of investment income

C. The taxpayer must be U.S. citizen or resident for the entire year

D. The taxpayer must have a valid social security number.

B, C and D are all requirements of the Earned Income Tax Credit. A taxpayer can claim the

Earned Income Tax Credit only if all the following requirements are met for the year:

(1) The taxpayer has earned income

(2) The taxpayers’ adjusted gross income does not exceed certain limits

(3) The taxpayer does not have more than $3,600 of investment income

(4) The taxpayer is a U.S. citizen or resident for the entire year

(5) The taxpayer uses a filing status other than Married Filing Separately

(6) The taxpayer has a valid social security number, and

(7) The taxpayer does not claim the foreign earned income exclusion or the foreign

housing exclusion or deduction $2,000. The maximum credit is $1,000 per person.

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Retirement savings eligible for the credit

The Savers Credit63 can be taken for a contribution to a traditional or Roth IRA; 401(k), SIMPLE

IRA, SARSEP, 403(b), 501(c)(18) or governmental 457(b) plan; and a voluntary after-tax

employee contributions to a qualified retirement or 403(b) plan. Rollover contributions are not

eligible for the Saver’s Credit.

Savers Credit for 2019

Credit Rate Married Filing Joint Head of Household All Other Filers

50% of Contribution AGI not more than

$38,500

AGI not more than

$28,875

AGI not more than

$19,250

20% of Contribution $38,501 -$41,500 $28,876 - $31,125 $19,251 - $20,750

10% of Contribution $41,501 - $64,000 $31,126 - $48,000 $20,751 - $32,000

0% of Contribution More than $64,000 More than $48,000 More than $32,000




$39,000

AGI not more than

$29,250

AGI not more than

$19,500

20% of Contribution $39,001 -$42,500 $29,251 - $31,875 $19,501 - $20,750

10% of Contribution $42,501 - $65,000 $31,876 - $48,750 $21,251 - $32,500


A saver’s credit can be claimed using Form 8880, Credit for Qualified Retirement Savings

Contributions. The credit is calculated by multiplying the applicable rate by the qualified

retirement plan contributions not to exceed the limits above.

Example: Jan works at a retail store, where she earned $33,000 in 2020. Jan is married

and files a joint return with her husband who was unemployed in 2020 and did not have

any earnings. Jan contributed $1,500 to her IRA in 2020. After deducting her IRA

contribution, the adjusted gross income shown on her joint return is $31,500. Jan may

claim a 50% credit of $750, for her $1,500 IRA contribution.

Adoption Expense Credit for 2019

The maximum amount of the credit for each eligible child is $14,080 for 2019.

Any unused credit may be carried forward up to five tax years.

For tax year 2019 returns, the credit begins to phase-out if the modified adjusted gross

income (MAGI) is more $211,160. The credit is eliminated at MAGI of $251,160.

Adoption Expense Credit for 2020

The maximum amount of the credit for each eligible child is $14,300 for 2020.

Any unused credit may be carried forward up to five tax years.

For tax year 2020 returns, the credit begins to phase-out if the modified adjusted gross

income (MAGI) is more $214,520. The credit is eliminated at MAGI of $254.250.

63 IRC§25B(b)(1)(A)

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The adoption credit is the largest nonrefundable tax credit available to individuals. Those

claiming the credit on their income taxes must file Form 8839, Qualified Adoption Expenses.

Documentation of qualified adoption expenses, including any adoption decree or court order,

should be retained with copies of the tax return.

Limits on Income Subject to Social Security Tax

In 2019, the taxable wage base rises to $132,900. The $132,900 represents the maximum amount

the wage earner of earned income has to pay for Social Security Tax. There is no maximum

amount on Medicare Tax. For 2020, the maximum Social Security wage amount increases to

$137,700.

Employer Provided Education Assistance - Tax free education assistance from an employer

has been permanently set at $5,250.

Charitable contribution of an IRA distribution have been made permanent. An IRA owner is

able to exclude from gross income up to $100,000 per taxpayer of a qualified charitable

distribution (QCD) from a traditional IRA made for the year.

A QCD is a nontaxable distribution made directly by the trustee of the taxpayers’ IRA to an

eligible charitable organization.

The taxpayer must be 70 ½ years of age or older at the time of the QCD.

All or part of the taxpayers’ required minimum distribution (RMD) may be included in

the QCD.

QCD’s are limited to $100,000.

The deduction is allowed only to the extent that the distribution would be otherwise

included in taxable income.

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2020 Form W-4

IRS issued a new W-4 for 2020, below is a copy of this form and the new worksheet.

The IRS developed the new design to reduce the form's complexity. While it uses the same

underlying information as the old design, it replaces complicated worksheets with more

straightforward questions that make accurate withholding easier for employees.

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Update

Allowances are no longer used in the redesign of Form W-4. This change is meant to increase

transparency, simplicity, and accuracy of the form. Beginning with the 2020 Form W-4,

employees will no longer be able to request adjustments to their withholding using withholding

allowances. Instead, using the new Form W-4, employees will provide employers with amounts

to increase or reduce taxes and amounts to increase or decrease the amount of wage income

subject to income tax withholding.

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Update

Employers are required to withhold federal income tax from each wage payment according to the

employee’s Form W-4 and correct withholding rate. For an online W-4 calculator, see

www.irs.gov/ Individuals/tax-withholding-estimator. Employers are not required to notify the

IRS if an employee claims exempt from withholding or claims a large number of withholding

allowances (such as 10 or more). The IRS may notify the employer to increase withholding if

withholding reported on the W-2 is not enough to cover the tax liability reported on the tax

return.

The 2020 Form W-4 contains five steps. Every 2020 Form W-4 employers receive from an

employee should show a completed Step 1 (name, address, social security number, and filing

status) and a dated signature on Step 5. Employees will complete Steps 2, 3, and/or 4 only if

relevant to their personal situations. Steps 2, 3, and 4 show adjustments that will affect

withholding calculations.

Steps 2, 3 and 4 are available to enter information regarding the number of jobs the taxpayer and

spouse hold; the number of dependents; deductions; and additional income. The form is not

familiar to those preparers who have assisted clients with withholding in the past. The IRS

recommends using the estimator at www.irs.gov/W4App.

The IRS recommends the use of the estimator in the following instances: 1. Expect to work only part of the year;

2. Have dividend or capital gain income, or are subject to additional taxes, such as the additional

Medicare tax;

3. Have self-employment income (see below); or

4. Prefer the most accurate withholding for multiple job situations. (Read Form W-4 carefully for

tips on multiple employers)

Self-employment. Generally, you will owe both income and self-employment taxes on any self-

employment income you receive separate from the wages you receive as an employee. If you

want to pay these taxes through withholding from your wages, use the estimator at

www.irs.gov/W4App to figure the amount to have withheld.

For additional information refer to Publication 505, Tax Withholding and Estimated Tax; and

Publication 15-T Federal Income Tax Withholding (this publication is mostly for employers but

will assist preparers in the preparation of Form W-4.

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Update

2020 Form 1099-MISC and Form 1099-NEC

Redesigned Form 1099-MISC. due to the creation of Form 1099-NEC, Form 1099-MISC has

been redesigned and rearranged. The biggest change has been the box for reporting

Nonemployee compensation (Box 7) has be eliminated from this form and included on Form

1099-NEC

Changes in the reporting of income and the form’s box numbers are listed below.

Payer made direct sales of $5,000 or more (checkbox) in box 7.

Crop insurance proceeds are reported in box 9.

Gross proceeds to an attorney are reported in box 10.

Section 409A deferrals are reported in box 12.

Nonqualified deferred compensation income is reported in box 14.

Boxes 15, 16, and 17 report state taxes withheld, state identification number, and amount

of income earned in the

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Update

Form 1099-NEC and Form 1099-MISC64 The due date for filing Form 1099 includes

nonemployee compensation (NEC) from February 28 to January 31 and eliminated the automatic

30-day extension for forms that include NEC. Beginning with tax year 2020, use Form 1099-

NEC to report nonemployee compensation.

See 2020 General Instructions for Certain Information Returns for additional information.

Report on Form 1099-NEC only when payments are made in the course of a trade or business.

Personal payments are not reportable. The taxpayer is engaged in a trade or business if the

business is operated for gain or profit. However, nonprofit organizations are considered to be

engaged in a trade or business and are subject to these reporting requirements. Other

organizations subject to these reporting requirements include trusts of qualified pension or profit-

sharing plans of employers, certain organizations exempt from tax under section 501(c) or

501(d), farmers' cooperatives that are exempt from tax under section 521, and widely held fixed

investment trusts. Payments by federal, state, or local government agencies are also reportable.65

65 PATH Act, P.L. 114-113, Div. Q, §201

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Update

What Do You Think?

Q1: Sally is a Single taxpayer. She has earnings on her 2020 W-2 of $39,000 and

an AGI of $20,250. She contributed $2,000 to her IRA account for the year. How

much is her Savers Credit?

A. -0-

B. $1,000

C. $4,050

D. $400

77

Update


Answer Q1: Sally is a Single taxpayer. She has earnings on her W-2 $39,000

and an AGI of $20,250. She contributed $2,000 to her IRA account for the year.

How much is her Savers Credit?

A. Is incorrect - Sally meets the requirements for the Savers Credit

B. $ 1,000 Is incorrect – Sally’s AGI is over $19,250 so the credit is 20% of her contribution

not 50%.

C. Is incorrect - $4,050 is 20% of her AGI not her contribution.

D. Is the correct answer. Sally’s AGI is $20,250 so she is entitled to a Retirement

Savings Credit of 20% of her IRA contribution of $2,000 or $400.




$39,000

AGI not more than

$29,250

AGI not more than

$19,500

20% of Contribution $39,001 -$42,500 $29,251 - $31,875 $19,501 - $20,750

10% of Contribution $42,501 - $65,000 $31,876 - $48,750 $21,251 - $32,500


78

Update

1

TaxLaw

2020

TaxEase, LLC


2020 TAX LAW IRS COURSE NUMBER: B8FQK-T-00035-20-S CTEC COURSE NUMBER 3064-CE-0063





2

TaxLaw

Chapter 1 – Filing

2020 Economic Impact Payment

(CARES Act) The Coronavirus Aid, Relief, and Economic Security Act (CARES Act)

provides Economic Impact Payments (EIP) to taxpayers (subject to income limits) as a credit66

of $1,200 per individual ($2,400 for married couples filing a joint return) plus $500 per

qualifying child who is under age 17. The EIP is reduced by 5% of the taxpayer’s adjusted

gross income in excess of $75,000 ($112,500 for head of household; $150,000 for joint filers).

The payment will fully phase out when income reaches $99,000 for single filers, $146,500 for

head of households with one child and $198,000 for joint filers.

Eligible taxpayers include anyone except:

• Nonresident aliens

• Any taxpayer who does not have a Social Security number (SSN) or Adoption

Taxpayer Identification number (ATIN)

• Taxpayers who qualify as a dependent of another taxpayer67

• Estate or trust

Individuals who have no income, as well as those whose income comes entirely from non-

taxable benefit programs, such as Social Security benefits also qualify for the advance

payment. Joint filers are each treated as having received one-half of the advanced payment.

The eligibility for the payment is based on the taxpayer’s 2019 tax return, or if the taxpayer has

not filed a 2019 return, eligibility is based on the 2018 return. If no returns were filed in 2018

or 2019, information from 2019 Forms 1099-SSA and 1099-RRB will be used.

The EIP is also considered an advanced refund for tax year 2020. The 2020 tax returns include

a computation for reconciling any EIP received during 2020 (using 2019 or 2018 information).

If the EIP amount is less the advance refund amount because a qualifying child was born to the

taxpayer during 2020, the taxpayer can claim the difference as a refundable credit against 2020

income tax liability. If, however, the result is that the taxpayer's AGI was higher in 2020 and

was in the phase out range, the taxpayer's 2020 tax liability is not increased. In addition, a

taxpayer that did not receive an EIP is entitled to claim the recovery rebate amount on his or

her 2020 income tax return. Failure to reduce the recovery rebate amount by any advance

refund amount is treated as a mathematical or clerical error. Otherwise, the EIP has no effect

on income tax returns filed for 2020; the amount is not includible in gross income, and it does

not reduce withholding or employers wages. See examples in the Update Section of this

Syllabus.

66 §6428 67 IRC §151

Objective:

Discuss 2020 CARES act issues.

Discuss Filing of 2020 returns

Compare the 2019 tax returns to 2020.

3

TaxLaw

A very common question, taxpayers are asking of tax preparers this year regards getting an

Economic Impact Payment for a dependent.

Example: Parents have a son, age 23, who is a full-time student and a dependent of his

parents. The son's only income in 2019 was $2,800 from a part-time summer job. The

parents want to maximize their benefit. They have not yet filed their 2019 tax return

and are hoping to file quickly so the IRS will use the 2019 return to determine the

amount of their stimulus checks.

The parents ask if they can forego claiming their son so that he can claim himself. They

believe that if they file this way, instead of them receiving a $500 stimulus check for

the dependent son, that he can claim himself and receive a $1,200 stimulus check. Can

they do this to achieve a higher stimulus amount for the son?

If the parents do not claim the son, this does not change the fact that the son is still a

dependent under §151. Dependents under §151 may not claim themselves and,

therefore, are not eligible for the $1,200 advanced stimulus tax credit. The other time a

question commonly comes up similar to this with AOTC, when the parents’ income is

too high to qualify for the education credit; they often ask to drop the child as a

dependent. IRC §151 is the guiding force in these matters, the classification of a child

as a dependent is not an option.

Filing Season Statistics Cumulative Statistics Comparing 4/20/18 and 4/19/2019

2018 2019 % Change

Individual Tax Returns

Total Returns Received 136,919,000 137,233,000 0.2

Total Returns Processed 130,477,000 130,775,000 0.2

E-Filing Receipts

Total 124,515,000 126,264,000 1.4

Tax Professionals 70,983,000 70,476,000 -0.7

Self-Prepared 53,532,000 55,788,000 4.2

Total Refunds

Number 95,434,000 95,737,000 0.3

Amount $265.326 Billion $260.919 Billion -1.7

Average Refund $2,780 $2,725 -2.0

4

TaxLaw

Tax Filings

As of Dec. 27, 2019, the IRS had received 155.8 million tax returns for the 2018 tax year and

of those, 138.2 million were filed electronically. Of e-filed returns, tax professionals prepared

80.6 million of them; the remaining 57.6 million were self-prepared.

There were about 111.8 million refunds issued totaling $320.1 billion, with the average refund

being $2,869, a 1.4 percent drop from $2,910 the previous year. Of the refunds, more than 92

million were direct-deposited, which is a 2.1 percent increase from the previous year when

slightly more than 90 million refunds were direct-deposited.

Tax Brackets Thresholds

The income tax bracket thresholds are all adjusted for inflation after December 31, 2018, and

then rounded to the next lowest multiple of $100 in future years. Unlike tax brackets prior to

TCJA (which uses a measure of the consumer price index (CPI) for all-urban consumers), the

inflation adjustment uses the chained consumer price index68 for all-urban consumers (C-CPI-

U). The chained consumer price index results in lower inflation adjustments, which means

smaller annual increases than with the current tax.

Chained CPI is a variant of the traditional CPI. Both are reported monthly by the U.S. Labor

Department’s Bureau of Labor Statistics, and both track the prices of a "basket" of 80,000

goods and services bought by consumers in urban areas. Chained CPI adjusts for substitution

bias by recognizing that consumers tend to shift their purchasing behavior as the relative prices

of things change.

For example, when the price of Granny Smith apples increases, people may buy Gala apples

instead. As a result, chained CPI shows a slower pace of price gains, or inflation, than

traditional CPI. The gauge’s official name is the Chained Consumer Price Index for All Urban

Consumers, or C-CPI-U. Using chained CPI will decrease the rate of inflation.

68 TCJA §11002



https://www.bls.gov/news.release/cpi.t05.htm

5

TaxLaw

Gross Income Threshold For Filing Form 1040

Gross Income Threshold69 2020 2019

Single and under 65

Single and 65 or older

Married Filing Jointly, under 65 (both spouses)

Married Filing Jointly, 65 or older (one spouse)

Married Filing Jointly, 65 or older (both spouses)

Married Filing Separately, any age*

Head of Household, under 65

Head of Household, 65 or older

Surviving spouse with dependent child, under 65

Surviving spouse with dependent child, 65 or older

$12,400

14,050

24,800

26,100

27,400

5

18,350

20,300

24,800

26,100

$12,200

13,850

24,400

25,700

27,000

5

18,350

20,000

24,400

25,700

* If either spouse files separately, the other spouse is required to file a return, without

exception.

Gross income70 means all income received in the form of money, goods, property, and

services that is not exempt from tax, including any income from sources outside the United

States or from the sale of the taxpayers main home (even if an exclusion applies on part or all

of it). Taxable portion of Social Security Benefits are included. Gross income includes gains,

but not losses, reported on Form 8949 or Schedule D. Gross income from businesses, farms, or

rentals means income prior to expenses, for example, the amount on Schedule C, line 7.

Exemptions Repealed by TCJA

Personal exemption amount is -0-. TCJA repeals71 the deduction for personal exemptions for

tax year 2018 - 2025.

In addition, the provision modifies the requirements for those who are required to file a tax

return. In the case of an individual who is not married, the individual is required to file a tax

return if the taxpayers’ gross income for the tax year exceeds the applicable standard

deduction. Married taxpayers’ are required to file a return if that the taxpayers’ gross income,

when combined with the spouse's gross income for the tax year is more than the standard

deduction for a joint return, provided that:

The taxpayer and spouse, at the close of the tax year, had the same household as their

home;

Neither the taxpayer nor spouse file a separate return.

69 TCJA 70 IRS Pub 501 71TCJA §11041 repealing IRC §§151-153

6

TaxLaw

Filing Status

Filing status is an essential component of tax computation. The following is a review of the

filing status; for the most part the filing status requirements have not changed under TCJA. The

Child Tax Credit and the enhanced Standard Deduction are designed to take the place of the

repealed exemptions.

Maximum Rates on Capital Gains and Qualified Dividends

TCJA generally retains the present-law maximum rates on net capital gain and qualified

dividends. The breakpoints between the zero- and 15-percent rates ("15-percent breakpoint")

and the 15- and 20-percent rates ("20-percent breakpoint") are the same amounts as the

breakpoints under current law, except the breakpoints are indexed using the Consumer Price

Index for all Urban Consumers (C-CPI-U) in tax years beginning after 2018.

Individual Long-Term Capital Gain Rates

Rate Income Level Breakpoint (2020) Income Level Breakpoint (2019)

0% Single: $40,000

MFS: $40,000

MFJ/SS: $80,000

HOH: $53,600

Single: $39,375

MFS: $39,375

MFJ/SS: $78,750

HOH: $52,750

15%

Single: $441,450

MFS: $248,300

MFJ/SS: $496,600

HOH: $469,050

Single: $434,550

MFS: $244,425

MFJ/SS: $488,850

HOH: $461,700

20% No Breakpoint No Breakpoint

Unrecaptured Code Sec. 1250 gain generally is taxed at a maximum rate of 25 percent, and

Collectibles are taxed at a maximum rate of 28 percent.


Filing Status

Single $12,200 $12,400




Married Filing Separately $12,200 $12,400

Additional Amount for Aged or Blind* $1,300-1,650

__________

* The additional standard deduction for a spouse age 65 or older, or blind is

$1,300. These amounts are increased to $1,650 if the taxpayer is also unmarried

and not a surviving spouse


7

TaxLaw

Amended Returns

For the first time the IRS will be able to e-file Form 1040-X, Amended U.S Individual Income

Tax Return, using available tax software products. Making the 1040-X an electronically filed

form has been an ongoing request from the nation's tax professional community and a

continuing recommendation from the Internal Revenue Service Advisory Council (IRSAC) and

Electronic Tax Administration Advisory Committee (ETAAC). The new electronic option

allows the IRS to receive amended returns faster while minimizing errors normally associated

with manually completing the form. This service is expected in late summer 2020.

8

TaxLaw

What Do You Think?

Q1. The 2020 tax returns include a computation for reconciling any Economic

Impact Payment received during 2020 (using 2019 or 2018 information). Which

of the following is not correct?

A. If the recovery rebate amount is less the EIP because a qualifying child

was born to the taxpayer during 2020, the taxpayer can claim the

difference as a refundable credit on the 2020 return.

B. If the taxpayer's AGI was higher in 2020 and was in the phase out range

the taxpayer's 2020 tax liability is not increased.

C. Failure to reduce the recovery rebate amount by any EIP is treated as a mathematical or

clerical error.

D. The EIP is includible in gross income.

9

TaxLaw


Answer is D

Q1. The 2020 tax returns include a computation for reconciling any EIP received

during 2020 (using 2019 or 2018 information). Which of the following is not

correct?

A. If the recovery rebate amount is less the EIP because a qualifying child

was born to the taxpayer during 2020, the taxpayer can claim the difference as a

refundable credit on the 2020 return.

B. If the taxpayer's AGI was higher in 2020 and was in the phase out range the taxpayer's

2020 tax liability is not increased.

C. Failure to reduce the recovery rebate amount by any EIP is treated as a mathematical or

clerical error.

D. The EIP is includible in gross income,

The EIP is also considered an advanced refund for tax year 2020. The 2020 tax returns include

a computation for reconciling any EIP received during 2020 (using 2019 or 2018 information).

If the EIP amount is less the advance refund amount because a qualifying child was born to the

taxpayer during 2020, the taxpayer can claim the difference as a refundable credit against 2020

income tax liability. If, however, the result is that the taxpayer's AGI was higher in 2020 and

was in the phase out range, the taxpayer's 2020 tax liability is not increased. In addition, a

taxpayer that did not receive an EIP is entitled to claim the recovery rebate amount on his or

her 2020 income tax return. Failure to reduce the recovery rebate amount by any advance

refund amount is treated as a mathematical or clerical error. Otherwise, the EIP has no effect

on income tax returns filed for 2020; the amount is not includible in gross income, and it does

not reduce withholding or employers wages.

10

TaxLaw

Limitation on Deduction for State and Local Taxes (SALT)

TCJA limits the deduction for state and local property, income, and excess profits

taxes72 to $10,000 ($5,000 in the case of a married individual filing a separate return),

unless the taxes are paid or accrued in carrying on a trade or business73 or an activity

relating to expenses for the production of income. TCJA also repeals the deduction for

foreign property taxes. As under current law, taxpayers may elect to deduct state and

local sales taxes in lieu of state and local income taxes.

Generally, only foreign income taxes qualify for the foreign tax credit.74 Other taxes,

such as foreign real and personal property taxes, do not qualify for the foreign tax

credit. However, a taxpayer may be able to deduct these other taxes even if he or she

claims the foreign tax credit for foreign income taxes. Taxpayers generally can deduct

these other taxes only if the taxes are expenses incurred in a trade or business or in the

production of income. However, for tax years before 2018 and after 2025, a taxpayer

can deduct foreign real property taxes that are not trade or business expenses as an

itemized deduction on Schedule A (Form 1040). No deduction is allowed for 2018-

2025 for foreign real property taxes.75

Limitation on Mortgage Interest Deduction

TCJA provides that a taxpayer may treat no more than $750,000 as acquisition

indebtedness ($375,000 in the case of married taxpayers filing separately) for purposes

of the mortgage interest deduction76. This applies to new home loans after December

14, 2017. In the case of acquisition indebtedness incurred before December 15, 2017,

the limitation is the same as it is under current law: $1,000,000 ($500,000 in the case of

married taxpayers filing separately). If the taxpayer owns two personal residence, the

total amount of acquisition indebtedness cannot exceed $1,000,000 ($500,000 in the

case of married taxpayers filing separately).

TCJA repeals the deduction for home equity indebtedness. Points not related to home

acquisition are no longer deductible.

Treatment of Mortgage Insurance Premiums as Qualified Residence Interest

For 2018, 2019, and 2020, the taxpayer can treat amounts paid during the year for

qualified mortgage insurance as qualified residence interest. The insurance must be in

connection with acquisition debt for a qualified residence.77

72 TCJA §11042 73 IRC §212 74 IRC §901(b) 75 IRC §164(a)(6)(A) 76 TCJA §11043 77 Taxpayer Certainty and Disaster Relief Act of 2019 – Division Q

11

TaxLaw

The federal Further Consolidated Appropriations Act, 2020, signed by the president

on December 20, 2019, extends the Qualified Principal Residence Indebtedness (QPRI)

exclusion through the year 2020. This exclusion allows some taxpayers who've had

mortgage debt forgiven—like after a foreclosure, loan modification, short sale, or deed

in lieu of foreclosure—to exclude the canceled amount from their income for federal

tax purposes.

If a 1099-C (Cancellation of Debt) form is issued from the mortgage lender for the

2019 tax year, or if the taxpayer filed a tax return for the 2018 tax year that included

income from mortgage loan forgiveness, pay close attention to this extension. If the

QPRI exclusion applies, the taxpayer does not have to report the forgiven principal as

income on their tax return.

Exclusion from gross income of discharge of qualified personal residence indebtedness,

discharges up to $2 million of mortgage debt on taxpayer’s main home. This provision

has been retroactively extended through Dec. 31, 2020.

Raising the Limits on Deductions for Cash Charitable Contributions During 2020 The CARES Act temporarily modified the percentage limitations on the income tax

charitable deduction for cash contributions to certain charities available to individuals

who are itemizers and corporations if these taxpayers elect to have these provisions

apply for the 2020 tax year. For 2020, individuals may deduct qualified contributions to

the extent of their contribution base (i.e., the individual's 2020 adjusted gross income

without regard to any net operating loss carryback to 2020). This provision is very

favorable to those donors who wish to make large cash contributions in 2020, the

deductibility of which might otherwise have been curbed due to the percentage

limitations. The election would allow much more to be deducted in 2020 and less

carried forward for deduction in future years.

Net Investment Income Tax

TJCA retains the 3.8 percent net investment income tax (NIIT) without changes.

The net investment income tax apply only to citizens or residents of the U.S. The NIIT is 3.8%

of the lesser of:

Net investment income of the year.

The excess of modified adjusted gross income (MAGI) over the threshold amount of

$250,000 for MFJ and QW; $125,000 for MFS; and $200,000 for HH and Single.

https://www.nolo.com/legal-encyclopedia/foreclosure-basics-terms-parties-steps-and-defenses.html

https://www.nolo.com/legal-encyclopedia/do-it-yourself-mortgage-loan-modification.html

https://www.nolo.com/legal-encyclopedia/deed-lieu-vs-short-sale.html

https://www.nolo.com/legal-encyclopedia/deed-lieu-vs-short-sale.html

12

TaxLaw

In general, net investment income for purpose of this tax, includes, but is not limited to:

Interest, dividends, certain annuities, royalties, and rents (unless derived in a trade or

business in which the NIIT does not apply),

Income derived in a trade or business which is a passive activity or trading in financial

instruments or commodities, and

Net gains from the disposition of property (to the extent taken into account in

computing taxable income), other than property held in a trade or business to which

NIIT does not apply.

The NIIT applies to income from a trade or business that is (1) a passive activity78, of the

taxpayer; or (2) trading in financial instruments or commodities79.

The NIIT does not apply to certain types of income that taxpayers can exclude for regular

income tax purposes such as tax-exempt state or municipal bond interest, Veterans

Administration benefits, or gain from the sale of a principal residence on that portion that is

excluded for income tax purposes.

Modified adjusted gross income (MAGI), for purposes of the NIIT, is generally defined as

adjusted gross income (AGI) for regular income tax purposes increased by the foreign earned

income exclusion (but also adjusted for certain deductions related to the foreign earned

income). For individual taxpayers who have not excluded any foreign earned income, their

MAGI is generally the same as their regular AGI.

Section 529 Plan (Qualified Tuition Programs) Distributions and Rollovers

TCJA modifies Section 529 plans to allow such plans to distribute not more than $10,00080 in

expenses for tuition incurred during the tax year in connection with the enrollment or

attendance of the designated beneficiary at a public, private or religious elementary or

secondary school. This limitation applies on a per-student basis, rather than a per-account

basis. Thus, under the provision, although an individual may be the designated beneficiary of

multiple accounts, that individual may receive a maximum of $10,000 in distributions free of

tax, regardless of whether the funds are distributed from multiple accounts. Any excess

distributions received by the individual will be treated as a distribution subject to tax.

TCJA also allows rollovers between 529 plans and other qualified 529 accounts owned by the

beneficiary. These rollovers are considered part of the total contributions. Any amount rolled

over that is in excess of this limitation will be includible in the gross income of the

distribution.81

78 IRC§469 79 IRC §475 (e)(2) 80 TCJA §10032 81 IRC §72

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TaxLaw

TCJA Changes to Adjustments to Income

Repeal of Deduction for Moving Expenses

TCJA repeals the deduction for moving expenses for tax year 2018 through 2025.

However, under the provision, rules providing for exclusions of amounts attributable to

in-kind moving and storage expenses (and reimbursements or allowances for these

expenses) for members of the Armed Forces of the United States (or their spouse or

dependents) are not repealed.

Repeal of Deduction for Alimony Paid

Generally, effective for any divorce or separation instrument executed before January 1,

2019, amounts received as alimony or separate maintenance payments are includible in

income in the year received and are deductible by the payer in the same year. For these

divorces, the Social Security Number of the spouse and the date of the divorce is

required.

As a result of changes made by the Tax Cut and Jobs Act of 2017 (TCJA), effective for

any divorce or separation instrument executed after December 31, 2018 or modified

after that date, if the modification expressly provides that the TCJA changes apply to

such modification, alimony and separate maintenance payments are excluded from the

payee's income and no deduction is allowed to the payer.

Student Loans

Treatment of Student Loans Discharged Due to Death or Disability

TCJA modifies the exclusion of student loan discharges.

Loans eligible for the exclusion under the provision are loans made by

The United States (or an instrumentality or agency thereof),

A state (or any political subdivision thereof),

Certain tax-exempt public benefit corporations that control a state, county, or

municipal hospital.

An educational organization that originally received the funds from which the

loan was made from the United States, a State, or a tax-exempt public benefit

corporation; or

Private education loans (for this purpose, private education loan is defined in

Section 140(7) of the Consumer Protection Act).

14

TaxLaw

(CARES Act) Student Loan Interest Deduction

The CARES Act has two different items that may be of assistance to those who owe

student loans:

1. The CARES Act includes automatic suspension of principal and interest payments

on federally held student loans (does not apply to student loans held privately) from

March 13 through September 30, 2020, the interest rate is set to 0% and payments

are suspended for student loans owned by the federal government. The federal

student loan servicer will suspend all interest and payments without any action from

the taxpayer. There is no need for the taxpayer to contact the student loan servicer.

If a payment of federally held student loans made after March 13, the borrower can

request a refund from the student loan servicer. All payments during this period will

apply directly to principal. The loan cannot be for a dependent and cannot be

through a private lender.

2. The CARES Act82 amends the existing code section to provide an exclusion83 from

income for payments of interest or principal made by an employer on any qualified

education loan incurred by an employee for the education of the employee. The

amendment applies to payments made after March 27, 2020, and before January 1,

2021. Payments of principal and/or interest by the employer to the employee or to

the lender will be tax-free. The exclusion from income is up to $5,250 in employer-

paid educational assistance.

Previously any student loan payments made by an employer was part of wages and

subject income tax and FICA.

The maximum allowable Student Loan Interest Deduction for 2019 and 2020 is $2,500. The

student loan income phase-out ranges are:

Filing Status 2020 Phase-out 2019 Phase-out

Married Filing Jointly $140,000-170,000 $140,000-$170,000

Qualifying Widow(er) $70,000-85,000 $70,000-$85,000

Head of Household $70,000-85,000 $70,000-$85,000

Single $70,000-85,000 $70,000-$85,000

Married Filing Separately N/A N/A

82 §2206 83 IRC §127(c)1

15

TaxLaw

Recharacterization of an IRA

The taxpayer can convert the entire balance of a traditional IRA account to a Roth account,

paying the taxes that are owed on this conversion. In the past, it was legal for the taxpayer to

change their mind and recharacterize that Roth conversion back to a traditional IRA account.

However, the Tax Cuts and Jobs Act of 2017 banned recharacterizing a Roth conversion back

to a traditional IRA.

To recharacterize a regular IRA contribution, the taxpayer must tell the trustee of the financial

institution holding the IRA to transfer the amount of the contribution plus earnings to a

different type of IRA (either a Roth or traditional) in a trustee-to-trustee transfer or to a

different type of IRA with the same trustee. If this is done by the due date for filing the tax

return (including extensions), the taxpayer can treat the contribution as made to the second IRA

for that year (effectively ignoring the contribution to the first IRA).

Child Tax Credit 2020:

The increases in the Child Tax Credit is an essential component of TCJA, it was designed to

make up some of the difference

TCJA increases the child tax credit to $2,000.

TCJA iincreases the adjusted gross income phase-out thresholds to $400,000 for

married taxpayers filing joint returns and $200,000 for other individuals. The phase-out

thresholds are not indexed for inflation.

The credit is refundable up to $1,400 in 2020 (indexed).

Earned income threshold is lowered to $2,500,

Retains maximum age for a qualifying child (age 16) from present law.

Any qualifying child claimed for the credit is required to use a Social Security number

as that child’s taxpayer identification number.

A child permanently and totally disabled does qualify as a dependent but does not

qualify for the child tax credit because there is no exception for the age test. A child

must be under 17 regardless of any disability.

Keep in Mind: The child must be a dependent of the taxpayer to qualify for the Child Tax

Credit. The child must be a U.S. citizen, a U.S. national, or a U.S. resident alien (the Child Tax

Credit is not allowed for nonresident alien children residing in Canada or Mexico even if they

qualify as dependents. He or she must have a Social Security number; the credit cannot be

claimed if the Social Security Number is obtained for the child after the filing of the return.

16

TaxLaw

“Earned Income” Formula for Computing the Additional Child Tax Credit

To the extent, the child credit exceeds the taxpayers’ income tax liability; the taxpayer is

eligible for a refundable credit (also referred to as "the additional child tax credit") equal to the

lesser of $1,400 for each qualifying child or 15 percent of earned income in excess of a

threshold dollar amount (the "earned income" formula). For 2020, the inflation-adjusted

amount is $1,40084 the same as 2019. The threshold amount for years 2018 through 2025 is

$2,500.85 Families with three or more children may determine the additional child tax credit

using the "alternative formula," if this results in a larger credit than determined under the

earned income formula. Under the alternative formula, the additional child tax credit equals the

amount by which the taxpayers’ social security taxes exceed the taxpayers’ earned income tax

credit86 (EITC).

Earned income is defined as the sum of wages, salaries, tips, and other taxable employee

compensation plus net self-employment earnings. Unlike the EITC, which also includes the

preceding items in its definition of earned income, the additional child tax credit is based only

on earned income to the extent it is included in computing taxable income. For example, some

ministers' parsonage allowances are considered self-employment income, and are considered

earned income for purposes of computing the EITC, but the allowances are excluded from

gross income for individual income tax purposes, therefore it is not considered earned income

for purposes of the additional child tax credit since the income is not included in taxable

income. However, there is exception to this rule for combat pay excluded from gross income.

Even though excluded from income, the taxpayer may treat it as earned income for purposes of

the additional tax credit.87

Example: For 2020, Sarah is a single taxpayer with two qualifying children. She has

adjusted gross income and earned income of $8,000 and a total tax liability of $300.

Because of the tax liability limitation, Sarah is allowed a nonrefundable child tax credit

of only $300. However, she is eligible for an additional child tax credit (i.e., a

refundable credit) of $825, which is equal to the lesser of:

(1) $3,700 (the child tax credit not allowed due to the tax liability limitation

($4,000 - $300)); or

(2) $825 (15% × ($8,000 - $2,500)).

A taxpayer with three or more qualifying children can use an alternative computation. In

computing the additional child tax credit, such a taxpayer can use the amount by which the

taxpayers’ social security taxes for the tax year exceed his or her earned income credit for the

year in lieu of 15 percent of the amount by which the taxpayers’ earned income exceeds

$2,500.

84 Rev Proc 2018-57 85 IRC §24(h)(6) 86 IRC §24(d)(1)(B)(ii) 87 IRC §24(d)(1)(B)(i)

17

TaxLaw

The amount of the additional child tax credit taken reduces the amount of the nonrefundable

child tax credit allowable before application of the tax liability limitation. In other words, the

total of a taxpayers’ nonrefundable child tax credit and additional child tax credit cannot be

greater than the amount of the nonrefundable child tax credit allowable before application of

the tax liability limitation.

Remember, the TCJA says the refundable portion of the credit is up to this amount. The refund

is actually equal to 15% of the earned income over $2,500. A taxpayer would need earned

income of approximately $12,000 a year to qualify for and receive the full $1,400 refund:

$12,000 less $2,500 is $9,500, and 15% of $9,500 works out to $1,425. At $12,000 in earned

income, the taxpayer would forfeit that extra $25 because the refundable portion of the credit

caps out at $1,400.

NOTE: The Child Tax Credit (CTC) is included in the due diligence requirement. Form 8867,

Preparer’s Due Diligence Checklist includes the Child Tax Credit. For an in-depth discussion

of Due Diligence, see the TaxEase Ethics Section.

18

TaxLaw

What Do You Think?

Q1. Jack works for Corp. in 2020 and has withholding of $6,850 for CA and SDI of

$1,150. His property tax for the year was $5,400. What is the total amount of state

and local taxes deduction included on Schedule A for Jack, who itemizes deductions

for tax year 2020?

A. $13,400

B. $12,700

C. $10,000

D. None of the above

Q2. Which of the following is correct for 2020?

A. In 2020 Amended returns can be electronically filed.

B. TCJA retained Net Investment income at 3.8%.

C. Payments of student loan principal and/or interest by the employer to the employee or

to the lender will be tax-free from March 13 through September 30, 2020.

D. All of the above are correct

19

TaxLaw


.

Answer Q1. Jack works for Corp. in 2020 and has withholding of $6,850 for

CA and CA SDI of $1,150. His property tax for the year was $5,400. What is

the total amount of state and local taxes deduction included on Schedule A for Jack, who

itemizes deductions for tax year 2020?

A. $13,400 – A and B are not correct because State and local taxes for tax years 2019 –

2025 cannot exceed $10,000

B. $12,700

C. $10,000 – The amount that would be deducted if not for the $10,000 limitation is

$13,400. $6,850 of CA withholding plus $1,150 of CA State Disability Insurance

and $5,400 in property tax.


Answer Q2: D is the correct answer.

Q2. Which of the following is correct for 2020?

A. In 2020, Amended returns can be electronically filed.

B. TCJA retained Net Investment income at 3.8%.

C. Payments of student loan principal and/or interest by the employer to the employee or

to the lender will be tax-free from March 13 through September 30, 2020.


A is correct because the IRS will be able to e-file Form 1040-X, Amended U.S Individual

Income Tax Return, using available tax software products. Making the 1040-X an

electronically filed form has been an ongoing request from the nation's tax professional

community and a continuing recommendation from the Internal Revenue Service Advisory

Council (IRSAC) and Electronic Tax Administration Advisory Committee (ETAAC). The new

electronic option allows the IRS to receive amended returns faster while minimizing errors

normally associated with manually completing the form. This service is expected in late

summer 2020.

B is correct because TJCA retains the 3.8 percent net investment income tax (NIIT) without

changes.

C is correct because the CARES Act includes automatic suspension of principal and interest

payments on federally held student loans (does not apply to student loans held privately) from

March 13 through September 30, 2020, the interest rate is set to 0% and payments are

suspended for student loans owned by the federal government.

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Chapter 2 – Itemized Deductions

Standard Deductions versus Itemized Deductions

As mentioned previously, TCJA has eliminated

exemptions. The standard deduction has been increased

significantly. The Child Tax Credit has been increased, to

help make up for the loss of exemptions. Child Tax Credit

is for dependents under age 17. There is also a small credit

for dependents other than children of $500. Keep in mind neither of these credits or

exemptions are available for the taxpayer or spouse. The higher of itemized deductions or the

standard deduction can be taken on the tax return; whichever results in the lower tax.


Filing Status

Single $12,200 $12,400




Married Filing Separately $12,200 $12.400

Additional Amount for Aged or Blind* $1,300-$1,650

__________

* The additional standard deduction for a spouse age 65 or older, or blind is $1,300. These

amounts are increased to $1,650 if the taxpayer is also unmarried and not a surviving spouse

Medical Expense Deduction Floor

The reduction in the medical expense deduction floor from 10% to 7.5% expired for tax

years ending before Jan. 1, 2019. This provision is extended through Dec. 31, 2020.88

88 Taxpayer Certainty and Disaster Tax Relief Act of 2019 Subtitle A.

Objectives:

• Review itemized deductions for

2019 and 2020.

• Discuss CARES Act and other

Covid-19 legislation in

relationship to itemized

deductions.

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Tax Deduction for Long-Term Care Insurance89

The rates have steadily increased each year. The deductible limits are includable as a

medical deduction on Schedule A. For taxable years beginning in 2018, the

limitations90 regarding eligible long-term care premiums includible in the term

"medical care," are as follows:

Age before Close of Taxable

Year

2020 Deduction

Limits

2019 Deduction

Limits

40 or less $430 $420

More than 40 not more than 50 $810 $790

More than 50 not more than 60 $1,630 $1,580


More than 70 $5,430 $5,270

Medical Expenses

The CARES Act repeals the Medicine Cabinet Tax provision of the Affordable Care Act

(ACA), expanding the list of qualifying expenses that can be purchased with health savings

accounts (HSAs), health reimbursement arrangements (HRAs) and flexible spending accounts

(FSAs).

Under the CARES Act, the definition of a qualifying medical expense now includes certain

over-the-counter medications and products. Specifically, the act treats additional over-the-

counter medications, along with menstrual care products, as qualified medical expenses that

may be paid for using HSAs or other tax-advantaged accounts.

A taxpayer may deduct unreimbursed medical expenses91 paid for medical care of the taxpayer,

his or her spouse, and dependents. After 2018 and before 2026, the medical expense deduction

or both regular tax and AMTI is limited to the excess amount over 7.5 percent of the taxpayers’

adjusted gross income,

The CARES Act contains several provisions that affect employer-sponsored retirement

and health and welfare plans. The CARES Act reverses the Affordable Care Act (“ACA”)

restriction on reimbursement for over-the-counter (“OTC”) drugs and products and allows

HSAs, Archer MSAs, Health FSAs, and HRAs to reimburse for OTC drugs and products

after December 31, 2019. Interestingly, the CARES Act did not explicitly remove the

ACA’s reimbursement restrictions. Instead, it replaced the operative Code provisions with

a clarification that menstrual care products are to be treated as qualified medical expenses.

89 IRC §213(d)(10) 90 IRC §213(d)(10) 91 IRC §213

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Medical care expenses92 include payments for the diagnosis, cure, mitigation, treatment, or

prevention of disease, or payments for treatments affecting any structure or function of the

body, and some over-the-counter drugs discussed above. Also included are insurance

premiums paid for the taxpayer, spouse and dependent for policies that cover medical care or

for a qualified long-term care insurance policy covering qualified long-term care services (see

deductible limitations below). If the taxpayer is an employee, medical expenses do not include

that portion of their premiums treated as paid by the employer under its sponsored group

accident or health policy or qualified long-term care insurance policy.

For the purposes of the Federal income tax deduction allowed for medical expenses, “medical

care” generally refers to the diagnosis, cure, mitigation, treatment, or prevention of illness or

disease, or for affecting any structure or function of the body. It includes:

• Transportation primarily for and essential to medical care;

• Medical insurance (including all Medicare premiums93);

• Prescribed drugs and insulin;

• Nursing services;

• Hospital care;

• Eye care;

• Fertility treatments;

• Legal expenses incurred to establish the right to proceed with a course of treatment;

• Weight reduction programs prescribed by a physician for treatment of medical

conditions related to obesity;

• Smoking cessation programs;

• Substance abuse counseling;

• Mental health counseling;

• Equipment and devices bought for medical reasons, such as eyeglasses, hearing aids

and crutches;

• Capital improvements to a residence for medical care to the extent they exceed the

increase in the property's value;

• Specially-equipped automobiles;

• Non-institutional food eaten solely for the alleviation or treatment of illness;

• Books and magazines in Braille;

• A special school for a mentally or physically handicapped person to alleviate a

handicap;

• Retirement home fees attributable to medical care;

• Qualified long-term care services as well as eligible premiums for insurance covering

qualified long-term care; and

• Expenses paid for the treatment of gender identity disorder

92 Pub. 502, Schedule A Instructions 93 CCA 201228037

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Who is a Dependent for Medical Purposes?

The definition of “dependent”94 is expanded for purposes of the medical expenses deduction.

For these purposes, an individual can qualify as a dependent even if he or she has income in

excess of the exemption amount or if he or she files a joint return with his or her spouse. To

include medical care expenses paid for a spouse or dependent, the person must have been the

taxpayers’ spouse or dependent either at the time, the medical services were provided or at the

time, the expenses were paid. Additionally, the minor child of divorced or separated parents is

treated as the dependent of both parents for purposes of the medical expenses deduction.

Example: Jan received medical treatment before she married Sam. Sam paid for the

treatment after they married. Sam can include these expenses in calculating his medical

expense deduction even if he and Jan file separate returns. If Jan had paid the expenses,

Sam could not include Jan's expenses in his separate return. Jan would include the

amounts she paid during the year in her separate return. If they filed a joint return, the

medical expenses both paid during the year would be used to figure their medical

expense deduction.

A person who otherwise qualifies as a dependent95 is considered a taxpayers’ dependent for

medical expense purposes even if: That person received gross income equal to or greater than the personal exemption

amount and/or filed a joint return for the year; or

The taxpayer, or the taxpayers’ spouse if filing jointly, could be claimed as a dependent

on someone else's return.

A child of divorced or separated parents can be treated as a dependent of both parents.96 Each

parent can include the medical expenses he or she pays for the child, even if the other parent

claims the child's dependency exemption, if:

The child is in the custody of one or both parents for more than half the year;

The child receives over half of his or her support during the year from his or her

parents; and

The child's parents are divorced or legally separated under a decree of divorce or

separate maintenance, are separated under a written separation agreement, or live apart

at all times during the last six months of the year.

This does not apply if the child's exemption is being claimed under a multiple support

agreement. A taxpayer who is considered to have provided more than half of a qualifying

relative's support under a multiple support agreement can include medical expenses the

taxpayer pays for that person. Any medical expenses paid by others who joined in the

agreement cannot be included as medical expenses by anyone.97

94 IRC §213(a) 95 IRC §151 96 IRC §213(d)(5) 97 Reg. Sec. 1.213-1(a)(3)

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Rowena and her three sisters each provides one-fourth of their mother's total support.

Under a multiple support agreement, Rowena treats her mother as her dependent.

Rowena paid all of her mother's medical expenses. Rowena's sisters repaid Rowena for

three-fourths of these expenses. In figuring her medical expense deduction, Rowena can

include only one-fourth of her mother's medical expenses. Rowena's sisters cannot

include any part of the expenses. However, if Rowena and her sisters share the

nonmedical support items and Rowena separately pays all of her mother's medical

expenses, Rowena can include the unreimbursed amount she paid for her mother's

medical expenses in her medical expenses.

The amount an adopting parent pays for medical services rendered directly to a child before its

placement in the adopting parents' home is deductible as a medical expense, provided that:

The child qualifies as a dependent of the adopting parent at the time the medical

services are rendered or at the time the expenses are paid; and

The medical expenses are paid by the adopting parent, or his agent, for the medical care

of the particular child and are not paid merely as reimbursement for expenses incurred

and paid by the adoption agency or other persons prior to adoption negotiations

between the agency and the adopting parent.98

If the medical expenses are paid by the adoption agency or other agent of the adopting

parent under an agency agreement made before the payment, reimbursement of those

expenses by the adopting parent is considered a payment of medical expenses by the

adopting parent. However, the adopting parent must clearly substantiate that any

deduction claimed is directly attributable to medical care of the child.

A taxpayer who receives benefit payments (such as social security benefits) as a guardian of a

dependent; and then pays the dependent's medical expenses, the expenses are not medical

expenses paid by the taxpayer. The dependent has paid his or her own medical expenses to the

extent of those benefits99 (Hodge v. Comm'r, 44 T.C. 186 (1965)).

98 Rev. Rul. 60-255 99 Hodge v. Comm'r, 44 T.C. 186 (1965)

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Tax Deduction for Long-Term Care Insurance100

The rates have steadily increased each year. The deductible limits are includable as a

medical deduction on Schedule A. For taxable years beginning in 2019, the limitations

regarding eligible long-term care premiums includible in the term "medical care," are as

follows:

Age before Close of Taxable

Year

2019 Deduction

Limits

2020 Deduction

Limits

40 or less $420 $430

More than 40 not more than 50 $790 $810



More than 70 $5,270 $5,430

The taxpayer may not deduct funeral or burial expenses, over-the-counter medicines,

toothpaste, toiletries, cosmetics, a trip or program for the general improvement of their health,

or most cosmetic surgery. No deduction is allowed for the amounts paid for nicotine gum and

nicotine patches, which do not require a prescription. No deduction is allowed for Medical

Marijuana.

The taxpayer can only include the medical expenses paid by the taxpayer during the year. The

total deductible medical expenses for the year must be reduced by any reimbursement of

deductible medical expenses. It makes no difference if the reimbursement is paid directly to the

taxpayer or if it is paid directly to the doctor, hospital, or other medical provider.

NOTE: Some expenses incurred by a physically handicapped individual to remove

structural barriers in their residence in order to accommodate their physical condition

such as constructing access ramps, widening doorways, and installing special support

bars are presumed not to increase value of the residence and are deductible in full.

IRA Withdrawals for Certain Medical Expenses The tax law creates an exception to the 10% penalty tax101 on early withdrawals from both an IRA

and a qualified plan for medical expenses in excess of 10% of adjusted gross income. In addition,

the taxpayer can withdraw money from an IRA (but not a qualified plan) for medical insurance

premiums102 (without regard to the 10% floor) if the individual has received unemployment

compensation under Federal or state law for at least 12 weeks.

100 IRC §213(d)(10) Notice 2019-41 101 IRC §72(t)(2)(B) 102 IRC §72(t)(2)(D)

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Capital Expenses Deductible as Medical Expenses

The cost of home improvements and special equipment is deductible as medical expenses if

their main purpose is medical care. The cost is deductible to the extent it does not increase the

value of the home or other capital asset. The costs must be reasonable to accommodate a home

for a person with a disability.

Example: John adds a ramp to the front of his home to allow access for his wife who is

confined to a wheelchair. The ramp cost $7,000 and according to an appraisal increased

the value of the house by $4,000. John can deduct the $3,000 of the home improvement

cost as a medical expense. Elevators, swimming pools, and other permanent improvements to taxpayers’ property

(including capital expenditures to accommodate a residence to a physically handicapped

individual) qualify as a medical expense only to the extent the total expense exceeds the

amount by which the improvement increases the value of the property.

Example: A taxpayer spends $5,000 to put in a central air conditioning system after

their daughter’s allergist recommends the installation to alleviate an asthmatic

condition. If the air conditioning unit boosts the value of the taxpayers’ home by

$4,500, the allowable deduction shrinks to only $500, the amount by which the cost

exceeds the increase in value. A renter could claim the entire cost because the

improvement adds nothing to the value of his or her property.

A written opinion from a competent real estate appraiser detailing how much the installation

raised the value of the property is recommended. The appraisal fee does not count under the

10% of AGI limit for medical expenses.

Whether the taxpayer is an owner or a renter, deductible items include the entire cost of

detachable equipment – such as a window air conditioner that relieves a medical problem. The

taxpayer may also include as part of the medical deduction amounts spent for such operating

and maintenance expenses as electricity, repairs, or a service contract.

A car specially equipped for medical reasons, the cost of special hand controls and other

special equipment installed in a car for use by a person with a disability is deductible as a

medical expense. The difference between the regular cost of the car and the specially equipped

vehicle can be deducted as a medical expense. The cost of operating the specially equipped

vehicle is not deductible.

Example: Fred Jackson had switched jobs in January 2019 and joined the electrical

union. The union does not pay for medical insurance for Fred and his family until

January 2020. Fred can deduct the medical insurance purchased with after tax dollars

through the union’s provider in 2019.

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What Do You Think?

Q1. Which of the following is a medical expense for 2020?

A. Weight reduction prescribed by a doctor.

B. Over the counter menstrual supplies

C. Long-term care insurance premiums

D. All of the above

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TaxLaw

What Do You Think - Answers

Answer Q1: D is the correct answer Q1: All of the items listed are deductible medical expenses. Medical

expenses can be medical or long-term insurance; capital improvements to the

home; the entire cost of detachable equipment that relieves a medical

problem and certain over the counter medications.

Under the CARES Act, the definition of a qualifying medical expense now includes certain

over-the-counter medications and products. Specifically, the act treats additional over-the-

counter medications, along with menstrual care products, as qualified medical expenses that

may be paid for using HSAs or other tax-advantaged accounts. As such, the CARES Act,

which took effect on March 27, 2020, permits reimbursement of over-the-counter products and

medications without the need of a prescription

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Schedule A Taxes

Nondeductible Taxes Federal income and excise taxes

Social Security, Medicare, FUTA and RRTA taxes

State and local gasoline taxes

Car inspection fee

Special assessments for improvements to taxpayers’ property.

Tax paid for someone else

License fees, such as dog license, driver’s license or marriage license

California fire prevention fee

Foreign Real Property Tax

The following are the categories of taxes103 that are deductible regardless of the existence of a

trade or business or for-profit activity. Specifically, taxpayers may deduct the following:

• State and local real property taxes;

• State, local and foreign income taxes;

• State and local personal property taxes;

• The higher of state and local income tax or state and local sales tax.

• The generation-skipping transfer tax;

• State and local sales or excise taxes on certain motor vehicles.

SALT - State and Local Taxes

Among the biggest changes of TCJA are the state and local tax deduction amounts, also

referred to as the SALT deduction cap. Now that deduction limits are standard across the board

regardless of income, both middle and upper class taxpayers are feeling the financial

consequences of the new limits.

Previously, limits on how much single taxpayers could deduct were only implemented to

people with adjusted gross incomes over $150,000. However, after the introduction of the

TCJA, that has changed.

Now, all taxpayers, regardless of their income can deduct no more than $10,000 of total state

and local taxes, including property taxes. It is estimated by the White House Office of

Management and Budget that the cap on these deductions is saving the government over $57

billion; before the cap, SALT deductions cost the U.S. Treasury about $100 billion each year.

Up until the TCJA was passed, homeowners could deduct interest on home equity loans up to

$100,000; now, they only can if the funds are used for home improvement, nothing else.

The elimination of exemptions, SALT and limitations on home equity lines of credit, as well as

the increase in the standard deduction, have made many taxpayers take the standard deduction.

This has increased the taxable income of the taxpayers significantly in many cases.

103 IRC §164 (a),(b)

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Changes for tax years 2018-2025: (1) No deduction is allowed for foreign real property taxes; and

(2) The aggregate amount of taxes listed above that taken into account, including sales

taxes imposed in lieu of state income taxes is limited to $10,000 ($5,000 in the case of a

married individual filing a separate return).104

State and local taxes and property taxes paid while carrying on a trade or business, a rental

activity or an activity described in IRC §212 remain fully deductible.

Real Estate Taxes

State, local taxes paid on real estate owned by the taxpayer that was not used for business area

is deductible, but only if the taxes are based on the assessed value of the property. In addition,

the assessment must be made uniformly on property throughout the community, and the

proceeds must be used for general community or governmental purposes. If a mortgage

company pays taxes on behalf of the taxpayer, the deductible portion is the amount the

mortgage company pays, not the amount paid into the escrow account by the taxpayer. A

taxpayer can deduct all real estate taxes paid. Unlike mortgage interest, real estate taxes are not

limited to the first two personal residences. Charges for services, such as trash, water or sewer

are not deductible. Special assessments may be part of the tax bill.105

Improvement assessments, which improve the value of the property, increase the basis of the

property and are not deductible as real estate taxes. Maintenance assessments on existing

public facilities already in service are deductible as real estate taxes as well as interest charges

regardless of the assessment purpose.

Personal Property Tax

Enter the state and local personal property taxes paid by the taxpayer, but only if the taxes are

based on value alone and are imposed on a yearly basis.

Mortgage Payment Forbearance

The CARES Act allows taxpayers to suspend their mortgage payments by using forbearance.

A forbearance is a temporary postponement or reduction of mortgage payments. It is not

payment forgiveness. Under the CARES Act, borrowers are entitled to an initial forbearance

period of up to 180 days, upon a borrower’s request. In addition, upon a borrower’s request,

the forbearance must be extended for up to an additional 180 days. A borrower can, at any time

the borrower chooses, shorten the forbearance and resume repayment of the loan.

The taxpayer requests forbearance through their lender, no fees, penalties or interest is charged.

No documentation is required to prove the hardship beyond the assertion that the taxpayer is

suffering from such a hardship. However, if the taxpayer can still make their mortgage

payments, they should continue to do so.

104 IRC §164(a)(6) 105 Pub 530

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If the taxpayer has a Fannie Mae, Freddie Mac, FHA, VA, or USDA loan, they will not have

to pay back the amount that was suspended all at once—unless able to do so. Forbearance will

not affect the credit rating of the borrower. If their credit status when forbearance is granted

will remain through the time of forbearance.

At the end of the forbearance, the options can include paying all of the missed payments at one

time, spread out over a period of months, or added as additional payments or a lump sum at the

end of the mortgage. Information regarding this is handled by the lender.

If the mortgage is not through one of the lenders above, the borrower should contact their

lender, many private lenders are offering forbearance, but the terms may differ.

Home Mortgage Interest

TCJA provides that a taxpayer may treat no more than $750,000 as acquisition indebtedness

($375,000 in the case of married taxpayers filing separately) for purposes of the mortgage

interest deduction. In the case of acquisition indebtedness incurred before December 15, 2017,

the limitation are the same as before December 15, 2017: $1,000,000 ($500,000 in the case of

married taxpayers filing separately).

TCJA repeals the deduction for home equity indebtedness.

Under the Tax Cuts and Jobs Act, the acquisition indebtedness limits have been reduced, and

home equity indebtedness will no longer be deductible. Home equity indebtedness is any debt

(other than acquisition indebtedness) secured by a qualified residence, but only to the extent,

the total home equity indebtedness is not more than: (1) The qualified residence's fair market value, reduced by

(2) The amount of acquisition indebtedness on the qualified residence106

106 IRC §163(h)(3)(C)(i)

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The definition of acquisition indebtedness remains unchanged. In order to be considered

"acquisition debt" for deduction of mortgage interest on a qualified residence the debt must be

incurred in acquiring, constructing, or substantially improving any qualified residence of the

taxpayer, and the debt must be secured by the residence.107 TCJA reduces the debt principal

limit on acquisition indebtedness from the prior $1M threshold, down to just $750,000 instead.

The lower debt limitation only applies to new mortgages taken out after December 15, 2017;

any existing mortgages retain their deductibility of interest on the first $1M of debt principal.

In addition, a refinance of such “grandfathered” mortgages will retain their $1M debt limit (but

only to the extent of the then-remaining debt balance, and not any additional debt).

TCJA rules eliminate the ability to deduct interest on home equity indebtedness. There are no

grandfathering provisions for existing home equity debt. The determination is based not on

how the loan is structured and characterized, but on how the loan proceeds are used, and

specifically, whether they are used to acquire, build, or substantially improve the primary or

second residence. (Notably, the fact that acquisition indebtedness must be used to acquire,

build, or substantially improve a residence, and the loan must be secured by “such” residence,

means that borrowing against a primary home to acquire, build, or substantially improve a

second residence is not treated as acquisition indebtedness)

Further complicating the matter is the fact that IRS Form 1098, which reports the amount of

mortgage interest paid each year, makes no distinction between whether or how much of the

mortgage principal (and associated interest) is deductible acquisition indebtedness or not. This

is not entirely surprising, given that the mortgage lender (or the mortgage servicer) would not

necessarily know how the mortgage proceeds were subsequently spent. Nonetheless, the fact

that mortgage servicers will routinely report the full amount of mortgage interest on Form

1098, when not all of that interest is necessarily deductible, will almost certainly create

taxpayer confusion, and may even spur the IRS to update the form.

Guidance in IRS Publication 936 does provide mortgage interest calculator worksheets to

determine how to apply principal repayments with so-called “mixed-use mortgages” (where a

portion is acquisition indebtedness and a portion is not). Specifically, the rules stipulate that

principal payments will be applied towards home equity.

107 IRC §163(h)(3)(B)

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Whether property is a taxpayers’ principal residence depends on all the facts and

circumstances. If a taxpayer alternates between two properties, using each as a residence for

successive periods, the property that the taxpayer uses a majority of the time during the year

ordinarily will be considered the taxpayers’ principal residence108. Other relevant factors in

determining a taxpayers’ principal residence include:

(1) The taxpayers’ place of employment;

(2) The principal place of abode of the taxpayers’ family members;

(3) The address listed on the taxpayers’ Federal and state tax returns, driver's license,

automobile registration, and voter registration card;

(4) The taxpayers’ mailing address for bills and correspondence;

(5) The location of the taxpayers’ banks; and

(6) The location of religious organizations and recreational clubs with which the taxpayer

is affiliated.

A second home to be deductible must be identified as a qualified residence and used as a

residence. After December 31, 2017, the combined acquisition debt on the first and second

homes are limited to $750,000.

A taxpayer can treat a residence under construction as a qualified residence for a period of up

to 24 months, if the residence actually becomes a qualified residence as of the time it is ready

for occupancy.

Qualified Residence Interest is interest secured by the taxpayers’ debt on the principal

residence or second home subject to certain limitations. The home loan is normally recorded

under state and local law, with the home as collateral for the debt. Debt not secured by the

home is personal debt.

Example: Money borrowed from parents or others for a down payment is unsecured

debt, unless the loan is legally recorded with the home as collateral.

A taxpayer must be legally liable for a loan to deduct interest on a home mortgage.

Payment made on a loan where the taxpayer is not directly liable are deductible only if

the taxpayer is the legal or equitable owner of the real estate.

Mortgage Interest Statement

If a taxpayer paid $600 or more of mortgage interest (including certain points) during the year

on any one mortgage, they generally will receive a Form 1098, Mortgage Interest Statement, or

a similar statement from the mortgage holder. A taxpayer will receive the statement if they

paid interest to a person (including a financial institution or a cooperative housing corporation)

in the course of that person's trade or business.

108 IRC §163(h)(4)(A)(i)(I)

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Note: The statement should be received for each year by January 31 of the following

year. A copy of this form will also be sent to the IRS. This statement will show the total

interest paid during the year. If a home was purchased during the year, it will also show

the deductible points paid during the year, including seller paid points.

Form 1098 was Issued in Taxpayers’ SSN

Report deductible mortgage interest on Schedule A, Line 10.

Attach a statement of explanation if the deductible amount and the amount reported are

not the same.

If more than one person paid the deductible mortgage interest, include amounts paid by

each party on the statement.

Form 1098 was Not Issued in Taxpayers’ SSN

Report deductible mortgage interest on Schedule A, Line 11.

Include the name, identifying number and the address of the interest recipient in the

space provided on Line 11.

In general, if more than one individual is liable on a mortgage, he or she is each entitled to

deduct the mortgage interest that he or she personally paid, regardless of his or her ownership

interest in the property.109

Example: George and his wife file married filing separate and are jointly liable on a

mortgage, but George paid all of the mortgage interest from his separate funds, George

can deduct all of it, even if his wife owns 100% of the property.

If two people are jointly liable for the mortgage, and the interest is paid out of a joint checking

account, each individual generally can only deduct 50% of the interest.110 However, if one

liable person can prove that he or she supplied all of the funds in the joint checking account,

that person can deduct all of the mortgage interest.111

109 George A. Neracher, 32 BTA 236 110 Mark B. Higgins, 16 TC 140 111 Barbara S. Finney, TC Memo 1976-329

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Loan Origination Fees - Points

Points are deductible in full if all of the following requirements are met:

1. The loan is secured by the taxpayers’ main home.

2. Paying points is an established business practice in the area.

3. The points paid were not more than the amount generally charged in that area.

4. The taxpayer uses the cash method of accounting. This means they report income in the

year received and deduct expenses in the year paid.

5. The points were not paid for items that usually are separately stated on the settlement

sheet such as appraisal fees, inspection fees, title fees, attorney fees, or property taxes.

6. The funds the taxpayer provided at or before closing, and any points the seller paid,

were at least as much as the points charged. The taxpayer cannot have borrowed the

funds from the lender or mortgage broker in order to pay the points.

7. The loan is used to buy or build the taxpayers’ main or second home.

8. The points were computed as a percentage of the principal amount of the mortgage.

9. The amount is clearly shown as points on the settlement statement.

Points that are an additional interest charge constitute prepaid interest. They must be

capitalized by a cash-basis taxpayer and deducted ratably over the term of the loan if incurred

in a business transaction, the same as if the taxpayer were on the accrual basis.112

Points charged for specific services by the lender for the borrower’s account are not interest.

Examples of fees for services not considered interest are:

1) Lender’s appraisal fee,

2) Preparation costs for the mortgage note or deed of trust,

3) Settlement fees, and

4) Notary fees.

It is important for the taxpayer to understand how refinancing his or her mortgage works for

tax purposes. When he or she take out a mortgage to buy or build a home, it counts as home

acquisition debt and gets the $750,000 limit. A mortgage for other purposes is treated as a

home equity loan and gets no interest deduction. If the taxpayer refinances a mortgage that

counted as home acquisition debt, the points count as prepaid interest and are deductible. The

refinanced mortgage will also count as home acquisition debt as long as it is in the same

amount. If the taxpayer borrows more in the refinancing, then the original acquisition loan,

then the extra amount of cash pulled out will be treated as home equity debt unless it is used to

improve the home.

112 IRC §461(g)(1)

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The taxpayer can fully deduct (in the year paid) points paid on a loan to improve their main

home if the above tests one through six are met. Points that do not meet these requirements

may be deductible over the life of the loan. Points paid for refinancing generally can only be

deducted over the life of the new mortgage. However, if the taxpayer uses part of the

refinanced mortgage proceeds to improve the main home, and they meet the first six

requirements stated above, they can fully deduct the part of the points related to the

improvement in the year they paid with their own funds. The taxpayer can deduct the rest of

the points over the life of the loan.

Because of the principal residence requirement, a taxpayer cannot fully deduct in the year paid

points paid on loans secured by a second home; those points can be deducted only over the life

of the loan.

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TaxLaw

What Do You Think?

Q1. The CARES Act allows taxpayers to suspend their mortgage payments by

using forbearance. Which of the following is not correct regarding

forbearance?

A. A borrower can, at any time the borrower chooses, shorten the

forbearance and resume repayment of the loan.

B. The initial period of forbearance is 180 days.

C. Forbearance is a form of loan forgiveness.

D. A forbearance is a temporary postponement or reduction of mortgage payments.

Q2. Kelly, who is single, bought a principal residence for its fair market value of $850,000 in

May 2019. She paid $200,000 down payment and financed the remainder by borrowing

$650,000 through a loan secured by the house. Kelly also took out a loan for $50,000 for a new

kitchen, secured by the home. Which of the following is the correct.

A. Kelly may deduct, interest paid on acquisition debt of $650,000 and on the home equity

loan.

B. Kelly may deduct, interest paid on acquisition debt of $650,000 only.

C. Kelly may deduct interest on the $850,000 purchase price of the home.

D. Kelly may not deduct interest paid in the year she purchased the home.

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TaxLaw


Answer Q1 – C is the correct answer

Q1. The CARES Act allows taxpayers to suspend their mortgage payments by

using forbearance. Which of the following is not correct regarding forbearance?

A. A borrower can, at any time the borrower chooses, shorten the forbearance and resume

repayment of the loan.

B. The initial period of forbearance is 180 days.

C. Forbearance is a form of loan forgiveness.

D. A forbearance is a temporary postponement or reduction of mortgage payments

The CARES Act allows taxpayers to suspend their mortgage payments by using forbearance.

A forbearance is a temporary postponement or reduction of mortgage payments. It is not

payment forgiveness. Under the CARES Act, borrowers are entitled to an initial forbearance

period of up to 180 days, upon a borrower’s request. In addition, upon a borrower’s request,

the forbearance must be extended for up to an additional 180 days. A borrower can, at any time

the borrower chooses, shorten the forbearance and resume repayment of the loan

Answer Q2. – A is the correct answer.

Q2. Kelly, who is single, bought a principal residence for its fair market value of $850,000 in

May 2019. She paid $200,000 down payment and financed the remainder by borrowing

$650,000 through a loan secured by the house. Kelly also took out a loan for $50,000 for a new

kitchen, secured by the home. Which of the following is the correct.

A. Kelly may deduct, interest paid on acquisition debt of $650,000 and on the home equity

loan.

B. Kelly may deduct, interest paid on acquisition debt of $650,000 only.

C. Kelly may deduct interest on the $850,000 purchase price of the home.

D. Kelly may not deduct interest paid in the year she purchased the home.

Kelly can deduct the interest on the acquisition debt of $650,000. The equity line for home

improvements is deductible in 2019/2020 since it is secured by the home and used for home

improvement (Total loans secured by the home is $700,000).

TCJA provides that a taxpayer may treat no more than $750,000 as acquisition indebtedness

($375,000 in the case of married taxpayers filing separately) for purposes of the mortgage,

interest deduction. TCJA repeals the deduction for home equity indebtedness not used for

home improvement.

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TaxLaw

Charitable Contributions

CARES Act: The adjusted gross income limit for cash contributions was increased for

individual donors. For cash contributions (not donations of goods) made in 2020, the taxpayer

can elect to deduct up to 100 percent of their AGI (increased from 60 percent). The AGI limit

for cash contributions was also increased for corporate donors. Corporations can now deduct

up to 25 percent of taxable income (increased from 10 percent).

The CARES Act allows for an additional, “above-the-line” deduction for charitable gifts made

in cash of up to $300. This is for taxpayers who do not itemize on their 2020 taxes, It is an

above the line deduction.

Existing carry-over rules still apply, if the donations in 2020 exceed the AGI deduction limits,

the taxpayer may carry forward excess deductions for up to five subsequent tax years.

A Qualified Charitable Distribution (QCD) is a direct transfer of funds from an IRA trustee to

a qualified charity. The CARES Act did not change the rules around the QCD, which allows

individuals over 70½ years old to donate up to $100,000 in IRA assets directly to charity1

annually, without taking the distribution into taxable income.

However, remember that under the CARES Act an individual can elect to deduct 100 percent

of their AGI for cash charitable contributions. This effectively affords individuals over 59½

years old the benefits similar to a QCD; they can take a cash distribution from their IRA,

contribute the cash to charity, and may completely offset tax attributable to the distribution by

taking a charitable deduction in an amount up to 100 percent of their AGI for the tax year.

If the taxpayer is planning a large donation in 2020, this may be a smart strategy as long as he

or she is between the ages of 59½ and 70½ and are not dependent on existing retirement funds.

Partial Above-the-Line Charitable Contribution Deduction

A charitable contribution not in excess of $300 made in taxable years beginning in 2020 is

allowed to taxpayers who do not itemize. The contribution must be made in cash to a qualified

charitable organization or a new or existing donor advised fund.

Temporary Suspension of Contribution Limitations

The 50% limitation (60% in years 2018-2025) under §170(b) and (d) is suspended for cash

contributions made in 2020.

For corporations, the 10% limitation is increased to 25% of taxable income. This provision also

increases the limitation on deductions for contributions of food inventory from 15% percent to

25%.

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TaxLaw

In general, a deduction is permitted for charitable contributions113, subject to certain limitations

that depend on the type of taxpayer, the property contributed, and the donee organization. The

amount of deduction generally equals the fair market value of the contributed property on the

date of the contribution. Charitable deductions are provided for income, estate, and gift tax

purposes.

To be deductible charitable contributions must meet the following requirements:

1. Contributions must be to or for the use of qualifying organizations, the IRS lists most

qualifying organizations in Publication 78,

2. Generally, they must be paid within the year, even if the taxpayer is on the accrual

basis,

3. They cannot exceed certain statutory limits, and

4. They must be itemized deductions for individuals.

Note: A contribution made to an individual is not deductible unless he or she is acting as an

agent for a qualified organization, even though he or she may be in need. Go,FundMe pages,

which are not 501(c) organizations, are not deductible.

For a contribution of cash, check, or other monetary gift (regardless of amount), the taxpayer

must maintain as a record of the contribution114 a bank record or a written communication from

the qualified organization containing the name of the organization, the date of the contribution,

and the amount of the contribution. In addition to deducting cash contributions, generally the

taxpayer can deduct the fair market value of any other property donated to qualified

organizations. For any contribution of $250 or more (including contributions of cash or

property), the taxpayer must obtain and keep a written acknowledgment from the qualified

organization indicating the amount of the cash and a description of any property contributed.

The acknowledgment must say whether the organization provided any goods or services in

exchange for the gift and, if so, must provide a description and a good faith estimate of the

value of those goods or services. The preparer should inquire whether these requirements were

met by the taxpayer and, if possible, view these documents.

Any contribution involving the payment of money to or on behalf of a charity is considered as

a cash contribution whether it is in the form of cash, check, credit card payroll deduction, out

of pocket expense, student living expense or foster parent expense.

113 IRC §170 114 IRC §170(f)(8)(A)

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TaxLaw

Generally, a contribution is considered to be made at the time of its unconditional delivery. The

unconditional delivery or mailing of a check that subsequently clears in due course constitutes

a contribution on the delivery or mailing date. Contributions a taxpayer charges on a bank

credit card are deductible in the year the taxpayer makes the charge.115 For contributions a

taxpayer makes through a pay-by-phone account, the date the financial institution pays the

amount is the contribution date. This date should be shown on the statement the financial

institution sends the taxpayer.

The following is a tax law case involving proper statements and substantiation of charitable

donations. The case Durden v. Commissioner116, involved a Texas couple who claimed a

deduction of $25,171 for cash contributions to their church. The church sent a letter of

acknowledgement in January of 2008, but that receipt lacked a statement of whether any goods

or services were provided to the Durdens in exchange for their contributions. Obviously trying

to make up for the error, the church provided a second acknowledgement in June of 2009,

which did include the proper statements. Nevertheless, the IRS denied the deduction because

the Durdens failed to get a proper receipt from their church. In the IRS's view, the first

acknowledgement was lacking a statement of whether goods or services were provided by the

church, and the second acknowledgement was not a "contemporaneous" receipt, because it was

not received by the Durdens by the due date for filing their original return for the year. Because

the Durdens did not have proper receipts, the judge agreed with the IRS that the Durdens failed

to comply with the substantiation requirements of IRC 170(f) (8).

If an individual makes a gift to someone in the organization, the individual does not get a

charitable contribution deduction, and the individual receiving the gift does not report it as

income. Since the contribution did not occur through the organization, there is no reporting

responsibility for the organization.

Example: A church member gives the pastor a restaurant gift card in appreciation of

his kindness. This is a gift between two individuals; it is not a tax matter.

The key here is that the gift did not go through the church, nor was it related to services

provided.

Note: The pastor cannot receive gifts from the congregation in lieu of a salary. In this case, the

IRS would rule that the gifts were disguised compensation and would be taxable income to the

pastor. This situation applies only in cases where the pastor had rendered no special services

for the member.

Example: The pastor was compensated by a member for performing a wedding that

would be taxable income to the pastor, reported on Schedule C.

115 Rev. Rul. 8-38 116 T.C. Memo. 2012-140 (May 17, 2012)

http://www.ustaxcourt.gov/InOpHistoric/DurdenMemo.TCM.WPD.pdf

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TaxLaw

TCJA Increase of Cash contributions TCJA has increased the amount of cash contributions allowed to be contributed tax years 2018

through 2025. If contributions are all to 50% charities, the deduction for contributions is increased

from 50% of adjusted gross income before any net operating loss carryback, to 60% of adjusted

gross income. There is an exception for appreciated capital gain property.

Charities that are 50% organizations include:

Churches,

Tax-exempt educational organizations,

Tax-exempt hospitals and certain medical research organizations,

Certain organizations holding property for state and local colleges and universities,

A state, a possession of the U.S., or any political subdivision of any of the foregoing, or

the U.S. or the District of Columbia, if the contribution is for exclusively public

purposes,

An organization organized and operated exclusively for charitable, religious,

educational, scientific, or literary purposes or for the prevention of cruelty to children

or animals or to foster national or international amateur sports competition if it

normally gets a substantial part of its support from the government or the general

public,

Limited private foundations, and

Certain membership organizations more than one-third of whose support comes from

the public (§170(b)(1)).

A 30% limit applies to the following contributions:

Contributions to all qualified organizations other than 50% limit organizations. This

includes contributions to veterans' organizations, fraternal societies, nonprofit

cemeteries, and certain private nonoperating foundations.

Contributions for the use of any qualified organization.

However, if these contributions are of capital gain property, they are subject to the 20%

limit, described later, rather than the 30% limit.

Special 30% Limit for Capital Gain Property

A special 30% limit applies to contributions of capital gain property to 50% limit

organizations. However, the special 30% limit does not apply when the taxpayer chooses to

reduce the fair market value of the property by the amount that would have been long-term

capital gain if he or she had sold the property. Instead, only the 50% limit applies.

Two separate 30% limits. This special 30% limit for capital gain property is separate from the

other 30% limit. Therefore, the deduction of a contribution subject to one 30% limit does not

reduce the amount of the deduction for contributions subject to the other 30% limit. However,

the total deduction cannot be more than 50% of the adjusted gross income.

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TaxLaw

Example: The adjusted gross income is $50,000. During 2020, Jane gave capital gain

property with a fair market value of $15,000 to a 50% limit organization. Jane did not

choose to reduce the property's fair market value by its appreciation in value. Jane also

gave $10,000 cash to a qualified organization that is not a 50% limit organization. The

$15,000 contribution of property is subject to the special 30% limit. The $10,000 cash

contribution is subject to the other 30% limit. Both contributions are fully deductible

because neither is more than the 30% limit that applies ($15,000 in each case) and

together they are not more than the 60% limit ($30,000).

20% Limit

The 20% limit applies to all contributions of capital gain property to or for the use of qualified

organizations (other than contributions of capital gain property to 50% limit organizations).

Noncash Contributions

A noncash contribution is a donation of property. The preparer must fill out Form 8283, and

attach it to the return, if the deduction for a noncash contribution is more than $500.

Another case of interest is Mohamed v. Commissioner. In this case, a California couple made

gifts of "extremely valuable" real property (more than $18.5 million total) to their charitable

trust in 2003 and 2004. The IRS denied the deduction for these contributions because the

Mohameds did not have the property independently appraised, as required by Treasury

regulations for noncash property contributions of more than $5,000. The taxpayer in this case

prepared and filed his own tax return, including the required Form 8283 for noncash charitable

contributions. The taxpayer admitted that he did not read the Form 8283 instructions, although

the form itself appeared simple enough, and perhaps was even a little misleading. (The IRS has

since revised Form 8283 (see below). The tax court agreed with the IRS that the Mohameds

had failed to satisfy the appraisal requirements of the Section 170 regulations, and therefore,

their charitable deductions were completely denied. The court agreed that this was a harsh

result, but found that "the problems of misvalued property are so great that Congress was quite

specific about what the charitably inclined have to do to defend their deductions, and we

cannot in a single sympathetic case undermine those rules”.

As is apparent from Durden v. Commissioner discussed earlier in this chapter and Mohamed v.

Commissioner. Above, it is essential that the taxpayer obtain the proper paperwork from the

charitable organization. Taxpayers’ should read the forms whether they prepare the return on

their own or go to a preparer. Being diligent regarding the information being filed is essential.

The example above Form 8283 is of a contribution of less than $5,000 and the example below

is of page three of Form 8283, which is a contribution if more.

http://www.irs.gov/pub/irs-pdf/f8283.pdf

http://www.ustaxcourt.gov/InOpHistoric/MohamedMemo.TCM.WPD.pdf



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TaxLaw

To substantiate a charitable cash contribution of less than $250, a taxpayer must be able to

provide:

• Bank record (canceled check; bank or credit card statement);

• Written communication from the donee showing:

• The donee's name;

• The date of the contribution; and

• The amount of the gift; or

• Other reliable written records showing the name of the donee, the date of the

contribution, and the amount of the contribution

The quality of the item when new, and its age must be considered, but it must be in good

condition to allow a deduction. Below is a guide regarding the value of used household goods..

Generally, for a charitable contribution of property with a claimed value of more than

$5,000117, a taxpayer must provide information about the donated property in Section B, Part I

of Form 8283, the taxpayer must also obtain a qualified appraisal of the property prepared by a

qualified appraiser. The appraiser must sign Part III of Form 8283, and the donee must sign

and provide the information required in Part IV.

117 IRC §170(f)(11)(A) , (C) , (D

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Form 8283, Page 2

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TaxLaw

Donated Goods Valuation Chart

Women’s Clothing

Blouse ($4 – $9)

Sweater ($4 – $13)

Pants ($4 – $23)

Dress ($6 – $28)

2pc Suit ($10 – $96)

Handbag ($2 – $10)

Hat ($1 – $9)

Shoes ($3 – $30)

Men’s Clothing

Shirt ($4 – $6)

Sweater ($4 – $6)

Pants ($4 – $23)

2pc Suit ($5 – $96)

Shoes ($3 – $30)

Jacket ($10 – $45)

Overcoat ($3 – $9)

Children’s Clothing

Shirt ($2 – $10)

Sweater ($2 – $10)

Pants/Jeans ($2 – $10)

Dress ($2 – $10)

Shoes ($3 – $10)

Boots ($6 – $10)

Snowsuit ($2 – $10)

Dry Goods

Pillow ($2 – $5)

Sheet ($2 – $9)

Blanket ($3 – $14)

Curtain ($2 – $7)

Drapes ($7 – $23)

Area Rug ($2 – $16)

Books ($0.59 – $2)

CD’s ($2 - $5)

Furniture

Floor Lamp ($8 – $34)

Sofa ($40 – $395)

Table Lamp ($3 – $20)

Stuffed Chair ($10 – $75)

Kitchen Set ($35 – $135)

End Tables ($10 – $75)

Coffee Table ($15 – $100)

Dresser ($20 – $80)

Appliances

Iron ($3 – $10)

Vacuum Cleaner ($5 – $70)

Coffee Maker ($5 – $10)

Radio ($1 – $10)

Working Television ($5 – $50)

DVD Player ($5 - $15)

Sewing Machine $5 -$75)

Bicycle ($5 - $80)

Miscellaneous

Battery Back-ups ($1.50 – $2)

Computers ($5 - $50)

Keyboards ($0.30 – $10)

Laptops ($5- $15)

Mice ($0.30 – $5.00)

Printers ($1 – $10)

Golf Clubs ($2 - $25)

Luggage ($5 - $15)

Remember: Noncash contributions must be receipted and itemized.

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TaxLaw

Contribution Carryovers

Contributions are deductible in the year they are actually donated to a qualified charity

regardless of the taxpayers’ method of accounting.

Contributions is excess of 20%, 30% or 60% of the taxpayers’ AGI are carried over118 to the

next tax year. If the 20%, 30% or 60% ceilings limit the contributions, the amount not deductible

in the year contributed may be carried forward for up to five years and deducted on a future return.

See above for a definition of 20%, 30% and 60% of AGI contributions.

Taxpayers with a large charitable contribution carryover can take advantage of the CARES Act

change, which allows the taxpayer to donate up to 100% of their AGI. This includes the

carryover.

If the taxpayer takes the standard deduction while carrying forward a charitable contribution,

the contribution cannot be claimed in that year.119 However, the excess is carried over reduced

by the amount he or she would have been able to claim had he or she itemized their deductions

in the current year.

Recordkeeping Rules for Charitable Contributions

Required written acknowledgements from the charity must be received by the taxpayer by the

earlier of the date of filing or due date of the return, including extensions.

Part contribution, part goods or services. A written statement from a charity is required if a

donation is more than $75 and is partly a contribution and partly for goods and services. The

statement must contain an estimate of the value of goods or services received.

Exception: A written statement for goods or services is not required if one of the following is

true.

1. The charity is Federal, state, or local government or a religious organization where the

benefit is an intangible religious benefit, such as admission to a religious ceremony.

2. The goods or services are of token value.

3. The goods or services are membership benefits, as described under Membership fees or

dues as a donation.

Benefits Received

If a taxpayer contributes to a charitable organization and receives a benefit from it, he or she

may deduct only the amount that is more than the value of the benefit he or she received.

118 Pub 526, Charitable Contributions 119 Reg §1.170A-10(a)(2

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TaxLaw

Examples of charitable contributions, which are not deductible because of benefits received

include:

(1) Tuition, even for children attending parochial school, and

(2) Payment in connection with an aged person’s admission to a home operated by a

charity, to the extent allocable to care to be given or the privilege of being admitted.

If a taxpayer pays more than the fair market value to qualified organizations for charity balls,

banquets, shows, etc., the amount that is more than the value of the privileges or other benefits

received is deductible as a contribution.

The presumption here is that the payment is not a gift. The taxpayer must show that a clearly

identifiable part of the payment is a gift. Only that part of the payment made with the intention

of making a gift and for which the taxpayer received no consideration qualifies as a

contribution.

NOTE: A receipt is not required where it is impractical to get one, such as leaving property at a

charity’s unattended drop site. The organization’s name, date of contribution, and description

of property are still required.

TCJA Casualties and Theft

Personal casualty losses, which include theft losses, are temporarily limited under the Tax Cuts

and Jobs Act of 2017. In the case of an individual, any personal casualty loss, which would

otherwise be deductible in tax years 2018-2025 is only allowed as a deduction in those years to

the extent it, is attributable to a federally declared disaster.120 There is an exception, however,

for personal casualty gains during those years. Such gains can be used to offset a personal

casualty loss not attributable to a federally declared disaster to the extent the loss does not

exceed the gain.

A Federally Declared Disaster

(A) In general. The term "Federally declared disaster" means any disaster subsequently

determined by the President of the United States to warrant assistance by the Federal

Government under the Robert T. Stafford Disaster Relief and Emergency Assistance

Act.

(B) Disaster area. The term "disaster area" means the area so determined to warrant

such assistance.

Any allowable casualty loss deductions are still deductible as an itemized deduction and

subject to $100 per casualty and 10% of AGI limitations.121

120 IRC §165(i)(5). 121 TCJA §11044

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TaxLaw

Casualty Losses

A casualty is the loss of property (including damage and destruction) because of a sudden

event. The event must be federally declared, identifiable, unexpected, and unusual. Events that

meet these criteria include:

Car accidents,

Disaster-related demolition,

Earthquakes,

Fires,

Floods,

Hurricanes,

Shipwrecks,

Storms,

Terrorist attacks,

Tornadoes,

Vandalism, and Volcanic eruptions

Miscellaneous Itemized Deductions

Deductions Subject to 2% of Adjusted Gross Income Are Repealed under TCJA

This has been one of the most asked questions from taxpayer. Depending on the profession of the

taxpayer, these deductions were large and along with the loss of exemptions were a significant

difference.

The following items are not deductible after December 31, 2017 through December 31, 2025:

Unreimbursed employee business expenses

Tax preparation fees

Excess deductions of an estate

Fees to claim a tax refund

Hobby expenses

Indirect deductions of pass-through entities

Investment fees and expenses

Legal expenses

Loss on traditional IRA or Roth IRA

Repayments of Income if $3,000 or less.

Repayments of Social Security benefits

Trustee administrative fees for an IRA

Appraisal fees for a casualty loss on a contribution

Job seeking expense

Education expense

Union Dues

.

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TaxLaw

Gambling Winnings and Losses

Taxpayers must report the full amount of their gambling winnings (with no reduction for

gambling losses) for the year as income on Form 1040, and then deduct their gambling losses

(up to the amount reported as gambling winnings) for the year separately on Schedule A (Form

1040) as a miscellaneous itemized deduction not subject to the 2 percent floor.122 When

spouses file a joint return for the tax year, their combined gambling losses are deductible to the

extent of their combined winnings. Gambling losses in excess of winnings are not

deductible.123

For tax years after December 31, 2017 through December 31, 2025, different rules apply with

respect to professional gamblers. Whereas casual gamblers must claim their gambling losses

(up to the amount of their gambling winnings) as an itemized deduction, a professional

gambler can deduct his or her losses (up to the amount of his or her winnings) as an above-the-

line deduction in arriving at adjusted gross income. Additionally, the Tax Court held that the

limitation does not limit deductions for expenses incurred to engage in the trade or business of

gambling. A gambler's business expenses are not "losses from wagering transactions" subject

to the Code Sec. 165 deduction limitation.

Thus, such expenses are considered deductible business expenses.124 In Mayo, the Tax Court

also stated that it would no longer follow the contrary holding of Offutt v. Comm'r, and other

cases applying the Code Sec. 165(d) deduction limitation to Code Sec. 162 business expenses.

The deduction for gambling losses is temporarily modified under the Tax Cuts and Jobs Act of

2017 (TCJA) for tax years 2018-2025. For these years, the limitation on losses from gambling

transactions applies not only to the actual betting costs, but also not to other expenses incurred

in connection with gambling activity. For instance, an individual's otherwise deductible

expenses in traveling to or from a casino are permitted only to the extent of gambling winnings

for tax years 2018-2025. The TCJA Conference Report specifically notes that the TCJA

provision is meant to overturn the Tax Court's holding in Mayo.

A professional gambler is an individual engaged in the trade or business of gambling (engages

in gambling for profit). To determine whether an individual is a professional gambler, courts

have looked to the profit motive factors125. The Tax Court found the taxpayers’ gambling

activity was operated in a businesslike manner because he kept detailed accounts of his

gambling transactions and maintained numerous statistics for each horserace. The taxpayer

also spent a considerable amount of time handicapping races and studying racing programs,

frequently sought advice from other experienced gamblers, and enjoyed a modest profit from

his activities in the year at issue. Professional gamblers, like casual gamblers, can deduct their

gambling losses only up to the amount reported as gambling winnings.126

122 IRC§67(b)(3) 123 IRC §165(d) 124 IRC §162 125 Reg. Sec. 1.183-2(b) 126 Alabsi v. Comm'r, T.C. Summary 2017-5


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Example: Yosemite Sam was in the trade or business of gambling on horse races. During

2017, Yosemite incurred $10,000 of business expenses relating to gambling. He also had an

$11,000 loss from gambling (gambling gains of $120,000 less gambling losses of $131,000).

Yosemite cannot deduct the $11,000 of excess gambling losses over gambling gains. However,

he can deduct the $10,000 of gambling business expenses on his Schedule C. In 2018,

Yosemite had a $13,000 gambling loss (gambling gains of $120,000 less gambling losses of

$133,000) and also incurred $8,000 of business expenses relating to gambling. Yosemite

cannot deduct the $13,000 gambling losses and cannot deduct the $8,000 of business expenses.

Claim of Right - Recoveries

If a taxpayer receives earnings under a claim of right, and without restriction as to its

disposition, he must pay tax on it, even if there is some dispute as to whether he is entitled to

retain the money. If, in a later year, the dispute is resolved against the taxpayer and he is forced

to return the money, he may claim a deduction of the repayment in the year that it is made. The

deduction in the later year is not a miscellaneous itemized deduction subject to the 2% floor.

If the amount of the repayment is $3,000 or less, report the repayment on the form or schedule

that was originally reported. If reported as a capital gain, report the repayment as a capital loss

on Schedule D, if it was reported as income on a Sole Proprietorship, report the repayment as

an expense on the Schedule C, etc.

If reported as wages, unemployment or other income report the repayment as a miscellaneous

itemized deduction subject to 2% of AGI, on Schedule A. Under TCJA, this is repealed after

December 31, 2017 through December 31, 2025.

If the amount of the deduction exceeds $3,000127, a special computation is provided for the

year of the repayment.

The tax for that year is the lower of the following:

(1) The tax computed with the deduction for the repayment (reported on Schedule A

Other Miscellaneous Deductions), or

(2) The tax computed without the deduction, but reduced by the amount by which the

tax for the earlier year would have been reduced if the amount subsequently repaid had

never been included in income in the first place. This refigured tax is then subtracted

from the tax shown on the original return. Enter the result on Line 71 if Form 1040 and

enter “IRC 1341” next to Line 71.

The purpose is to protect the taxpayer when, due to a lower tax bracket, the deduction in the

later year does not save him as much tax as the inclusion in the earlier year cost him.

127 IRC §1341(a)

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What Do You Think?

Q1. Which of the following is allowed as a deduction in 2020?

A. Tax preparation expenses.

B. Employee business expenses

C. Gambling losses to the amount of gambling winnings.

D. Investment fees and expenses.

Q2. Which of the following statements are true regarding charitable contributions?

A. In the case of a noncash contribution the item donated must be in good condition in

order to claim the deduction.

B. In 2019, a charitable contribution may be deductible up to 60% of adjusted gross

income.

C. In order to deduct a charitable donation the taxpayer must itemize their deductions.

D. All of the above are true statements.

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What Do You Think? – Answer

Answer Q1 –C is the correct answer

Tax preparation expense, employee business expenses, and investment

fees and expenses are all 2% deductions that were repealed under TCJA.

Gambling losses to the amount of gambling winnings are allowed as an itemized deduction

(not subject to the 2% floor).

Answer Q2 – D all of the statements are correct.

Which of the following statements are true regarding charitable contributions?

A. In the case of a noncash contribution the item donated must be in good condition in

order to claim the deduction.

B. In 2019, a charitable contribution may be deductible up to 60% of adjusted gross

income.

C. In order to deduct a charitable donation the taxpayer must itemize their deductions.

D. All of the above are true statements

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Chapter 3 – Education and Related Issues

When figuring an education credit, use only the amounts

paid and those deemed to be paid during the tax year for

qualified education expenses.

Education credits are reported on Schedule 3, which is used for nonrefundable credit other than

the child tax credit or the credit for other dependents, such as the foreign tax credit, education

credits and general business credit.

Form 1098-T requirement. To be eligible to claim the American opportunity credit or the

lifetime learning credit, the law requires a taxpayer (or a dependent) to have received Form

1098-T, Tuition Statement, from an eligible educational institution. If a student’s educational

institution is not required to provide a Form 1098-T to the student, a taxpayer may claim a

credit without a Form 1098-T if the taxpayer otherwise qualifies, can demonstrate that the

taxpayer (or a dependent) was enrolled at an eligible educational institution, and can

substantiate the payment of qualified tuition and related expenses.

American Opportunity Credit

A taxpayer who pays qualified education expenses may elect to claim an American opportunity

tax credit of up to $2,500 per year for each eligible student.128 The amount of the credit for

each student is computed as 100 percent of the first $2,000 of qualified education expenses

paid for the student and 25 percent of the next $2,000 of such expenses paid.129

Generally, 40 percent of the American opportunity tax credit is refundable. Thus, a taxpayer

can get a refund for that portion of the credit to the extent it exceeds the taxpayers’ tax

liability.130

In 2019, refundable credits are reported on Form 1040, Page 2, Line 18, The taxpayer can

claim a refundable credit other than the earned income credit, American opportunity credit

(Form 8863), or additional child tax credit (Form 8812). Have other payments, such as an

amount paid with a request for an extension to file or excess social security tax withheld.

A taxpayer cannot treat any portion of the American opportunity tax credit as refundable if:

(1) At the end of the tax year, he was:

(a) under age 18,

(b) age 18 and his earned income was less than half his support, or

(c) a full-time student over age 18 but under age 24 and his earned income

was less than half his support;

128 IRC §25A(i) 129 IRC §25A(b)(1) 130 IRC §25A(i)(5)

Objectives:

Discuss and explain through relevant

examples the education credits and

adjustments.

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(2) At the end of the tax year, at least one of his parents was alive; and

(3) He or she is not filing a joint return for the tax year.

Taxpayers claiming the American opportunity tax credit must provide the employer

identification number of any institution to which qualified tuition and related expenses were

paid. The reporting of the education expenses is done by the Education Institution on Form

1098-T, Tuition Statement.

If there are qualified education expenses for a dependent during a tax year, the taxpayer may be

able to claim an American opportunity credit for their dependent expenses that year.

For the taxpayer to claim an American opportunity credit for the dependent’s expenses, the

dependent must be claimed as a dependent on the taxpayers’ tax return.

If the taxpayer claims on the tax return an eligible student who is their dependent, treat any

expenses paid (or deemed paid) by the dependent as if the taxpayer had paid them. Include

these expenses when figuring the amount of the American opportunity credit.

Qualified education expenses paid directly to an eligible educational institution for a dependent

under a court-approved divorce decree are treated as paid by the dependent.

If the taxpayer claims a dependent who is an eligible student, only the taxpayer can include any

expenses paid when figuring the amount of the American opportunity credit. If neither the

taxpayer nor anyone else claims the dependent, only the dependent can include any expenses

paid when figuring the American opportunity credit.

Form 1098-T Tuition Statement is issued by an eligible educational institution (a college,

university, vocational school, or other postsecondary educational institution that is described in

IRC §481 of the Higher Education Act of 1965), reporting amount of payments received during

the year. When figuring the education credit use only the amount actually paid during the

taxable year. Form 1098-T may also contain other information, such as adjustments from prior

years, the amount of scholarships or grants, reimbursements or refunds and whether the student

was enrolled at least half-time or as a graduate student.

Form 8863 is used to claim either the American Opportunity Credit or the Lifetime Learning

Credit. Part III of this form must be completed to determine which credit is claimed. The

definition of qualified education expenses is generally the same for both the American

Opportunity Tax Credit and the Lifetime Learning Credit.

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Example: In 2020, Ms. Allen makes a payment directly to an eligible educational

institution for her grandson Todd’s qualified education expenses. For purposes of

claiming an American opportunity credit, Todd is treated as receiving the money from

his grandmother and, in turn, paying his qualified education expenses himself.

Unless Todd is claimed as a dependent on someone else’s 2020 tax return, only Todd

can use the payment to claim an American opportunity credit.

If anyone, such as Todd’s parents, claims Todd on his or her 2020 tax return, whoever

claims him may be able to use the expenses to claim an American opportunity credit. If

anyone else claims Todd, Todd cannot claim an American opportunity credit.

American Opportunity Credit or Lifetime Learning Credit (2020) Caution. Both the American opportunity credit and the lifetime learning credit can be claimed on the same

return—but not for the same student.

American Opportunity Credit Lifetime Learning Credit

Maximum credit Up to $2,500 credit per eligible student Up to $2,000 credit per return

Qualified

expenses

Tuition, required enrollment fees, and

course materials that the student needs

for a course of study whether or not the

materials are bought at the educational

institution as a condition of enrollment or

attendance

Tuition and enrollment fee amounts required to be

paid to the institution for course-related books,

supplies, and equipment.

Modified adjusted

gross income

(MAGI) phase-

out

$160,000-180,000 if Married Filing

Jointly; $80,000-90,000 if Single, Head

of Household, or Qualifying Widow(er)

$116,000-$136,000 if Married Filing Jointly;

$58,000-$68,000 if Single, Head of Household, or

Qualifying Widow(er)

Eligibility

At least a half-time student in program

leading to a degree for the first 4 years of

postsecondary education

Taking one or more courses Undergraduate &

graduate or

Courses to acquire or improve job skills

Refundable/

nonrefundable

40% of credit may be refundable; the rest

is nonrefundable

Nonrefundable—credit limited to the amount of tax

on the taxable income

Form Used Form 8863 Form 8863

Felony drug

conviction

The student had not been convicted of a

felony for possessing or distributing a

controlled substance

Felony drug convictions are permitted

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Form 8863

Fees, Books Supplies and Equipment

American Opportunity Tax Credit: Generally, a fee is treated as a qualified education

expense only if the fee is a required payment to the eligible educational institution as a

condition of the student’s enrollment or attendance at the institution.131 Generally, qualified

education expenses are claimed as an education credit only if they are paid for an academic

period that begins in the same year. However, qualified education expenses paid for an

academic period that begins during the first three months of the following tax year can be

claimed as an education credit in the tax year they are paid. For a calendar year taxpayer,

qualified education expenses paid for an academic period that begins in January, February, or

March of the following tax year are treated as qualified education expenses in the year they are

paid.132

Fees that are unrelated to the student’s course of study (nonacademic fees) are not qualified

education expenses. For example, student activity fees and athletic fees are not qualified

education expenses. Expenses for books, supplies, and equipment are qualified education

expenses if they are required for a course of study.

Lifetime Learning Credit

For purposes of the lifetime learning credit, expenses for books, supplies, and equipment are

qualified education expenses only if the fee is a required payment to the eligible educational

institution as a condition of enrollment or attendance.

Form 1098-T Tuition Statement is issued by an eligible educational institution (a college,

university, vocational school, or other postsecondary educational institution that is described in

section 481 of the Higher Education Act of 1965), reporting either payments received during

the year or amounts billed during the year. When figuring the education credit use only the

amount actually paid during the taxable year. Form 1098-T may also contain other information,

such as adjustments from prior years, the amount of scholarships or grants, reimbursements or

refunds and whether the student was enrolled at least half-time or as a graduate student.

For taxable years beginning in 2019, a taxpayers’ modified adjusted gross income must be less

than $68,000 ($136,000 for a joint return) to qualify for the Lifetime Learning Credit (LLC).

The credit will phase-out between $58,000 and $68,000 ($116,000 and $136,000). The credit is

20% of the first $10,000 of qualified education expenses paid for all eligible students.

131 Reg. Sec.1.25A-2(d)(2)(i) 132 IRC § 25A(g)(4)

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An eligible student for LLC includes a student who is the taxpayer, the taxpayers’ spouse, or

the taxpayers’ dependent. The following rules apply:

The lifetime learning credit is allowed if the student is enrolled in one or more courses

at an eligible educational institution and the course or courses are part of a

postsecondary degree program or are taken to acquire or improve job skills.133

o The American opportunity tax credit is allowed only for courses taken as part of

a postsecondary degree program in which the student is carrying at least half the

normal full-time workload. In contrast, for purposes of the LLC, a student need

not be carrying a specific workload. The credit may be allowed for the qualified

education expenses related to a single course. Moreover, for purposes of the

lifetime learning credit, the course or courses the student is taking need not be

part of a postsecondary degree program. The credit may be allowed if the course

or courses are taken by the student to acquire or improve job skills.

The lifetime learning credit is available for all years of postsecondary education of a

student and for all courses taken by a student to acquire or improve job skills.

There is no limit to the number of tax years that a taxpayer may claim a lifetime

learning credit for any particular student.134

The lifetime learning credit may be claimed for a student even if the student has a

felony drug conviction.

133 Code §25A(c)(2)(B) 134 Reg. Sec. 1.25A-4(b)

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What Do You Think?

An eligible student for LLC includes a student who is the taxpayer, the

taxpayers’ spouse, or the taxpayers’ dependent. Which of the following is not a

true statements regarding the Lifetime Learning Credit?

A. For taxable years beginning in 2019, a taxpayers’ modified adjusted gross income must

be less than $68,000 ($136,000 for a joint return) to qualify for the Lifetime Learning

Credit (LLC).

B. The credit is 20% of the first $10,000 of qualified education expenses paid for all

eligible students.

C. The lifetime learning credit is available for all years of postsecondary education of a


D. The LLC can be claimed for only 4 years of post-secondary degree program.

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What Do You Think?-Answers

A1. An eligible student for LLC includes a student who is the taxpayer, the

taxpayers’ spouse, or the taxpayers’ dependent. Which of the following is

not a true statements regarding the Lifetime Learning Credit?

A. For taxable years beginning in 2019, a taxpayers’ modified adjusted

gross income must be less than $68,000 ($136,000 for a joint return) to qualify for the

Lifetime Learning Credit (LLC).

B. The credit is 20% of the first $10,000 of qualified education expenses paid for all

eligible students.

C. The lifetime learning credit is available for all years of postsecondary education of a


D. The LLC can be claimed for only 4 years of post-secondary degree program.

Answer Q1 – D is the correct answer.

The statement is incorrect because, there is no limit to the number of tax years that a taxpayer

may claim a lifetime learning credit for any particular student

A – C are all correct statements

For taxable years beginning in 2019, a taxpayers’ modified adjusted gross income must be less

than $68,000 ($136,000 for a joint return) to qualify for the Lifetime Learning Credit (LLC).

The credit is 20% of the first $10,000 of qualified education expenses paid for all eligible

students.

The lifetime learning credit is available for all years of postsecondary education of a


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Qualified Tuition Plan or §529 Plan

A qualified tuition program (commonly referred to as a “qualified tuition plan” or “529 plan”)

is a program established and maintained by either a state; or an eligible educational institution

under which a taxpayer can prepay, or contribute to an account that will be used to pay a

designated beneficiary’s qualified higher education expenses.

Observation: Prior to 2018, the term “higher education expenses”, as used in IRC §529, had

roughly the same meaning as it does in everyday use: expenses incurred for college and other

forms of postsecondary education. Beginning in 2018, however, the term was expanded to

include tuition for elementary and secondary schools, making the definition more taxpayer-

friendly, but also more confusing.

Contributions to QTPs are not deductible. QTP distributions used for postsecondary education

expenses are generally nontaxable. Distributions used for tuition paid in connection with

enrollment or attendance at a public, private, or religious elementary or secondary school are

also nontaxable, but are subject to a $10,000 annual limit. In certain instances, taxes may apply

to QTP distributions. While it is possible to lose money on an investment in a QTP, it is not

common. However, should this occur, a limited deduction may be available.

Allowing 529 plans to be used for K-12 tuition 529 plans are tax-advantaged investment accounts originally designed to help families pay for

college. The earlier the taxpayer starts saving, the greater he or she will benefit from tax-free

compounding. Currently, 529 withdrawals are tax-free as long as the funds are spent toward

qualified higher education expenses, which include tuition, room and board, and computer

software and equipment at any eligible post-secondary institution.

Under TCJA, parents who send their children to private elementary and high school will have

more options when it comes to saving for tuition. Up until now, the only vehicles that offered

tax-free savings for K-12 were Coverdell Education Savings Accounts (ESAs). With tax-free

earnings growth and tax-free withdrawals for qualified purchases, Coverdell ESAs operate

very similar to a 529 savings plan. There are, however, a few key differences:

TCJA allows 529 plans to be used for up to $10,000 per year in K-12 tuition expenses, giving

more families an opportunity to save tax-free for private and religious schools. Families who

are currently saving with a Coverdell ESA and want to switch to a 529 plan can do a rollover

with no tax consequences.

Qualified education expenses must be reduced by any expenses paid directly or indirectly using

tax-free educational assistance.

https://www.savingforcollege.com/eligible_institutions/

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In general, for the purposes of the education tax credits, “qualified tuition and related

expenses135” are defined as tuition and fees (such as fees for books, supplies, and equipment

used in a course of study) that are required for the enrollment or attendance of an eligible

student at an eligible educational institution

Generally, qualified education expenses paid on behalf of the student by someone other than

the student (such as a relative) are treated as paid by the student. However, qualified education

expenses paid (or treated as paid) by a student who is claimed as a dependent on another tax

return are treated as paid by that taxpayer.

For more information and additional examples, see Who Can Claim a Dependent’s Expenses in

Pub. 970, Chapter 2 or 3.

Most students receive his or her Form 1098-T136 through his or her online accounts at the

college or university. It is a common item, which is not presented by the taxpayer at the tax

interview, it is essential that the preparer review this form to complete the allowable Education

Credits.

Recapture of Education Credit

With respect to any student, the amount of qualified tuition and related expenses for a tax year

is calculated by adding all qualified tuition and related expenses paid for the tax year, and

subtracting any refund of such expenses received from the eligible educational institution

during the same taxable year (including refunds of loan proceeds).137

If a taxpayer or someone other than the taxpayer receives a refund (including refunds of

loan proceeds) of qualified tuition and related expenses paid on behalf of a student in a

prior tax year and the refund is received before the taxpayer files a Federal income tax

return for the prior tax year, the amount of the qualified tuition and related expenses for

the prior tax year is reduced by the amount of the refund.

If a taxpayer receives a refund or someone other than the taxpayer receives a refund

(including refunds of loan proceeds) of qualified tuition and related expenses, paid on

behalf of a student for which the taxpayer claimed an education tax credit in a prior tax

year, the income tax for the refund year is increased by the recapture amount.

The recapture amount is the difference in tax liability for the prior tax year; and the

results the prior year is credit calculated with the refund included.

135 IRC§25A(f)(1)(A) 136 Form 1098T Instructions 137 Reg. Sec. 1.25A-5(f)

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If loan proceeds used to pay qualified tuition and related expenses during a tax year are

refunded by an eligible educational institution to a lender on behalf of the borrower, the

refund is treated as a refund of qualified tuition and related expenses.

If, a taxpayer or someone other than the taxpayer receives any excludable educational

assistance for the qualified tuition and related expenses paid on behalf of a student

during a prior tax year (or attributable to enrollment at an eligible educational

institution during a prior tax year), the educational assistance is treated as a refund of

qualified tuition and related expenses. If the excludable educational assistance is

received before the taxpayer files, a Federal income tax return for the prior tax year, the

amount of the qualified tuition and related expenses for the prior tax year is reduced by

the amount of the excludable educational assistance. If the excludable educational

assistance is received after the taxpayer has filed a Federal income tax return for the

prior tax year, any education tax credit claimed for the prior tax year is subject to

recapture

Example: Jack paid $7,000 of qualified education expenses in August 2017 and his son began

college in September 2017. Jack filed his 2017 tax return on February 15, 2018, and claimed an

American opportunity tax credit of $2,500 on his return. In March 2018, he received a refund

of $4,000 of the qualified education expenses. Jack must recalculate the credit using $3,000

($7,000 - $4,000) of qualified education expenses. The recalculated credit is $2,250. Jack must

include $250 ($2,500 - $2,250) of additional tax liability on his 2018 return.

There is a special rule for the treatment of refunds where qualified tuition and related expenses

are paid in two tax years for the same academic period. Under this rule, the taxpayer may

allocate the refund in any proportion to qualified tuition and related expenses paid in the prior

tax year or the subsequent taxable year if the taxpayer or someone other than the taxpayer:

Pays qualified tuition and related expenses in one tax year for a student’s enrollment or

attendance at an eligible educational institution during an academic period beginning in

the first three months of the taxpayers’ next tax year;

Pays qualified tuition and related expenses in the subsequent tax year for the academic

period beginning in the first three months of the subsequent tax year; and

Receives a refund of qualified tuition and related expenses during the subsequent tax

year for the academic period beginning in the first three months of the subsequent tax

year.

However, the amount of the refund allocated to a tax year may not exceed the qualified tuition

and related expenses paid during the tax year with respect to the academic period beginning in

the subsequent tax year. The sum of the amounts allocated to each tax year cannot exceed the

amount of the refund.

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Qualified Tuition Program and Coverdell Education Savings Comparison

Qualified Tuition Program 138(QTP)

Coverdell Education Savings

Account139 (Coverdell ESA)

Description A program that allows the taxpayer

to either prepay or contribute to an

account for a student’s higher

education. Up to $10,000 can be

used for K-12. May be state or

private plan.

Accounts used to pay qualified

education expenses of a

designated beneficiary.

Ownership U.S. Citizen with a valid SSN,

including beneficiary. Beneficiary

and owner do not need to be

related.

Beneficiary or parent.

Age limit None No contribution once beneficiary

is over 18 and balance must be

distributed by age 30. Age limits

do not apply to beneficiaries with

special needs.

Contributors Any individual including

beneficiary.

No income limits.

$2,000 per beneficiary, no matter

how many Coverdell ESA’s are

set up for that beneficiary.

Contribution Limits No annual limits.

Account balance limits may be set

by plan. Most state plans are over

$200,000

Contributor subject to annual

phase-out range of $95,000 to

$110,000 ($190,000 to $220,000

for MFJ)

Who is Taxed? Owner, unless the distribution is

paid directly to beneficiary or for

the benefit of beneficiary.

Designated Beneficiary

Deadline None April 15 of the year following the

close of the tax year.

QTP and Coverdell ESA

When dealing with QTPs and ESAs it is important to understand all terminology:

A half-time student is a student who is enrolled for at least half the full-time academic

workload for the course of study the student is pursuing. The school determines what is

considered a fulltime workload for a particular course of study. Form1098-T Box 8 will

be checked.

138 IRC §529 139 IRC §530

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Tax-free education assistance includes:

o The tax-free portion of a scholarship or fellowship – Form 1098-T, Box 5

o Veterans’ educational assistance

o Pell grants – Form 1098-T, Box 5

o Employer-provided educational assistance

o Any other tax-free payments received as educational assistance (except gifts or

inheritances)

Tax-free Distributions

o Distributions are not taxable if less than the beneficiary’s adjusted qualified

expenses for the year.

o Nontaxable distributions are not reported on the tax return.

Taxable Distributions

o If distributions are more that the adjusted expenses, portion of the earnings are

taxable

Keep in Mind: A student or the student’s parent may claim the American Opportunity and

Lifetime Learning Credits in the same year as a Coverdell ESA or a QTP distribution is

taken as long as the same qualified expenses are not used for both.

NOTE: Covid-19 has disrupted many plans in 2020. A taxpayer withdrew money from a QTP

or 529 plan to pay for qualified higher education expenses, including room and board for his

son; Covid-19 force the dorms to close and his son had to return home. The son completes the

semester online and the father got a refund for the room and board. The refund for qualified

education expenses including room and board can be recontributed to the QTP within 60 days

of receiving it. The recontributed amount cannot exceed the refunded amount. 140

ABLE Accounts TCJA increases the contribution limitation to Achieving a Better Life Experience (ABLE)141

accounts under certain circumstances. While the general overall limitation on contributions

(the per-donee annual gift tax exclusion ($15,000 for 2020) remains the same, the limitation is

increased with respect to contributions made by the designated beneficiary of the ABLE

account. Under the provision, after the overall limitation on contributions is reached, an ABLE

account's designated beneficiary can contribute an additional amount, up to the lesser of (1) the

federal poverty line for a one-person household; or (2) the individual's compensation for the

tax year. Additionally, the provision allows a designated beneficiary of an ABLE account to

claim the saver's credit for contributions made to his or her ABLE account.

The provision is effective for tax years beginning after December 22, 2017 and will sunset

after December 31, 2025.

140 IRC §529(c)(3)(D) 141 IRC §529A

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Rollovers: TCJA allows existing 529 savings plans to be rolled into 529 ABLE accounts.

ABLE accounts were first introduced in 2014, to help Americans living with disabilities save

for education and other living expenses. Prior to the ABLE Act, if a person with a disability

earned more than $700 per month, or had $2,000 or more in savings, they risked having to

forfeit eligibility for public benefits like Medicaid. Like traditional 529 plans, ABLE accounts

offer tax-free investment growth and tax-free withdrawals when the funds are used to pay for

qualified expenses. For ABLE accounts, this includes things like college, job training, and

healthcare and financial management.

In some cases, parents start saving for their child’s college education in a traditional 529 plan,

and later learn that the child has a disability. Before now, these parents had limited options,

since taking a distribution from the 529 plan to fund an ABLE account would have been

considered a non-qualified withdrawal – triggering income tax and a 10% penalty on the

earnings portion. Twenty-seven states currently offer ABLE plans, each with their own fee

structure and investment options. Some plans also offer a debit or purchasing card for everyday

expenses.

U.S. Savings Bonds Interest Exclusion

When purchasing a Series EE bond, or I bond the taxpayer pays the face value of the bond. It

accrues interest until the bond matures.

The difference between the purchase price and the redemption value is taxable interest income.

The taxpayer can report interest income142 from Series EE, and I bonds in one of these ways:

Report the interest in the year it is earned.

Report the entire amount of interest earned when the bond matures or when it is

redeemed whichever comes first.

Example: The taxpayer purchased a $1,000 Series I bond that earns 4% interest, and keeps

it for 5 years. The taxpayer can either report $40 each year in interest, or wait to report

$200 in interest when he redeems the bond.

Upon redemption, the taxpayer will receive a Form 1099-INT that reports the full amount of

interest the bond earned. If the interest was reported when earned every year, the taxpayer

subtracts the interest paid in prior years from his or her taxable income.

By reporting interest annually, the taxpayer can even out income over the years. This is useful

if the U.S. Savings Bond interest is substantial. If this method is chosen, it must be continued.

This:

Includes the interest for bonds owned or later acquired

Applies to all Series EE, Series E, and Series I bonds

For most investors, it probably works out better to report the interest when the bond is

redeemed.

142 Regs. § 1.61-7(b)(3) (The election is set forth in § 454 ).

https://www.savingforcollege.com/529-able-accounts/

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Income from United States Savings Bonds for Taxpayers Who Pay Qualified Higher

Education Expenses 143 The taxpayer can help cover college expenses by investing in bonds or by cashing in bonds

previously purchased. The bond interest can be excluded from taxable income if both of these

apply:

The taxpayer redeems Series EE bonds purchased after 1989 or Series I bonds.

The money is used to pay qualified education expenses.

To qualify for this tax break:

The bonds must be Series EE bonds purchased after 1989 or Series I bonds.

The student cannot own the bonds. The bonds must be in one of these names:

o Taxpayers’ name

o Taxpayers’ spouse’s name

o Both the taxpayer and the spouse’s names as co-owners

The taxpayer must be at least age 24 in the month before the bond was issued.

If the redemption amount of the bond is more than the total qualified education expenses, the

taxpayer can only exclude a portion of the interest. Use Form 8815 to figure the interest that

can be excluded from income. The interest exclusion is phased out at higher income levels

based on modified adjusted gross income (MAGI). Use Form 8815 to figure the modified AGI.

For taxable years beginning in 2020, the exclusion, regarding income from United States

savings bonds for taxpayers who pay qualified higher education expenses, begins to phase-out

for modified adjusted gross income above $123,550 for joint returns and $82,350 for all other

returns. The exclusion is completely phased out for modified adjusted gross income of

$153,550 or more for joint returns and $97,350 or more for all other returns.

Qualified educational expenses include:

Tuition and fees (such as lab fees and other required course expenses).

Expenses that benefit the taxpayer, spouse, or a dependent for which the taxpayer can

claim an exemption.

Expenses paid for any course required as part of a degree or certificate-granting

program.

Expenses paid for sports, games, or hobbies qualify only if part of a degree or

certificate program.

Keep in Mind: The costs of books or room and board are not qualified expenses.

The amount of qualified expenses is reduced by the amount of any scholarships, fellowships,

employer-provided educational assistance, and other forms of tuition reduction (such as

education credits).

143 IRC §135

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The taxpayer must apply both the principal and interest from the bonds to pay qualified

expenses in order to exclude the interest from his or her gross income. If the amount of eligible

bonds cashed during the year exceeds the amount of qualified educational expenses paid during

the year, the amount of excludable interest is reduced pro rata.

Example: John and Maria Sample cashed his or her Series EE Bonds to pay for his or

her daughter Jasmine’s college education. Their modified adjusted gross income is

$111,000.The qualified education expenses is $9,000, the amount of interest income is

$3,240 the total principal and interest of the bond is $6,240.

The entire amount of interest would be excluded, since the qualified expenses are more

than the distribution and the Sample’s adjusted gross income is less than the phase-out

of the exclusion. The interest is reported as income on Schedule B, Line 1; the

exclusion is reported on Line 3 of Schedule B, Form 8815 must be included in the

return.

Student Loan Interest144

The student loan interest paid in 2019 limited to $2,500 is an above the line deduction

depending on the AGI and filing status of the taxpayer. For 2019, the deduction phase-out for

Single, Head of Household or Qualifying Widow is more than $70,000 but less than $85,000.

The MFJ phase-out is more than $140,000 but less than $170,000.

The deduction is claimed as an adjustment to income so John does not need to itemize his

deductions on Schedule A. He can claim the deduction if all of the following apply:

He paid $3,200 in interest on a qualified student loan in tax year 2019.

He is legally obligated to pay interest on a qualified student loan

His filing status is not Married Filing Separately

His modified adjusted gross income is less than a specified amount which is set

annually, and

o John and his wife, if filing jointly, cannot be claimed as dependents on someone

else's return

o A qualified student loan is a loan taken out solely to pay qualified higher

education expenses.

Since John paid $700 over the maximum in student loan interest, he received Form 1098-E.

John can deduct the full $2,500 in 2019.

144 IRC §221

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Student Loans Discharged on Account of Death or Disability

TCJA modifies the exclusion of student loan discharges from gross income, by including

within the exclusion certain discharges at death or total and permanent disability of the student.

Loans eligible for the exclusion under the provision are loans made by

(1) The United States (or an instrumentality or agency thereof),

(2) A state (or any political subdivision thereof),

(3) Certain tax-exempt public benefit corporations that control a state, county, or

municipal hospital and whose employees have been deemed to be public employees

under state law,

(4) An educational organization that originally received the funds from which the loan

was made from the United States, a State, or a tax-exempt public benefit corporation, or

(5) Private education loans.145

Under previous legislation, loans discharged due to death or totally and permanently, disabled

were viewed as income tax by the IRS. This means that individuals had to pay taxes on this

money just as they would with their yearly wages. The higher income status actually

disqualified many from receiving means-based government benefits like Medicaid and SSI–

benefits designed in part to help individuals with disabilities who cannot work.

Example: If someone with the current average student loan debt of $37k had their

student loans discharged, they would end up with a tax bill of anywhere between

$3,700 to $14,800 depending on their tax bracket.

The provision applies to discharges of loans after December 31, 2017, and before January 1,

2026.

MAGI when using Form 1040.

If the taxpayer files Form 1040, the MAGI is the AGI on line 8b of that form figured without

taking into account any amount on Schedule 1 (Form 1040), line 20 (student loan interest

deduction), line 21 (tuition and fees deduction) and modified by adding back any:

Foreign earned income exclusion,

Foreign housing exclusion,

Foreign housing deduction,

Exclusion of income by bona fide residents of American Samoa, and

Exclusion of income by bona fide residents of Puerto Rico.

145 Section 1407 of Consumer Protection Act

https://www.studentdebtrelief.us/student-loans/student-debt-statistics/

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What Do You Think?

Q1. A graduate student took one class at Harvard in 2020 and received a Form

1098T. He wants to take an education credit (assume he meets all

requirements). Which of the following is not correct?

A. The Lifetime Learning Credit applies to undergraduate, graduate, and

professional degree courses, and even to post-graduate courses that

help improve job skills

B. For purposes of the Lifetime Learning Credit, qualified education

expenses are tuition and certain related expenses required for enrollment in a course at

an eligible educational institution.

C. The graduate student would qualify for either the American Opportunity Credit or the

Lifetime Learning Credit.

D. The Lifetime Learning Credit is not refundable, so it will not be paid to the taxpayer in

a refund, it will decrease the tax liability.

Q2. All of the following are a true statement, except?

A. The maximum credit available to a taxpayer who has three children in college, for each

of which the taxpayer claims a dependent exemption, is $7,500 if claiming the

American Opportunity Credit.

B. A taxpayer whose parents claim his or her dependent exemption is allowed American

Opportunity Credit.

C. A taxpayer receives an education credit for tuition expense paid in 2018. He or she

receives a refund of those expenses paid the following year after his or her 2018 return

was filed. The taxpayer must repay the difference in tax liability on his 2019 tax return.

D. The American Opportunity Credit is usually the more favorable education credit if the

student qualifies.

Q3. Which of the following is not a correct statement regarding Form 1098-T?

A. Student Loans are reported on Form 1098-T.

B. Grants or Scholarships are reported on Form 1098-T.

C. Tuition paid to the educational institution is reported on Form 1098-T.

D. The Federal ID Number of the educational institution is reported on Form 1098-T.

Q4. Which of the following was created as a savings account to assist parents in paying for

educational expense for K-12?

A. Coverdell ESA

B. Student Loan Interest Deduction

C. American Opportunity Credit

D. Lifetime Learning Credit

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A1: C – Is the correct answer - IRC §25A – Hope and Lifetime Learning

Credits

The American Opportunity Credit applies only to the first four year of post-

secondary school education. Therefore, the graduate student is not eligible

for the American Opportunity Credit.

The Lifetime Learning Credit applies to undergraduate, graduate, professional degree courses,

and post-graduate courses to improve job skills. There is no limit as to the number of years the

taxpayer can claim the credit and no minimum enrollment requirements. Qualified expenses

include tuition and certain related expenses required for enrollment in a course at an eligible

educational institution. Unlike the American Opportunity Credit, the Lifetime Learning Credit

is not refundable and can be used only to reduce tax liability.

A2: B – Is the correct answer

The taxpayer cannot claim the American Opportunity Credit if the parents chose not to claim

the dependent exemption even though they are allowed to do so. The taxpayer is not allowed to

claim the personal exemption for him or herself.

The maximum American Opportunity Credit available is $2,500 per eligible student compared

to the Lifetime Learning Credit, which allows a maximum credit of $2,000 per tax return.

What does a taxpayer do who uses education expenses to calculate an education credit and

after the return is filed, receives a refund of education expenses that were used in this

calculation? He or she must refigure the education credit using the amount of education

expenses originally used less the refund. The taxpayer must then pay any difference in tax

liability cause by the decrease in education credit on the taxpayers’ next tax return.

A3: A is the correct answer Form 1098T, Tuition Statement does not report student loan interest, that is reported on Form

1098-E, Student Loan Interest Statement. A 1098T is a vehicle to report information to the

taxpayer regarding the payments made or billed through the year, as well as pertinent

information needed to complete Form 8863.

A4: A - Is the correct answer.

This account was created as an incentive to help parents and students save for education

expenses. A Coverdell ESA can be used to pay a student’s eligible K-12 expenses, as well as

post-secondary expenses. On the other hand, income limits apply to contributors, and the total

contributions for the beneficiary of this account cannot be more than $2,000 in any year, no

matter how many accounts may have been established.

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A beneficiary is someone who is under age 18 or is a “special needs” individual.

Contributions to a Coverdell ESA are not deductible, but amounts deposited in the account

grow tax free until distributed. The beneficiary will not owe tax on the distributions if less than

a beneficiary’s qualified education expenses at an eligible institution. This benefit applies to

qualified higher education expenses as well as to qualified elementary and secondary education

expenses.

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Objective: Explanations and examples of :

Relevant Pass-through Entities

Rental Activities

QBI

Form 1040 and Schedules

Forms 8995 and 8995A

Chapter 4 –Relevant Pass-through Entities (RPE), Rental Activities and

Qualified Business Income (QBI)

On January 18, 2019, the IRS and the Treasury Department issued final regulations and three

related pieces of guidance, implementing the new qualified business income (QBI) deduction

under §199A. Tax Cuts and Jobs Act (TCJA) added Code Sec. 199A, which provides the

deduction for qualified business income (QBI) for tax years beginning after December 31,

2017, and before January 1, 2026. The QBI deduction was enacted to provide tax relief to

small businesses that do not operate as C corporations, because C corporation tax rates were

significantly reduced under the TCJA, from graduated rates with a top rate of 35% to a flat rate

of 21%. Unlike the qualified business income (QBI) deduction, the corporate rate change is

permanent, and the TCJA eliminated the alternative minimum tax (AMT) for corporations.146

In general, if the total taxable income in 2019 was under $160,700 for single filers or $321,400

for joint filers, the taxpayer may qualify for the deduction. In 2020, the limits are $163,300 for

single filers or $326,600 for joint filers. If the taxpayer is over that limit, complicated IRS rules

determine whether the business income qualifies for a full or partial deduction

Qualified Business income comes from a relevant pass-through entity (RPE) such as a

partnership (other than a Publicly Traded Partnership (PTP)) or an S corporation that is owned,

directly or indirectly, by at least one individual, estate, or trust or a sole proprietorship.

The final regulations are similar to the proposed regulations in defining a trade or business.

The IRS has declined to adopt a definition other than deferring to §162 and saying it is an

activity (other than as an employee) carried on regularly and continuously for profit. The

regulations provide one exception to the trade or business requirement for rentals.

A rental activity will be treated as trade or business if it is rented as a commonly controlled

trade or business owned by the taxpayer making a self-rental a trade or business even if the

activity might not have otherwise satisfied that standard. Commonly control means the

property must be rented as an individual or pass-through. The individual or pass-through must

own 50 percent or more of both the property and business.147 This differs from the proposed

regulations.

The final regulations note that taxpayers should report items consistently in all cases where the

Code uses the trade or business standard. For example, if the taxpayer is treating a rental

activity as a trade or business for purposes of §199A, the taxpayer should comply with the

information reporting requirements and issue Form 1099 when appropriate.

146 TCJA §§13001 and 12001 147 IRC §§707(b), 267(b)

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A qualified trade or business is any Section 162 trade or business, with three exceptions:

1. A trade or business conducted by a C corporation.

2. For taxpayers with taxable income that exceeds the threshold amount, specified service

trades or businesses (SSTBs). An SSTB is a trade or business involving the

performance of services in the fields of health, law, accounting, actuarial science,

performing arts, consulting, athletics, financial services, investing and investment

management, trading, dealing in certain assets or any trade or business where the

principal asset is the reputation or skill of one or more of its employees or owners.

NOTE: The SSTB exception does not apply for taxpayers with taxable income below

the threshold amount and is phased in for taxpayers with taxable income above the

threshold amount. For 2019, the threshold amount is $321,400 for a married couple

filing a joint return, or $160,700 for all other taxpayers. The threshold amounts will be

adjusted for inflation in subsequent years.

3. The trade or business of performing services as an employee

NOTE: Wages or salaries, reasonable compensations to S-Corporation owners

(Form W-2) or guaranteed payments from a partnership (Form 1065 K-I Part III,

Line 4) are not included in QBI.

Regulations Regarding Section 199A

The QBI of an RPE is determined at the shareholder/partner level, and the deduction has no

effect on the adjusted basis of a partner's interest in the partnership or a shareholder's basis in S

corporation stock.

Relevant Pass-through Entities (RPE)

S Corporation Partnership LLC

Pertinent Part

of Internal

Revenue Code

Subchapter S; Code

Sections 1361 through

1379.

Subchapter K; Code


777.

Subchapter K; Code


777.

IRS Resource Form 2553, Election

by a Small Business

Corporation.

Publication 541,

Partnerships.

Form 8832, Entity

Classification Election.

Ownership and

Capital

Structure

No more than 100

shareholders and

limitations on who can

own stock. Can only

have one class of stock

(but voting differences

allowed).

Need at least two

partners; otherwise no

limitation on "who and

how many." Limited

partnerships have one

or more limited

partners.

Default for single

member LLCs is

disregarded for federal

tax purposes while

multi-member LLCs

are treated as

partnerships.

http://www.parkertaxpublishing.com/LinkDirector.aspx/C%5E~DataLocal~_LinksToPDF~pub~Publications_1_-_972~350-29459-Pub_541z

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S-Corporation Partnership LLC

Limited

Liability for

Owners

Shareholders are not

liable for debts

incurred by the

corporation. Their

liability is generally

limited to amount

invested.

General partners are

personally liable for all

partnership debts.

Limited partner's

liability is generally

limited to amount

invested.

Like shareholders,

members are not liable

for debts incurred by

the LLC, whether a

single member LLC or

a multi-member LLC.

Continuity of

Life

Usually unlimited life,

unless otherwise

limited in Articles of

Incorporation.

However, a number of

eligibility rules must

be monitored and met

to retain S status.

Depends on state law

or entity agreement.

Terminates for federal

tax purposes if 50% or

more of capital and

profits interests are

transferred within a 12-

month period.

Depends on state law or

articles/agreement.

Multi-member LLC

termination governed

by partnership rules,

while single member

LLC ends/dissolves

when owner dies.

Management

of Entity

Managed by board of

directors who appoint

the corporate officers.

In a general

partnership, the

partners specify each

person's role. In a

limited partnership, the

general partners

manage the business.

LLC can be member-

managed, in which case

all members share

responsibility for the

day-to-day operations,

or manager-managed.

Transferability

of Ownership

Interests

Transferable, but may

be limited by buy/sell

agreement. In addition,

transfer must not

terminate S status.

Transfer rights are

governed by state law

and the partnership

agreement, if one

exists.

Transfer rights are

governed by state law

and the operating

agreement.

Income

Taxation of

Entity

Income taxed once to

the shareholders,

although some S

corporations are

subject to built-in gains

tax.

Income taxed once to

the partners.

In single member LLC,

owner is taxed. In

multi-member LLC,

income taxed once to

members.

Income

Taxation of

Owners (Who

are Assumed to

be Individuals)

Pass-through and

distributions taxed at

maximum rate of 20%

or 39.6%.

Partnership items and


maximum rate of 20%

or 39.6%.

LLC items and


maximum rate of 20%

or 39.6%.

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Self-

employment

(SE) and

Payroll

Taxation of

Owners

No SE tax. Wages

subject to payroll taxes,

while dividend

distributions subject

only to income tax.

However, risk that

distributions will be

classified as wages

subject to payroll taxes

if reasonable wages are

not paid.

General partners treat

their share of business

income and guaranteed

payments for services

or use of capital as SE

income. Limited

partners only report

guaranteed payments

for services as SE

income.

Members generally

treat their share of

business income and

guaranteed payments

for services or use of

capital as SE income.

Members treated as

limited partners only

report guaranteed

payments for services

as SE income.

Capital Gains

and Losses

Passed through to

shareholders who may

be eligible for reduced

tax rate.

Passed through to

partners who may be

eligible for reduced tax

rate.

Passed through to

members who may be

eligible for reduced tax

rate.

Alternative

Minimum Tax

(AMT)

Owed by shareholders;

entity must provide

AMT information to

them.

Owed by partners;

entity must provide

AMT information to

them.

Owed by members;

entity must provide

AMT information to

them.

Entity-level

Penalty Taxes

Built-in gains tax, tax

on excess net passive

investment income,

and LIFO recapture

tax.

No income taxes of any

kind can be assessed

against partnership.

No income taxes of any

kind can be assessed

against LLC taxed as

partnership.

Deductibility of

Losses

Losses passed through

to shareholders, and

are deductible under

the basis, at-risk, and

passive activity loss

rules, in that order.


to partners, and are

deductible under the

basis, at-risk, and




to members, and are

deductible under the

basis, at-risk, and



Passive Activity

Loss (PAL)

Rules

Apply at the

shareholder level; do

not apply to the S

corporation.

Apply at the partner

level; do not apply to

the partnership.

Apply at the member

level; do not apply to

the LLC.

At-risk Rules Apply at the

shareholder level.

Apply at the partner

level.

Apply at the member

level.

Unreasonable

Compensation

Unreasonably, low

compensation can be

paid to shift income to

family members or

avoid employment

taxes.

Not an issue, although

IRS may question

partner's status as

employee.

Not an issue, although

IRS may question

member's status as

employee.

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Section 179

Dollar

Limitation

Applies at the S

corporation level and

the shareholder level.

Applies at the

partnership level and

the partner level.

Applies at the LLC

level and the member

level.

Fringe Benefits

for Owners

Health and some other

benefits for

shareholders owning

more than 2% of stock

treated as

compensation or a

distribution.


benefits for partners

treated as guaranteed

payment or a

distribution.


benefits for members

treated as guaranteed

payment or a

distribution.

As for carryovers of unused deductions, the regulations clarify that QBI cannot be less than

zero, and the carryforward of QBI does not affect the current-year deduction for purposes of

other sections of the code. They also clarify that if an individual has an overall loss after

adding qualified REIT dividends and PTP income, then the portion of the Sec. 199A deduction

related to the REIT and PTP income is zero for the tax year, and it does not affect QBI for the

year. Instead, the loss from the REIT or PTP is carried forward and used to offset REIT/PTP

income in the succeeding year or years for Sec. 199A purposes.

For taxpayers who have multiple trades or businesses, the regulations provide that losses are

netted with income before the application of limitations for individuals over the threshold

amount, based on W-2 wages and unadjusted basis immediately before acquisition (UBIA) of

qualified property and determining QBI. The regulations also clarify that QBI deduction does

not reduce net earnings from self-employment or net investment income and it does not result

in AMT.

If an individual's taxable income exceeds the threshold amount, QBI imposes a limit on the

deduction based on the greater of either W-2 wages paid or the wages paid and UBIA.

Simultaneously with its release of the regulations, the IRS also issued Rev. Proc. 2019-11,

which provides three methods of calculating W-2 wages. The three methods for determining

W-2 wages are substantially similar to the methods provided in Rev. Proc. 2006-47.

The regulations clarify that QBI applies to income that is effectively connected with a U.S.

trade or business148. The QBI is computed on the trade or business (IRC §162) not on the

individual receiving the deduction.

148 IRC §864(c)

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Any item of short-term capital gain, short-term capital loss, long-term capital gain, or long-

term capital loss, including any item treated as one of these items, that are treated as capital

gains or losses, is not taken into account as a qualified item of income, gain, deduction, or loss.

If they are not capital gains or losses, they are included in QBI.

Interest income on accounts or notes receivable for services or goods of the trade or business is

included in QBI, while interest income on working capital and reserves is not QBI, since it is

held for investment.

Reasonable compensation149 is excluded from the computation of QBI. Similarly, guaranteed

payments from a partnership150 for services are excluded. The regulations clarify that the term

"reasonable compensation" is limited to the compensation paid by an S corporation but does

not extend this rule to partnerships for purposes of this section. Rather, the regulations state

that this rule is intended to clarify that even if an S corporation fails to pay a reasonable salary

to its shareholder-employees, it is nonetheless precluded from including an amount equal to

reasonable compensation in QBI.

In the case of expenditures that are allocable to more than one of the taxpayers’ trades or

businesses, the regulations do not specify any allocation methods, but they allow the use of any

reasonable method as long as it is consistently applied.

149 IRC §199A (c)(4)(A) 150 IRC§707(c)

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Form 1040

Form 1040 (Page 1 and 2 on the next pages) were redesigned for 2019 tax year. The number of

schedule were reduced and combined into three new schedules. These schedules will be used

as needed to complete complex tax returns. Also included with Form 1040 are schedules and

forms that were used in prior years. These schedules and forms were revised in 2019.

Form 1040 example is of John Sample who is a photographer; he lives with his son Michael

and files Head of Household. Michael has lived with John full time since 2015; he qualifies for

the Child Tax Credit. John files Head of Household.

John is the only shareholder of ABC Photography, an S-Corporation. The S-Corporation pays

John wages of $70,000 and pays his family health insurance of $9,500.

S corporations must pay himself a reasonable compensation as a shareholder-employee

in return for services that the employee provides to the corporation before non-wage

distributions may be made to the shareholder-employee. The amount of reasonable

compensation will never exceed the amount received by the shareholder either directly

or indirectly.

Health insurance premiums paid on behalf of a greater than 2-percent S corporation

shareholder-employee are deductible by the S corporation and reportable as wages on

the shareholder-employee’s Form W-2, subject to income tax withholding.

In the example, John is a 100% shareholder and $9,500 of health insurance premiums

are included in Box 1 of his W-2, wages, tips and other compensation. The $9,500

premium is not included in Box 3, Social Security wages and tips or in Box 5, Medicare

wage. These additional wages are not subject to Social Security, Medicare (FICA), or

Unemployment (FUTA) taxes if the payments of premiums are made to or on behalf of

an employee under a plan or system, that makes provision for all or a class of

employees (or employees and their dependents).

John is the sole proprietor of a design business (See Schedule C below). John

contributed $15,000 to his IRA account.

John Sample reported his wages on Line 1 of Form 1040. John received a 1099DIV from

Morgan Stanley which reported ordinary dividends of $4,500 of which $1,650 were qualified

dividends (see Form 1040, Line 3). Form 1099DIV from Morgan Stanley also reported Section

199A dividends in Box 5 of $800 which is a portion of the ordinary dividends reported in Box

1 of Form 1099DIV. (See the Form 8995, line 6 later in this text). John contributed $5,000 to

his IRA account. John is also the sole proprietor of his design business.

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Schedule 1, Part 1 is used for additional income and adjustments to income. Schedules 1, 2 and

3 all flow to Form 1040. In this example the additional income is from Schedule C and the S-

Corp which flow to Schedule E, page 2 and then to Schedule 1 and Form 1040. The

adjustments are John’s deductible portion of SE Tax, self-employed health insurance and his

IRA contribution. (See the example below).

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A 2-percent shareholder-employee is eligible for an above-the-line deduction in arriving at

AGI for amounts paid during the year for medical care premiums (Self-employed health

insurance, Line 16, Schedule 1) if the medical care coverage was established by the S

corporation and the shareholder met the other self-employed medical insurance deduction

requirements. If, however, the shareholder or the shareholder’s spouse was eligible to

participate in any subsidized health care plan, then the shareholder is not entitled to the above-

the-line deduction.151 Since the SE health insurance amount is not included in the gain or loss

in Box 1 of Schedule K-1 it is not a deduction on determining the QBI.

151 IRC § 162(l).

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Schedule C and QBI Worksheet

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In the example below the unadjusted basis immediately after acquisition (UBIA) of qualified

property generally equals the cost of tangible property subject to depreciation that satisfies all

of the following criteria:

The property is both held by and available for use in the trade or business at the close of

the tax year;

The property is used at any point during the tax year in the production of the trade or

business's QBI; and

The property's depreciable period for UBIA of qualified property purposes has not

ended before the close of the taxpayer's tax year.

For purposes of the third criterion, the property's depreciable period is either 10 years after the

property is placed in service, or the last day of the last full year of the property's normal Sec.

168(c) depreciable period, whichever is later.

An asset with a five- or seven-year depreciable life under the modified accelerated cost

recovery system (MACRS) has a depreciable life of 10 years for UBIA of qualified property

purposes, while a building has a depreciable life of 39 years for both MACRS and UBIA

purposes. In 2018, John had purchased a computer used 100% for his design business for

$3,860 with a five year life. John took bonus depreciation on the computer in 2018. He must

continue to include the UBIA for 10 years or until the day he removes the computer from

service. (See Line 14 Below

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S-Corporation and QBI Worksheet

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The income from S-Corporation - ABC Photography is reported on Schedule E, page 2 (see

above). The Section 179 deduction is netted with the income before reporting it on Schedule 1

and before the computation of QBI. TCJA and the related regulations state that losses or

deductions that were disallowed, suspended limited or carried over from taxable years ending

before January 1, 2018152 and in a later taxable year for purposes of computing QBI. QBI does

not affect the taxpayers’ basis in the S-Corporation or a partnership, the basis computation is

done on the entity level.

The income from each entity is computed separately and then combined on 2019 Form 8995.

The Schedule C is John’s second business and qualifies for QBI. The net profit from Schedule

C, which includes the Section 179 and the business use of home deductions, is entered on line

1 below. The gain from Schedule C is reduced by the deductible portion of self-employment

tax, which is directly related to this business.

For individuals with taxable income that does not exceed the threshold amount the QBI

deduction is determined by adding:

(1) 20 percent of the total QBI amount (including QBI attributable to a

Specified Service Trades or Business); plus

(2) 20 percent of the combined amount of qualified REIT dividends and

qualified publicly traded partnership (PTP) income (including the individual's

share of qualified REIT dividends, and qualified PTP income from RPEs).

REIT Dividends

Qualified REIT dividends include any dividend received from a real estate investment trust

held for more than 45 days and for which the payment is not obligated to someone else and that

is not a capital gain dividend or qualified dividend plus qualified REIT dividends received

from a regulated investment company.

Ordinary REIT dividends are taxed at ordinary rates as opposed to the lower qualified dividend

rates. The new Sec 199A rules allow a taxpayer to deduct 20 percent of the REIT dividend

amount reported as income. Qualified Dividends are also part of ordinary dividends and are

shown in box 1b of the Form 1099-DIV.

The maximum rate of tax on qualified dividends is the same as long term capital gains:

• 0% on any amount that otherwise would be taxed at a 10% or 15% rate.

• 15% on any amount that otherwise would be taxed at rates greater than 15% but

less than 39.6%.

• 20% on any amount that otherwise would be taxed at a 39.6% rate.

152 IRC §§465,469,704(d) & 1366(d)

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To qualify for the maximum rate, all of the following requirements must be met.

The dividends must have been paid by a U.S. corporation or a qualified foreign

corporation.

The dividends are not of the type specifically excluded from qualified dividends.

The holding period must be met

To be qualified dividends the stock must be held for more than 60 days during the 121-day

period that begins 60 days before the ex-dividend date. The ex-dividend date is the first date

following the declaration of a dividend on which the buyer of a stock is not entitled to receive

the next dividend payment. When counting the number of days a stock is held include the day

the stock is disposed of but not the day it is acquired.

Along with IRC §199A dividends John has two other sources of QBI. John does computer

designs and layouts; this is a separate business from his S Corporation and is reported on

Schedule C as a sole-proprietorship.

The sum of these two items is then compared to 20 percent of the amount by which the

individual's taxable income exceeds net capital gain. The lesser of these two amounts is the

individual's deduction.153 The term "net capital gain" for purposes of Code Sec. 199A is

defined as net capital gain plus any qualified dividend income for the tax year.

If the total QBI amount is less than zero, the portion of the individual's Code Sec. 199A

deduction related to QBI is zero for the tax year. The negative total QBI amount is treated as

negative QBI from a separate trade or business in the succeeding tax year154.

If the combined amount of REIT dividends and qualified PTP income is less than zero, the

portion of the individual's QBI deduction related to qualified REIT dividends and qualified

PTP income is zero for the tax year. The negative combined amount must be carried forward

and used to offset the combined amount of REIT dividends and qualified PTP income in the

succeeding tax year of the individual for purposes of Code Sec. 199A. This carryover rule does

not affect the deductibility of the loss for purposes of other provisions.155

153 Reg. §1.199A-1(b)(3) 154 Reg. §1.199A-1(c)(2)(i) 155 Reg. § 1.199A-2(c)(2)(ii)

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Form 8995

2019 Form 8995 is used for this example (2020 Form 8995 has not been released as of the

printing of this document), the thresholds are based on 2019.

Form 8995 is used when the taxpayer

Has QBI, qualified REIT dividends, or qualified PTP income or loss,

The 2019 taxable income before the QBI deduction is less than or equal to $160,700

($160,725 if married filing separately or a married nonresident alien; $321,400 if

married filing jointly), and

The taxpayer is not a patron in a specified agricultural or horticultural cooperative.

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What Do You Think?

Q1. Which of the following is an exception to a qualified trade or business as

describe in Section 162?

A. Taxpayers with taxable income that exceeds the threshold amount,

specified service trades or businesses (SSTBs).

B. A trade or business conducted by a C corporation

C. The trade or business of performing services as an employee


Q2. Maria reports her income from her accounting business on Schedule C. Her profit for the

year is $60,000, her adjustments on Schedule 1 of Form 1040 directly related to her business

are $4,300 deductible portion of self-employment tax, $23,000 contribution to her SEP, and

$5,000 self-employed health insurance. What is the amount carried to Line 1 of Form 8995

(Qualified Business Income or Loss)?

A. $25,700

B. $12,000

C. $35,000.


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What Do You Think? _Answers

A1. Answer D Which of the following is an exception to a qualified trade or

business as describe in Section 162?

A. Taxpayers with taxable income that exceeds the threshold amount, specified

service trades or businesses (SSTBs).

B. A trade or business conducted by a C corporation

C. The trade or business of performing services as an employee


A qualified trade or business is any Section 162 trade or business, with three exceptions:

1. A trade or business conducted by a C corporation.

2. For taxpayers with taxable income that exceeds the threshold amount, specified service

trades or businesses (SSTBs). An SSTB is a trade or business involving the

performance of services in the fields of health, law, accounting, actuarial science,

performing arts, consulting, athletics, financial services, investing and investment

management, trading, dealing in certain assets or any trade or business where the

principal asset is the reputation or skill of one or more of its employees or owners. For

2019, the threshold amount is $321,400 for taxpayers filing MFJ, $160,700 for

taxpayers filing Single or HoH and $160,725 for MFS. The threshold amounts will be

adjusted for inflation in subsequent years.

3. The trade or business of performing services as an employee

A2. Answer – A Maria reports her income from her accounting business on Schedule C. Her

profit for the year is $60,000, her adjustments on Schedule 1 of Form 1040 directly related to

her business are $4,300 deductible portion of self-employment tax, $23,000 contribution to her

SEP, and $5,000 self-employed health insurance. What is the amount carried to Line 1 of Form

8995 (Qualified Business Income or Loss)?

A. $25,700- This is correct. $60,000- ($4,300+$23,000+$5000)=$25,700

B. $12,000 - This is incorrect, no deductions were taken, This is 20% of the

profit.

C. $35,000 - This is incorrect because only the SEP was deducted in

determining QBI.


QBI Explanation Worksheet.

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Calculating the Qualified Business Income Deduction below the Threshold

Speedy and Jumpy are married and earn $220,000/year, which includes $90,000 in

wages from Speedy’s job managing a theater, and $130,000 of net income from

Jumpy’s clothing store (a sole proprietorship business reported on her Schedule C). In

addition, the couple has $5,000 of ordinary dividends income. The couple’s taxable

income is $225,000, of which $130,000 is “Qualified Business Income”. Speedy and

Jumpy have no capital gains.

In 2019, the couple is eligible for a $24,400 standard deduction, making their taxable

income $200,600 (before calculating QBI). They will report a $26,000 QBI deduction,

further reducing their taxable income to $169,600. The calculation is as follows:

The lesser of

20% of taxable income - $200,600 x 20% =$40,120, or

20% of QBI - $130,000 x 20% = $26,000

Hewie, Dewie and Lewie all have $110,000 of net qualifying business income in 2019, but

each has different amounts of other income, itemized deductions and capital gains.

Example Hewie Dewie Lewie

(A) Net qualifying business income $110,000 $110,000 $110,000

Taxable Income before IRC §199A 140,000 80,000 130,000

Capital Gains 0 0 40,000

(B) Taxable Income less capital gains 140,000 80,000 90,000

Lesser of (A) or (B) 110,000 80,000 90,000

IRC §199A deduction (20% of above) $ 22,000 $ 16,000 $ 18,000

Trade or Business Requirement for QBI; Rental Real Estate Activities

Like any activity, to rise to the level of being a trade or business,156 a rental real estate activity

must be considerable, regular, and continuous in scope. In determining whether a rental real

estate activity meets those criteria, the IRS has stated that relevant factors might include, but

are not limited to, the following:

(1) The type of rented property (commercial real property versus residential property);

(2) The number of properties rented;

(3) The owner's or the owner's agents day-to-day involvement;

(4) The types and significance of any ancillary services provided under the lease; and

(5) The terms of the lease (for example, a net lease versus a traditional lease and a

short-term lease versus a long-term lease)

156 IRC§162

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Recognizing the difficulties taxpayers and practitioners may have in determining whether a

taxpayers’ rental real estate activity is sufficiently regular, continuous, and considerable for the

activity to constitute a trade or business, the IRS has provided a safe harbor under Code Sec.

199A for rental real estate activities.157.

Safe Harbor for Rental Real Estate Enterprise to Be Treated as a Trade or Business

The safe harbor for a rental real estate enterprise will be treated as a trade or business solely for

purposes of Code Sec. 199A and the calculation of the QBI deduction. For this purpose, a

rental real estate enterprise is defined as an interest in real property held for the production of

rents and may consist of an interest in multiple properties.

According to Notice 2019-7, the individual or relevant pass-through entity (RPE) relying on

the safe harbor must hold the interest directly or through an entity disregarded as an entity

separate from its owner. Taxpayers must either treat each property held for the production of

rents as a separate enterprise or treat all similar properties held for the production of rents (with

the exception of certain rental real estate arrangements that are excluded from the safe harbor

provisions, as discussed below) as a single enterprise. Commercial and residential real estate

may not be part of the same enterprise. Taxpayers may not vary this treatment from year-to-

year unless there has been a significant change in facts and circumstances.

Under the safe harbor and solely for the purposes of the QBI deduction, a rental real estate

enterprise will be treated as a trade or business if the following requirements are satisfied

during the tax year with respect to the rental real estate enterprise:

(1) Separate books and records are maintained to reflect the income and expenses for

each rental real estate enterprise.

(2) For tax years, beginning prior to January 1, 2023, 250 or more hours of rental

services are performed per year with respect to the rental enterprise.

For tax years, beginning after December 31, 2022, in any three of the five consecutive tax

years that end with the tax year (or in each year for an enterprise held for less than five years),

250 or more hours of rental services are performed (as described in the safe harbor) per year

with respect to the rental real estate enterprise.

(3) The taxpayer maintains contemporaneous records, including time reports, logs, or

similar documents, regarding the following:

(i) Hours of all services performed;

(ii) Description of all services performed;

(iii) Dates on which such services were performed; and

(iv) Who performed the services. Such records are to be made available for

inspection at the request of the IRS.

The contemporaneous records requirement will not apply to tax years beginning before January

1, 2019.

157 Notice 2019-7



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For purposes of the safe harbor, rental services include:

(1) Advertising to rent or lease the real estate;

(2) Negotiating and executing leases;

(3) Verifying information contained in prospective tenant applications;

(4) Collection of rent;

(5) Daily operation, maintenance, and repair of the property;

(6) Management of the real estate;

(7) Purchase of materials; and

(8) Supervision of employees and independent contractors.

Rental services may be performed by owners or by employees, agents, and/or independent

contractors of the owners. The term "rental services" does not include financial or investment

management activities, such as arranging financing; procuring property; studying and

reviewing financial statements or reports on operations; planning, managing, or constructing

long-term capital improvements; or hours spent traveling to and from the real estate.

Form 8995, Qualified Business Income Deduction Simplified Computation is a one-page form

and does not contain any lines for a taxpayers’ allocable share of W-2 wages from a trade,

business, or aggregation; nor does it include a line for the taxpayers’ allocable share of the

unadjusted basis immediately after acquisition (UBIA) of all qualified property. It is to be used

by taxpayers that do not have W-2 wages or UBIA. Examples are on the following pages.

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QBI Rental Example – Form 8995

Garfield and Lizzy are a married couple. Lizzie works in a pet shop; she received a W-2 for

$48,000. Garfield has three single-family rentals and one duplex. None of his property is

commercial. Garfield manages all of his rentals and keeps a separate bank account for rental

incomes and expenses. He does all the collection of rents, advertising, repairs, gardening and

upkeep. Garfield kept a log of his hours and averages 14 hours a week working on the rental

properties. Garfield received $2,200 in qualified dividends from Purina.

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The taxable income prior to QBI is $119,800 ($48,000 (wages) + $94,000 (rental income) +

$2,200 (dividends) - $24,400 (standard deduction)). Form 8995 is new for 2019; the IRS also

issued Form 8995A for more complex QBI calculations.

For 2019, all of the rentals were rented throughout the year.

Rental 1: $20,000 Triplex: $66,000

Rental 2: $16,000 Rental 3: ($8,000)

No QBI Worksheet is needed in this example since there are no adjustments to income which

go in this QBI calculation.

Notice 2019-07 includes procedures for a safe harbor for treating a rental activity as a trade or

business for purposes of §199A. If the activity meets the harbor requirements, the activity will

be treated as a trade or business as defined under §199A(d) and the regulations. If the safe

harbor requirements are not met, the activity may still be treated as a

trade or business if the activity otherwise meets the definition of a trade or business under §162

[Reg. §1.199A-1(b)(14)]. Taxpayers who already qualify as a real estate professional easily

qualify as a trade or business under this test assuming they keep the required records.

Rental Activity Defined

An interest in real property, or multiple properties, held to produce rents.

The individual or relevant pass through entity (RPE) must hold the activity directly

or, through a disregarded entity separate from its owner under Reg. §301.7701-3.

Each rental activity must be treated as a separate activity OR all similar properties

treated as a single activity. This treatment cannot vary from year to year unless

there is a significant change in the facts and circumstances.

Commercial and residential real estate activities cannot be treated as the same

activity.

Safe Harbor Test

Separate books and records are maintained that reflect income and expenses for each rental

activity.

For taxable years beginning prior to Jan. 1, 2023, taxpayers must perform 250 or more

hours of rental services per year for each rental activity. For taxable years beginning after

Dec. 31, 2022, taxpayers must perform 250 or more hours of rental services per year for

each rental activity in any 3 of the 5 consecutive years that end with the taxable year (every

year if the activity was held for less than five years).

The taxpayer must maintain contemporaneous records, including time reports, logs or

similar documents all the following:

o Hours of all services performed.

o Description of all services performed.

o Dates the services were performed.

o Who performed the services?

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Rental Services Rental services may be performed by owners or by employees, agents, and/or independent contractors

of the owners. They include:

Advertising to rent or lease the property.

Negotiating and executing leases.

Verifying information in prospective tenant applications.

Collection of rent.

Daily operation, maintenance and repair of the property.

Management of the real estate.

Purchase of materials.

Supervision of employees and independent contractors.

Rental services do not include financial or investment management activities such as:

Arranging financing.

Procuring property.

Studying and reviewing financial statements on operations.

Planning, managing or constructing long-term capital improvements.

Hours spend traveling to and from the rental property.

Other Rules

Certain rental activities are excluded from using the safe harbor method. They include:

Real estate used by the taxpayer (including an owner or beneficiary of an RPE

relying on this safe harbor) as a residence for any part of the year under §280A.

Real estate rented or leased under a triple net lease. For purposes of this revenue

procedure, a triple net lease includes a lease agreement that requires the tenant or

lessee to pay taxes, fees, and insurance, and to be responsible for maintenance

activities for a property in addition to rent and utilities or a portion of such allocable

to the part of the property the tenant rents or leases.

Procedural Requirements

The taxpayer or RPE must include a statement attached to the return claiming or

passing through the §199A deduction information that the requirements in Section

3.03 of this revenue procedure have been satisfied.

The statement must be signed by the taxpayer, or an authorized representative of an

eligible taxpayer or RPE, which states:

“Under penalties of perjury, I (we) declare that I (we) have examined the

statement, and, to the best of my (our) knowledge and belief, the statement

contains all the relevant facts relating to the revenue procedure, and such facts

are true, correct, and complete.”

The individual or individuals who sign must have personal knowledge of the facts

and circumstances related to the statement.

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Different Rules Apply at Different Levels of Taxable Income

The rule disqualifying specified service trades or businesses from being considered a qualified

trade or business does not apply to individuals with taxable income of less than $160,700

($321,400 for joint filers) for 2019 and $163,300 for single filers or $326,600 for joint filers for

2020. Other rules, such as one preventing individuals from claiming the QBI deduction for

employment income, and disallowing of corporate income apply to all taxpayers, regardless of

their level of taxable income.

Reasonable Compensation and Guaranteed Payments Are Not QBI

What is a Reasonable Salary? – The instructions for Form 1120S (“U.S. Income Tax Return

for an S Corporation”) state: “Distributions and other payments by an S corporation to a

corporate officer must be treated as wages to the extent the amounts are reasonable

compensation for services rendered to the corporation.” There are no specific guidelines in the

tax code regarding the definition of reasonable compensation. The various courts that have

ruled on this issue have based their determinations on the facts and circumstances of the

individual cases.

NOTE: Wages or salaries, reasonable compensations to S-Corporation owners

(Form W-2) or guaranteed payments from a partnership (Form 1065 K-I Part III,

Line 4) are not included in QBI.

These are some factors that courts have considered, when determining reasonable

compensation.

The officer’s training and experience

The officer’s duties and responsibilities

The time and effort that the officer devotes to the business

The corporation’s dividend history

The corporation’s payments to non-shareholder employees

The timing and manner of the bonuses paid to key people at the corporation

The payments that comparable businesses have made for similar services

The corporation’s compensation agreements

The formulas that similar corporations have used to determine compensation

The IRS has provided lists of contributing factors that courts have used when determining

reasonable compensation, but has not provided additional guidance in this area. The IRS leaves

it to each corporation to quantify these factors and determine a reasonable salary; this allows

the IRS the ability to challenge the amount of reasonable compensation The IRS has a long

history of examining S-Corporations’ tax returns to ensure that reasonable compensation is

being paid, particularly when a corporation pays no compensation to employee-stockholders.

TCJA added the QBI deduction. This deduction applies to S corporations (among many other

business entities) and adds another level of complexity to the determination of reasonable

compensation.

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The wages of an S corporation’s employee-stockholder are NOT treated as qualified business

income (QBI) that is eligible for the individual’s 199A deduction. However, the corporation

deducts these wages as a business expense when it calculates the profit that passes through to

the shareholder as QBI on Schedule K-1. Larger wages mean less K-1 flow-through income

(QBI) and a smaller QBI deduction. In this case, S corporations tend to minimize stockholders’

salaries in order to maximize flow-through income; this strategy increases the employee-

stockholder’s QBI deduction and lowers the payroll taxes for both the corporation and the

employee-stockholder.

The IRS, however, can recharacterize "dividends" that are paid lieu of reasonable

compensation for services performed for the S corporation.158 Therefore, “reasonable

compensation” of an S corporation shareholder refers to any amounts paid by the S corporation

to the shareholder, up to the amount that would constitute reasonable compensation.

Astro is the sole shareholder and CEO of MARS, Inc., an S corporation that is a

qualified trade or business. MARS has net income in 2019 of $250,000 after deducting

Astro’s $100,000 salary. MARS makes payments of $350,000 to Astro in 2019, of

which it classifies $100,000 as wages and $250,000 as ordinary income. Assume that

reasonable compensation for someone with Astro’s experience and responsibilities is

$200,000. Astro’s qualified business income from MARS in 2019 is $150,000, which is

its net income of $250,000, minus the $100,000 of “ordinary income” that are actually

reasonable compensation ($200,000 reasonable compensation - $100,000 of payments

classified as wages by MARS). The $200,000 treated as reasonable compensation is not

QBI.

If married taxpayers who are filing a joint return in 2019 have 1040 taxable income that

exceeds $321,400 and is a SSTB, the QBI deduction begins to be subject to a wage

limitation. Once the 1040 taxable income for married taxpayers filing jointly exceeds

$421,400, the wage limitation is fully phased in. In that event, the QBI deduction becomes

the lesser of the wage limitation or 20% of the QBI; if the wage limitation is zero, there is no

QBI deduction.

The wage limitation comprises the wages that the S-Corporation paid, including those paid to

stockholders, plus the unadjusted cost of the qualified property that the S-Corporation owned

and used during the year. To be more specific, the wage limitation is the larger of

50% of the wages that the S-corporation paid or

25% of the S-Corporations’ paid wages plus 2.5% of the unadjusted cost of its

qualified property.

158 Rev. Rul 74-44

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For those high-income shareholders for whom the wage limitation applies, if the corporation

pays no wages and has no qualified property, the shareholder will not have a QBI deduction.

If shareholder of an S-Corporation which is a specified service trade or business, that has

wages or qualified property, the shareholder is subject to the phase out on their individual

return.

The IRS describes specified service trades or businesses are those in the fields of health, law,

accounting, actuarial science, performing arts, athletics, consulting, financial services, and

brokerage services, as well as those for which reputation and/or skill are contributing factors .

QBI does not include reasonable compensation paid to the taxpayer by any qualified trade or

business of the taxpayer for services rendered with respect to the trade or business.

Guaranteed Payments. Guaranteed payments include payments made by a partnership,

without regard to its income, to a partner, for services provided to the partnership. Partnerships

are not required by federal tax law to make guaranteed payments to partners who provide

services to the partnership, and are not constrained by a reasonableness standard if they choose

to do so. To the extent a partnership makes such payments to a partner, the partnership’s

ordinary income (and qualified business income) is reduced by the amount of the payment

because guaranteed payments are deductible to the partnership. To the partner receiving the

guaranteed payment, the payment is ordinary income but is not qualified business income.

Antoinettte and JoanArc are the equal owners of French, a partnership that is a

qualifying trade or business. In 2019, French had $1,250,000 of ordinary income before

deducting $700,000 in guaranteed payments made to Antoinettte and JoanArc for their

services to French ($350,000 each), and $550,000 of ordinary income after deducting

the guaranteed payments ($1,250,000 - $700,000). Antoinettte and JoanArc’s qualified

business income for 2019 is $550,000, or $275,000 each.

TCJA provides that if the net amount of qualified business income from all qualified trades or

businesses during the tax year is a loss, it be carried forward as a loss from a qualified trade or

business in the next tax year for QBI purposes only. Any deduction allowed in a subsequent

year is reduced (but not below zero) by 20 percent of any carryover qualified business

loss.Wages or salaries, reasonable compensations to S-Corporation owners (Form W-2) or

guaranteed payments from a partnership (Form 1065 K-I Part III, Line 4) are not included in

QBI.

In 2018, Popeye has qualified business income of $20,000 from Spinach Design a sole

proprietorship, and a qualified business loss of $50,000 from Olive Oil. Popeye is not

permitted a QBI deduction for 2018 and has a QBI carryover loss of $30,000 to 2019. In 2019,

Popeye has qualified business income of $40,000 from Spinach Design and income of $70,000

from Olive Oil. Refer to the QBI Explanation Worksheets, for a breakdown of the income.

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Popeye’s wife Quacky earned $12,000 in feather gathering from the Down Co. Popeye and

Quacky had no other income for the 2019. The 2019 taxable income for Popeye and Quacky

before the QBI deduction is $97,600. ($12,000 (wages) + $110,000 (business income)-$24,400

(standard deduction)).

See Form 8995, Line 3 for the carryover from 2018. Keep in mind that carryovers of

QBI only affect QBI not ordinary income.

The amounts on line 12 of these worksheets go to Line 1 of Form 8995. (See next page)

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Determining the Final Amount of the QBI Deduction These additional calculations will only change the QBI deduction in two situations:

(1) The taxpayer has qualified REIT dividends, qualified cooperative dividends, or

qualified publicly traded partnership income, or

(2) The taxpayers’ taxable income (reduced by any net capital gain) is less than his or

her qualified business income.

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Example: Peter Popple a single taxpayer sells pots and pans. He reports his net income of

$70,000 on Schedule C. During the year, he sold stock in Pickled Pepper Corp for a long-term

gain of $9,000. The long term capital gain is not included in the QBI see Line 12 of Form

8895 in the following example.

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Qualified Property Defined

For purposes of the QBI deduction, TCJA defines “qualified property” as tangible property of a

character subject to depreciation that is held by, and available for use in, the qualified trade or

business at the close of the tax year. The property is used in the production of qualified

business income, and for which the depreciable period has not ended before the close of the tax

year. The depreciable period with respect to qualified property of a taxpayer means the period

beginning on the date the property is first placed in service by the taxpayer and ending on the

later of

(1) The date 10 years after that date, or

(2) The last day of the last full year in the applicable recovery period that would apply

to the property under Code Sec. 168 (without regard to Code Sec. 168(g)).

Calculating W-2 Wage Limitation

Rev. Proc. 2019-11 provides the following three methods for calculating W-2 wages:

(1) The unmodified Box method, which allows for a simplified calculation;

(2) The modified Box 1 method; and

(3) The tracking wages method.

The discussions of "wages" in Rev. Proc. 2019-11 and in the Code Sec. 199A regulations are

for purposes of Code Sec. 199A only and have no application in determining whether amounts

are wages for purposes of the Federal Insurance Contributions Act (FICA), Federal

Unemployment Tax Act (FUTA), or for purposes of federal income tax withholding, or any

other wage-related determination.

NOTE: The final regulations prevent employees from qualifying for the 20 percent

QBI deduction by becoming an independent contractor. The final regulations create the

presumption that if a person was an employee of an employer, but suddenly becomes an

independent contractor while providing substantially the same services directly or

indirectly to the former employer, it is presumed for the next three years that they are

still an employee for purposes of §199A, thus no §199A deduction. This

recharacterization is only for the purposes of §199A and does not convert the taxpayer

to an employee for payroll tax purposes

While the unmodified Box method allows for a simplified calculation, the other two methods

provide greater accuracy.

The W-2 wages calculated are not necessarily the W-2 wages that are properly allocable to

QBI and eligible for use in computing the Code Sec. 199A limitations. Only W-2 wages that

are properly allocable to QBI may be taken into account in computing the Code Sec.

199A(b)(2) W-2 wage limitations. Therefore, when computing W-2 wages taxpayers must

determine the extent to which the W-2 wages are properly allocable to QBI. Then, the properly

allocable W-2 wages amount is used in determining the W-2 wages limitation under for that

trade or business.

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As previously mentioned, W-2 wages for purposes of Code Sec. 199A include:

(1) The total amount of wages;

(2) The total amount of elective deferrals;

(3) Compensation deferred under Code Sec. 457; and

(4) The amount of designated Roth contributions.159.

Form W-2, the elective deferrals160 and the amounts deferred under Code Sec. 457 directly

correlate to code items reported in Box 12 on Form W-2.

Box 12, Code D is for elective deferrals to a Code Sec. 401(k) cash or deferred

arrangement plan (including a SIMPLE 401(k) arrangement);

Box 12, Code E is for elective deferrals under a Code Sec. 403(b) salary reduction

agreement;

Box 12, Code F is for elective deferrals under a Code Sec. 408(k)(6) salary reduction

Simplified Employee Pension (SEP);

Box 12, Code G is for elective deferrals and employer contributions (including

nonelective deferrals) to any governmental or nongovernmental Code Sec. 457(b)

deferred compensation plan;

Box 12, Code S is for employee salary reduction contributions under a Code Sec.

408(p) SIMPLE (simple retirement account);

Box 12, Code AA is for designated Roth contributions (as defined in Code Sec. 402A)

under a Code Sec. 401(k) plan; and

Box 12, Code BB is for designated Roth contributions (as defined in Code Sec. 402A)

under a Code Sec. 403(b) salary reduction agreement. However, designated Roth

contributions are also reported in Box 1, Wages, tips, other compensation and are

subject to income tax withholding.

For any tax year, a taxpayer must calculate W-2 wages for purposes of QBI using one of the

three methods161 described below. Special rules are provided for a taxpayer with a short tax

year. In calculating W-2 wages for a tax year under the methods below, the taxpayer includes

only those Forms W-2 that are for the calendar year ending with or within the taxable year of

the taxpayer and that meet the rules of application.

159 Rev. Proc 2019-11 (Section 4) 160 IRC §402(q)(3) 161 Rev Proc. 2019-11


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Unmodified Box Method

Under the unmodified box method, W-2 wages are calculated by taking, without modification,

the lesser of: (1) The total entries in Box 1 of all Forms W-2 filed with SSA by the taxpayer with

respect to employees of the taxpayer for employment by the taxpayer; or

(2) The total entries in Box 5 of all Forms W-2 filed with SSA by the taxpayer with

respect to employees of the taxpayer for employment by the taxpayer.

Modified Box 1 Method

Under the Modified Box 1 method, the taxpayer makes modifications to the total entries in Box

1 of Forms W-2 filed with respect to employees of the taxpayer. W-2 wages under this method

are calculated as follows: (1) Total the amounts in Box 1 of all Forms W-2 filed with SSA by the taxpayer with

respect to employees of the taxpayer for employment by the taxpayer,

(2) Subtract from the total obtained in (1) amounts included in Box 1 of Forms W-2

that are not wages for federal income tax withholding purposes, including amounts that

are treated as wages for purposes of income tax withholding under section 3402(o); and

(3) Add to the amount obtained in (2) the total of the amounts that are reported in Box

12 of Forms W-2 with respect to employees of the taxpayer for employment by the

taxpayer and that are properly coded D, E, F, G, and S.

Tracking Wages Method

Under the tracking wages method, the taxpayer actually tracks total wages subject to federal

income tax withholding and makes appropriate modifications. W-2 wages under this method

are calculated as follows: (1) Total the amounts of wages subject to federal income tax withholding that are paid

to employees of the taxpayer for employment by the taxpayer and that are reported on

Forms W-2 filed with SSA by the taxpayer for the calendar year; plus

(2) The total of the amounts that are reported in Box 12 of Forms W-2 with respect to

employees of the taxpayer for employment by the taxpayer and that are properly coded

D, E, F, G, and S.

Calculating the phase-in of QBI with W-2 wage limitation phases in for a taxpayer with taxable

income in excess of the threshold amounts. Therefore, for a taxpayer with taxable income

below these thresholds, the W-2 limitation does not apply. For purposes of phasing in the wage

limit, taxable income is computed without regard to the 20 percent deduction.

Taxpayers between the taxable income thresholds, who are not in a specified service trade or

business are subject to only a partial wage and capital limitation. The deductible QBI amount

for a business of a taxpayer with taxable income between the thresholds is 20% of QBI, less an

amount equal to a “reduction ratio” multiplied by an “excess amount.”

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The “reduction ratio” is calculated as the amount of taxable income in excess of the lower

threshold amount of $321,400 for Married Filing Jointly ($160,700 for Single and Head of

Household), divided by $100,000 for joint filers ($50,000 for other taxpayers)162. The more the

taxable income, the higher the reduction ratio and the more the wage and capital limitations

apply until they are fully phased in at $415,000 (or $207,500 Single, Head of Household).

The “excess amount163” is the amount of the difference between:

(1) The deductible QBI amount of the qualified business with no wage and capital

limitation (20% of QBI); and

(2) The deductible QBI amount of the qualified business with a fully phased-in wage

and capital limitation. The reduction ratio is applied to this amount to determine the

reduction of the wage and capital limitation.

Form 8995-A, Qualified Business Income Deduction

This form is six pages and is composed of four parts and four schedules:

Part I, Trade, Business, or Aggregation Information;

Part II, Determine The Adjusted Qualified Business Income;

Part III, Phased-in Reduction; and

Part IV, Determine The Qualified Business Income Deduction.

Schedule A, Specified Service Trades or Businesses, is composed of two parts, one for

non-publicly traded partnership information, and one for publicly traded partnership

information.

Schedule B, Aggregation of Business Operations, has space for three aggregations of

trades or businesses and asks taxpayers to explain the factors that allow aggregation of

the taxpayers’ businesses.164 Additionally, if a taxpayer holds a direct or indirect

interest in a relevant pass-through entity (RPE) that aggregates multiple trades or

businesses, the taxpayer is required to attach a copy of the RPE’s aggregations.

Schedule B also asks taxpayers if there were any changes in aggregations from the prior

year and to explain such changes.

Schedule C, Loss Netting and Carryforward, is the same as in the 2018 Schedule C

worksheet used for 2018 tax returns. The 2019 Schedule C calculates the qualified

business net loss and the carryforward amount for each of the taxpayers’ trades or

businesses or the aggregation of trades or businesses.

Schedule D, Special Rules for Patrons of Agricultural or Horticultural Cooperatives

(COOP), is also the same as the 2018 Schedule D worksheet used for 2018 tax returns.

The 2019 Schedule D is to be completed only by a patron of an agricultural or

horticultural cooperative and is used to compute the patron reduction used in

calculating the qualified business income component.

162 IRC§ 199A(b)(3)(B)(ii) 163 IRC§ 199A(b)(3)(A)(ii) 164 Reg Sec. 1.19A-4

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Overall limitation applied after combined QBI is calculated

After the deductible QBI amount is calculated for each of taxpayers’ qualified businesses under

the various taxpayer scenarios above, the deductible QBI amounts are combined to determine

the taxpayers’ combined qualified business income. Therefore, if the taxpayer has only one

qualified business, the combined QBI amount is the same as the deductible QBI amount for

that business. After determining the taxpayers’ combined QBI amount, the overall limitation is

applied. Under the overall limitation, the Sec. 199A deduction is the lesser of the combined

QBI or 20% of the taxpayers’ taxable income in excess of net capital gain.

To calculate UBIA, the regulations state that the existing rules used to determine “unadjusted

basis” in Regs. Secs. 1.263(a)—(h)(5) provide a reasonable basis to determine UBIA under

Sec. 199A. Similarly, the rules for determining UBIA for qualified property subject to a Sec.

1031 like-kind exchange or a Sec. 1033 involuntary conversion are described in Regs. Sec.

1.199A-2.

According to the regulations “immediately after acquisition” means the date the property was

placed in service. For qualified property contributed to a partnership or an S corporation in a

Sec. 721 or 351 transaction, respectively, and immediately placed in service, the basis will be

the same basis determined under Secs. 723 and 362, respectively. However, to avoid abuse of

these property basis rules, property acquired within 60 days of the end of the tax year and

disposed of within 120 days without having been used for at least 45 days before disposition

will generally not be qualified property included in the UBIA computation.

Calculating QBI over the Threshold

Bob and Carol are married and file a joint tax return. Bob is a shareholder in ABC, an entity

taxed as an S corporation for tax purposes that conducts a single trade or business. ABC holds

no qualified property. Bob’s share of ABC’s QBI is $300,000 in 2019. Bob’s share of the W-2

wages from ABC in 2019 is $40,000. Carol earns wage income from employment by an

unrelated company. After allowable deductions unrelated to ABC, Bob and Carol’s taxable

income for 2019 is $325,600. Bob and Carol are within the phase-in range because their

taxable income exceeds the applicable threshold amount, $321,400, but does not exceed the

threshold amount plus $100,000, or $421,400. Consequently, the QBI component of Bob and

Carol’s Code QBI deduction may be limited by the W-2 wage and UBIA of qualified property

limitations but the limitations will be phased in. The UBIA of qualified property limitation

amount is zero because ABC does not hold qualified property

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*A “Patron reduction” (Line 14) is a refund issued to those who purchase goods or services

from a cooperative, and is calculated based upon the amount that each patron spends at the

cooperative in a given taxable year.

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W-2 wages are the total wages subject to wage withholding165 under elective deferrals, and

deferred compensation paid by the qualified trade or business with respect to employment of

its employees during the calendar year ending during the tax year of the taxpayer.

Van owns and operates Rubber Soles, a shoe store, as a single owner S Corporation of

which he has one employee. Assume that Rubber Soles is qualified trade or business,

and that it has no qualified property. Van pays himself a reasonable salary of $150,000,

he has one employee who he pays $65,000, the S corporation has $128,000 of taxable

income, which is Van’s ordinary business income. Van’s taxable income before QBI is

$198,500 ($150,000 (W-2 Income) $128,000 (1120S K-1) – $52,000 (Section 179

deduction from 1120S K-1) - $27,500 (Itemized deductions))

165 IRC §3401(a)

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Guaranteed payments to a partner in a partnership and the profit from a sole-proprietorship, do

not meet the definition of W-2 wages. Such payments are not subject to withholding (partners

and sole proprietors pay estimated taxes), and are reported to the IRS, not the SSA. Thus, and

profits from a Schedule C fail two of the tests for W-2 wages.

Assume the same facts as Rubber Soles, except that Chip is a sole-proprietor of Chip

and Dale Soles. Chip receives compensation in the form of a profit of $278,000. The

profit is the qualified business income. Chip’s taxable income is $193,310. Chip’s

employee wages are $65,000.

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See the QBI Explanation Worksheet below, note the $65,000 of wages on line 18.

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To calculate the QBI deduction, Chip uses the lower of QBI or taxable income before

Qualified Business Income Deduction. The QBI is on Line 2 of Form 8995-A ($266,037). The

taxable income before the Qualified Business Income Deduction is on line 34 of Form 8995-A

($241,637). The example has the QBI Deduction of $48,327 ($241,637 x 20%).

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QBI Deduction – Specified Service Trade or Business

Certain types of businesses defined as “specified service trades or business” (SSTBs) are not

considered qualified businesses for individuals whose taxable income exceeds certain

thresholds (discussed below). A specified service trade or business means any trade or business

involving the performance of services in the fields of health, law, accounting, consulting,

financial services, brokerage services, actuarial science, athletics, or performing arts.

Specified service trades or businesses also include any trade or business where the principal

asset of such trade or business is the reputation or skill of one or more of its employees or

owners.

Specified service trades or businesses also include trades or businesses, which involve the

performance of services that consist of investing and investment management, trading, or

dealing in securities, partnership interests, or commodities. For this purpose, the terms

“security” and “commodity” have the same meanings as those provided in the rules for the

mark-to-market accounting method for dealers in securities.166

Specified Service Trades or Businesses (SSTB)167 include the following:

• Health

• Law

• Accounting

• Actuarial science • Performing arts

• Consulting

• Athletics

• Financial services

• Brokerage services

• Investing and investment management

• Services in trading

• Services in dealing securities, commodities, and partnership interests

• Any trade or business where the principal asset of such trade or business is the reputation or

skill of one or more of its employees or owners

Code Section 199A specifically excludes Engineering and Architecture from SSTB

classification. For clarification, the final regulation for Code Section 199A state that

Engineering and Architecture are not included in “consulting”.

Health

The provision of medical services by physicians, pharmacists, nurses, dentists, veterinarians,

physical therapists, psychologists, and other similar healthcare professionals performing

services.

166 IRC §§475(c)(2), 475(e) (2) 167 §1.199A-5

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Regulations point out that, a radiologist might be never come into direct contact with the

patient, but it remains health. The skilled nursing and assisted living facilities are also difficult

and will be decided by the general facts and circumstances.

An outpatient surgical center is not included in SSTB; the IRS does not believe it is a trade or

business providing services in the field of health. The medical professionals were separately

billed and not provided by the surgery center.

Sales of pharmaceuticals and medical devices by a retail pharmacy is not by itself a trade or

business performing services in the field of health, A pharmacist and a physical therapist will

be included in the health field.

Law

The services by lawyers, paralegals, legal arbitrators, mediators, and similar professionals are

part of SSTB.

Accounting

Final Section 1.199A-5 defines the “Accounting” SSTB

The provision of services by accountants, enrolled agents, return preparers, financial auditors,

and similar professionals. Tax return advice, preparation, and bookkeeping services are

included.

Accounting does not include payment processing and billing analysis.

Consulting

Consulting is defined as professional advice and counsel to clients to assist the client in

achieving goals and solving problem. It includes providing advice and counsel regarding

advocacy with the intention of influencing decisions made by a government or governmental

agency and all attempts to influence legislators and other government officials on behalf of a

client by lobbyists and other similar professionals.

If a trade or business provides consulting services that are not separately purchased or billed,

then such trades or businesses are not in a trade or business in the field of consulting.

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Financial services

The field of financial services includes the provision of financial services to clients including

managing wealth, advising clients with respect to finances, developing retirement plans,

developing wealth transition plans, the provision of advisory and other similar services

regarding valuations, mergers, acquisitions, dispositions, restructurings and raising financial

capital by underwriting, or acting as the client’s agent in the issuance of securities, and similar

services.

Financial advisors, investment bankers, wealth planners, and retirement advisors and other

similar professionals are also included in SSTB, but insurance is not.

Services provided by stockbrokers and other similar professionals is an SSTB but does not

include services provided by real estate agents and brokers, or insurance agents and brokers.

Investing and investment management

The regulations define “Investing and investment management” as a trade or business

involving the receipt of fees for providing investing, asset management, or investment

management services, including providing advice with respect to buying and selling

investments. Directly managing real property is not included in SSTB.

Reputation or skill is defined as:

A. A trade or business in which a person receives fees, compensation, or other income

for endorsing products or services.

B. A trade or business in which a person licenses or receives fees, compensation, or

other income for the use of an individual’s image, likeness, name, signature, voice,

trademark, or any other symbols associated with the individual’s identity.

C. Receiving fees, compensation, or other income for appearing at an event or on radio,

television, or another media format.

Special Rules for Partnerships and S Corporations

TCJA provides that, in the case of a partnership or S corporation, the business income

deduction apply at the partner or shareholder level. Each shareholder of an S corporation takes

into account the shareholder’s pro rata share of each qualified item of income, gain, deduction,

and loss. Each shareholder is treated as having W-2 wages for the tax year equal to the

shareholder’s pro rata share of W-2 wages of the S corporation, and a pro rata share of

qualified property equal to the shareholder’s allocable share of pro rata share depreciation.

Similar rules apply to a partner in a partnership, who takes into account his or her allocable

share of all of same items mentioned in the preceding paragraph. The partner’s allocable share

of W-2 wages is required to be determined in the same manner as the partner’s allocable share

of wage expense (which is typically the same as the partner’s allocable share of ordinary

income). The partner’s allocable share of qualified property is equal to the shareholder’s

allocable share of depreciation. If the partnership agreement does not provide for special

allocations of depreciation, the partner’s allocable share of qualified property will be the same

as the partner’s allocable share of ordinary income.

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Estates and Trusts

Estates and trusts are separate legal entities for federal income tax purposes. Therefore, the

fiduciary of an estate or trust generally must file a separate federal income tax return for the

estate or trust.

In general, trusts are taxed in the same manner in which an individual is taxed. Thus, the for

example, gross income of an estate or trust consists of all items of gross income received

during the tax year, including:

(1) Income accumulated in trust for the benefit of unborn or unascertained persons or

persons with contingent interests;

(2) Income accumulated or held for future distribution under the terms of the will or

trust;

(3) Income that is to be distributed currently by the fiduciary to the beneficiaries, and

income collected by a guardian of an infant that is to be held or distributed as the court

may direct;

(4) Income received by estates of deceased persons during the period of administration

or settlement of the estate; and

(5) Income that, in the discretion of the fiduciary, may be either distributed to the

beneficiaries or accumulated.

However, one important difference between the taxation of an individual and the taxation of a

trust is that a trust can take a deduction for distributions made to beneficiaries, and the

beneficiary is generally required to include in their income the amount of the distribution. IRC

§642 also provides specific rules relating to deductions that do not apply to individual

taxpayers. Taking certain tax attributes from the system governing the taxation of individuals,

corporations and partnerships, Subchapter J creates a unique set of rules for a trust and its

beneficiaries.

Whether or not, a beneficiary will be required to include in his or her income amounts received

as a distribution from a trust is determined by computing the trust’s taxable income, and its

distribution deduction. If a beneficiary receives, a distribution that the trust took a distribution

deduction for, the beneficiary includes that amount in his or her taxable income. However, if

the trust made a distribution for which it did not receive a distribution deduction, that amount is

generally not included in a beneficiary’s gross income.

The taxable income of an estate or trust must be distinguished from its fiduciary accounting

income (FAI) and its distributable net income (DNI). In determining the taxable income of an

estate or trust, the income and deductions of the estate or trust are generally determined in the

same manner as they are for individual taxpayers. In addition, estates and trusts are allowed a

special deduction for income distributed to beneficiaries

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Special Rules for Trusts and Estates

TCJA provides that trusts and estates are eligible for the 20-percent deduction. The section

further provides that rules similar to the ones under now-repealed Code Sec. 199 (as in effect

on December 1, 2017) apply for apportioning between fiduciaries and beneficiaries any W-2

wages and unadjusted basis of qualified property under the limitation based on W-2 wages and

capital.

Real Estate Investment Trust (REIT) Dividends, Cooperative Dividends, and Publicly Traded

Partnership Income.

A deduction is allowed under the provision for 20 percent of the taxpayers’ aggregate amount

of qualified REIT dividends, qualified cooperative dividends, and qualified publicly traded

partnership income for the tax year.

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What Do You Think?

Q1. Which one of the following is not a factor when determining if rental

real estate rises to the level of being a trade or business for QBI?

A. Determining that the property is residential rental property

B. The owner’s or the owner’s agents day-to-day involvement

C. The types of services provided under the lease

D. The amount of income generated by the rental property.

Q2. Sponge Bob owns and operates Yellow Bubbles, a sole proprietorship that is a qualified

trade or business. Sponge Bob has $100,000 in qualified business income from Yellow

Bubbles, and no other items of income or loss. He has a total of $25,000 in itemized

deductions. His taxable income, prior to applying any QBI deduction, is $75,000 ($100,000

income from Yellow Bubbles - $25,000 in individual deductions).

How much is Sponge Bob’s QBI deduction?

A. $15,000,

B. -0-

C. $25,000

D. $75,000

Q3. What is the total QBI deduction allowed on the Toe’s tax return?

Bunion Toe is working as a Podiatrist for Footies, an S Corporation. Bunion’s share of the S

Corporation wages is $50,000 and he receives qualifying business income of $36,000.

Bunion’s wife Helen is a sole proprietor designing websites, her qualifying business income is

$90,000, Helen has no depreciable assets; she has no employees. The Toe’s taxable income is

$150,000, which includes capital gains of $7,600.

A. $126,000

B. $25,200

C. $142,400

D. $150,000

Q4. Which of the following is not a correct method for calculating W-2 wages for the

computation of qualified business income deduction?

A. The Unmodified Box Method is a simplified method used to calculate the wages

for the QBI calculation by comparing Box 1 and Box 5 of Form W-2.

B. The Modified Box 1 method, the taxpayer makes modifications to the total

entries in Box 1 of Forms W-2.

C. The Tracking Wages Method is more accurate than the unmodified method

when used to determine the wages for the QBI calculation.

D. The Reduction Ratio Method applies a phase-in method.

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A1. D is the correct Answer. Which one of the following is not a factor when

determining if rental real estate rises to the level of being a trade or business for

QBI?

A. Determining that the property is residential rental property

B. The owner’s or the owner’s agents day-to-day involvement

C. The types of services provided under the lease

D. The amount of income generated by the rental property.

Like any activity, to rise to the level of being a trade or business, a rental real estate activity

must be considerable, regular, and continuous in scope. In determining whether a rental real

estate activity meets those criteria, the IRS has stated that relevant factors might include, but

are not limited to, the following:

(1) The type of rented property (commercial real property versus residential property);

(2) The number of properties rented;

(3) The owner’s or the owner’s agents day-to-day involvement;

(4) The types and significance of any ancillary services provided under the lease; and

(5) The terms of the lease (for example, a net lease versus a traditional lease and a short-term

lease versus a long-term lease)

Recognizing the difficulties taxpayers and practitioners may have in determining whether a

taxpayers’ rental real estate activity is sufficiently regular, continuous, and considerable for the

activity to constitute a trade or business, the IRS has provided a safe harbor under Code Sec.

199A for rental real estate activities.

A2.. A is the correct answer. $15,000 Sponge Bob owns and operates Yellow Bubbles, a sole

proprietorship that is a qualified trade or business. Sponge Bob has $100,000 in qualified

business income from Yellow Bubbles, and no other items of income or loss. He has a total of

$25,000 in itemized deductions. His taxable income, prior to applying any QBI deduction, is

$75,000 ($100,000 income from Yellow Bubbles – minus $25,000 in individual deductions).

For a taxpayer eligible for the QBI deduction who does not have any qualified REIT

dividends, qualified cooperative dividends, or qualified publicly traded partnership

income, calculation of the final amount of the QBI deduction is straightforward. For

such taxpayers, the QBI deduction amount is the lesser of –

(1) The sum of the taxpayers’ QBI deduction for all qualified trades or

businesses (reduced, but not below zero, by 20 percent of any carryover

qualified business loss); or

(2) An amount equal to 20 percent of the taxpayers’ taxable income (reduced by

any net capital gain).

The effect of reducing taxable income by any net capital gain is to ensure that the QBI

deduction does not exceed 20 percent of income taxed at regular rates. The amount in

(2), above (“taxable income limitation”), will only apply in situations where taxable

income is less than the taxpayers’ total QBI from all qualified trades or businesses

(reduced by any QBI loss carryover).


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A3. B is the correct answer. $25,200. What is the total QBI deduction allowed on the Toe’s

tax return? Bunion Toe is working as a Podiatrist for Footies, an S Corporation. Bunion’s share

of the S Corporation wages is $50,000 and he receives qualifying business income of $15,000.

Bunion’s wife Helen is a sole proprietor designing websites, her qualifying business income is

$90,000, Helen has no depreciable assets; she has no employees. The Toe’s taxable income is

$150,000, which includes capital gains of $7,600.

Example Footies Rentals Sole Proprietor

Net qualifying business income $36,000 $90,000

(A) Total qualified business income $126,000

(B) Taxable Income less capital gains $150,000 - $7,600 = $142,400

Lesser of (A) or (B) $126,000

IRC §199A deduction (20% of above) $25,200

After the deductible QBI amount is calculated for each of taxpayers’ qualified businesses under

the various taxpayer scenarios above, the deductible QBI amounts are combined to determine

the taxpayers’ combined qualified business income. Therefore, if the taxpayer has only one

qualified business, the combined QBI amount is the same as the deductible QBI amount for

that business. After determining the taxpayers’ combined QBI amount, the overall limitation is

applied. Under the overall limitation, the Sec. 199A deduction is the lesser of the combined

QBI or 20% of the taxpayers’ taxable income in excess of net capital gain.

A4. D is the correct answer. Which of the following is not a correct method for calculating

W-2 wages for the computation of qualified business income deduction?

A. The Unmodified Box Method is a simplified method used to calculate the wages

for the QBI calculation by comparing Box 1 and Box 5 of Form W-2.

B. The Modified Box 1 method, the taxpayer makes modifications to the total

entries in Box 1 of Forms W-2.

C. The Tracking Wages Method is more accurate than the unmodified method

when used to determine the wages for the QBI calculation.

D. The Reduction Ratio Method applies a phase-in method.

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.

Unmodified Box Method

Under the unmodified box method, W-2 wages are calculated by taking, without modification,

the lesser of: (1) The total entries in Box 1 of all Forms W-2 filed with SSA by the taxpayer with

respect to employees of the taxpayer for employment by the taxpayer; or

(2) The total entries in Box 5 of all Forms W-2 filed with SSA by the taxpayer with

respect to employees of the taxpayer for employment by the taxpayer.

Modified Box 1 Method

Under the Modified Box 1 method, the taxpayer makes modifications to the total entries in Box

1 of Forms W-2 filed with respect to employees of the taxpayer. W-2 wages under this method

are calculated as follows: (1) Total the amounts in Box 1 of all Forms W-2 filed with SSA by the taxpayer with

respect to employees of the taxpayer for employment by the taxpayer,

(2) Subtract from the total obtained in (1) amounts included in Box 1 of Forms W-2

that are not wages for federal income tax withholding purposes, including amounts that

are treated as wages for purposes of income tax withholding under section 3402(o); and

(3) Add to the amount obtained in (2) the total of the amounts that are reported in Box

12 of Forms W-2 with respect to employees of the taxpayer for employment by the

taxpayer and that are properly coded D, E, F, G, and S.

Tracking Wages Method

Under the tracking wages method, the taxpayer actually tracks total wages subject to federal

income tax withholding and makes appropriate modifications. W-2 wages under this method

are calculated as follows: (1) Total the amounts of wages subject to federal income tax withholding that are paid

to employees of the taxpayer for employment by the taxpayer and that are reported on

Forms W-2 filed with SSA by the taxpayer for the calendar year; plus

(2) The total of the amounts that are reported in Box 12 of Forms W-2 with respect to

employees of the taxpayer for employment by the taxpayer and that are properly coded

D, E, F, G, and S.

The “reduction ratio” is not a method of calculating W-2 wages for QBI.

The “reduction ratio” is calculated as the amount of taxable income in excess of the lower

threshold amount divided by $100,000 for joint filers ($50,000 for other taxpayers). The more

the taxable income, the higher the reduction ratio, and the more the wage and capital

limitations apply until they are fully phased out.

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Rental Income

Rental income is any payment the taxpayer receives for the use or occupation of property or a

dwelling unit over a specific time. The gross income from the rental is principally for customer

use.

A dwelling unit includes apartments, condominiums, mobile home, boat, vacation home, or

similar property. A dwelling unit has basic living accommodations such as sleeping space, a

toilet and cooking facilities. Income from room rentals at a hotel or motel is not considered

rental income and is reported on a Schedule C.

The following items are included as part of Rental Income:

Security deposits - that are kept by the property owner or used as the last months’

rent are included in rent. Security deposits that are returned to the tenant are not

income, if any portion of the security deposit is kept for damages, etc. it is included

in income. Some states require the property owner to pay interest on the security

deposit.

Tax Court has held that a deposit is not taxable income to its recipient unless the

recipient has some guarantee that it will be allowed to keep the funds. Deposits were

taxable if the facts and circumstances indicated that they were advance payments of

rent or prepayments for services rendered, whereas, deposits were nontaxable if

their primary purpose was to serve as security for the depositor's

performance.168Later Tax Court cases have decided the issue based upon whether

the taxpayer or the customer had control over the disposition of the payment.169

Advance rent is any amount received before the period that it covers. Include

advance rent in rental income in the year it is received, regardless of the period it

covers or the method of accounting used.

Payment for canceling a lease is included in income in the year received with no

effect on the remaining lease.

An expense that is paid by the tenant is rental income and can be deducted as any

other rental expense by the property owner170.

Example: The tenant’s dishwasher broke while the property owner was out of

town. The tenant contacted the property owner who gave permission for the tenant

to have it repaired. The tenant got the dishwasher repaired and deducted the amount

from the rent. The property owner would report the amount of the repair as rental

income and report the amount as a rental expense.

168 Kansas City S. Indus., Inc. v. Comr., 98 T.C. 242 (1992 169 Herbel v. Comr., 106 T.C. 392 170 IRC §109

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If property or services are received instead of money as part of the rent, include the

fair market value in income. If services are agreed upon at a specified price, that

price is the fair market value.

Example: Sam owns three houses, John lives in one of the houses that he rents for

$1,400 per month, John is a gardener and he does the gardening for all three houses.

John and Sam agreed on $300 per month, which he subtracts from his rent. Since

they agreed upon the price that is considered the FMV of the gardening, the $300 is

included as rental income and the $300 for gardening is included as an expense.

If the tenant has a lease with an option to buy, the payments received under the

agreement are usually rental income. If the tenant exercises the option, the

payments received after the date of sale are considered part of the selling price.

Rental Expenses

Ordinary and necessary expenses are deductible for managing, conserving or maintaining

rental property from the time it is first available for rent. Accurate record keeping is mandatory

for expenses to be deductible.

Repairs are considered an expense and deductible in the year they are paid. Repairs are

costs that keep the property in good condition, do not add material value to property

and do not substantially prolong the life of the property.

Improvements add to the basis of the property must be depreciated. An improvement

adds to the value of property, prolongs its useful life or adapts it to new uses. The cost

of an improvement must be capitalized and can generally be depreciated as if the

improvement was separate property. Repairs made within extensive remodeling or

restoration of property are included as part of the improvement and capitalized. The

cost of an improvement is depreciated according to the MACRS class and recovery

period of the underlying property.

Work done on the rental property that does not add much value to the house or the life

of the property, but rather keeps the property in good condition is considered a repair,

not an improvement. Repainting, fixing gutters, repairing floors, or replacing broken

windows are examples of repairs.

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The following is a list of common rental expenses:

Advertising

Cleaning and maintenance

Utilities

Insurance

Taxes

Interest

Points

Commissions

Tax return preparation fees

Local transportation costs

Rental payments or leases on equipment

Example: John and Mary Sampler own two single-family rentals. They purchased one of the

rentals in 2015 and the other in 2016. John and Mary had a loss on one of their rentals and a

small gain on the other rental. The full amount of the rental income is in the total.

Certain expenses are more difficult to determine whether they are deductible. Vacant property

expenses are deductible beginning at the time the property is available for rent regardless of

when rental income is actually received. Mortgage interest reported to the owner of the

property on Form 1098 (if over $600) is a deductible expense. Points or “loan origination

fees”, if any, are charges solely for the use of the money and are considered interest. Insurance

premiums paid in advance cannot be deducted in full in the year paid. The premium must be

allocated to the period covered and deducted in that year. Local benefit taxes that increase the

value of the property, such as charges for putting in sewers, streets or sidewalks are non-

depreciable capital expenditures and are added to the basis only.

Depreciation is deductible on the house from the time it is available for rent, but not on the

land. Land value can normally be determined from the tax bill or the closing statements.

Appliances, fixtures and improvements are depreciable items and can be deducted.

Travel expenses that are ordinary and necessary expenses of traveling are deductible if the

primary purpose of the trip was to collect rents, or to manage, conserve, or maintain the rental

property. The travel expenses must be properly allocated between rental and non-rental

activities. The business relationship of the travel expense to the property should be clear. The

ordinary local transportation expenses to collect rents, or to manage, conserve, or maintain the

rental property is deductible. Commuting for investment or rental real estate purposes is

nondeductible.171

171 Reg. §1.212-1

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Condominiums and Cooperatives

Special rules apply to the rental of a condominium or cooperative. If a taxpayer is a tenant-

stockholder 172in a cooperative housing corporation or a member of a condominium

management association for a condominium that he/she owns, then the taxpayer is treated as

having made his/her proportionate share of the cooperative corporation's or condominium

association's qualifying expenditures.

A condominium is a dwelling in a multi-unit building. Along with owning the unit, the owner

also owns some of the common elements of the structure such as land, lobbies, elevators, and

service areas. The owners of the units may pay dues or assessments for the care of these

common areas. If the condominium is a rental, expenses such as depreciation, repairs, upkeep,

dues, interest, taxes and assessments for the care of the common parts of the structure are

deductible. Any special assessments for improvements to the rental must be capitalized and

depreciated.

All of the maintenance fees paid to cooperative housing authority for a cooperative apartment

rented to others are deductible. Any payment for improvements or a capital asset cannot be

deducted. The payment is added to the basis of the stock in the cooperative. In addition to the

maintenance fees, direct payments for repairs, upkeep and other rental expenses can be

deducted. The cooperative will give the owner a breakdown of the expenses.

Classification of Activities

1. Passive activities - investment in a trade or business with no material participation which

includes most rental activities, limited partnerships.

There are limits on passive activity deductions and credits. Generally, income

cannot be offset by passive losses (other than passive income). Nor can taxes be

offset by income (other than passive income) with the credits resulting from passive

activities. Any excess loss or credit is suspended to the next year

Rental real estate activities are generally considered a passive activity and the

amount of deduction allowed is limited. Active participation in rental real estate

activity allows a taxpayer with an adjusted gross income of under $100,000 to

deduct up to $25,000 ($12,500 if Married Filing Separately) in passive losses

against non-passive income. Taxpayers are considered actively participating if they

own 10% of the rental activity and make management decisions in a significant and

bona fide sense. Use Form 8582 to compute and track passive activities and

suspended amounts from year to year

2. Non-passive activities - trade or business activities with material participation. Include

wages and SE income. A person engaged in a trade or business is not subject to passive

loss rules if material participation rules are met.

3. Portfolio Income - interest, dividends, and royalties from investments such as stocks, bonds

and interest bearing accounts.

172 IRC 25D(e)(5)

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Material Participation

A taxpayer “materially participates” in an activity if the individual is involved in the operations

of the activity on a regular, continuous or substantial basis. The individual must meet one of

the seven tests used by the IRS in determining material participation. Specifically, the

individual must be able to demonstrate:

• More than 500 hours of participation in an activity

• More than 100 hours of participation in an activity and no one else participates as

much

• That his or her participation includes “substantially all” of active participation of all

individuals in participation activity

• That the activity is a significant participation activity (SPA) and individual's aggregate

participation in all SPAs exceeds 500 hours

• That he or she materially participated in activity in any 5 years out of the last 10 years

• That, for a personal service activity, he or she materially participated in any 3 prior

taxable years; or

• That, based on all the facts and circumstances, the individual's participation in the

activity was material because it was regular, continuous and substantial.

Keep in Mind: When determining material participation in an activity review the “regular,

continuous and substantial” participation.

Passive Activity Rules

Passive activity loss rules apply to this example. A passive loss173 is a loss that arises from:

• An activity which involves the conduct of a trade or business in which the taxpayer

does not “materially participate”; or

• Any rental activity

If the taxpayer “actively participates” 174in the residential rental activity, he or she may be able

to deduct a loss of up to $25,000 against ordinary (nonpassive) income such as wages or

investment income.

The taxpayer actively participates in the rental activity if:

He or she make key management decisions such as the people who the taxpayer

rents to, the rental terms, approving capital expenditures, etc.

He or she arrange for others to provide services.

Active participation does not require regular, continuous, substantial involvement with the

property. However, in order to satisfy the active participation test, the taxpayer and spouse

must own at least 10% of the rental property. Ownership as a limited partner does not count as

active participation in rental real estate.

173 IRC§469(c) 174Reg. § 1.469-9(j)

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If the taxpayer meets the above tests, he or she can claim a loss against nonpassive income up

to $25,000. If the taxpayer is filings Married Filing Separately and lives apart from the spouse

for the entire year, he or she may claim $12,500. If the taxpayer is Married Filing Separately

and did not live apart from the spouse for the entire year, he or she is not eligible for the special

allowance.

Modified AGI Limitation (MAGI is explained below)175

If the MAGI is above $100,000, the $25,000 allowance amount is reduced by

one-half the excess over $100,000.

If Married, Filing Separately, the $12,500 allowance amount is reduced by one-

half the excess over $50,000.

If MAGI is $150,000 ($75,000 Married File Separate), the allowance is reduced

to zero.

Losses, which are not allowed because of the amount limitations, are suspended losses.

Suspended losses are allowed as a deduction in the year the activity is fully disposed of in a

taxable transaction. If the sale of the passive activity results in a gain that exceeds that

activity’s current and suspended losses, the excess gain is passive income, which will allow the

deduction of losses from other passive activities. The activity must be passive in the year of

sale.

Even if a taxpayer qualifies for the $25,000 special allowance, the rental real estate remains a

passive activity. Meeting the active participation standard simply means that the taxpayer may

use some or all of the $25,000 offset if modified adjusted gross income is less than $150,000.

The difference between active participation and material participation is that active

participation can be satisfied without regular, continuous, and substantial involvement in

operations, so long as the taxpayer participates, in the making of management decisions or

arranging for others to provide services (such as repairs), in a significant and bona fide sense.

Management decisions must be relevant include approving new tenants, deciding on rental

terms, approving capital or repair expenditures, and other similar decisions. The active

participation standard is a lower standard than the material participation standard. Unlike the

material participation requirements, there are no specific hourly requirements. It is possible

that the taxpayer can meet the active participation standard for a rental property even when

there is an on-site manager or a real estate agent handling the property. However, the taxpayer

must be exercising his independent judgment and not simply ratifying the decisions made by

the manager.176

175 IRC § 469(i)(6)(A) 176 Madler v. Comm'r, T.C. Memo. 1998-112

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Since John and Mary collect the rents and do all the work around the rental, they meet the

requirement for active participation in rental real estate. Since the taxpayer and spouse actively

participated in a passive rental real estate activity, they can deduct up to $25,000 ($12,500

MFS) of loss from the activity, depending on their adjusted gross income.

Modified adjusted gross income for this purpose is the adjusted gross income figured without

the following.

Taxable social security and tier 1 railroad retirement benefits.

Deductible contributions to individual retirement accounts (IRAs) and Section

501(c)(18) pension plans.

The exclusion from income of interest from qualified U.S. savings bonds used to pay

qualified higher education expenses.

The exclusion from income of amounts received from an employer's adoption

assistance program.

Passive activity income or loss included on Form 8582.

Modified adjusted gross income is simply adjusted gross income computed without any

passive activity loss (or passive income). In this case, MAGI is adjusted gross income

computed without any of the following:

Taxable social security and tier one railroad retirement benefits;

Deductible contributions to IRA’s and pension plans;

The amounts excludible from income relating to income from savings bonds used to

pay higher education tuition and fees177 and relating to income for certain adoption

assistance payments from employers178;

Amounts allowed as a deduction relating to the domestic production activities

deduction, relating to the deduction for certain retirement savings amounts, relating to

the deduction allowed for education loan interest, relating to the deduction for qualified

tuition and related expenses179; and

Any passive activity loss or any rental real estate loss allowed because the taxpayer is a

real estate professional who materially participated in the rental activity.180

Generally, the taxpayer may deduct suspended passive losses in the year that they dispose of

their entire interest in the activity.

177 IRC §135 178 IRC §137 179 IRC §§199; 219; 221; 222. 180 IRC §469 (i)(3)(F)

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Passive Losses

The passive loss limitation rules, were enacted to limit the extent taxpayers could offset

ordinary income with losses arising from activities in which they did not have "substantial and

bona fide involvement." It was meant to address the concern that some taxpayers were

engaging in certain activities in order to generate losses that could be used to shelter income

from other activities.

The underlying concepts of Form 8582 is relatively simple. Form 8582 merely computes the

allowable loss for the given year. Passive activity losses are allowed to the extent of passive

income - and rental real estate losses with active participation are permitted to the extent of the

$25,000 special allowance. The Form 8582 worksheets simply allocate passive income

amongst the various passive activities on a pro rata basis, and the worksheets allocate the

$25,000 offset amongst the rental real estate activities.

Part II of Form 8582 computes the special allowance for rental real estate, based on the

taxpayers’ modified adjusted gross income. Rental real estate losses with active participation

are allowed up to $25,000, but that amount is reduced when the taxpayers’ modified adjusted

gross income exceeds $100,000. Refer to the modified adjusted gross income limitation

discussion earlier in this chapter.

Personal Use

A personal use dwelling does not qualify for QBI. The personal use of a dwelling unit comes

into play if a personal residence or any other property was changed to a rental at any time

during the year other than the beginning of the tax year. The yearly expenses such as taxes and

insurance must be divided between rental and personal use. For depreciation purposes, treat the

property as being placed in service on the conversion date.

If only part of a property is rented, the expenses and depreciation must be divided between the

rental and personal use. Direct expenses of the rental do not have to be divided. The cost of the

first phone line cannot be deducted, but a portion of other utilities can be deducted. The most

common ways to divide the expenses are by either square footage or number of rooms.

For each property listed on line 1 of Schedule E, report the number of days in the year each

property was rented at fair rental value and the number of days of personal use.

A day of personal use is any day, or part of a day, that the unit was used:

The owner for personal purposes,

Any other person for personal purposes, if that person owns part of the unit (unless

rented to that person),

Anyone in the owners family (or in the family of someone else who owns part of the

unit), unless the unit is rented at a fair rental price to that person as his or her main

home,

Anyone who pays less than a fair rental price for the unit, or

Anyone under an agreement that lets the owner use some other unit.

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Do not count as personal use:

Any day spent working substantially full time repairing and maintaining the unit, even

if family members used it for recreational purposes on that day, or

Any days the unit is used as the main home before or after renting it or offering it for

rent, if the owner rented or tried to rent it for at least 12 consecutive months (or for a

period of less than 12 consecutive months at the end of which it was sold or

exchanged).

The tax treatment of rental income and expenses for a dwelling unit that is also used for

personal purposes depends on whether it is used as a home. The dwelling unit is considered a

home for tax purposes if during the year181 it is used for personal purposes more than the

greater of:

1. 14 days …or

2. 10% of the total days, it is rented to others at a fair rental price.

If a home is rented fewer than 15 days during the year, none of the rental income or expenses is

to be included. If the home is rented more than 15 days, all the income and expense must be

reported, including depreciation. All expenses and depreciation must be allocated between

personal and rental use.

Rental Activity Treated as a Business

There are six major exceptions to an activity being treated as a rental activity under the passive

activity loss (PAL) rules. Each of the six exceptions is briefly discussed below with some

examples. These exceptions apply to rental real estate as well as any equipment leasing

activity.

An activity is not considered a rental activity for purposes of the PAL rules where the

average customer use is seven days or less182. For example, this rule might apply to

many vacation condos, vacation homes, beach cottages, bed and breakfasts, charter

boats, aircraft leases, and businesses that lease out automobiles, short-term rentals of

DVDs/videos, tools, or tuxedos. Not qualified for QBI.

An activity is not considered a rental activity where the average customer use is thirty

days or less and significant personal services183 are provided. For example, providing a

hotel or motel room with daily house cleaner service would fall within this definition.

Not qualified for QBI.

181 IRC §§280A(e)(1) , 280A(c)(5 182 Reg. Sec. 1.469-1T(e)(3)(ii)(A) 183 Reg. Sec. 1.469-1T(e)(3)(iv)

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An activity is not considered a rental activity where extraordinary personal services are

provided by or on behalf of the owner of the property in connection with making the

property available for use by customers. Services are extraordinary only if the services

provided in connection with the use of the property are performed by individuals, and

the use by customers of the property is incidental to their receipt of such services. For

example, the use by patients of a hospital's boarding facilities generally is incidental to

their receipt of the personal services provided by the hospital's medical and nursing

staff. Not qualified for QBI.

An activity is not considered a rental activity where the rental is incidental to a non-

rental activity. The rental of property during a tax year is treated as incidental to a

nonrental activity of the taxpayer if the principal purpose for holding the property

during the tax year is to realize gain from appreciation of the property. Not qualified for

QBI.

An activity is not considered a rental activity where the taxpayer customarily makes the

property available during defined business hours for nonexclusive use by customers.

For example, this rule might apply to activities involving the operation of health clubs,

spas, and golf courses. Not qualified for QBI.

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What Do You Think?

Q1 – Which of the following is not a true statement?

A. Improvements are considered an expense and deductible in the year

they are paid.

B. Improvements add to the basis of the property and are depreciated.

C. The cost of an improvement must be capitalized and can generally

be depreciated as if the improvement was separate property.

D. Repairs made within extensive remodeling or restoration of

property are included as part of the improvement and capitalized.

Q2 –Which of the following is a component of active participation in rental real estate?

A. Active participation requires regular, continuous, substantial involvement with the

property.

B. The taxpayer makes key management decisions such as the people to whom the

taxpayer rents, the rental terms, approving capital expenditures, etc.

C. An individual can show active participation if he or she arranges for others to provide

services.

D. B and C above

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A1: A - Is the correct answer Repairs are considered an expense and deductible in the year they are paid,

not improvements. Repairs are costs that keep the property in good condition,

do not add material value to property and do not substantially prolong the life

of the property.

Improvements add to the basis of the property and are depreciable. An improvement adds to

the value of property, prolongs its useful life or adapts it to new uses. The cost of an

improvement must be capitalized and can generally be depreciated as if the improvement was

separate property. Repairs made within extensive remodeling or restoration of property are

included as part of the improvement and capitalized. The cost of an improvement is

depreciated according to the MACRS class and recovery period of the underlying property

A2: D – Is the correct answer

The taxpayer actively participates in the rental activity if they make key management decisions

such as the people. To whom the taxpayer rents, the rental terms, approving capital

expenditures, etc. They also can show active participation if they arrange for others to provide

services. Active participation does not require regular, continuous, substantial involvement

with the property. However, in order to satisfy the active participation test, the taxpayer and

spouse must own at least 10% of the rental property. Ownership as a limited partner does not

count.

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Chapter 5 –Depreciation and Cost Basis

Bonus Depreciation for Qualified Improvement

Property The special depreciation allowance (bonus depreciation184) allows taxpayers to write-off 100%

of the cost of qualified property acquired and placed in service during the year, rather than

write-off the cost through depreciation over the MACRS recovery period of the property.

Qualified property includes both new and used property. Bonus deprecation is the default

method in the year placed in service. An election is required to opt out of bonus depreciation.

TCJA. Prior to the Tax Cuts and Jobs Act (TCJA), qualified improvement property was

classified as a specified type of property eligible for bonus depreciation. Qualified

improvement property is defined as any improvement to an interior portion of a building that is

non-residential real property if such improvement is placed in service after the date such

building is first placed in service. Qualified improvement property does not include any

improvement for which the expenditure is attributable to the enlargement of the building, an

elevator or escalator, or the internal structural framework of the building. One of the

requirements to claim bonus depreciation is that qualified property must be tangible property

depreciated under MACRS with a recovery period of 20 years or less.

Although Congress intended to treat qualified improvement property as eligible for bonus

depreciation. TCJA eliminated qualified improvement property185 placed in service after

December 31, 2017 as a specified category of qualified property, and amended IRC section

168(e) to eliminate the 15-year MACRS property classification for qualified leasehold

improvement property, qualified restaurant property, and qualified retail improvement

property. Although the Conference Report for TCJA indicated that Congress intended qualified

improvement property to have a 15-year recovery period, the amended version of IRC section

168(e) made by TCJA does not classify it as having a recovery period of 20 years or less.

Thus, a legislative change had to be enacted to provide for a recovery period of 20 years or less

for qualified improvement property placed in service after 2017. Regulations issued by the IRS

after TCJA clarified that qualified leasehold improvement property, qualified restaurant

property that is qualified improvement property, and qualified retail improvement property

acquired by the taxpayer before January 1, 2018 is classified as 15- year MACRS property,

eligible for bonus depreciation. Such property placed in service after 2017 is 39-year MACRS

property, not eligible for bonus depreciation.

184 IRC §168 185§13204 of TCJA

Objective: TCJA and CARES Act Depreciation

Changes

1. Explain qualifying property

2. New rules for Bonus Depreciation

3. §179 TCJA changes

4. Explanation of Original Use requirement

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CARES Act. The Coronavirus Aid, Relief, and Economic Security Act amended the code186to

provide that qualified improvement property is classified as 15-year property under MACRS.

The CARES Act also amended the definition of qualified improvement property by providing

that the improvement must be made by the taxpayer. The CARES Act also states qualified

improvement property has a class life of 20 years for purposes of the alternative depreciation

system. These amendments are effective as if included in TCJA. As a result, qualified

improvement property placed in service by the taxpayer after December 31, 2017 is 15-year

property and thus eligible for bonus depreciation.

Revenue Procedure 2020-25. The IRS has issued guidance allowing a taxpayer to change its

depreciation method for qualified improvement property placed in service after December 31,

2017 for tax years ending in 2018, 2019, or 2020. The revenue procedure also allows a

taxpayer to make a late election, or to revoke or withdraw one or more of the following

elections for 2018, 2019, or 2020:

• The election to use the alternative depreciation system [IRC §168(g)(7)],

• The special election to use bonus depreciation for certain plants bearing fruits and nuts [IRC

§168(k)(5)],

• The election not to use bonus depreciation for qualified property [IRC §168(k)(7)], or

• The election to use 50% bonus depreciation instead of 100% bonus depreciation for the first

tax year ending after September 27, 2017187.

Election not to use bonus depreciation. IRC section 168(k)(7) allows a taxpayer to make an

election not to deduct bonus depreciation for any class of property that is qualified property

placed in service during the tax year. The election must be made by the due date, including

extensions, of the tax return for the tax year in which the qualified property is placed in service.

The election is made by attaching a statement to the return indicating the class of property for

which the taxpayer is not claiming any bonus depreciation. If the election is not made on the

original return, an election can be made on an amended return if filed within six months of the

due date of the original return, excluding extensions. Once made, the election cannot be

revoked without IRS consent.

Qualified improvement property is included in the 15-year property class and is not a separate

class of property. However, qualified improvement property acquired after September 27, 2017

and placed in service before January 1, 2018 is a separate class of property. In light of the

CARES Act retroactively treating qualified improvement property as 15- year property,

Revenue Procedure 2020-25 provides the following special rules:

186 IRC§168(e) 187 IRC §168(k)(10)

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If a taxpayer

(a) Placed in service depreciable property during its 2018, 2019, or 2020 tax year,

(b)Timely filed its federal income tax return or partnership return for the year the

property was placed in service, and such return was filed on or before April 17, 2020,

(c)Wants to make the election to not claim bonus depreciation for qualified

improvement property, and

(d) Did not previously revoke or withdraw the election, then the taxpayer may make the

election:

1) By following the normal procedure for making the election on a timely filed

tax return for the year the property is placed in service as described above, or

2) By filing an amended income tax return or partnership return by October 15,

2021 for the year the property is placed in service, but no later than the

applicable statute of limitations for the tax year for which the amended return is

being filed (See Revenue Procedure 2020-23 regarding filing an amended return

for partnerships subject to the centralized partnership audit regime), or

3) By filing Form 3115 with the taxpayer’s timely filed original federal income

tax return or partnership return:

a) For the taxpayer’s first or second tax year succeeding the tax year in

which the taxpayer placed in service the property, or

b) That is filed on or after April 17, 2020 and on or before October 15,

2021.

The option to file Form 3115 is considered a change from an impermissible method of

depreciation to a permissible method of depreciation and thus is treated as a change in method

of accounting with an IRC section 481(a) adjustment required for the year of change. Amended

return or Form 3115. If a taxpayer placed in service qualified improvement property after

December 31, 2017 and began depreciating the property as 39-year property under MACRS,

the CARES Act now makes that depreciation method an improper method of depreciation.

To correct this situation, Revenue Procedure 2020-25 permits the taxpayer to:

• File an amended return for the year(s) the qualified improvement property was placed

in service to correct the method of depreciation (even if the improper method has been

used on two or more consecutive returns),

• File an administrative adjustment request (AAR) under IRC section 6227 (for certain

partnerships subject to the centralized partnership audit regime), or

• File Form 3115, Application for Change in Accounting Method, to change to a

permissible depreciation method. If the taxpayer chooses to file an amended return or

AAR, it must include the adjustment to taxable income for the change in determining

depreciation of the qualified improvement property and any collateral adjustments to

taxable income or to tax liability.

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This revenue procedure also provides rules for taxpayers who want to:

• Elect to use the alternative depreciation system under IRC section 168(g)(7) for

qualified improvement property,

• Elect to use bonus depreciation for certain plants bearing fruits and nuts under IRC

section 168(k)(5), or revoke a previously made election to use bonus depreciation for

such plants,

• Elect to use 50% bonus depreciation instead of 100% bonus depreciation for the first

tax year ending after September 27, 2017 under IRC section 168(k)(10), or revoke a

previously made election to use 50% bonus depreciation instead of 100% bonus

depreciation for such property, or

• Revoke a previously made election to not use bonus depreciation for a class of

property.

Adjustments also must be made on original or amended returns or AARs for any affected

succeeding tax year. If the taxpayer chooses to file Form 3115, the taxpayer corrects the prior

year improper method of depreciation on the next tax return that is filed. Since 15-year

depreciation or bonus depreciation produces a greater deduction than 39-year depreciation,

prior year depreciation claimed is less than the correct amount. This is referred to as a

“negative IRC section 481 adjustment,” and results in a decrease in taxable income for the tax

year of change.

Report the entire negative IRC Section 481 adjustment as “Other Expenses” on the business

return for the year of change. One-year qualified improvement property. Under normal

procedures, if the improper depreciation method was claimed for only one year, the taxpayer

has not yet adopted a method of accounting and, therefore, corrects the error on an amended

return.

Revenue Procedure 2020-25 provides a special rule for one-year qualified improvement

property that was placed in service by the taxpayer in the tax year immediately preceding the

year of change. Under this special rule, the taxpayer has the option to either file an amended

return, or make the change following the Form 3115 procedures.

TCJA Expansion of Bonus Depreciation

The TCJA significantly expands bonus depreciation: For qualified property placed in service

between September 28, 2017, and December 31, 2022 (or by December 31, 2023, for certain

property with longer production periods), the first-year bonus depreciation percentage

increases to 100%.

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Expands the definition of qualified property to include qualified film, television, and live

theatrical productions for which a deduction otherwise would have been allowable.188

The provision extends and modifies the additional first-year depreciation deduction through 2026

(through 2027 for longer production period property and certain aircraft). The 50-percent

allowance is increased to 100 percent for property placed in service after September 27, 2017, and

before January 1, 2023, (January 1, 2024, for longer production period property and certain

aircraft), as well as for specified plants planted or grafted after September 27, 2017, and before

January 1, 2023. Thus, the provision repeals the phase-down of the 50-percent allowance for

property placed in service after December 31, 2017, and for specified plants planted or grafted after

such date. The 100-percent allowance is phased down by 20 percent per calendar year for property

placed in service, and specified plants planted or grafted, in taxable years beginning after 2022

(after 2023 for longer production period property and certain aircraft). Under the provision, the

bonus depreciation percentage rates are as follows:

The 100-percent allowance is phased down by 20 percent per calendar

year for property placed in service, and specified plants planted or

grafted, in taxable years beginning after 2022. Under the provision, the

bonus depreciation percentage rates are as follows:

Bonus Depreciation

Percentage

Placed in Service Year Qualified Property in General Certain Aircraft

2023 80 percent 100 percent




2027 None 20 percent

For purposes of the bonus depreciation allowance that applies to qualified property acquired

and placed in service after September 27, 2017, the term “qualified property,” means property

that:

a. Is MACRS property that has a recovery period189, regardless of any election

made by the taxpayer under the alternative depreciation system, of 20 years or

less;

b. Is computer software for which a deduction is allowable under 190without regard

to the bonus depreciation rules;

c. Is water utility property;

d. Is a qualified film or television production for which a deduction would have

been allowable or is qualified live theatrical production for which a deduction

would have been allowable under IRC §181;

e. Meets either an original use requirement or acquisition requirement (see below);

and was placed in service by the taxpayer before January 1, 2027 (January 1,

2028, for certain longer life property).

188 IRC §181 189 IRC §168 (c) 190 IRC §167 (a)

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Listed Property

Special rules apply to the depreciation of listed property, which includes cars and other

property used for transportation, property used for entertainment, and certain computers and

cellular phones.

If a taxpayer owns listed property that is not used more than 50 percent in a qualified business

for the tax year, the taxpayer must determine the MACRS depreciation deduction for the

business use of that listed property by using the alternative depreciation system (ADS) rather

than the normal MACRS accelerated depreciation rules.191

Original Use Requirement for Bonus Depreciation and IRC §179

Under the original use requirement, the original use of the property has to begin with the

taxpayer. Under the acquisition requirement, property qualifies for bonus depreciation if the

property was not used by the taxpayer at any time before the acquisition, and the acquisition of

the property meets the requirements of IRC §§ 179(d)(2)(A), 179(d)(2)(B), 179(d)(2)(C), and

179(d)(3). Therefore, for property placed in service after September 27, 2017, bonus

depreciation is allowed for new and used property.

To prevent abuses, the additional first-year depreciation deduction applies only to property

purchased in an arm’s-length transaction. It does not apply to property received as a gift or from

inheritance. In the case of trade-ins, like-kind exchanges, or involuntary conversions, it applies only

to any money paid in addition to the traded-in property or in excess of the adjusted basis of the

replaced property.

IRC §179

Eligible Property

Expands the definition of

Section 179 property to include certain depreciable tangible personal property used

predominantly to furnish lodging or in connection with furnishing lodging; and

Qualified real property to include any of the following improvements to nonresidential

real property placed in service after the date the property was first placed in service:

o Roofs;

o Heating,

o Ventilation and air-conditioning property;

o Fire protection and alarm systems; and

o Security systems.

191 IRC §280F(b)

http://www.parkertaxpublishing.com/LinkDirector.aspx/C%5E~DataLocal~_Frequent~irc~HTML~0101_0199~390-4999815_0179%5E%5E179(d)(2)(A)

http://www.parkertaxpublishing.com/LinkDirector.aspx/C%5E~DataLocal~_Frequent~irc~HTML~0101_0199~390-4999815_0179%5E%5E179(d)(2)(B)

http://www.parkertaxpublishing.com/LinkDirector.aspx/C%5E~DataLocal~_Frequent~irc~HTML~0101_0199~390-4999815_0179%5E%5E179(d)(2)(C)

http://www.parkertaxpublishing.com/LinkDirector.aspx/C%5E~DataLocal~_Frequent~irc~HTML~0101_0199~390-4999815_0179%5E%5E179(d)(3)

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To qualify for the IRC §179 deduction, property must be one of the following types of

depreciable property:

(1) Tangible personal property to which the modified accelerated cost recovery system

(MACRS) rules under IRC §168 apply;

(2) Other tangible property described in IRC §1245(a) (3) (except buildings and their

structural components) used as:

(a) An integral part of manufacturing, production, or extraction or of furnishing

transportation, communications, electricity, gas, water, or sewage disposal

services;

(b) A research facility used in connection with any of the activities; or

(c) A facility used in connection with any of the activities in (a) for the bulk

storage of fungible commodities;

(3) A single-purpose agricultural (livestock) or horticultural structure;

(4) A storage facility (except buildings and their structural components) used in

connection with distributing petroleum or any primary product of petroleum;

(5) Off-the-shelf computer software placed in service in a tax year beginning after

2002, and meet the following criteria

o The software must be subject to a non-exclusive license

o The software must not have been substantially modified.

(6) Qualified real property placed in service in any tax year beginning after 2009.

In order to be eligible for the IRC §179 deduction, the property must have been acquired by

purchase192 for use in the active conduct of a trade or business. IRC §179 property can be

either new or used.

Taxpayers would be able to fully and immediately expense 100 percent of the cost of qualified

property acquired and placed in service after September 27, 2017 and before January 1, 2023

(with an additional year for certain qualified property with a longer production period). Under

the provision, qualified property would not include any property used by a regulated public

utility company or any property used in a real property trade or business

Tangible Personal Property Tangible personal property is any tangible property that is not real property, including

machinery and equipment; property contained in or attached to a building (other than structural

components). Refrigerators, grocery store counters, office equipment, printing presses, testing

equipment, and signs; gasoline storage tanks and pumps at retail service stations; and livestock,

including horses, cattle, hogs, sheep, goats, and mink and other furbearing animals are

examples of tangible personal property.

192 IRC §179(d)(1)(C)



http://www.parkertaxpublishing.com/LinkDirector.aspx/C%5E~DataLocal~_Frequent~irc~HTML~1201_1298~390-4999333_1245%5E%5E1245(a)(3)


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The treatment of property as tangible personal property for IRC §179 deduction is not

controlled by its treatment under local law. For example, property may not be tangible personal

property for the deduction even if treated so under local law, and some property (such as

fixtures) may be tangible personal property for the deduction even if treated as real property

under local law.

IRC §179 was amended in 1981 and the definition of qualifying property was substantially

changed. The definition now includes (in part) any property of a character subject to the

allowance for depreciation that is used as an integral part of manufacturing, production, or

extraction.

TCJA also requires a real property trade or business electing out of the limitation on the

deduction for interest to use ADS to depreciate any of its nonresidential real property,

residential rental property, and qualified improvement property.

Section 179 at a Glance for 2020

2020 Deduction Limit = $1,040,000. This deduction is good on new and used equipment, as

well as off-the-shelf software. To take the deduction for tax year 2020, the equipment must be

financed or purchased and put into service between January 1, 2020 and the end of the day on

December 31, 2020.

2020 Spending Cap on equipment purchases = $2,590,000. This is the maximum amount that

can be spent on equipment before the Section 179. Deduction available to his or her company

begins to be reduced on a dollar for dollar basis. This spending cap makes Section 179 a true

“small business tax incentive” (because larger businesses that spend more than $3,630,000 on

equipment will not get the deduction.)

Bonus Depreciation: 100% for 2020. Bonus Depreciation is generally taken after the Section

179 Spending Cap is reached. The Bonus Depreciation is available for both new and used

equipment. In 2019 maximum amount a taxpayer may expense under IRC §179 for 2019 to

$1,020,000, and or increases the phase-out threshold amount to $2,550,000.

Note: Bonus depreciation has no limit and is allowed in the first year, only.

Property that is predominantly used to furnish lodging or in connection with furnishing lodging

now qualifies for §179 expensing. This means that if a taxpayer purchases §1245 property

(furniture for an apartment complex, hotel, motel or dormitory) he or she can now expense

these items instead of depreciating.



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Luxury Autos

A taxpayer who uses his personal car (or other vehicle) for business purposes, can deduct his or

her actual car expenses or use the business standard mileage rate to figure the amount of his

deduction as long as the deduction is not being taken as an itemized unreimbursed employee

business expense deduction in 2018 – 2025193(TCJA eliminated employee business expenses).

If a taxpayer wants to use the business standard mileage rate, he or she must use that method in

the first year the car is available for business use and, after that, he or she can choose to use

either the standard mileage rate or actual expenses on a year-by-year basis. A taxpayer who

uses the business standard mileage rate method must figure his deduction by multiplying the

business standard mileage rate by the number of business miles the car was driven during the

year.

Beginning on Jan. 1, 2019 the standard mileage rates for the use of a car, van, pickup or panel

truck will be:

58 cents per mile for business miles driven, up from 54.5 cents in 2018.

14 cents per mile driven for in service for charitable organizations

20 cents per mile driven for medical and moving expenses, up from 18 cents in 2018

(Moving expenses as an adjustment to income are repealed by TCJA, moving expenses

related to a trade or business is allowed as a deduction.)

Beginning on Jan. 1, 2020 the standard mileage rates for the use of a car, van, pickup or panel

truck will be:

57.5 cents per mile for business miles driven, down from 58 cents in 2019.

14 cents per mile driven for in service for charitable organizations

17 cents per mile driven for medical and moving expenses, down from 20 cents in 2018

(Moving expenses as an adjustment to income are repealed by TCJA, moving expenses

related to a trade or business is allowed as a deduction.)

The standard mileage rate for business is based on an annual study of the fixed and variable

costs of operating an automobile, including depreciation, insurance, repairs, tires, maintenance,

gas and oil.

193 IRC §162(a)(2), 67(g)

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There is also a special rule that applies to luxury automobiles. The depreciation deductions

allowable for such automobiles are limited to a maximum dollar amount each tax year.194 This

is known as the luxury automobile limitation. The bonus depreciation deduction available for

automobiles is limited by the luxury automobile limitations. The Tax Cuts and Jobs Act of

2017 (TCJA) increased the depreciation limitations that apply to listed property. For passenger

automobiles placed in service after December 31, 2017, for which the additional first-year

depreciation deduction195is not claimed, the maximum amount of allowable depreciation is

$10,000 for the year in which the vehicle is placed in service, The allowable depreciation is

$16,000 for the second year, $9,600 for the third year, and $5,760 for the fourth and later years

in the recovery period. The limitations are indexed for inflation for passenger automobiles

placed in service after 2018.

The limitation for SUVs has also increased as part of TCJA. It will be adjusted for inflation

after 2018. For vehicles purchased in 2018, the limitation is still $25,000.

The Tax Cuts and Jobs Act changed depreciation limits for passenger vehicles placed in

service after Dec. 31, 2017. If the taxpayer does not claim bonus depreciation, the greatest

allowable depreciation deduction is:

$10,000 for the first year

$16,000 for the second year

$9,600 for the third year

$5,760 for each later taxable year in the recovery period

If a taxpayer claims 100 percent bonus depreciation, the greatest allowable depreciation

deduction is:

$18,000 for the first year

$16,000 for the second year

$9,600 for the third year

$5,760 for each later taxable year in the recovery period

Strict substantiation rules also apply for listed property. No deduction is allowed for any listed

property unless the taxpayer substantiates each element of the expenditure or use as

specifically provided in the regulations.196

These caps are adjusted annually for inflation effective for vehicles placed in service after

2018.197 The $8,000 bump-up to the first-year cap if bonus depreciation is claimed is not

adjusted for inflation.

194 IRC §280F(a) 195 IRC §168(k) 196 IRC §274(d)(4) 197 IRC §280F(d)

https://www.irs.gov/newsroom/new-rules-and-limitations-for-depreciation-and-expensing-under-the-tax-cuts-and-jobs-act

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In the case of a vehicle, a mileage log is essential. The mileage log should be kept; there are

many types of mileage logs including paper logbooks, phone applications, printouts from map

programs etc. Whichever type of log that is used should include the time, and business

purpose. Many apps can be used to track and store the mileage.

Larger Vehicles

As noted above, the TCJA increased bonus depreciation to 100 percent for qualifying property

acquired and placed into service after September 27, 2017, and before January 1, 2023. It also

extended bonus depreciation to used property acquired and placed into service after September

27, 2017.

SUVs with a gross vehicle weight rating above 6,000 lbs. are not subject to depreciation limits.

They are, however, limited to a $25,000198 IRC §179 deduction. No depreciation or §179 limits

apply to SUVs with a GVW more than 14,000 lbs. Trucks and vans with a GVW rating above

6,000 lbs. but not more than 14,000 lbs. generally have the same limits: no depreciation

limitation, but a $25,000 IRC §179 deduction. These vehicles, however, are not subject to the

§179 $25,000 limit if any of the following exceptions apply:

The vehicle is designed to have a seating capacity of more than nine persons behind the

driver’s seat;

The vehicle is equipped with a cargo area at least 6 feet in interior length that is an open

area or is designed for use as an open area but is enclosed by a cap and is not readily

accessible directly from the passenger compartment; or

The vehicle has an integral enclosure, fully enclosing the driver compartment and load-

carrying device, does not have seating behind the driver’s seat, and has no body section

protruding more than 30 inches ahead of the leading edge of the windshield.

Although SUVs purchased after September 27, 2017, remain subject to the $25,000 IRC § 179

limit, they are eligible for 100% bonus depreciation if they are above 6,000 lbs. This is true for

both new and used vehicles. For a taxpayers’ first taxable year ending after Sept. 27, 2017,

taxpayers may elect to apply a 50 percent allowance instead of the 100 percent allowance. To

make the election, they must attach a statement to a timely filed return (including extensions)

indicating they are electing to claim a 50% special depreciation allowance for all qualified

property. Once made, the election cannot be revoked without IRS consent. As noted above,

taxpayers may also elect out of bonus entirely for any class of property by filing an election on

a timely filed return. Once filed, that election can also not be revoked without IRS consent

Taxpayers can only take these deductions to the extent of qualified business use. If the business

use is 50 percent or less, the taxpayer is not eligible for IRC §179 or additional first-year

depreciation. Straight line depreciation over a 5-year life must be used for the portion allocable

to business use. All calculations in this article assume 100 percent business use.

198 IRC §179(b)(5)(A

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What Do You Think?

Q1. Jack purchased a small pickup on July 1, 2017. He started using the pickup for

his business in January 2019. He uses this pickup only for business, he purchase

another vehicle for personal use. What is the maximum amount of depreciation

allowed for tax year 2019?

A. $18,000

B. $16,000

C. $16,400

D. $10,000

Q2. Betty purchased a duplex as a rental in 2015. On Oct 1, 2019 she purchased a new heating

and air conditioning unit for Apt 1 for $6,500 she installed the units on January 15, 2020. She

purchased and installed new flooring in Apt. 2 for $4,500 on Feb 10, 2019. On Jan 20, 2019,

Betty purchased a computer for $1,250, she kept track of her use of the computer and uses it

70% for business. How much is Betty allowed to deduct under IRC §179 on her 2019 tax

return.

A. $11,000

B. $12,250

C. $11,875

D. $ 5,375

Q3. James acquired and placed into service an SUV in February of 2018 (bought for $45,000)

as his primary farming vehicle. He is able to document 100 percent business use through travel

logs. The SUV has a GVW of 8,000 lbs.

Which of the following is not correct?

A. James could expense $25,000 under IRC § 179 and then apply 50 percent bonus

depreciation ($20,000).

B. James is able to depreciate the entire amount in 2018 using 100 percent bonus

depreciation.

C. James is able to expense the entire amount using IRC §179.


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A1: D – Is the correct answer

Jack purchased a small pickup on July 1, 2017. He started using the pickup for his business in

January 2019. He uses this pickup only for business, he purchase another vehicle for personal

use. What is the maximum amount of depreciation allowed for tax year 2019?

A. $18,000 – is the correct answer (See below)

B. $16,000

C. $16,400

D. $10,000

Depreciation Limits for Passenger Automobiles, Trucks, and Vans Acquired after September

28, 2017, and Placed in Service during Calendar Year 2018 for which the §168(k) Additional

First Year Depreciation Deduction Applies:

Tax Year Amount

1st Tax Year $18,000

2nd Tax Year 16,000

3rd Tax Year 9,600

Each Succeeding Year 5,760

A2. Betty purchased a duplex in 2015. On Oct 1, 2019 she purchased a new heating and air

conditioning unit for Apt 1 for $6,500 she installed the units on January 15, 2020. She

purchased and installed new flooring in Apt. 2 for $4,500 on Feb 10, 2018. On Jan 20, 2019,

Betty purchased a computer for $1,250, she kept track of her use of the computer and uses it

70% for business. How much is Betty allowed to deduct under IRC §179 on her 2019 tax

return. C is the correct answer.

A. $11,000

B. $12,250

C. $11,875 is the correct answer. $6500+$4500+875 100% of the heating unit + 100%

of the flooring +70% of the computer.

D. $ 5,375

A3. James acquired and placed into service an SUV in February of 2018 (bought for $45,000)

as his primary farming vehicle. He is able to document 100 percent business use through travel

logs. The SUV has a GVW of 8,000 lbs.

Which of the following is not correct? A is the correct answer

A. James could expense $25,000 under IRC § 179 and then apply 50 percent bonus

depreciation ($20,000). This answer is incorrect; if the SUV had been placed in service

in 2017 this would be correct.

B. James is able to depreciate the entire amount in 2018 using 100 percent bonus

depreciation.

C. James is able to expense the entire amount using IRC §179.


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Cost Basis

Cost basis is the amount invested in the property for tax purposes. Basis is generally the cost of

the property if acquired by purchase. Cost includes cash and debt obligations paid for the

property as well as the FMV of other property or services the taxpayer provides in obtaining

property.

The cost basis of an asset includes amounts paid for the following items:

• Sales tax charged on the purchase.

• Freight charges to obtain the property.

• Installation and testing charges.

• Excise taxes.

• Legal fees incurred to obtain the property.

• Recording fees and revenue stamps.

• Commissions.

Real Property Real property is land and generally anything built on, growing on, or attached to the land. If

acquiring property for a lump sum and the property consists of land and buildings, allocate the

cost basis according to the respective FMVs of the land and buildings at the time of purchase.

Fair market value is the price at which the property would change hands between a willing

buyer and a willing seller, neither under compulsion to buy or to sell, and both having

reasonable knowledge of all the necessary facts.

Certain settlement expenses paid on the purchase of real property are included in basis.

Allocate these fees between land and buildings.

• Settlement costs added to basis include:

• Abstract fees.

• Charges for installing utility service.

• Legal fees.

• Recording fees.

• Surveys.

• Transfer taxes.

• Owner’s title insurance.

• Any amount the seller owes that the buyer assumes, such as real estate taxes.

Settlement costs do not include amounts placed in escrow for the future payment of expenses,

nor do they include fees and costs of getting a loan, casualty insurance premiums, rent for

occupancy of property before closing, or charges for utilities and other services related to

occupancy of the property before closing.

If a buyer assumes an existing mortgage, basis includes the amount paid for the purchase plus

the amount of the mortgage assumed.

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Points paid to get a mortgage do not add to the basis of the property. Deduct points over the

term of the loan unless the taxpayer meets the criteria to claim the points in full.

Constructed Property

The basis of constructed assets includes expenses of construction, such as:

• The cost of land.

• The cost of labor and materials.

• Architect’s fees.

• Building permit charges.

• Payments to contractors.

• Payments for rental equipment.

• Inspection fees.

Add demolition costs and other losses incurred for the demolition of any building to the cost of

the land on which the building was located. This includes the adjusted basis of the building

demolished. Allocate the cost of a tract of land purchased and subdivided to each of the lots in

the subdivision.

Intangible Asset

Intangible assets include goodwill, patents, copyrights, trademarks, trade names, and franchises.

The basis of an intangible asset is usually the cost to buy or create the asset. If created, the basis

does not include the time invested by the creator, author, or inventor.

Purchase of a Trade or Business

Purchasing a group of assets that constitutes a trade or business requires an allocation of the

separate assets purchased. If the buyer and seller enter into a written agreement that has an

allocation of the purchase price, this agreement is binding on both parties unless the IRS

determines the allocation is inappropriate. Both the buyer and the seller must complete Form

8594, Asset Acquisition Statement.

If no allocation was made in the written agreement, or the IRS determines the allocation is

inappropriate, the residual method allocates the purchase price to the various assets in

proportion to, but not more than, their FMV in the following order:

• Class I: Cash and general deposit accounts, other than certificates of deposit held in

banks, savings and loan associations and other depository institutions.

• Class II: Actively traded personal property, including certificates of deposit, foreign

currency, U.S. government securities and publicly traded stock.

• Class III: Assets the taxpayer marks-to-market, including accounts receivable.

• Class IV: Stock in trade, or other property of a kind that would properly be included in

the inventory of the taxpayer if on hand at the close of the taxable year, or property held

primarily for sale to customers in the ordinary course of a trade or business.

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• Class V: All assets other than Classes I, II, III, IV, VI, and VII. Furniture, fixtures,

buildings, land, vehicles, and equipment, which constitute all or part of a trade or

business, are generally in this class.

• Class VI: All §197 intangibles except goodwill and going concern value.

• Class VII: Goodwill and going concern value.

Adjusted Basis Before determining gain or loss, adjust the basis for certain items.

Increase the basis of property by:

• Capital improvements (having a useful life of more than one year).

• Assessments for local improvements.

• Rehabilitation expenses reduced by any rehabilitation credit taken.

• Expenditures to restore property that suffered a casualty loss.

• Certain legal fees, such as the cost of defending or perfecting title.

• Zoning costs.

Decrease the basis of property by various deductions, credits, or tax benefits allowed against

the property. Some examples include:

• Energy conservation subsidies.

• Casualty and theft losses.

• Certain credits allowed on the property, such as credits for employer provided childcare

and qualified electric vehicles.

• Deferred gain.

• Section 179 expense.

• Certain canceled debt excluded from income.

• Rebates received from the manufacturer or seller.

• Depreciation, amortization, and depletion.

• Various nontaxable distributions, such as nontaxable corporate distributions or amounts

received for granting an easement (sale of an interest in real property).

• •

• •

•

• •

• •

•

• •

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Basis Other Than Cost

Property Received for Services

The FMV of property received for services is included in income and then becomes the basis in

that property.

Restricted Property

If the property is restricted property, the basis is the property’s FMV when vesting occurs. The

taxpayer can make an election to include the FMV as income at the time of the transfer as

opposed to the time of vesting.

Property is substantially vested when it is transferable or when it is not subject to a substantial

risk of forfeiture.

Bargain Purchases

A bargain purchase is a purchase of an item for less than FMV. If the bargain purchase was

compensation for services, the difference between the purchase price and the FMV is included

in income. The FMV becomes the basis because that bargain element is included in income,

unless an exception applies (incentive stock options and qualified employee discounts).

Involuntary Conversions

Property received in an involuntary conversion, if similar or related in service or use to the

property involuntarily converted, generally has a basis equal to the old property’s basis on the

date of conversion, with the following adjustments:

Decreased by any loss recognized on the exchange or any money received that was

not spent on similar property.

Increased by any gain recognized on the exchange or any cost of acquiring

replacement property.

Like-kind Exchange Property received in a taxable exchange has a basis equal to the FMV of the property at the time

of the exchange.

Property received in a nontaxable like-kind exchange generally has the same basis as the

old property given up. If the taxpayer paid additional money to get the new property,

increase the basis by the additional money paid.

The basis of unlike property received is its FMV on the date of the exchange because the

receipt of unlike property is taxable.

Property received in a partially nontaxable exchange generally has the same basis as the

old property exchanged with the following adjustments:

o Decreased by any money received or any loss recognized on the exchange.

o Increased by any additional costs incurred or any gain recognized on the

exchange.

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Property Settlement A property settlement between divorcing or divorced couples is not a taxable event. The basis

of property in a spousal transfer is the transferor spouse’s adjusted basis. This also applies to a

transfer by a former spouse, incident to a divorce.

Gift The basis of property received as a gift depends on the donor’s adjusted basis, the FMV at the

time of the gift, and any gift tax paid.

If the FMV is less than the donor’s adjusted basis, the basis differs for figuring gain or loss.

Use the donor’s adjusted basis, increased or decreased by appropriate adjustments

during ownership, as the basis for determining depreciation or gain on disposition.

Use the FMV on the date of the gift, increased or decreased by appropriate adjustments

during ownership, as the basis for determining loss on a disposition.

A disposition could result in no gain or loss if sold for an amount between FMV and the

adjusted basis.

If the FMV is equal to or more than the donor’s adjusted basis, the recipient basis is the

donor’s adjusted basis increased by the part of the gift tax due to the net increase in the

value of the gift.

If received before 1977, increase the basis by all the gift tax paid; however, the increase

cannot exceed the FMV at the time of the gift.

If received after 1976, increase the basis by the part of the gift tax paid that is due to the

net increase in value of the gift. Determine the gift tax for a net increase in value by

multiplying the gift tax by a fraction. The numerator is the net increase in value of the

gift and the denominator is the amount of the gift. The amount of the gift is the value of

the gift reduced by any annual exclusion, or any marital or charitable deduction that is

applicable.

Inheritance

The basis of inherited property is one of the following amounts:

The FMV of the property at the date of the individual’s death.

The FMV on the alternate valuation date if the personal representative for the estate

chooses to use alternate valuation.

The value under the special-use valuation method for real property used in farming,

qualified woodlands, or closely held businesses, if chosen for estate tax purposes.

The decedent’s adjusted basis in land to the extent of the value excluded from the

decedent’s taxable estate as a qualified conservation easement.

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Converted Property For property converted from personal to business or rental use, the basis for depreciation is the

lesser of the FMV or the adjusted basis on the date of conversion. If the taxpayer later sells or

disposes of the property, the basis to use depends on whether figuring gain or loss.

The basis for gain is the adjusted basis in the property when sold.

The basis for loss is the smaller of the adjusted basis or the FMV at the time of the

conversion plus or minus required adjustments.

Example: A taxpayer sells his house, which he had changed to rental property after using it as

his home. When converted to rental use, it had a FMV of $33,000 and an adjusted basis of

$35,000. His basis for depreciation is $33,000, the lesser of FMV or adjusted basis. He claimed

$3,000 depreciation, figured under the straight-line method, while renting.

For figuring gain, his adjusted basis at the time of the sale is $32,000 ($35,000 adjusted basis

on conversion – $3,000 depreciation). For figuring loss, his adjusted basis at the time of the

sale is $30,000 ($33,000 FMV on conversion – $3,000 depreciation). In this example, use

FMV because it was smaller than the adjusted basis at the time of changing the house to

rental use. If the sales price is between $30,000 and $32,000, the taxpayer has neither a gain

nor loss on the sale.

Basis of Stocks The basis in stocks and bonds depends on the method of acquisition (purchase, gift,

inheritance, etc.). Certain events then adjust that basis.

A nondividend distribution is a distribution not paid out of earnings and profits of a

corporation. It is nontaxable to the recipient to the extent there is stock basis and it reduces that

shareholder’s stock basis. If the taxpayer cannot identify the specific shares subject to the

nondividend distribution, reduce the basis of the earliest shares purchased first.

Delivering certificates to a broker and identifying a specific purchase date or a specific purchase

price can accomplish identification. If a broker or agent holds the stock, inform the broker

which stock to sell, and receive written confirmation.

Dividend Reinvestment

Dividend reinvestment plans invest the dividends in additional shares or fractional shares of

stock. The basis is the actual cost of the shares.

For taxable stock dividends, the basis of the new stock is the FMV on the date of distribution.

For a per-share basis of stock received as nontaxable stock dividends, divide the taxpayers’

adjusted basis of the old stock between the shares of old stock and the new stock.

If the old and new shares are identical, divide the adjusted basis by the total number of old and

new shares.

A stock right is a right to acquire a corporation’s stock.

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Stock rights that have been exercised, sold, or expire have the following treatment:

If the rights are taxable, the basis of the right is the FMV at the time of the distribution.

If the rights are nontaxable when received, the basis is zero if allowed to expire. For the

exercise or sale of a right, the basis depends on the FMV at the time of the distribution.

If the rights had a FMV of 15% or more of the FMV of the old stock, the taxpayer must

divide the adjusted basis of the stock between the stock and the rights based on the

FMV of each.

If the FMV of the rights are less than 15%, the basis is zero unless the taxpayer chooses

to divide the basis of the old stock between the old stock and the stock rights. If the

taxpayer makes this choice, attach a statement to his or her return for the year the

taxpayer received the stock rights indicating he or she chooses to divide the basis in the

stock.

If exercised, the basis of the new stock is the sum of its cost and the basis of the stock

rights exercised.

Jackie owns 100 shares of ABC Company stock, which cost $22 per share. The ABC Company

gives Jackie 10 nontaxable stock rights that would allow her to buy 10 more shares at $26 per

share. At the time the stock rights were distributed, the stock had a FMV of $30, not including

the stock rights. Each stock right has a FMV of $3. Even though the FMV of the stock rights

were less than 15% of the FMV of the stock, the taxpayer chose to divide the basis of the old

stock between the old stock and the stock rights. Figure the basis of the stock rights and the

basis of the old stock as follows.

Basis of old stock: 100 shares x $22 $2,200 .00

FMV of old stock: 100 shares x $30 $3,000 .00

FMV of rights: 10 rights x $3 $30 .00

New basis of old stock: ($3,000 ÷ $3,030) x

$2,200

$2,178 .22

Basis of rights: $2,200 .00 – $2,178 .22 $21 .78

If Jackie sold the rights, the basis for figuring gain or loss is $2.18 per right ($21 .78 ÷ 10). If

Jackie exercised the rights, the basis of the stock acquired is the price paid ($26) plus the basis

of each right exercised for a total basis of $28 .18 ($26 .00 + $2 .18). The remaining basis of

the old stock is $21 .78 per share.

Basis of Mutual Funds To determine gain or loss on the disposition of mutual fund shares, basis is determined using

cost basis or an average basis.

Cost basis is either a specific share identification method or a first-in first-out (FIFO) method.

If average basis does not apply to other shares in the same mutual fund, use cost basis.

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Use the average basis method if acquiring shares at various times and for various amounts and

the custodian or agent holds the shares. Determine average basis using the single category

method. Add the basis of all shares regardless of long-term or short-term, and then the number

of shares for an average basis divides that total.

The FIFO method is required unless electing the average method or the specific share

identification requirements are satisfied.

Basis of Bonds The premium paid to acquire a taxable bond becomes part of the basis in the bond. The

taxpayer can elect to amortize the premium and then reduce the basis by the amount of

amortized premium deducted each year.

Amortization of the premium paid for tax-exempt bonds is required even though not deducted.

Reduce the basis of the tax-exempt bond by the amortization for the year.

Bond premium is the amount by which the taxpayers’ basis in the bond right after acquisition

is more than the total of all amounts payable on the bond.

Original issue discount (OID) is a form of interest included in income as it accrues over the

term of the debt instrument. Increase basis in the debt instrument by the amount of OID

included in income.

S Corporation Stock Various transactions within an S corporation adjust the shareholder’s basis annually. A

shareholder’s basis has two components: stock basis and loan basis.

The amount of money or adjusted basis of property transferred to the corporation in exchange

for stock determines the shareholder’s beginning basis in the corporate stock:

Increase the shareholder’s basis in S corporation stock by additional contributions, the

shareholder’s share of all income items of the S corporation, including tax-exempt

income, and both separately and not separately stated income passed through to the

shareholder.

Decrease the shareholder’s basis in S corporation stock by property distributions

(including cash), nondeductible expenses, depletion, and deductible losses and

deductions reported on Schedule K-1.

If total stock basis reductions exceed the amount needed to reduce stock basis to zero, the

excess (excluding a decrease due to distributions) reduces the basis of any loans the

shareholder made to the corporation.

Increases restore a shareholder’s reduced loan basis before increasing stock basis.

Distributions that exceed stock basis are taxed as capital gains and do not reduce loan

basis.

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Basis Reference

Chart

How Acquired Basis for Gain, Loss, and Depreciation

Purchase Usually cost. Includes cash, FMV of other property and services,

sales tax, freight, testing and installation, closing costs, and

indebtedness assumed.

Nontaxable and partially

taxable exchanges

Basis of property acquired is the same as the basis of the property

given up increased by additional costs and any gain recognized,

and decreased by money or unlike property received and any loss

recognized.

Gifts If the FMV is less than the donor’s adjusted basis:

Basis for gain or depreciation is the donor’s adjusted basis

increased or decreased by adjustments to basis while the

taxpayer held the property. The basis for loss is the FMV at the

time of the gift, increased or decreased by adjustments to basis.

If the FMV is equal to or greater than the donor’s adjusted basis:

The basis for gain, loss, and depreciation is the donor’s adjusted

basis increased by all or a portion of the gift tax paid.

Conversion from

personal use to business

use

Depreciation: Lesser of adjusted basis or FMV at the date of

conversion .

Gain: Adjusted basis .

Loss or depreciation: Lesser of adjusted basis or FMV at the

date of conversion adjusted for improvements, disposals, or

depreciation allowed or allowable .

Inherited FMV at date of death or alternate valuation date if elected .

Transfer between

spouses

Carryover of basis prior to transfer . No gain or loss recognized .

Stocks and bonds Usually cost. Either first acquired, first sold (FIFO), or specific

identification.

Stock split: Divide the original basis between the old and new

stock.

Dividend reinvestment: FMV on the dividend payment date .

Reduced by nontaxable distributions .

Mutual fund shares Cost . May use average basis if bought at different times and prices, or specific identification.

Original issue discount Cost, increased by OID included in income .

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Sales and Other Dispositions

A sale is the transfer of property for money, a mortgage, note, or other promise to pay money.

A trade is the transfer of property for other property or services.

A gain is the excess of the amount realized over the adjusted basis of the property. A loss is the

excess of the adjusted basis over the amount realized.

The amount realized is the total of all money received plus the FMV of all property and

services received and minus expenses of the sale. The amount realized also includes any

liabilities assumed by the buyer and liabilities to which the property traded is subject (mortgage,

real estate taxes, etc.). The amount realized is not necessarily the same amount that is included

in income and subject to tax.

Realized gain or loss is the amount realized less the adjusted basis of the property.

The amount recognized is the amount that is included or deducted in determining gross income

for tax purposes. The amount recognized could differ from the amount realized. This may

occur in a like-kind exchange when the recognized gain is limited to the amount of boot

received.

Recognized gain or loss is the gain or loss included in determining gross income.

If the taxpayer sells or exchanges property used partly for business or rental and partly for

personal, figure the gain or loss as if selling two separate properties.

Allocate the selling price, expenses of the sale, and the basis of the property to each

portion.

Adjust the basis of the business portion by depreciation allowed or allowable.

Report the following in the same manner as a sale:

A redemption of stock generally receives sale treatment and is subject to the capital gain or loss

provisions unless the redemption is a dividend or other distribution on stock. Treat a

redemption as a sale or trade of stock if any of the following apply:

The redemption is not essentially equivalent to a dividend.

There is a substantially disproportionate redemption of stock.

There is a complete redemption of all the stock owned by a taxpayer.

The redemption is a distribution in partial liquidation of a corporation.

A redemption or retirement of bonds or notes at maturity is a reportable sale or trade.

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Treat a surrender of stock by a majority shareholder who retains control of a corporation as a

contribution to capital rather than an immediate loss deductible from taxable income. The

shareholder must reallocate the basis in the surrendered shares to the retained shares.

Treat stocks, stock rights, and bonds that become worthless during the tax year as if sold on the

last day of the year.

Treat payments received by a tenant for the cancellation of a lease as an amount realized from

the sale of property.

Treat payments received for granting the exclusive use of a copyright throughout its life in a

particular medium as received from the sale of property.

Subtract the amount received for granting an easement from the basis of the property. Any

amount received that is more than the basis attributable to that part of the property is a taxable

gain. If the taxpayer transfers a perpetual easement for consideration and does not keep any

beneficial interest in the part of the property affected by the easement, treat the transaction as a

sale of property.

The amount realized from the disposition of a life interest in property, an interest in property for

a set number of years, or an income interest in a trust is a recognized gain under certain

circumstances:

If the taxpayer received the interest as a gift, inheritance, or a transfer incident to

divorce, disregard the basis and the amount realized is a recognized gain.

This rule does not apply if all the interests in the property are disposed of at the same

time.

For property converted from personal use to rental or business use, and used for business or

rental at the time of the sale, a loss on the sale is deductible.

If the adjusted basis of the property was more than the FMV at the time of the conversion to

business use, the loss is limited. The deductible loss is determined as follows:

Lesser of the property’s adjusted basis or FMV at the time of

conversion.

+ Cost of improvements and other increases to basis since the change.

– Depreciation and other decreases to basis.

– Amount realized on the sale.

= The result is the deductible loss. If the amount realized is more, treat

the result as zero.

Gain is determined by subtracting the adjusted basis from the amount realized. If the property

was the taxpayers’ main home prior to the conversion and still within the two-out-of-five-year

use period, exclude part of the gain.

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The abandonment of property is a disposition of property. Deduct a loss on abandonment of

business or investment property as an ordinary loss. The adjusted basis at the time of

abandonment is the loss in the year of abandonment. Gain or loss can result from a foreclosure

or repossession on a later date.

Treat a foreclosure or repossession as a sale or exchange from which the borrower realizes a

gain or loss. Report the transaction the same as other sales with the gain or loss being the

difference between the adjusted basis in the property and the amount realized. This reportable

event is separate from the cancellation of debt that may result if there is any loan balance

remaining after the foreclosure or repossession.

Involuntary Conversion

An involuntary conversion occurs when the individual’s property is destroyed, stolen,

condemned, or disposed of under a threat of condemnation and the taxpayer receives other

property or money in payment, such as insurance or a condemnation award. Report gain or

loss from an involuntary conversion on the tax return for the year realized. Depending on the

type of involuntary conversion and the replacement property, gain is eligible for deferral.

Condemnation is the legal taking, without the owner’s consent, of private property for public

use by a federal, state, or local government or political subdivision for a reasonable amount of

money or property.

A condemnation award is money the taxpayer is paid or the value of other property received

for the condemned property. This includes the amount paid for the sale of property under threat

of condemnation.

Severance damages are not part of a condemnation award. Severance damages result if there is

a decrease in the value of the portion of the property retained when the other part of the

property was condemned. Severance damages reduce the basis of the remaining property.

Taxable gain results if the severance damages are more than the basis of the remaining part.

The taxpayer can choose to postpone gain on an involuntary conversion.

Gain results if the award, less expenses of obtaining it, is more than the adjusted basis in the

property. If not replaced within a specific period or the taxpayer receives dissimilar property or

cash, the gain is taxable. To postpone the entire gain, the cost of the replacement property must

be equal to or more than the reimbursement for the property. A taxpayer may choose to

postpone recognizing the gain if either of the following provisions apply:

The taxpayer purchases property similar or related in service or use to the condemned

property.

The taxpayer purchases a controlling interest (at least 80%) in a corporation that owns

similar property.

A loss results when money or other property received is less than the adjusted basis in the

property.

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The replacement period for a condemnation or threat of condemnation begins on the earlier of

the date the condemned property was disposed of or the date on which threat of condemnation

began. For property damaged, destroyed, or stolen in a casualty or theft, the replacement period

begins on the date of the casualty or theft.

The replacement period ends two years after the close of the first tax year of realizing any part

of the gain from the condemnation, casualty, or theft. The replacement period ends three years

after the end of the first tax year of realizing any part of the gain from a condemnation of real

property held for business or investment. For a main home located in a federally designated

disaster area, the replacement period is four years.

Like-Kind Exchange

The IRS has provided relief to taxpayers having difficulty completing like-kind exchanges due

to the COVID-19 pandemic. Under IRS Notice 2020-23, like-kind exchange deadlines that

would otherwise fall between April 1 and July 14 are extended to July 15

TCJA retains Section 1031 for real estate exchanges. However, Section 1031 may no longer be

utilized to defer taxes for transactions involving personal property. Real estate exchanges are

subject to the same rules and regulations as under previous law. The 45-day identification and

180-day exchange periods remain unchanged, as does the role of the Qualified Intermediary.

All real estate in the United States, improved or unimproved, also remains like-kind to all other

domestic real estate. Foreign real estate continues to be not like-kind to real estate in the U.S.

Personal property assets that can no longer be exchanged include intangibles, such as

broadband spectrums, fast-food restaurant franchise licenses and patents; aircraft, vehicles,

machinery and equipment, railcars, boats, livestock, artwork and collectibles.

The exchange of property for the same kind of property is the most common type of

nontaxable exchange.

To be a like-kind exchange199, the property traded and the property received must be qualifying

property and like-kind property.

Qualifying property is property the taxpayer holds for investment or for productive use

in a trade or business. The like-kind exchange rules do not apply to the following:

Property used for personal purposes.

Stock in trade or other property held primarily for sale.

Stock, bonds, notes, or other securities or evidence of indebtedness, such

as accounts receivable.

Partnership interests.

Certificates of trust or beneficial interest.

Choses in action.

199 IRC §1031(a)

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Like-kind property is property of the same nature or character, even if it differs in grade or

quality. Depreciable tangible personal property can be either like-kind or like-class.

Like-class properties are depreciable tangible personal properties within the same

General Asset Class or Product Class. The same product class includes property listed

in a 6-digit product class in sections 31 through 33 of the North America Industry

Classification System (NAICS).

Real property is more flexible in that unimproved real property and improved real

property are like-kind.

Intangible personal property and not depreciable personal property may qualify

depending on the nature and the character of the rights involved. It also depends on the

nature or character of the underlying property to which those rights relate.

The exchange of goodwill or going concern value of one business for the goodwill or

going concern value of another business is not a like-kind exchange.

A deferred exchange200 is an exchange where the taxpayer transfers property used in a business or

held for investment and later receives like-kind property to use in a business or held for

investment.

Treat the transaction as a sale instead of deferred exchange if the taxpayer actually or

constructively receives money or unlike property before receiving the replacement property.

The taxpayer must identify replacement property within 45 days of transferring the relinquished

property.

The taxpayer must receive replacement property by the earlier of the following dates:

The 180th day after the date of transfer of the relinquished property.

The due date, including extensions, for the tax return for the tax year in which the

transfer of the relinquished property occurs.

If meeting all the requirements for a nontaxable exchange, but the taxpayer receives unlike

property or cash (called boot) in addition to like property, the exchange is partially nontaxable.

Gain to the extent of boot received is included in income.

200 Reg. Sec. 1.1031(k)-1(a

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What Do You Think?

Q1. Which of the following is true regarding the purchase of a business?

A. Purchasing a group of assets that constitutes a trade or business

requires an allocation of the separate assets purchased.

B. Form 8594, Asset Acquisition Statement must be completed by both

parties.

C. The written agreement is binding by both the buyer and the seller, if

the allocation was part of the purchase price.

D. All of the above

Q2. Compensation given to a property owner for the loss in value of a portion of land and for

the decrease in value to the remaining property which the government takes for public use by

condemnation under its eminent domain rights, is known as which of the following?

A. Like-Kind Exchange

B. Severance Damage

C. Inheritance

D. Disposition

Q3. Which of the following is not a decrease in adjusted basis?

A. Energy conservation subsidies.

B. Assessments for local improvements.

C. Section 179 expense.

D. Certain canceled debt excluded from income.

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What Do You Think? – Answer

A1. – Answer

The correct answer is D, they are all correct

Purchasing a group of assets that constitutes a trade or business requires an

allocation of the separate assets purchased. If the buyer and seller enter into a written

agreement that has an allocation of the purchase price, this agreement is binding on both

parties unless the IRS determines the allocation is inappropriate. Both the buyer and the seller

must complete Form 8594, Asset Acquisition Statement.

A2. The correct answer is B

Compensation given to a property owner for the loss in value of a portion of land and for the

decrease in value to the remaining property which the government takes for public use by

condemnation under its eminent domain rights, is known as which of the following?

A. Like-Kind Exchange

B. Severance Damage

C. Inheritance

D. Disposition

A3. The correct answer is B

Which of the following is not a decrease in adjusted basis?

A. Energy conservation subsidies.


C. Section 179 expense.

D. Certain canceled debt excluded from income.

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Chapter 6 – Clergy Tax

Changes in society have prompted significant

changes in the way religious and charitable organizations carry out their missions. As a result,

ministers now work in a variety of organizations, and their duties extend beyond those

associated with traditional church pastors. These changes have made determining who meets

the definition of a “minister of the gospel” a complex decision.201 A minister for tax purposes

is determined based on who employs the individual and the duties the individual performs. An

individual does not have to work for a church or denomination to be considered a minister but

must perform the duties of a minister as specified in the regulations to be treated as a minister.

Those who qualify as ministers are subject to a unique set of tax rules. These rules include the

benefit of a tax-free housing allowance and the detriment of being self-employed for Social

Security tax purposes. Thus, clarity on the definition of minister is an important issue for these

taxpayers. In addition to a salary, ministers are also often compensated with a housing

allowance. The U.S. 7th Circuit Court of Appeals upheld the constitutionality of the housing

allowance benefit in 2019 in Gaylor, et al v. Mnuchin, et al. The Seventh Circuit held that the

exclusion from gross income for housing allowances provided to ministers does not violate the

Establishment Clause of the First Amendment.202 The court found that the statute has a secular

legislative purpose, does not either advance or inhibit religion, and does not foster excessive

government entanglement with religion. This ruling provides a substantial income tax benefit

for ministers. The housing allowance excluded from gross income remains subject to self-

employment (SE) tax.

Definition of Minister under the Regulations

The regulations under Secs. 107 and 1402 provide guidelines for determining who qualifies as

a minister. Both sections state that a minister is distinguished by the duties he or she performs.

The regulations state that the duties of a minister include the ministration of sacerdotal

functions and the conduct of religious worship, and the control, conduct, and maintenance of

religious organizations (including the religious boards, societies, and other integral agencies of

such organizations), under the authority of a religious body constituting a church or church

denomination.2

201 IRC§107 202 Gaylor, et al. v. Mnuchin, 2019 PTC 86 (7th Cir. 2019)

Objective:

Identify and review the major points of

the Affordable Care Act

Understand important items in the ACA.

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The duties of a minister203 include the performance of sacerdotal functions, the conduct of

religious worship, the administration and maintenance of religious organizations and their

integral agencies, and the performance of teaching and administrative duties at theological

seminaries.

The definitions above identify the following categories of people who qualify as ministers:

Those in traditional clergy roles (e.g., priests, pastors, rabbis) who typically perform

sacerdotal functions and conduct worship;

Those who work for secular organizations to the extent they perform sacerdotal

functions and conduct worship;

Those who control and maintain religious organizations at the local church or

denomination level; and

Teachers and administrators at seminaries.

Two key issues arise in defining those who qualify as ministers: whether their service is

conducted under the authority of a church or denomination and whether their duties are

encompassed by the regulations above. Those under the control of a church or denomination

whose predominant duties are specified in the regulations have the strongest positions.

The more crucial of the two issues is the duties performed by the minister. Individuals

performing minister duties outside the auspices of a church or denomination can qualify as

ministers based on duties performed. For example, chaplains employed by secular

organizations have successfully qualified as ministers because they conducted worship and

administered sacraments.3

The following examples204 help identify those outside traditional minister roles who qualify as

ministers. In these examples, either the specific duties of the minister or the assignment of

duties by the religious organization, determines whether the person qualifies as a minister.

An ordained chaplain at a university, who teaches a religion class, provides spiritual

counseling, and conducts worship services is considered a minister. 4 In this example, the

duties of the chaplain qualify him or her as a minister even though he or she is not working

at a religious organization.

A person performs the duties of a minister while conducting religious worship and

performing sacerdotal functions even if other employment is not ministry related. In effect,

a person can have two careers simultaneously, one as a minister and another in a secular

position.

An ordained minister directing an agency of the denomination qualifies as a minister.

An ordained minister assigned by his or her denomination to advise a company in the

publication of a book about the denomination is considered a minister.

203 Regs. Sec. 1.107-1(a) 204 Regs. Sec. 1.1402(c)-5

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In the last two examples, the taxpayers are ministers based mainly on their conduct and

maintenance of a denomination, not because their daily tasks are those of a typical minister.

IRS and Judicial Determinations

The above examples from the regulations notwithstanding, those performing tasks outside

traditional ministry roles have a more time that is difficult qualifying as ministers. This issue

has come up in court cases and IRS rulings involving employees in religious and secular

organizations. This section summarizes how the Tax Court has interpreted the definition of a

minister.

Employees of Churches

The Tax Court provided what is probably the most widely cited and useful analysis of the law

in Knight.8 Knight was not ordained and could not administer the sacraments. However, he

conducted worship, was licensed, and was considered a spiritual leader in his church. The court

held that Knight qualified as a minister, applying a five-factor test initially established in

Wingo.9 205In that case, the Tax Court set forth the following attributes and duties of a minister:

Is ordained, commissioned, or licensed;

Is recognized by the religious body as a spiritual leader;

Conducts religious worship;

Administers sacraments; and

Is involved in the control, conduct, or maintenance of a religious organization.

In Knight, the court stated that the first factor must be met and the other factors should be

weighed against the facts and circumstances of each taxpayer to make a determination. The

Knight decision is particularly influential because it is the most recent case on this issue

decided by the full Tax Court. In addition, IRS audit guidelines cite this decision, referring

those auditing ministers back to these five factors.

The guidance provided in Knight is even more important given two recent moves by the IRS.

First, the IRS no longer provides a definition of minister in the latest edition of its Tax Guide

for Churches and Religious Organizations. Second, the IRS has stated that it will no longer

issue private letter rulings addressing the issue of whether a taxpayer meets the definition of a

minister.206 Lacking IRS guidance, ministers and their employers must rely on judicial

interpretations to determine those who qualify as ministers.

205 Wingo 89 TC 911 (1987) 206 Rev. Proc 2006-3,2006-1 IRB 122

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Subsequent Tax Court decisions measured the facts of each case against the five factors from

Wingo. For example, in Haimowitz, the taxpayer did not meet the definition of a minister

because he was not ordained, commissioned, or licensed in the Jewish faith, and his duties

were mainly administrative. Haimowitz failed to meet any of the five factors. In Brannon, he

Tax Court ruled that the taxpayer satisfied the definition of a minister because he met four of

the five factors specified in Wingo. He was licensed, conducted worship, presided over the

sacerdotal functions of baptism, communion, and marriage, and was assigned to control and

maintain the Trinity-Weoka Church.

Most ministers work for local churches, and many court decisions address whether church

employees qualify as ministers. There are fewer decisions providing guidance on whether those

employed by church-affiliated organizations qualify as ministers. The next section draws

heavily on IRS guidance to provide parameters that determine how those employed by these

organizations can qualify as ministers.

Employees of Church-Affiliated Organizations

Ordained administrators and teachers at seminaries qualify as ministers207. The IRS has taken a

narrow interpretation of this regulation. The educational institution must be an integral part of a

church or denomination. Thus, faculty and administrators at interdenominational seminaries

are not ministers because the seminaries are not controlled by a specific church or

denomination.

Control by a church or denomination must be evident. In Colbert, 208a religion professor at a

church-affiliated college was denied a housing allowance because there was no evidence that a

church exercised control over the school. Church control was also a key issue in this ruling,

four ordained religion professors at a Christian college qualified as ministers and were eligible

for a housing allowance. The IRS ruled that the church controlled the college because it was

founded and partially funded by the church and controlled by a board of trustees, the majority

of whom the church selected.

Teachers and administrators at elementary and secondary schools have also attempted to

qualify as ministers. Lack of control by a church or denomination prevents these individuals

from qualifying even if the school has a religious purpose. Even those employed by church-

controlled schools cannot qualify as ministers if they are not ordained or commissioned and

their duties are indistinguishable from those of employees at secular schools.

Given the IRS interpretation, seminaries and religious colleges should carefully examine their

circumstances to ensure that employees meet IRS parameters before treating them as ministers.

Teachers in elementary and secondary schools would qualify as ministers only in unusual

circumstances. For example, an ordained rabbi at a school controlled by a local synagogue who

teaches religion classes, conducts worship services, and prepares students for adult Jewish life

could qualify as a minister.

207 Under Regs. Sec. 1.107-1(a), 208 Colbert 6 TC 449 (1974)

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Employees of Nonchurch Organizations

Those employed outside churches have a time that is more difficult qualifying as ministers.

Nevertheless, the regulations provide leeway for some individuals to qualify. The

determination depends on duties performed and affiliation with a religious organization, with

duties performed being the most important factor. Individuals in this category include

chaplains in prisons and hospitals and those employed by parachurch organizations.

Chaplains working for nonchurch organizations who conduct worship and perform sacerdotal

functions have successfully qualified as ministers. Performance of these two functions is the

key factor in the following cases and rulings.

In Boyd,209the taxpayer was a chaplain employed by the Indianapolis Police Department. The

IRS conceded that he performed the duties of a minister. However, it took issue with his

employment outside a religious organization. The court ruled in favor of Boyd because he

performed the duties of a minister under the close supervision of a federation of churches,

providing a connection to a religious organization.

IRS rulings that address whether chaplains qualify as ministers are relatively old. This limits

their value, since it is likely that IRS perspective has changed. Chaplains in government-owned

hospitals and private nonprofit hospitals were ministers because they conducted worship and

performed sacraments (baptisms, marriages, funerals, and prayers for the sick).

Three IRS letter rulings also held that chaplains were ministers. Only the taxpayers who

requested these rulings can rely on them, but they reveal IRS reasoning. A negative aspect of

these rulings is that they were issued more than 20 years ago.

A chaplain for a state Department of Human Services was held to be a minister based on duties

performed. A chaplain for a nonprofit, nonchurch-related hospital was a minister because he

conducted worship, performed sacraments, and provided counseling to patients, their relatives,

and hospital staff.

Those employed by parachurch organizations face the challenge of qualifying as ministers

under the same rules as those employed by churches. Ministers receiving favorable rulings

have succeeded by producing evidence of their connection to local churches.

A 1994 Tax Court decision considered the situation of two Baptist ministers who established

an organization to promote world missions. The organization carried out its mission by

producing videotapes for local churches, and the taxpayers were the key people in the

production process. The court held that this production and distribution of videos supported the

cause of foreign missions, a sacerdotal function within the Baptist faith. Although the

taxpayers were not affiliated with any local church, the tapes they produced were used by over

30,000 churches. This was evidence of a connection to local churches.

209 Boyd TC Memo 181-528

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In a more recent decision, an ordained minister working for an evangelical organization

qualified as a minister. The organization produced religious literature and television programs

and conducted crusades. The IRS disallowed the minister’s housing allowance because he did

not work for a church or denomination. In siding with the taxpayer, the Tax Court saw the

followers of the organization as a “body of believers” similar to a church. They were loyal to

the organization and consistently attended its worship services and crusades. 210

Regardless of their place of employment, taxpayers seeking to qualify as ministers must

establish that they perform the duties of a minister as described in the regulations. They have a

stronger position if they can show that they perform their duties in association with a

denomination or a local church. Employees of churches, church-affiliated organizations, and

secular organizations who qualify as ministers are subject to the benefits and requirements

described in the next section.

Tax Rules Unique to Ministers

Those meeting the definition of minister face a unique set of tax rules in three areas. Ministers

are:

Eligible for the housing allowance and parsonage exclusion;

Considered self-employed for Social Security tax purposes; and

Exempt from federal income tax withholding.

Those advising ministers should be familiar with the application of tax law in these areas.

Housing Allowance/Parsonage

Sec. 107 provides an exclusion from gross income to the extent that a minister’s employer pays

his or her housing costs. The employer can provide housing by paying housing costs

(parsonage) or providing cash that the minister uses to pay these costs (housing allowance).

Housing costs include rent, mortgage payments (principal and interest), utilities, maintenance,

insurance, and furnishings.

This exclusion is the most attractive benefit available to ministers because housing costs

represent a high percentage of income. Most state income tax laws also permit an exclusion,

increasing the tax savings. Most rulings and case law related to ministers concern the claiming

of this exclusion.

The employer must designate the amount of the housing allowance in advance. It is limited to

the lesser of:

The amount designated by the employer;

The fair rental value of the residence (FRV); or

The actual expenses incurred.

210 Whittington TC Memo 2000-296

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In 2002, Congress amended Sec. 107 to state explicitly that the amount excluded as housing

allowance cannot exceed the fair rental value of the residence plus the cost of utilities.211 This

upper limit on the amount of the housing allowance can be estimated using internet or print

sources that document local rental values.

To compute the allowable housing allowance, the tax preparer needs to obtain several pieces of

information from the minister regarding their home:

• Officially written document designating the allowance amount

• Reasonable pay for the minister’s services

• Fair rental value (FRV) of the home, including furnishings and a garage, if applicable

• Documentation of amounts used and paid for qualified housing allowance expenses

Common Qualified Housing Allowance Expenditures

• Rent or home purchase costs (down payment and mortgage principal payments)

• Interest payments for mortgage and financing furniture and/or appliances

• Home-owner’s insurance premiums

• Real estate property taxes

• Fixtures, appliances, and furnishings

• Repairs, maintenance, improvements, landscaping, and upkeep of home and contents

• Cleaning supplies, yard, and gardening tools

• Utilities

When FRV, actual costs, or reasonable pay are less than the official designated allowance, the

excess is subject to federal income tax withholding (FITW) and reported on Form 1040 as

wages with the designation “excess allowance.”

Example 1: Rev. Pete, an ordained minister, receives an employment contract from his church.

Annual Salary: $42,000

Fair Rental Value (FRV) $1,000 a month including utilities

Allowance -0-

Tax Purposes

Excludable Allowance $ 12,000

Subject to Federal Taxable Income (FTI) $ 42,000

Subject to SE Tax $ 54,000

211 Clergy Housing Allowance Clarification Act of 2002 PL 107-181

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The minister can either rent a home or own a home. The following items can be included when

the minister owns a home:

• Home purchase costs (down payment and mortgage principal payments)







• Utilities

Example 2: This example is of a Rabbi who owns his home. His employment contract

guaranteed him a salary of $52,000 and a housing allowance of $30,000. In this example, the

FRV is less than designated allowance. The excess allowance ($30,000 - $19,500) $10,500 is

added to wages (FTI) on Form 1040.

Annual Salary: $52,000

Fair Rental Value (FRV) including furnishing and utilities $19,500

Allowance paid per agreement $30,000

Actual home costs listed above expended $22,000

Tax Purposes

Excludable Allowance $ 19,500

Subject to Federal Taxable Income (FTI) ($52,000 + ($30,000-$19,500)) = $62,500

Subject to SE Tax $ 82,000

If the FRV $30,000 and the allowance per agreement $19,500, the amount expended $22,000,

and the Rabbi’s salary $52,000 the taxable amounts would be:

Tax Purposes

Excludable Allowance $19,500

Subject to Federal Taxable Income (FTI) $52,000

Subject to SE Tax $71,500

Self-Employed Status

Ministers are self-employed for Social Security tax purposes with respect to their ministerial

services, even though most are treated as employees for federal income tax purposes. Self-

employment tax is assessed on taxable compensation and nontaxable housing

allowance/parsonage. The 15.3% self-employment tax rate presents a challenge to new

ministers who are used to paying half this rate in secular jobs. Quarterly estimated tax

payments are typically necessary to ensure that the minister has paid an adequate amount of tax

throughout the year. The minister can also increase his or her withholding on taxable

compensation to meet estimated tax payment requirements.

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Classification as Employees or Independent Contractors

Most ministers are classified as employees for federal income tax reporting based on tests

established by the IRS and the courts. The extent of control by the employer determines the

minister’s classification. Because most employers have the right to designate how the minister

performs his or her job, including when and where the work is performed, ministers are most

likely to be classified as employees.

These ministers receive Form W-2 and report their taxable gross income as employees.

However, the minister’s status as self-employed for Social Security tax purposes comes into

play here. Since they are considered self-employed, ministers are exempt from federal income

tax withholding.32 However, ministers can request that their employers withhold taxes.

Conclusion

The tax rules applicable to ministers provide a challenge to employers and tax preparers trying

to comply with the tax law in this area. The first challenge is determining those who meets the

definition of a minister under Sec. 107. The second is applying a unique set of rules to those

who qualify as ministers.

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What Do You Think?

Q1. The minister can either rent a home or own a home. The following items can be

included when the minister owns a home. Which of the expenses below are

allowed?

A. Home purchase costs (down payment and mortgage principal

payments)

B. Real estate property taxes

C. Cleaning supplies, yard, and gardening tools

D. All of the above

Q2. Changes in society have prompted significant changes in the way religious and charitable

organizations carry out their missions. Which of the following is correct?

A. A minister for tax purposes is determined based on who employs the individual and the

duties the individual performs.

B. An individual does not have to work for a church or denomination to be considered a

minister but must perform the duties of a minister as specified in the regulations to be

treated as a minister.

C. An individual who follows the guideline of IRC Sections. 107 and 1402 as a minister.

D. All of the above

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What Do Your Think – Answers

A1. D is the correct answer. The minister can either rent a home or own a home.

Which of the expenses below are allowed?

A. Home purchase costs (down payment and mortgage principal payments)

B. Real estate property taxes

C. Appliances, and furnishings

D. All of the above

Common Qualified Housing Allowance Expenditures

• Rent or home purchase costs (down payment and mortgage principal payments)







• Utilities

A2. D is the correct answer. Changes in society have prompted significant changes in the way

religious and charitable organizations carry out their missions. Which of the following is

correct?

A. A minister for tax purposes is determined based on who employs the individual and

the duties the individual performs.

B. An individual does not have to work for a church or denomination to be considered a

minister but must perform the duties of a minister as specified in the regulations to

be treated as a minister.

C. An individual who follows the guideline of IRC Sections. 107 and 1402 as a

minister.

D. All of the above

Changes in society have prompted significant changes in the way religious and

charitable organizations carry out their missions. As a result, ministers now work in

a variety of organizations, and their duties extend beyond those associated with

traditional church pastors. These changes have made determining who meets the

definition of a “minister of the gospel” a complex decision.212 A minister for tax

purposes is determined based on who employs the individual and the duties the

individual performs. An individual does not have to work for a church or

denomination to be considered a minister but must perform the duties of a minister

as specified in the regulations to be treated as a minister.

212 IRC§107

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The regulations under Secs. 107 and 1402 provide guidelines for determining who qualifies as

a minister. Both sections state that a minister is distinguished by the duties he or she performs.

The regulations state that the duties of a minister include the ministration of sacerdotal

functions and the conduct of religious worship, and the control, conduct, and maintenance of

religious organizations (including the religious boards, societies, and other integral agencies of

such organizations), under the authority of a religious body constituting a church or church

denomination.

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Chapter 7– Miscellaneous Items

Digital Signatures

Effective immediately, the IRS will accept images

of signatures (scanned or photographed) and

digital signatures on documents related to the

determination or collection of tax liability. In

addition, the IRS is allowing its employees to accept documents via email and to transmit

documents to taxpayers using SecureZip or other established secured messaging systems.

The taxpayer or representative must include a statement, either in the form of an attached cover

letter or within the body of the email, stating: “The attached [name of document] includes

[name of taxpayer] valid signature and the taxpayer intends to transmit the attached document

to the IRS.” The choice to transmit documents electronically is solely that of the taxpayer.

These guidelines apply to the following documents only:

Extensions of statute of limitations on assessment or collection

Waivers of statutory notices of deficiency and consents to assessment

Agreements to specific tax matters or tax liabilities (closing agreements)

Any other statement or form that needs the signature of a taxpayer or representative and

is traditionally collected by IRS personnel outside standard filing procedures (such as a

case-specific powers of attorney)

Virtual Currency

Investments in virtual currency are currently happening and the number of investors is ever

increasing. Numbers are showing that upwards of 15% of Americans are investing in virtual

currency.

As tax preparers, we must practice due diligence by asking clients, “Is the taxpayer investing in

virtual currency?” This is necessary because the small investor may not think of virtual

currency as a taxable event. They may view it more like collecting coins as a hobby.

Virtual currency is a digital representation of value, other than a representation of the U.S.

dollar or a foreign currency (“real currency”), that functions as a unit of account, a store of

value, and a medium of exchange. Some virtual currencies are convertible, which means that

they have an equivalent value in real currency or act as a substitute for real currency. The IRS

uses the term “virtual currency” to describe the various types of convertible virtual currency

that are used as a medium of exchange, such as digital currency and cryptocurrency.

Regardless of the label applied, if a particular asset has the characteristics of virtual currency, it

will be treated as virtual currency for Federal income tax purposes.

Objective:

Review Estate & Gift Tax Exclusions

Effects of TCJA on AMT & NOL

TCJA changes to Kiddie Tax

TCJA repealed items effect on 2019

tax

Review Foreign Account & Asset

Reporting (FinCen)

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The IRS says virtual currency is not currency but is “other property.” How it is held makes the

difference in how the virtual currency is accounted for and reported, whether it be a capital

gain, ordinary income or subject to SE tax.

Schedule 1 has a question “At any time during 2019, did the taxpayer receive, sell, send,

exchange, or otherwise acquire any financial interest in any virtual currency?” Answering this

question can be difficult. If a taxpayer has virtual currency but made no transactions during the

year, there is no guidance from the IRS how the question should be answered.

The Internal Revenue Service has begun sending letters to taxpayers with virtual currency

transactions that potentially failed to report income and pay the resulting tax from virtual

currency transactions or did not report their transactions properly.

"Taxpayers should take these letters very seriously by reviewing their tax filings and when

appropriate, amend past returns and pay back taxes, interest and penalties," said the IRS

Commissioner. "The IRS is expanding our efforts involving virtual currency, including

increased use of data analytics. We are focused on enforcing the law and helping taxpayers

fully understand and meet their obligations."

The IRS started sending the educational letters to taxpayers. By the end of August 2019, more

than 10,000 taxpayers were sent to taxpayers. The names of these taxpayers were obtained

through various ongoing IRS compliance efforts.

For taxpayers receiving an educational letter, there are three variations: Letter 6173, Letter

6174 or Letter 6174-A, all 3 versions strive to help taxpayers understand their tax and filing

obligations and how to correct past errors.

Last year the IRS announced a Virtual Currency Compliance campaign to address tax

noncompliance related to the use of virtual currency through outreach and examinations of

taxpayers. The IRS will remain actively engaged in addressing non-compliance related to

virtual currency transactions through a variety of efforts, ranging from taxpayer education to

audits to criminal investigations.

Virtual currency is an ongoing focus area for IRS Criminal Investigation. IRS Notice 2014-21

states that virtual currency is property for federal tax purposes and provides guidance on how

general federal tax principles apply to virtual currency transactions.

Compliance efforts follow these general tax principles. The IRS will continue to consider and

solicit taxpayer and practitioner feedback in education efforts and future guidance. The IRS

anticipates issuing additional legal guidance in this area in the near future.

Gamers

Gamers who transact in virtual currencies as part of a video game do not have to report the

transactions on a tax return if the currencies do not leave the game environment, the IRS made

clear in a statement released on its website.

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The clarification relates to whether, or when, a currency used in a video game should be

considered "convertible," meaning it can be converted into real currency. The Service's current

guidance on virtual currencies applies only to currencies that are convertible, a typical example

being bitcoin.

The clarification came two days after the IRS made an unannounced deletion of language from

its website about video game currencies.

On Feb 14 2020, the IRS the IRS stated on their website, that the language about virtual

currencies potentially caused concern for some taxpayers. We have changed the language in

order to lessen any confusion. Transacting in virtual currencies as part of a game that do not

leave the game environment (virtual currencies that are not convertible) would not require a

taxpayer to indicate this on their tax return.

Before the Feb. 12 website edit, the IRS "Virtual Currencies" webpage said that examples of a

convertible virtual currency include "Bitcoin, Ether, Roblox, and V-bucks." Roblox is an

online video game platform, and V-bucks is an in-game currency used in the game Fortnite.

The same webpage now lists bitcoin as the sole example of a convertible virtual currency.

The IRS treats virtual currencies such as bitcoin as property, rather than as currency, and says

that general tax principles applicable to property transactions apply to transactions using virtual

currency. In a set of frequently asked questions, the IRS notes that its current guidance about

the taxation of virtual currency transactions relates only to virtual currencies that are

convertible.

Some virtual currencies are convertible, which means that they have an equivalent value in real

currency or act as a substitute for real currency. The IRS uses the term "virtual currency" in

these FAQs to describe the various types of convertible virtual currency that are used as a

medium of exchange, such as digital currency and cryptocurrency.

The IRS recently revised Form 1040, Schedule 1 that now asks taxpayers, "Did the taxpayer

receive, sell, send, exchange, or otherwise acquire any financial interest in any virtual

currency?" As noted above, the IRS's Feb. 14 statement clarifies that transacting in virtual

currencies as part of a game that do not leave the game environment "would not require a

taxpayer to indicate this on their tax return."

Insolvency

In 2020, Covid-19 brought about business closures and increased sustained unemployment.

Although some government programs have assisted in payment of mortgages, several

taxpayers have been faced with losing their homes and cancellation of debt on their credit

cards. It is time to pull out Form 982 again and do a quick review.

https://www.irs.gov/businesses/small-businesses-self-employed/virtual-currencies

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Many clients can be insolvent without being bankrupt, but if they are in bankruptcy, they are

insolvent. Many clients think of the two as the same thing, but they are very different.

Bankruptcy is a court proceeding in which a judge and court trustee examine the assets and

liabilities of individuals and businesses who cannot pay their bills and decide whether to

discharge those debts so they are no longer legally required to pay them.

Insolvency is a problem that bankruptcy is designed to solve. Insolvency is the inability to pay

debts when they are due. Fortunately, there are solutions for resolving insolvency, including

borrowing money or increasing income so that you can pay off debt. You also could negotiate

a debt payment or settlement plan with creditors. Bankruptcy is usually a final alternative when

other attempts to clear debt fail. This segment is a quick review of insolvency.

A taxpayer is insolvent when his or her total liabilities exceed his or her total assets. The

forgiven debt may be excluded as income under the "insolvency" exclusion.213 Normally, a

taxpayer is not required to include forgiven debts in income to the extent that the taxpayer is

insolvent. The forgiven debt may also qualify for exclusion if the debt was discharged in a

Title 11 bankruptcy proceeding or if the debt is qualified farm indebtedness or qualified real

property business indebtedness. If the taxpayer believe he or she qualifies for any of these

exceptions, see the instructions for Form 982.

The discharge of indebtedness income from a debt discharged when a taxpayer is insolvent is

excludable from the taxpayer's gross income. The amount of the exclusion is limited to the

amount by which the taxpayer is insolvent.214 For example, in Newman v. Comm'r, a taxpayer

had cancellation of debt income because of overdrawing his bank account by $7,900 and not

correcting the negative balance. However, the court found that because the taxpayer had debts

totaling $50,000 and assets of only $35,500, he was insolvent to the extent of $14,500. Since

that amount was more than the $7,900 COD income, the COD income was excluded from his

gross income under the insolvency provision.

213 IRC §108(a)(1)(b) 214 IRC §108(a)(3)

https://www.debt.org/bankruptcy/

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A taxpayer is insolvent to the extent liabilities exceed the fair market value of assets

immediately before the debt is discharged.215 For purposes of determining insolvency, assets

include the value of everything the taxpayer owns. This includes assets that serve as collateral

for debt and exempt assets that are beyond the reach of the taxpayer's creditors under the law,

such as the taxpayer's interest in a pension plan and the value of his or her retirement account.

In valuing property such as a principal residence or vacation home, courts will not accept a

value placed upon property for local property tax purposes where there is no evidence of the

method used in arriving at that valuation. Similarly, a letter from a finance or mortgage

company showing the value of a home does not establish the home's fair market value where

the letter does not describe the property nor explain the methodology used to determine its

value. The court is usually looking for an appraisal, showing comparable values of homes and

a reasonable determination of FMV at the time of insolvency.

For purposes of determining insolvency, liabilities include:

(1) The entire amount of recourse debts;

(2) The amount of nonrecourse debt that is not in excess of the fair market value of the

property that is security for the debt; and

(3) The amount of nonrecourse debt in excess of the fair market value of the property

subject to the nonrecourse debt (excess nonrecourse debt), to the extent nonrecourse

debt in excess of the fair market value of the property subject to the debt is

discharged.

Example: The Shepherds were a married couple residing in New Jersey. They faced some

financial troubles and outstanding credit card debt of $9,962. The credit card company referred

the couple to an outside collection agency, which in turn agreed to settle the balance in

exchange for making payments of $5,550. The Shepherds made the required payments in 2008

and the remaining debt of $4,412 was cancelled. In January 2009, the credit card company

issued a 2008 Form 1099-C, Cancellation of Debt.

With the exception of three major items, the Shepherds and the IRS agreed on the value of all

assets and liabilities before reaching court.

The three items in dispute were a principal residence, a beach house and Mr. Shepherd’s

pension. The taxpayers included a loan against Mr. Shepherd’s pension as a liability, but did

not include the value of his pension as an asset. Mr. Shepherd had the ability to withdraw some

portion of his pension on the date of the debt discharge. The IRS stated that the value of the

pension should be included as an asset in the insolvency calculation.

215 IRC §108(d)(3)

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The other disagreement between the two parties was the value to be used in the insolvency

calculation of the couple’s principal residence and beach house. The Shepherds submitted

evidence from a 2018 property tax valuation appeal signed May 6, 2019, for the value of their

beach house. This appeal was based on comparable sales compiled by Mr. Shepherd, but no

evidence was provided for the court to determine their accuracy. The Court ruled that the

taxpayers failed to substantiate the FMV of the two homes and failed to include the value of

the pension. Because of this, they were deemed solvent and the full amount of cancellation of

debt income was taxable.

This case is an example of:

• If the taxpayer cannot substantiate the FMV of all assets and liabilities for an

insolvency calculation, the IRS and courts will most likely disallow the insolvency

exclusion.

• FMV must be determined immediately before the debt was cancelled.

• Property tax assessments are not an indication of true FMV.

• Comparable sales can be persuasive evidence of FMV, but evidence and

methodology to determine value are required.

• FMV determined at a date substantially before or after the cancellation, two years in

this case, does not prove FMV at the time of cancellation.216

Excess nonrecourse debt is not treated, as a liability to the extent the nonrecourse debt is not

discharged. In Jackson v. Comm'r,217 the court held that a taxpayer could not claim insolvency

because of retirement buyback payments. According to the court, the payments did not

constitute a liability for purposes of determining whether the taxpayer was insolvent because

the payments did not carry legal consequences for nonpayment.

Richard Jackson began working for the State of New York. At that time, he was enrolled as

participant in the New York State and Local Retirement System. Jackson was required to make

biweekly contributions equal to 3 percent of his salary until he accrued 10 years of service

credit. Jackson left his job and received a distribution of approximately $11,500 from the

retirement plan.

Jackson returned to employment with the State of New York. Jackson took advantage of an a

buyback agreement, Jackson agreed to repay the $11,500 distribution he received previously

plus interest. The payments were to be withheld from his pay for 228 payroll periods. Jackson

made the buyback payments for about two years, until his job was eliminated and he retired.

Jackson's monthly retirement benefit was reduced because he had not fully repaid the plan in

accordance with the buyback agreement.

216 TC Memo 2012-212 217 TC Summary 2018-43

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Jackson realized income from discharged indebtedness of $11,552 as the result of debts that

were discharged by two banks. On his 2013 tax return, Jackson did not report the discharged

indebtedness as income. The IRS audited his return and determined that the $11,552 was

required to be included in taxable income. Jackson petitioned the Tax Court to challenge the

IRS's determination.

The Tax Court held that Jackson was not insolvent in 2013 because the buyback payments

were not a liability. Evaluating the nature of the obligation, the court determined that the

payments served as a substitute for regular retirement plan contributions and that each payment

was credited to Jackson's retirement account. The court concluded that because the buyback

payments were deposited into Jackson's retirement account and did not carry legal

consequences for repayment, they were not a liability for purposes of insolvency.218 The court

concluded Jackson was not insolvent when he realized income from the discharge of

indebtedness, and was not entitled to an exclusion.

A taxpayer reports that he or she is excluding canceled debt from income under the insolvency

exclusion by attaching Form 982, Reduction of Tax Attributes Due to Discharge of

Indebtedness (and Section 1082 Basis Adjustment), to his or her federal income tax return and

checking the appropriate box on line 1. On line 2, the taxpayer includes the smaller of the

amount of the debt canceled or the amount by which the taxpayer was insolvent immediately

before the cancellation.

Below is an example of the Insolvency worksheet from IRS Publication 4681. I have the

taxpayer complete this form and sign and date the bottom for my files. This is not an IRS

requirement. Remind clients of the IRS requirement that the amounts on the worksheet are

immediately before the cancellation of debt. Form 982 is included in the tax return and

electronically filed.

Example: In the prior year, Jerry was released from his obligation to pay his personal credit

card debt for $5,000. In February of the current year, Jerry received a Form 1099-C from his

credit card lender showing canceled debt of $5,000 in Box 2. None of the exceptions to the

general rule that canceled debt is included in income applies. Jerry determines that his total

liabilities immediately before the cancellation were $15,000 and the fair market value of his

total assets immediately before the cancellation was $7,000. Thus, immediately before the

cancellation, Jerry was insolvent to the extent of $8,000 ($15,000 total liabilities minus $7,000

fair market value of his total assets). Because the amount by which Jerry was insolvent

immediately before the cancellation was more than the amount of his debt canceled, Jerry can

exclude the entire $5,000 canceled debt from income.

218 IRC§108(d)(3)

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Example: Assume the same facts as in the preceding example, except that Jerry's total

liabilities immediately before the cancellation were $10,000 and the fair market value of his

total assets immediately before the cancellation was $7,000. In this case, Jerry is insolvent to

the extent of $3,000 ($10,000 total liabilities minus $7,000 fair market value of his total assets)

immediately before the cancellation. Because the amount of the canceled debt was more than

the amount, by which Jerry was insolvent immediately before the cancellation, Jerry can

exclude only $3,000 of the $5,000 canceled debt from income under the insolvency exclusion.

Estate and Trust Tax Rates and Brackets

For 2018 through 2025, under TCJA, the tax rate for estates and trusts are 10% of taxable

income up to $2,550, 24% of the excess over $2,550 but not over $9,150; 35% of the excess

over $9,150 but not over $12,500; and 37% of the excess over $12,500.







Increase in Estate and Gift Tax Exclusion

TCJA doubled the exclusion and adjusted if for inflation. The exclusion for 2019 is

$11,400,000 (and $22,800,000 for a married couple). The exclusion for 2020 is $11,580,000

(and $23,160,000 for a married couple).

Under the new tax law, individuals are now able to transfer approximately $11,580,000 free of

estate, gift and GST tax during their lives or at death. A married couple will be able to transfer

approximately $23,160,000 during their lives or at death. Due to the portability provisions, any

unused Federal estate tax exclusion for the first spouse may be used by the surviving spouse

for lifetime gifting or at death.

For purposes of the Federal estate and gift taxes, a portability election allows a decedent’s

unused exclusion amount (deceased spousal unused exclusion amount, or DSUE amount) to

become available for application to the surviving spouse’s subsequent transfers during life or at

death.

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What Do You Think?

Q1. Which of the following is not correct?

A. A taxpayer can be insolvent without being bankrupt.

B. Individuals and businesses who cannot pay their bills are bankrupt.

C. Insolvency is the inability to pay debts when they are due.

D. Bankruptcy is a court proceeding to resolve insolvency.

Q2. Virtual currency is a digital representation of value, other than a representation of the U.S.


value, and a medium of exchange.

Which of the following is correct?

A. Some virtual currencies act as a substitute for real currency.

B. Virtual currency can be accounted for and reported as a capital gain.

C. Virtual currency can be accounted for and reported as ordinary income.

D. All of the above are correct.

Q3. Which of the following is a correct statement regarding Estate Tax in 2020?

A. Individuals are able to transfer approximately $5.6 million, free of estate, gift and GST

tax during their lives or at death.

B. A married couple will be able to transfer approximately $22,800,000 during their lives

or at death.

C. Portability provisions are no longer allowed in 2020.

D. None of the above are correct


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B is the correct answer.

A1. Which of the following is not correct?

A. A taxpayer can be insolvent without being bankrupt.

B. Individuals and businesses who cannot pay their bills are bankrupt. C. Insolvency is the inability to pay debts when they are due.

D. Bankruptcy is a court proceeding to resolve insolvency.

Many clients can be insolvent without being bankrupt, but if they are in bankruptcy, they are

insolvent. Many clients think of the two as the same thing, but they are very different.

Bankruptcy is a court proceeding in which a judge and court trustee examine the assets and

liabilities of individuals and businesses who cannot pay their bills and decide whether to

discharge those debts so they are no longer legally required to pay them.

Insolvency is a problem that bankruptcy is designed to solve. Insolvency is the inability to pay

debts when they are due. Fortunately, there are solutions for resolving insolvency, including

borrowing money or increasing income so that you can pay off debt. You also could negotiate

a debt payment or settlement plan with creditors. Bankruptcy is usually a final alternative when

other attempts to clear debt fail. This segment is a quick review of insolvency.

A2. Virtual currency is a digital representation of value, other than a representation of the U.S.



Which of the following is correct?

Answer D is the correct answer A. Some virtual currencies act as a substitute for real currency.

B. Virtual currency can be accounted for and reported as a capital gain.

C. Virtual currency can be accounted for and reported as ordinary income


The IRS uses the term “virtual currency” to describe the various types of convertible virtual

currency that are used as a medium of exchange, such as digital currency and cryptocurrency.

Regardless of the label applied, if a particular asset has the characteristics of virtual currency, it

will be treated as virtual currency for Federal income tax purposes. .

The IRS says virtual currency is not currency but is “other property.” How it is held makes the

difference in how the virtual currency is accounted for and reported, whether it be a capital

gain, ordinary income or subject to SE tax.



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A3. Which of the following is a correct statement regarding Estate Tax in 2020?

Answer - B -Is the correct answer.

B is the correct answer a married couple will be able to transfer approximately $23,160,000

during their lives or at death in 2020.

A is incorrect because, under TCJA, individuals are now able to transfer approximately

$11,580,000 free of estate, gift and GST tax during their lives or at death. A married couple

will be able to transfer approximately $23,160,000 during their lives or at death.

C is incorrect because portability provisions are still allowed. Any unused Federal estate tax

exclusion for the first spouse may be used by the surviving spouse for lifetime gifting or at

death.

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Alternative Minimum Tax

Taxpayers use Form 1040, Schedule 2 to report amounts they owe for the Alternative Minimum

Tax (AMT) or when they need to make an excess advance premium tax credit repayment.

The tax law gives special treatment to some kinds of income and allows special deductions and

credits for some kinds of expenses. Taxpayers who benefit from the law in these ways may have

to pay at least a minimum amount of tax through an additional tax. This additional tax is called

the alternative minimum tax (AMT). A taxpayer may have to pay the AMT if taxable income for

regular tax purposes, combined with certain adjustments and tax preference items, is more than

the AMT exemption amount.

The tentative minimum tax is a percentage of the amount by which alternative minimum taxable

income exceeds the applicable exemption amount for the taxpayers’ filing status. AMT is owed

when the tentative minimum tax is higher than the regular tax.

The AMT system taxes certain types of income that are tax-free under the regular tax system and

disallows some regular tax breaks. The maximum AMT rate is 28% versus the 37% regular tax

maximum rate that applies for 2018-2025 under the TCJA. For 2018, the 28% AMT rate starts

when AMT income exceeds $191,500 for married joint-filing couples and $95,750 for others.

The taxpayer is allowed an AMT exemption219, which is deducted in calculating AMT income.

The TCJA significantly increases the exemption amounts for 2018-2025. The exemption is

phased out when AMT income surpasses the applicable threshold, but the TCJA greatly

increases those thresholds for 2018-2025.

AMT risk factors

Various interacting factors make it difficult to pinpoint exactly who will be hit by the AMT and

who will not. High income (from whatever source) can cause his or her AMT exemption to be

partially or completely phased out, which increases the odds of owing the AMT.

The AMT exemption amounts for individuals for tax years beginning in 2019 are: (1) $111,700 in the case of a joint return or a surviving spouse; and

(2) $71,700 in the case of an individual who is unmarried and not a surviving spouse;

(3) $55,850 in the case of a married individual filing a separate return; and

(4) $25,000 in the case of an estate or trust

The AMT exemption amounts for individuals for tax years beginning in 2020 are: (1) $113,400 in the case of a joint return or a surviving spouse; and

(2) $72,900 in the case of an individual who is unmarried and not a surviving spouse;

(3) $56,700 in the case of a married individual filing a separate return; and

(4) $25,400 in the case of an estate or trust

The exemption amount is reduced by 25% of the excess of the AMT taxable income over the

applicable phase-out threshold. Under the TCJA, only those taxpayers with income exceeding to

219 IRC §55(d)(4)(A)

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$1 million and $500,000, respectively will hit the threshold.

The fact that the TCJA lowered five out of the seven regular tax rates while leaving AMT rates at

26% and 28% increases the odds of owing the AMT. The offsetting factor is the TCJA’s

liberalized AMT exemption rules. The interplay of these two factors may result in some upper-

middle income taxpayers still owing the AMT, but they will probably owe less than under prior

law.

Changes that effect AMT

Large itemized deductions for state and local taxes: Under the prior-law regular

federal income tax rules taxpayers who itemize could benefit from all state and local

taxes, but they are completely disallowed under the AMT rules. TCJA reduces the state

and local taxes to $10,000 ($5,000 for those who use married filing separate status). State

and local taxes being limited to $10,000, will lower the amount of AMT.

Personal and dependent exemptions: These deductions are completely disallowed

under the AMT rules. TCJA has repealed personal and dependent exemption. This

change will also lower AMT.

Significant miscellaneous itemized deductions: For 2018-2025, the new law eliminates

the miscellaneous itemized deductions and home equity interest that were disallowed

under the prior year AMT rules.

AMT will still be effected by the following items, which may cause AMT

The difference between the market value of the shares on the exercise date and the

ISO exercise price. The way to avoid this is to sell the incentive stock option on the

date it is exercised.

Interest income from private activity bonds

Standard deductions allowed under the regular tax rules are completely disallowed

under the AMT rules

An alternative tax net operating loss deduction and an alternative minimum tax foreign tax credit

(AMTFTC) are available in computing AMT. In addition, a taxpayer may be entitled to a

minimum tax credit (MTC) for AMT incurred in prior tax years. A taxpayers’ personal credits

may offset the taxpayers’ AMT liability in full. The AMT tax is the excess of the taxpayers’

tentative minimum tax over the taxpayers’ regular tax. TCJA also repealed the corporate AMT,

effective for tax years beginning after December 31, 2017.

Kiddie Tax.

The so-called kiddie tax has been around since 1986. The kiddie tax was an effort to close a tax

loophole for the wealthy; the idea was that taxing a child’s passive income at the same rate as

that of their parents would mean there would be little to no reason to shift income. Since the

creation of the tax, parents have scrambled to figure it out. The rules depend on many factors,

including the age of the children, as well as the amount and source of the income.

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TCJA simplifies the “kiddie tax” by effectively applying ordinary and capital gains rates

applicable to trusts and estates to the net unearned income of a child. Thus, taxable income

attributable to earned income is taxed according to an unmarried (single) taxpayers’ brackets and

rates. The child’s tax is no longer affected by the tax situation of the child’s parent or the

unearned income of any siblings.

The Kiddie Tax only applies to:

Children under 19 years of age, and

Children aged 19 through 23 who are full-time students and whose earned income does

not exceed half of the annual expenses for their support.

A child who turns 19 or 24 (if a full-time student) by the end of the tax year is not subject to the

kiddie tax. To be considered a student, a child must attend school full time during at least five

months of the year. It does not matter whether the child is claimed as a dependent on the parent’s

return. However, the tax does not apply to a child under 24 who is married and files a joint tax

return.

The kiddie tax applies only to unearned income a child receives from income-producing property

(or investment property), such as cash, stocks, bonds, mutual funds, and real estate. Any salary

or wages that a child earns through full-or part-time employment are not subject to the kiddie tax

rules – that income is taxed at the child’s regular income tax rate.

The Kiddie Tax Before 2018 and After 2025

Under the old law in effect before 2018, children could pay tax at their own income tax rate on

unearned income they received up to a threshold amount. All unearned income that kids received

above the threshold amount was taxed at their parent’s highest income tax rate, if higher than the

child’s rate. That rate could be as high as 39.6%, compared to the 10% rate that most children

would be paying. Figuring the kiddie tax could be complex. For example, if a parent had more

than one child subject to the kiddie tax, the net unearned income of all the children had to be

combined, and a single kiddie tax calculated. The TCJA eliminated these rules starting in 2018,

but they are to return for 2026 and later.

The Kiddie Tax 2018 through 2025

For 2018 through 2025 children’s unearned income is not taxed at their parents income tax rates.

Instead, all net unearned income over a threshold amount $2,200 for 2019 is taxed using the

brackets and rates for trusts and estates. The 2019 rates are shown in the following chart:

Kiddie Taxable Unearned Income Tax Rate

up to $2,600 10%

$2,601 to $9,300 24%

$9,301 to $12,750 35%

all over $12,750 37%

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This greatly simplified the kiddie tax by applying a single set of tax rates to all of a child’s

unearned income. Moreover, a child’s tax rate is no longer affected by his or her parents’ tax

situation or the unearned income of any siblings.

However, these rates can be higher than the parents’ rates, which would have applied under prior

law. For example, the kiddie tax rate is 37% on income over $12,750. A married couple would

have to have over $612,350 in income in 2019 to pay tax at this rate. It is not advantageous to

arrange for the dependent children to have substantial amounts of unearned income.

On the other hand, children with smaller unearned incomes can pay less under these tax rates.

For example, a child can have up to $4,800 in unearned income and pay only a 10% tax on

$2,600 of it, for a $260 total tax ($4,800 unearned income - $2,200 kiddie tax floor = $2,600

income subject to kiddie tax; 10% x $2,600 = $260). Most parents pay income tax at a higher

rate than 10% (married taxpayers would have to have a taxable income of $19,400 or less to pay

tax at this rate).

If the child has unearned income subject to the kiddie tax, he or she should file his or her own tax

return with IRS Form 8615, Tax for Certain Children Who Have Unearned Income.

Final Regulations Expand Use of Health Reimbursement Arrangements

The U.S. Departments of Health and Human Services, Labor, and Treasury issued final

regulations, which expand the use of a new type of health reimbursement arrangement (HRA)

and allow those HRAs to be integrated with individual health insurance coverage.

When employers have fully adjusted to the regulations, the Departments estimate that the

expansion of HRAs will benefit approximately 800,000 employers and more than 11 million

employees and family members, including an estimated 800,000 Americans who were

previously uninsured.

Background

Health reimbursement accounts or health reimbursement arrangements (HRAs) are employer-

funded group health plans from which employees are reimbursed tax-free for qualified medical

expenses up to a fixed dollar amount per year. Unused amounts may be rolled over to be used in

subsequent years. The employer funds and owns the account.On June 13, the Departments of

Labor, Health and Human Services, and Treasury issued final regulations, which permit

employers to offer a new "Individual Coverage HRA" as an alternative to traditional group

health plan coverage, subject to certain conditions. The final regulations, which are effective

beginning in January of 2020, also introduce another new HRA, the Excepted Benefit HRA.

Individual Coverage HRA and Excepted Benefit HRA

Among other medical care expenses, the new Individual Coverage HRAs can be used to

reimburse premiums for individual health insurance chosen by an employee as well as

subsidizing an employee's premiums in the individual Exchange (Obamacare) market. These

HRAs promote employee and employer flexibility, while also maintaining the same tax-favored

status for employer contributions towards a traditional group health plan.

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The final regulations also increase flexibility in employer-sponsored insurance by creating a

second limited kind of HRA, the "Excepted Benefit HRA" that can be offered to employees in

addition to a traditional group health plan. These "Excepted Benefit HRAs," the benefits of

which are capped at $1,800, permit employers to finance out-of-pocket medical care costs (for

example, the cost of copays, deductibles, or other expenses not covered by the primary plan)

even if the employee declines enrollment in the traditional group health plan.

Mechanics of an Individual Coverage HRA

An Individual Coverage HRA reimburses employees for their medical care expenses (and

sometimes their family members' medical care expenses), up to a maximum dollar amount that

the employer makes available each year. The employer can allow unused amounts in any year to

roll over from year to year. Employees must enroll in individual health insurance (or Medicare)

for each month the employee (or the employee's family member) is covered by the Individual

Coverage HRA. This can be individual health insurance offered on or off an Exchange.

However, it cannot be short-term, limited-duration insurance (STLDI) or coverage consisting

solely of dental, vision, or similar "excepted benefits." There are many other important

requirements as well.

The following are some of the features and/or requirements of Individual Coverage HRAs:

(4) An employer must offer the same terms to all participants within a class, with the

exception that an employer can (i) offer higher HRA contributions based on an

employee's age (limited to up to three times as much as the contribution to the HRA's

youngest participant), and (ii) offer higher HRA contributions based on an employee's

family size;

(5) Employers that offer traditional group health insurance coverage to current employees

can offer Individual Coverage HRAs to new employees in the same class;

(6) Individual Coverage HRAs allow for the combination of classes of employees but, in

certain circumstances, apply a minimum class size requirement;

(7) A minimum class size requirement, which varies based on employer size, applies to

certain classes of employees in certain circumstances in which the potential for health

factor discrimination is greatest;

(8) A minimum class size requirement applies for Individual Coverage HRAs only if the

plan sponsor offers a traditional group health plan to at least one other class of

employees and offers an Individual Coverage HRA to at least one class of employees;

(9) If the minimum class size requirement applies, it applies only to certain classes that are

offered an Individual Coverage HRA and does not apply to a class of employees

offered a traditional group health plan or to a class of employees that is not offered any

group health plan;

(10) Where the minimum class size rules apply, the minimum class size is equal to 10

employees for an employer with fewer than 100 employees; equal to 10 percent of the

total number of employees (rounded down to a whole number), for an employer with

100 to 200 employees; and equal to 20 employees for an employer that has more than

200 employees;

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(11) Individual Coverage HRAs are not the property of the employee and employers

may limit the amount that can be carried over from year-to-year or accessed by the

employee after separation, subject to applicable COBRA or other continuation of

coverage requirements;

(12) Individual Coverage HRAs do not require that a minimum number of individual

health insurance plans be available to employees in order for the employer to offer an

Individual Coverage HRA; and

(13) Individual Coverage HRA may include full-time employees and part-time

employees as separate permitted classes.

Individual Coverage HRA and Premium Tax Credit

The premium tax credit (PTC) provided in Code Sec. 36B was enacted as part of the Affordable

Care Act. It is a refundable tax credit for eligible individuals and families who purchase health

insurance through an insurance Exchange. The PTC, which is payable in advance directly to the

insurer, subsidizes the purchase of certain health insurance plans through an Exchange and is

available for lower income taxpayers.

A taxpayer cannot claim the PTC for Exchange health insurance coverage for any month the

taxpayer is covered by the Individual Coverage HRA. Nor can a taxpayer claim the PTC for the

Exchange coverage of any family members for any month those members are covered by the

Individual Coverage HRA. If a taxpayer opts out of the Individual Coverage HRA and the HRA

is considered unaffordable, the taxpayer may claim the PTC for him or herself and any family

members enrolled in Exchange coverage if such taxpayers are otherwise eligible. If a taxpayer

opts out of the HRA and the HRA is considered affordable, the taxpayer may not claim the PTC

for him or herself or any family members.

Advantages and Disadvantage of the Final Regulations

Many healthcare professionals have weighed in on whether these new rules will favorably or

unfavorably impact employees and the health insurance market in general. On the plus side,

Individual Coverage HRAs provide tax advantages because the reimbursements provided to

employees under the HRA are not includible in employees' taxable wages and the expenses are

deductible by employers. Individual Coverage HRAs extend the tax advantage for traditional

group health plans to HRA reimbursements of individual health insurance premiums. Employers

may also allow employees to pay for off-Exchange health insurance on a tax-favored basis, using

a salary reduction arrangement under a cafeteria plan, to make up any portion of the individual

health insurance premium not covered by the employee's Individual Coverage HRA. The term

"off-Exchange health insurance" refers to a health insurance policy that is purchased directly

from a health insurance carrier or through an agent or broker, outside of the official Affordable

Care Act-created health insurance exchange.

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According to HHS, in most cases, the Individual Coverage HRA rule is advantageous because it

will increase worker options for health insurance coverage by allowing workers to shop for plans

in the individual market and select coverage that best meets their needs. It will also result in

coverage being more portable for many workers. Citing a 2018 Kaiser Family Foundation

Employer Health Benefits Survey, HHS said that 81% of small to midsized employers (i.e., those

with fewer than 200 employees) and 42% of larger employers (i.e., those with at least 200

employees) offering health benefits in 2018 provided only one type of health plan to their

employees.

The HRA rule should also help small employers, who face larger administrative costs from

offering a traditional group health plan, compete for talent. HHS noted that a significant number

of small employers have stopped offering coverage since 2010. According to the 2018 Kaiser

survey, between 2010 and 2018, the percentage of firms offering coverage declined from 59% to

47% at firms with 3-9 workers, from 76% to 64% at firms with 10-24 workers, from 92% to 71%

at firms with 25-49 workers, and from 95% to 91% at firms with 50-199 workers. Expanding the

number of employers providing healthcare coverage means a broader market over which the

healthcare risks are distributed and this could lead to a lowering of premiums for that market.

Other healthcare professionals are taking a wait-and-see approach, noting that the new rules will

shake up the insurance market with respect to employer-provided health insurance, but it is

unclear how that will play out. Some commented on the fact that many opponents of the

Medicare-for-All insurance plan have used the fact that such a plan would disrupt employer-

provided health insurance as a reason to oppose the plan.

According to the Brookings Institute, a nonprofit public policy organization based in

Washington, D.C., changes in employer coverage arrangements under the new rules will create

winners and losers within firms to the extent that firms do not make offsetting changes to their

compensation structures, with younger and higher-income workers generally benefiting at the

expense of older and lower-income workers. The final rule's limitation on how much

contributions to Individual Coverage HRAs can vary by age makes such effects more likely.

Foreign Earned Income and Housing Exclusion

Covid-19 Qualified individuals may exclude a portion of their foreign earned income and

housing costs under IRC section 911.

The exclusion applies if the qualified individual:

A) Is a U.S. citizen whose tax home is in a foreign country and establishes that he or she

is a bona fide resident of a foreign country for an uninterrupted period that includes the

entire tax year, or

B) Is a U.S. citizen or resident who, during any period of 12 consecutive months, is

present in a foreign country during at least 330 full days.

A qualified individual will qualify as a bona fide resident or under the physical presence test if

the individual left the country because of war, civil unrest, or similar adverse conditions that

precluded the normal conduct of business.

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For 2019 and 2020, the IRS has ruled that the COVID-19 Emergency is an adverse condition that

precluded the normal conduct of business as follows:

• 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.

The period covered by the COVID-19 Emergency period ends on July 15, 2020, unless an

extension is announced by the IRS. Individuals who left China on or after December 1, 2019, or

another foreign country on or after February 1, 2020, but on or before July 15, 2020, will be

treated as a qualified individual; if such individual establishes a reasonable expectation that he or

she would have met the requirements under IRC section 911, but for the COVID-19 Emergency.

Example 1: An individual arrived in China on September 1, 2019, and established that he

reasonably expected to work in China until September 1, 2020, but departed China on

January 10, 2020, due to the COVID-19 Emergency. Assuming the individual meets all

the other requirements under IRC section 911, the individual is considered a qualified

individual.

Example 2: An individual was present in the United Kingdom on January 1 through

March 1, 2020, established that he reasonably expected to work in the United Kingdom

for the entire calendar year, but left the United Kingdom on March 2, 2020, due to the

COVID-19 Emergency. He returns to the United Kingdom on August 25, 2020, for the

remainder of the year. Assuming the individual meets all the other requirements under

IRC section 911, the individual is considered a qualified individual.

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FinCen

Foreign Account and Asset Reporting

A resident alien or U.S. citizen files Form 8938, Statement of Foreign Financial Assets, and/or

Financial Crimes Enforcement Network (FinCEN) Form 114, Report of Foreign Bank and Financial

Accounts, to report foreign bank accounts, securities, retirement plans, and other certain specified

assets.

Form 8938

The Form 8938 is an informational reporting form for reporting specified foreign financial assets

owned by a resident alien or U.S. citizen. A specified individual must file Form 8938 if the

individual has an interest in one or more specified foreign financial assets and the aggregate value of

those assets exceed a threshold.

Filing Status Living In U.S. Presence Abroad

Last Day Anytime Last Day Anytime

Unmarried (S,HH) $50,000 $75,000 $200,000 $300,000

MFJ $100,000 $150,000 $400,000 $600,000

MFS $50,000 $75,000 $200,000 $300,000

A specified individual is:

A U.S. citizen.

A U.S. resident alien for any part of the year.

A nonresident alien who elects treatment as a resident alien for purposes of filing a joint

income tax return.

A nonresident alien who is a bona fide resident of American Samoa or Puerto Rico.

The definition of a specified foreign financial asset for purposes of Form 8938 is:

Depository or custodial financial accounts maintained by a foreign financial institution.

To the extent not held in an account at a financial institution:

Stocks or securities issued by foreign corporations.

Any financial instrument or contract that has an issuer or counterparty that is not a U.S.

person.

Any interest in a foreign entity220

A taxpayer files Form 8938 with his or her Form 1040.

220 §6038D(b); Reg. §1.6038D-3

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Failure to File Form 8938

A taxpayer who is required to file Form 8938 but does not file a complete and correct form

by the due date is subject to a penalty up to $10,000.

For a failure to file within 90 days after the IRS sends a notice of the failure to file, an

additional penalty of $10,000 applies for each 30-day period the failure continues.

The maximum additional penalty is $50,000.

FinCEN Form 114

The FinCEN Form 114 is an informational reporting document reporting the ownership interest

or signature authority over a foreign bank or financial account. A taxpayer with at least $10,000 in

foreign financial or bank accounts at any time during the calendar year must file a FinCEN Form

114. A United States person has a financial interest if the U.S. person is the owner of record or

holder of legal title, regardless of whether maintaining the account for the benefit of the U.S.

person or for the benefit of another person.

In Ott. v. U.S221 a district court held that a taxpayer who owned several Canadian

brokerage accounts was liable for almost $1 million in penalties for failing to Report of

Foreign Bank and Financial Accounts (FBAR) for calendar years 2007, 2008, and 2009.

The court concluded that the taxpayer's failure to review his tax returns; his decision not

to ask his tax preparer about foreign account reporting obligations; his decision to send

his mail to a Canadian address; and his knowledge of almost a million dollars in account

balances for the years in question, all indicated that he acted with reckless disregard to his

reporting requirements

The filing threshold for married taxpayers filing a joint tax return starts when the combined total

account balance exceeds $10,000 at any time during the tax year. U.S. persons, U.S. citizens,

resident aliens, trusts, estates, and domestic entities are all subject to this filing requirement and

threshold amount. Taxpayers are required to report the ownership in the foreign account

electronically on a Financial Crimes Enforcement Network (FinCEN) Report 114, Report of

Foreign Bank and Financial Accounts (FBAR). Electronic filing is done by using FinCEN’s

BSA online e-filing system at http://bsaefiling.fincen.treas.gov/main.html.

Do not confuse the FinCEN Report 114 FBAR reporting and Form 8938, Statement of Specified

Foreign Financial Assets. These forms are used to report similar and sometimes the same

information, but the information reported can be different information. To understand the

difference, Form 8938 reports foreign financial assets. The FBAR reports foreign financial

accounts. The term “asset” incorporates more than just financial accounts. The filing threshold

for Form 8938, if living in the U.S., is $50,000 ($100,000 for MFJ) on the last day of the tax year

or $75,000 ($150,000 for MFJ) at any time during the tax year. Higher threshold amounts apply

to individuals living abroad. Form 8938 is filed with the tax return; FBAR reporting is a separate

filing requirement.

In August 2016, the IRS assessed penalties on Mr. and Mrs. Ott totaling $60,000 [10,000 x 2

221 2020 PTC 77 (E.D. Mich. 2020),

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accounts (3 years)] along with late payment penalties and interest for an addition of

approximately $13,000. The taxpayers appeared in court to request reasonable cause on their

failure to comply with the filing requirements. Mrs. Ott admitted they did not disclose the

accounts, but she was unable to present evidence in support of reasonable cause for failure to

disclose the foreign accounts.

The Otts suggested they took reasonable steps by hiring a tax professional who prepared their

income tax returns. Reliance on the tax professional would suggest reasonable cause, in which

penalties should be abated according to Tracey. For reasonable cause, the taxpayer must

ultimately rely upon the advice in good faith and prove the professional was competent by

having expertise in the subject matter, to justify the reliance. The taxpayer must also prove that

they provided all necessary and accurate information to that professional. Tracey was unable to

support reasonable cause due to the fact they never disclosed the accounts to their tax

professional.

The court moved to grant judgement summary against the Otts, stating the time to present

evidence in support of their defense was in court. Disputes of material fact must be submitted

timely. Reasonable cause circumstances include an honest misunderstanding of the law and good

faith in the reliance of a tax professional to the extent of the taxpayers’ effort to assess their

proper tax liability. The Otts failed to provide their foreign financial information to their tax

professional.

When preparing income tax returns, tax professionals should at least be asking their clients the

right questions, multiple times if applicable, to help determine whether the clients may have

other filing obligations.

A United States person also has a financial interest in a foreign financial account in which the

owner of record or holder of legal title is one of the following:

An agent, nominee, attorney, or a person acting in some other capacity on behalf of the

U.S. person with respect to the account.

A corporation in which the U.S. person owns directly or indirectly either:

o More than 50% of the voting power of shares of stock.

o More than 50% of the voting power of all shares of stock.

A partnership in which the U.S. person owns directly or indirectly either:

o An interest in more than 50% of the partnership’s profits.

o An interest in more than 50% of the partnership’s capital.

A trust of which the U.S. person:

o Is the grantor of the trust.

o Has an ownership percentage in the trust for U.S. federal tax purposes.

A trust in which the U.S. person has greater than 50% present beneficial interest in the

assets or income of the trust for the calendar year.

Any other entity in which the U.S. person owns directly or indirectly more than 50% of

the voting power, total value of equity interest or assets, or interest in profits.

In regards to Form 114, a person means a taxpayer (including a minor child) and legal entities

including but not limited to, a limited liability company, corporation, partnership, trust, and

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estate. Signature authority is the authority of a taxpayer (alone or in conjunction with another

individual) to control the disposition of assets held in a foreign financial account by direct

communication (whether in writing or otherwise) to the bank or other financial institution that

maintains the financial account. A foreign bank or financial account is any financial account

located outside the United States.

A reportable account includes:

Securities.

Brokerage.

Savings.

Demand.

Checking.

Deposit.

Time deposit.

Other accounts maintained by a financial institution or (other person performing the

services of a financial institution).

Commodity futures or options account.

Insurance policy with a cash value.

Annuity policy with a cash value.

Shares in a mutual fund or similar pooled fund (a fund that is available to the general

public with a regular net asset value determination and regular redemptions).

Due Date for FinCEN

The due date of the FinCEN Form 114 is on or before April 15 of the succeeding year and has an

automatic six-month extension (that means no request is needed to obtain an extension). In

addition, U.S. persons filing FinCEN Form 114 must file electronically through FinCEN’s BSA E-

Filing System. This is not part of the taxpayers’ federal income tax return.

FinCEN Form 114 Penalties

A taxpayer who is required to file FinCEN Form 114 and fails to do so is subject to a civil

penalty not to exceed $10,000 per violation.

For a taxpayer who reported all taxable income and paid the tax on that income in a prior

year, but just failed to file FinCEN Form 114, the IRS can waive the penalty.

A taxpayer who willfully fails to report an account or account identifying information

may be subject to a civil monetary penalty equal to the greater of

o $100,000 or

o 50% of the balance in the account at the time of the violation.

The criminal penalty for willful failure to file is a fine of not more than $250,000 or

imprisonment for not more than five years, or both. If the violation is part of a pattern of

illegal activity, the maximum fine is $500,000 and the maximum length of sentence is 10

years.

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What Do You Think?

Q1. Which of the following is not correct regarding Health Reimbursement Accounts

(HRAs)?

A. An HRA is an employer-funded group health plan.

B. Unused amounts may be rolled over to be used in subsequent years.

C. The employer arranges for outside funds who manages and owns the account.

D. Employees are reimbursed tax-free for qualified medical expenses up to a fixed

dollar amount per year.

Q2. Which of the following would be a qualified individual for the COVID-19

Emergency in an adverse condition for the foreign income exclusion and housing

allowance?

A. An individual arrived in China on August 1, 2019, and established that he reasonably

expected to work in China until August 1, 2020, but departed China on February 2,

2020, due to the COVID-19 Emergency. Assuming the individual meets all the other

requirements.

B. An individual was present in France on January 1 through March 1, 2020, established

that he reasonably expected to work in France for the entire calendar year, but left the

France on April 5, 2020, due to the COVID-19 Emergency. He returns to France on

September 1, 2020, for the remainder of the year. Assuming the individual meets all

the other requirements.

C. An individual was present in Denmark on November 12, 2019 through January 15,

2020, established that he reasonably expected to work in Denmark for the entire

calendar year, but left on January 5, 2020, due to the COVID-19 Emergency. He

returns to Denmark on July 1, 2020, for the remainder of the year. Assuming the

individual meets all the other requirements.

D. All of the above meet the requirements.

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What Do You Think? -Answers

A1.Which of the following is not correct regarding Health Reimbursement Accounts (HRAs)?

Answer C is not correct

A. An HRA is an employer-funded group health plan.

B. Unused amounts may be rolled over to be used in subsequent years.

C. The employer arranges for outside funds who manages and owns the account.

D. Employees are reimbursed tax-free for qualified medical expenses up to a fixed dollar

amount per year.

Health reimbursement accounts or health reimbursement arrangements (HRAs) are

employer-funded group health plans from which employees are reimbursed tax-free for

qualified medical expenses up to a fixed dollar amount per year. Unused amounts, may be

rolled over to be used in subsequent years. The employer funds and owns the account it is

not funded or owned by anyone other than the business.

A2 Answer C does not meet requirements

Which of the following would be a qualified individual for the COVID-19 Emergency in an

adverse condition for the foreign income exclusion and housing allowance?

A. An individual arrived in China on August 1, 2019, and established that he reasonably

expected to work in China until August 1, 2020, but departed China on February 2, 2020,

due to the COVID-19 Emergency. Assuming the individual meets all the other

requirements.

B. An individual was present in France on January 1 through March 1, 2020, established that

he reasonably expected to work in France for the entire calendar year, but left the France

on April 5, 2020, due to the COVID-19 Emergency. He returns to France on September

1, 2020, for the remainder of the year. Assuming the individual meets all the other

requirements.

C. An individual was present in Denmark on November 12, 2019 through January 15,

2020, established that he reasonably expected to work in Denmark for the entire

calendar year, but left on January 5, 2020, due to the COVID-19 Emergency. He

returns to Denmark on July 1, 2020, for the remainder of the year. Assuming the

individual meets all the other requirements.

D. All of the above meet the requirements.

C does not meet the requirements because he or she left Denmark prior to February 1, 2020.

For 2019 and 2020, the IRS has ruled that the COVID-19 Emergency is an adverse condition that

precluded the normal conduct of business as follows:

• 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

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Chapter 8 - Business Related Changes

Paycheck Protection Program

The Paycheck Protection Program is part of the CARES Act.

Information regarding this loan is discussed in the Update Section

of this Syllabus. This loan is designed to provide a direct

incentive for small businesses to keep their workers on the payroll.

SBA will forgive loans if all employees are kept on the payroll for eight weeks and the money is

used for payroll, rent, mortgage interest, or utilities.

The taxpayer can apply through any existing SBA 7(a) lender or through any federally insured

depository institution, federally insured credit union, and Farm Credit System institution that is

participating. Other regulated lenders will be available to make these loans once they are

approved and enrolled in the program. The taxpayer should consult with your local lender as to

whether it is participating in the program.

The ability for businesses to apply for and obtain a Paycheck Protection Program (PPP) loan was

established by CARES Act. Under the PPP, a recipient of a covered loan may use the proceeds to

pay:

Payroll costs including certain employee benefits relating to healthcare

Interest on mortgage and other debt obligations

Rent

Utilities

There has been many questions regarding this program and as a result changes have been

implemented and explanations released by the IRS. The following paragraphs are a few of those.

Paycheck Protection Loan Forgiveness Application - EZ

The U.S. Small Business Administration (SBA) posted a revised, Paycheck Protection Program

(PPP) loan forgiveness application implementing the PPP Flexibility Act of 2020. In addition

to revising the full forgiveness application, SBA also published a new EZ VERSION of the

forgiveness application that applies to borrowers who:

Are self-employed and have no employees; or

Did not reduce the salaries or wages of their employees by more than 25%, and did not

reduce the number or hours of their employees; or

Experienced reductions in business activity as a result of health directives related to

COVID-19 and did not reduce the salaries or wages of their employees by more than

25%.

The EZ application requires fewer calculations and less documentation for eligible borrowers.

Details regarding the applicability of these provisions are available in the instructions to the new

form.

Objectives:

Explain with examples the

miscellaneous business changes.

TCJA changes and CARES act are

discussed with examples.

https://content.sba.gov/sites/default/files/2020-06/PPP%20Loan%20Forgiveness%20Application%20%28Revised%206.16.2020%29.pdf

https://content.sba.gov/sites/default/files/2020-06/PPP%20Forgiveness%20Application%203508EZ%20%28%20Revised%2006.16.2020%29.pdf

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Both applications give borrowers the option of using the original 8-week covered period (if their

loan was made before June 5, 2020) or an extended 24-week covered period. These changes will

result in a more efficient process and make it easier for businesses to realize full forgiveness of

their PPP loan.

PPP Flexibility

The Congress has passed several bills modifying the PPP and other items contained in the

CARES Act. The following are a few changes and explanations of interest.

Extending the minimum maturity of PPP loans that still have a remaining balance after

the government forgives part of them to five years. The government would continue to

guarantee the remainder of the loan.

Extending the PPP lifespan from June 30, 2020, to Dec. 31, 2020, for using loan

proceeds.

Extending the period during which businesses may spend PPP loan funds from eight

weeks after issuance to the earlier of 24 weeks after issuance or Dec. 31, 2020 (though

eligible employers may elect to retain the eight-week covered period instead).

Specifying that PPP loans can be forgiven even if the number of full-time employees

decreases, as long as the employer can prove:

o it attempted to rehire the same number of employees, but its former employees

were unavailable;

o similarly qualified employees were unavailable; or its business is unable to return

to the same level of activity it had before Feb. 15, 2020.

Lowers the amount that must be spent on payroll to be eligible for forgiveness from 75%

to 60%.

Allowing all employers to take advantage of the CARES Act deferral of the 6.2%

employer portion of Social Security payroll taxes, regardless of whether they have had a

PPP loan forgiven.

All the changes would be effective retroactively, as if included in the CARES Act originally.

The SBA has reported that 4.5 million businesses have received approval for loans totaling

$510.6 billion. About $130 billion remain available for loans.

Clarification of Deductions

According to Notice 2020-32, businesses that qualify for PPP loan forgiveness, will not be able

to deduct certain business expenses, including wages, paid for by the loan, and the income

associated with the forgiveness is excluded from gross income.

"The money coming in the PPP is not taxable. So, if the money that is coming is not taxable, you

cannot double dip," Mnuchin said in a televised interview. "You cannot say that you are going to

get deductions for workers that you did not pay for."

Most tax professionals are used to this situation; however, some believe Congress intended for

these expenses to still be deductible. In fact, a bipartisan group of Senators introduced a bill this

week that would make this change. It is pending.

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The SBA issued updated PPP FAQ, https://www.sba.gov/document/support--faq-lenders-

borrowers that includes guidance on loan forgiveness if an employee declines to return to work.

The answer to question 40 states that the loan forgiveness amount will not be reduced if an

employee declines to return to work. Keep check the FAQ’s they are a good source of

information.

Excess Business Losses -TCJA

Under TCJA, for tax years beginning after December 31, 2017, excess business losses222 of a

taxpayer other than a corporation are not allowed for the tax year.

Such losses are carried forward and treated as part of the taxpayers’ net operating loss (NOL)

carryforward in subsequent tax years. Another significant change in the TCJA is the limitation of

excess losses for taxpayers other than corporations. For purposes of the excess business loss

limitation, a nonpassive activity is a trade or business activity in which the taxpayer owns an

interest and materially participates in the activity. Internal Revenue Code (IRC) Section 469

defines “material participation” as an activity in which the taxpayer is involved in the operation

on a regular, continuous and substantial basis.

Prior to the TCJA’s passage, there were no limitations on the amount of excess business losses

an individual taxpayer could deduct in a tax year. This allowed individual taxpayers to directly

offset other sources of income, including wages, interest, dividends and capital gains with losses

generated from nonpassive business activities, regardless of the size of the loss generated.

Effective for tax years beginning after December 31, 2017, the TCJA disallows excess business

losses for taxpayers other than corporations. This “deduction reduction” is calculated as the

excess of the taxpayers’ aggregate deductions attributable to trades or businesses, over the sum

of the aggregate gross income or gain attributable to trades or businesses plus a threshold amount

($500,000 for Married Filing Jointly and $250,000 for all other taxpayers). The excess loss

becomes an NOL carried forward indefinitely.223 This limitation applies at the partner or S

corporation shareholder level and expires December 31, 2025, absent future legislation.

The CARES Act, amended section 461(l) to restrict the limitation on excess business losses of

noncorporate taxpayers to tax years beginning after 2020 and before 2026. The CARES Act

repealed the limitation for tax years 2018, 2019, and 2020. Form 461, Limitation of Business

Losses, has been eliminated for those years. If the taxpayer filed a 2018 and/or 2019 return(s)

with the limitation, they can file an amended return.

222 IRC§§ 461(5)(l) & 199(A) 223 IRC§172

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Excess Business Losses – The CARES Act Overview -Section 2304 of the Act amended IRC Section 461 such that:

The $250,000 (or $500,000 for married taxpayers filing jointly) limitation on excess

business losses for non-corporate taxpayers does not apply until January 1, 2021. As a

result, affected taxpayers may be able to fully deduct business losses arising in 2018, 2019

and 2020.

An excess business loss for a taxable year is determined without regard to any:

1. NOL deduction;

2. Qualified Business Income deduction;

3. Capital loss deduction; and

4. Deductions, gross income or gains attributable to any trade or business of

performing services as an employee.

The amount of net capital gain included in the excess business loss calculation may not

exceed the lesser of the taxpayer’s:

1. Net capital gain attributable to trades or businesses; or

2. Total net capital gain

The CARES Act lifts the disallowance of “excess business losses” for individuals and flow-

through entities for taxable years beginning before December 31, 2020224. Under the TCJA,

noncorporate taxpayers were permitted deductions attributable to a trade or business only up to

the amount of the income or gain attributable to that trade or business for the tax year plus

$250,000 ($500,000 for joint filers). This TCJA limitation applied to tax years beginning after

December 31, 2017 and before December 31, 2026. The CARES Act lifts this limitation for tax

years beginning in 2018, 2019, and 2020, permitting deduction of business losses in excess of the

above threshold. For tax years beginning in 2021 through 2026, taxpayers may treat excess

business losses as NOLs for purposes of determining a net operating loss carryover in the

following year. As a result, individual taxpayers that incurred an excess business loss limitation

in 2018 and/or 2019 should consider amending their 2018 and/or 2019 income tax return(s) to

remove the limitation.

The CARES Act also makes certain technical corrections to the TCJA with respect to the

calculation of excess business losses.

The determination of excess business losses takes into account the lesser of

(i) Capital gain attributable to a trade or business or

(ii) Net capital gain income.

Excess business losses are determined without regard to any capital losses or any deductions,

gross income, or gains attributable to any trade or business of performing services as an

employee. Deductions allowable under Sections 172 and 199A are not taken into account in

determining excess business losses.

224 CARES Act §304, IRC §461(1)

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Modifications of Limitation on Deductibility of Business Interest225

Increase in Business Interest Expense Limitation. The CARES Act increases the business interest

expense limitation (as amended by the TCJA) from 30% to 50% of adjusted taxable income for

tax years beginning in 2019 and 2020. For these tax years, taxpayers subject to the limitation

(generally, taxpayers with average annual gross receipts for the prior three tax years below $26

million) may now deduct business interest expense up to 50% of their adjustable taxable income.

However, taxpayers may still elect to apply the 30% limitation. In the case of a partnership, the

election must be made by the partnership.

Special Rules for Partnerships. The increased limitation does not apply to partnerships for tax

years beginning in 2019. However, partners allocated excess business interest in a tax year

beginning in 2019 will be treated as having fully deductible business interest in the following tax

year equal to 50% of that allocated excess business interest amount. The remaining 50% of such

allocated excess business interest will be subject to the customary limitations for excess business

interest, such that it can only be applied against subsequent tax years’ excess taxable income

from the partnership.

Election to Use 2019 Taxable Income to Compute Limitation. For tax years beginning in 2020,

taxpayers may elect to use their 2019 adjusted taxable income to determine the limitation amount

(prorated if the taxpayer’s 2020 tax year is a short tax year). This election must also be made at

the partnership level.

Accelerated AMT Credit Recovery226

The CARES Act allows for accelerated recovery of corporate alternative minimum tax

refundable credits. TCJA repealed the AMT and allowed corporations to recover AMT credits,

including via refund, in years 2018 through 2021.

The CARES Act accelerates the recovery and refund of such credits to the taxable years

beginning in 2018 and 2019. Further, corporations may elect to recover the full amount of

refundable AMT credits in the first tax year beginning in 2018. The application must be filed

prior to December 31, 2020 and must state the amount of the refund claimed.

Technical Amendments Regarding Qualified Improvement Property227

The CARES Act makes qualified improvement property eligible for bonus depreciation.

Qualified improvement property is any improvement to an interior portion of a building, which is

nonresidential real property. This provision corrects a drafting error in TCJA that caused

qualified improvement property to be depreciated over 39 years as opposed to the intended 20

years, rendering qualified improvement property ineligible for bonus depreciation. The CARES

Act sets the depreciable life of qualified improvement property at 20 years, allowing taxpayers to

take advantage of bonus depreciation

225 CARES Act §2306, IRC §163(j) 226 CARES Act §2305, IRC §59 227 CARES Act §2307, IRC §168

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Net Operating Loss -TCJA

For tax years ending after December 31, 2017, the NOL is limited to 80% of taxable income. The

option to carryback an NOL is disallowed. The remaining NOL is carried forward to the

following year; it continues to be carried forward until it is used up.

To have an NOL, the loss must generally be caused by deductions from:

Trade or business,

Work as an employee (although not deductible for most taxpayers in 2018),

Casualty and theft losses resulting from a federally declared disaster,

Moving expenses (although not deductible for most taxpayers in 2018), or

Rental property.

A loss from operating a business is the most common reason for an NOL. Partners or

shareholders can use their separate shares of the partnership's or S-Corporation's business income

and business deductions to figure their individual NOLs.

For tax years beginning before January 1, 2018, NOLs were able to offset 100% of taxable

income. They were carried back two years and carried forward for twenty years. Under TCJA an

NOL can offset only 80% of taxable income in any given tax year. Furthermore, NOLs can no

longer be carried back, they must be carried forward. The 20-year carryforward period has been

replaced with an indefinite carryforward period.

NOLs created in tax years beginning before January 1, 2018 are subject to the old rules. Only

NOLs generated in tax years beginning after December 31, 2017 are subject to the new rules.

For tax years beginning before January 1, 2018, losses from a non-passive business were allowed

to offset other sources of income without restriction.

For tax years beginning January 1, 2018 through December 31, 2025, excess business losses of a

taxpayer other than a corporation are not deductible in the current year and the NOL.

Example: Bob the Builder is a single taxpayer owns a construction company. The company was

formed as an S Corp with the individual taxpayer as the sole owner. His business had always

shown a profit, but in 2018, the taxpayer suffers a $500,000 loss on operations. Bob has the

following income from other sources for the 2019 tax year:

In this scenario under prior tax law, disregarding adjustments for other deductions, the taxpayer

would report adjusted gross income (AGI) equal to the sum of these income and loss items for a

net loss of $40,000. This loss would be reported on the taxpayers’ 2018 federal income tax

return, creating an NOL that—under prior tax law—would be eligible for a two-year carryback

or 20-year carryforward.

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Under TCJA, the taxpayers’ loss generated from the business would be limited to a total of

$250,000, with any excess loss treated as part of the taxpayers’ NOL carryforward to subsequent

years. Therefore, in this scenario, the taxpayer would report AGI of $210,000 ($300,000 +

$10,000 + $150,000 - $250,000 (excess business threshold)) on the 2018 federal income tax

return and may be required to pay income tax, depending on other personal deduction items.

The $250,000 excess business loss is treated as an NOL under the new tax law and carried

forward indefinitely, subject to the 80 percent of taxable income limitation mentioned above.

The CARES Act includes corporate and other business tax relief, including permitting

carrybacks of (and the lifting of the taxable income limitation on the use of) net operating losses

(“NOLs”), increased business interest deductibility, and accelerated recovery of alternative

minimum tax credits, among other forms of relief.

Net Operating Loss – CARES Act

Overview - Section 2303 of the Act amended IRC Section 172 such that:

The 80 percent of taxable income limitation does not apply to NOLs arising in 2018,

2019 or 2020.

Any NOL arising in a taxable year beginning after December 31, 2017, and before

January 1, 2021, generally must be carried back to each of the five taxable years

preceding the taxable year in which the loss arises. As a result, taxpayers must generally

take into account such NOLs in the earliest taxable year in the five-year carryback

period, and carry forward the unused amount to each succeeding taxable year. However,

taxpayers are permitted to make an irrevocable election to relinquish the NOL carryback

period for any taxable year.

The CARES Act expands taxpayers’ ability to deduct NOLs arising before the 2021 taxable year,

by temporarily lifting the 80% limitation on NOLs. The Tax Cuts and Jobs Act of 2017 limited

NOL deductions for taxable years beginning after December 31, 2017 to 80% of taxable income

in the year of the deduction. The CARES Act lifts the 80% taxable income limitation on the use

of NOLs for taxable years beginning before January 1, 2021. However, NOLs carried forward

from 2018, 2019 or 2020 to taxable years beginning after December 31, 2020 will be subject to

the 80% limitation228.

228 CARES Act §2303,IRC §172

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The TCJA generally disallowed the use of NOLs against the income of prior tax years. The

CARES Act allows an NOL incurred by a corporation in tax years beginning after December 31,

2017 and before January 1, 2021 to be carried back to each of the five tax years preceding the tax

year of the NOL. An NOL arising during this period that a taxpayer elects to carry back must be

carried back to the earliest year within the five-year period in which the taxpayer has taxable

income. As under pre-CARES law, a taxpayer may elect to waive the carryback period.

A taxpayer that is a real estate investment trust for a given tax year may not carry back NOLs

incurred during that tax year to any preceding tax year. Similarly, any NOL incurred in a taxable

year in which a taxpayer is not a REIT may not be carried back to a preceding tax year in which

the taxpayer was a REIT.

For life insurance companies, any NOL carryback to a tax year beginning before January 1, 2018

will be treated in the same manner as an operations loss carryback under the rules existing before

TCJA.

TCJA required certain U.S. shareholders of a foreign corporation to include in gross income their

share of the foreign corporation’s earnings that were not previously subject to U.S. tax.229 Under

the CARES Act, income may not be taken into account in determining the amount of an NOL or

the amount of taxable income that may be reduced by any NOL carryback. Further, the taxpayer

may elect to exclude from the five-year carryback period all years in which the taxpayer included

income under Section 965. Such an election must be made by the filing return deadline for the

first taxable year ending after March 27, 2020.

Taxpayers considering whether to make the election to relinquish the carryback period or to

exclude taxable year in which the taxpayer had Section 965 income from the carryback period

for their 2018 or 2019 taxable years have until the due date (including extensions) for filing their

tax returns for the first taxable year ending after the date of enactment (March 27, 2020).

229 CARES Act §965

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Extended Time Limit for IRS Levy

The IRS reminds individuals and businesses that they have additional time to file an

administrative claim or bring a civil action for wrongful levy or seizure230. Tax reform legislation

enacted in December, 2018 extended the time limit from nine months to two years.

Here are some facts about levies and the extension of time to file a claim or civil action:

An IRS levy permits the legal seizure and sale of property to satisfy a tax debt. For

purposes of a levy, the term “property” includes wages, money in bank or other financial

accounts, vehicles and real estate.

The time-frames apply when the IRS has already sold the property it levied. Taxpayers

can make an administrative claim for return of their property within two years of the date

of the levy.

If an administrative claim is made within the extended two-year period, the two-year

period for bringing suit is extended for one of two periods, whichever is shorter:

o Twelve months from the date, the person filed the claim.

o Six months from the date, the IRS disallowed the claim.

The change in law applies to levies made before, on or after December 22, 2017, as long as the

previous nine-month period had not yet expired.

Anyone who receives an IRS bill titled, Final Notice of Intent to Levy and Notice of Your Right

to A Hearing, should immediately contact the IRS. By doing so, a taxpayer may be able to

arrange to pay the liability, instead of having the IRS proceed with the levy.

Applying for an EIN

As part of its ongoing security review, the Internal Revenue Service announced that starting May

13 only individuals with tax identification numbers may request an Employer Identification

Number (EIN) as the “responsible party” on the application.

An EIN is a nine-digit tax identification number assigned to sole proprietors, corporations,

partnerships, estates, trusts, employee retirement plans and other entities for tax filing and

reporting purposes.

230

https://www.irs.gov/businesses/small-businesses-self-employed/levy

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The change will prohibit entities from using their own EINs to obtain additional EINs. The

requirement will apply to both the paper Form SS-4, Application for Employer Identification

Number (PDF), and online EIN application.

Either individuals named, as responsible party must have a Social Security number (SSN) or an

individual taxpayer identification number (ITIN). The IRS made the announcement weeks in

advance, entities and their representatives will have time to identify the proper responsible

official and comply with the new policy.

The Form SS-4 Instructions (PDF) provide a detailed explanation of who should be the

responsible party for various types of entities. Generally, the responsible party is the person who

ultimately owns or controls the entity or who exercises ultimate effective control over the entity.

In cases where more than one person meets that definition, the entity may decide which

individual should be the responsible party.

Only governmental entities (federal, state, local and tribal) are exempt from the responsible party

requirement as well as the military, including state national guards.

There is no change for tax professionals who may act as third-party designees for entities and

complete the paper or online applications on behalf of clients.

The new requirement will provide greater security to the EIN process by requiring an individual

to be the responsible party and improve transparency. If there are changes to the responsible

party, the entity can change the responsible official designation by completing Form 8822-B,

Change of Address or Responsible Party. A Form 8822-B must be filed within 60 days of a

change.

https://www.irs.gov/pub/irs-pdf/fss4.pdf

https://www.irs.gov/pub/irs-pdf/fss4.pdf

https://www.irs.gov/businesses/small-businesses-self-employed/employer-id-numbers

https://www.irs.gov/pub/irs-pdf/iss4.pdf

https://www.irs.gov/forms-pubs/about-form-8822-b

https://www.irs.gov/forms-pubs/about-form-8822-b

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What Do You Think?

Q1. The Congress has passed several bills modifying the PPP and other items contained

in the CARES Act. Which of the following is a provision that has been modified?

A. The PPP lifespan from June 30, 2020, to Dec. 31, 2020, for using loan proceeds.

B. The amount that must be spent on payroll to be eligible for forgiveness from

75% to 60%.

C. Allowing all employers to take advantage of the CARES Act deferral of the 6.2%


PPP loan forgiven.

D. All of the above statements is correct.

Q2. Which of the following is not a correct statement regarding how the CARES Act affected

excess business losses?

A. The CARES Act lifted the disallowance of excess business losses starting before

December 31, 2020.

B. QBI is not included in the computation of excess business loss for a taxable year.

C. Capital loss are considered in the computation of an excess business loss for a taxable

year.

D. All of the above statements are correct.

Q3. Tax reform legislation changed the time allowed to file an administrative claim for property

seized due to wrongful levy or seizure. How long has the time been extended?

A. Nine months.

B. Twelve months.

C. Two years.

D. Six months.

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D is the correct answer, all of the statements are correct.

A1. The Congress has passed several bills modifying the PPP and other items

contained in the CARES Act. Which of the following is a provision that has

been modified?

A. The PPP lifespan from June 30, 2020, to Dec. 31, 2020, for using loan proceeds.

B. The amount that must be spent on payroll to be eligible for forgiveness from 75% to

60%.

C. Allowing all employers to take advantage of the CARES Act deferral of the 6.2%


PPP loan forgiven.


C is the correct answer

A2. Which of the following is not a correct statement regarding how the CARES Act affected

excess business losses?

A. The CARES Act lifted the disallowance of excess business losses starting before

December 31, 2020.

B. QBI is not included in the computation of excess business loss for a taxable year.

C. Capital loss are considered in the computation of an excess business loss for a taxable

year.


C is the correct answer because it is false. An excess business loss for a taxable year is

determined without regard to a capital loss deduction. A is correct taxpayers may be able to fully

deduct business losses arising in 2018, 2019 and 2020. B is also correct, QBI is not considered

when calculating excess business loss for the taxable year.

C is the correct answer. Taxpayers can make an administrative claim for return of their

property within two years of the date of the levy.

A3. Tax reform legislation changed the time allowed to file an administrative claim for property

seized due to wrongful levy or seizure. How long has the time been extended?

A. Nine months.

B. Twelve months.

C. Two years.

D. Six months.

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Chapter 9– Affordable Care Act

After December 31, 2018, the shared responsibility

provision has been repealed. This is not a repeal of

the Affordable Care Act. Taxpayers are still

obligated to carry health insurance, either through

their employers, through the ACA Exchange, or by

independently selecting and paying for their own ACA-compliant plans. They will no longer pay

a penalty if they do not. This is part of the Tax Cuts and Jobs Act of 2017. This change went into

effect on after Jan. 1, 2019.

The requirement that the employer, or the exchange or the insurance company provide proof of

insurance for tax purposes is still part of the law. The exemptions have not been repealed but

without any penalty, they are somewhat meaningless.

Under the Affordable Care Act (ACA), the Federal government, state governments, insurers,

employers, and individuals share responsibility for improving the quality and availability of

health insurance coverage in the United States. The ACA reforms the existing health insurance

market by prohibiting insurers from denying coverage or charging higher premiums because of

an individual’s preexisting conditions. The ACA also creates the Health Insurance Marketplace

(Marketplace, also known as the Exchange).

The Marketplace is where taxpayers find information about health insurance options, purchase

health insurance, and, if eligible, obtain help paying premiums and out-of-pocket costs. A new

tax credit, the premium tax credit, is available through the Marketplace and helps eligible

taxpayers pay for coverage.

NOTE: See the CA section of this syllabus for information on how CA will be using the

exchange known as Covered CA in the CA health mandate starting Jan 1, 2020.

Requirement to Have Health Insurance231

The ACA also includes the individual shared responsibility provision, which requires individuals

to have qualifying health care coverage (called minimum essential coverage) for each month of

the year, qualify for a coverage exemption, or make a shared responsibility payment (SRP) when

filing their Federal income tax returns.

Beginning January 1, 2014, all non-exempt U.S. citizens and legal residents without an

exemption are required to maintain minimum essential health insurance coverage or pay a

penalty tax on their individual tax return. The provision applies to individuals of all ages,

including children. The taxpayer or married couple who can claim a child or another individual

as a dependent for Federal income tax purposes is responsible for making the payment if the

dependent does not have coverage or an exemption.

231 IRC§ 5000A(d)

Objective:

Identify and review the major points of

the Affordable Care Act

Understand important items in the ACA.

Explain the value and pitfalls of the

Premium Tax Credit.

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Health care penalty eliminated

The penalty for failure to obtain health insurance coverage (the “individual mandate”) has been

eliminated as of the beginning in 2019. Taxpayer’s are no longer required to pay a penalty for

not having minimum essential coverage.

Premium Tax Credit The Premium Tax Credit232 (PTC) is a Federal tax credit to help eligible taxpayers pay for health

insurance. When enrolling in health coverage through the Marketplace, eligible taxpayers choose

to have some or all of the benefit of the credit paid in advance to their insurance company

(advance credit payments) or to get all of the benefit of the credit on their Federal tax return.

Those who choose to have advance credit payments made must file a Federal tax return even if

they have gross income that is below the income tax filing threshold.

Individuals and families can receive the PTC to help them afford health insurance coverage

purchased through an exchange or marketplace. Exchanges may operate in every state and the

District of Columbia. The premium tax credit is refundable so taxpayers who have little or no

income tax liability can still benefit. The credit also can be paid in advance to a taxpayers’

insurance company to help cover the cost of premiums. If taxpayers’ advance credit payments

for a taxable year exceed the PTC allowed for the year, the taxpayer owes the excess as an

additional tax233. The limitation amounts on the increase of tax for excess advance credit

payments are adjusted for inflation.

In general, taxpayers are allowed a premium tax credit if they meet all of the following:

• The taxpayer, spouse (if filing a joint return), or dependents were enrolled at some time during

the year in one or more qualified health plans offered through the Marketplace.

• One or more of the individuals listed above were not eligible for other MEC during the months

they were enrolled in the qualified plan through the Marketplace.

• The taxpayer is an applicable taxpayer. A taxpayer is an applicable taxpayer if he or she meets

the following three requirements:

o The taxpayers’ income is at least 100% but not more than 400% of the Federal

poverty line for the taxpayers’ family size.

o If married, the taxpayer files a joint return with his or her spouse (unless the

taxpayer is considered unmarried for Head of Household filing status, or meets

the criteria234, which allows certain victims of domestic abuse or spousal

abandonment to claim the premium tax credit using the MFS filing status). See

the instructions for Form 8962, Premium Tax Credit, for more details about these

exceptions.

o The taxpayer cannot be claimed as a dependent by another person

232 Federal Register /Vol. 77, No. 100 233 IRC §36B(f)(2)(B) 234 Notice 2014-23 or T.D. 9683

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A taxpayer with household income below 100% of the Federal poverty line can be an applicable

taxpayer as long as the taxpayer, the taxpayers’ spouse, or a dependent who enrolled in a

qualified health plan is not a U.S. citizen, but is lawfully present in the U.S. and not eligible for

Medicaid because of immigration status.

Premium Tax Credit Eligibility

• Household income must be between 100% and 400% of the Federal poverty level.

• Covered individuals must be enrolled in a “qualified health plan” through an Affordable

Insurance Exchange.

• Covered individuals must be legally present in the United States and not incarcerated.

• Covered individuals must not be eligible for other qualifying coverage, such as Medicare,

Medicaid, or affordable employer-sponsored coverage.

• The taxpayer cannot file a Married Filing Separately235 tax return (unless the taxpayer

meets the criteria, which allows certain victims of domestic abuse to claim the premium

tax credit using the Married Filing Separately filing status for the calendar year); and

• Cannot be claimed as a dependent by another person,236

NOTE: Individuals who purchase their own coverage, however, are entitled only to the

deduction allowed for unreimbursed medical expenses, including any health insurance premium

amounts, to the extent that the expenses exceed 25 percent of their adjusted gross income (AGI).

Credit Amount

• The credit amount is generally equal to the difference between the premium for the

“benchmark plan” and the taxpayers’ “expected contribution.”

• The expected contribution is a specified percentage of the taxpayers’ household income.

The percentage increases as income increases, from 2.04% of income for families at

100% of the Federal Poverty Level (FPL)237 to 9.69% of household income for families

at 400% of FPL. (The actual amount a family pays for coverage will be less than the

expected contribution if the family chooses a plan that is less expensive than the

benchmark plan.)

• The benchmark plan is the second-lowest-cost plan238 that would cover the family at the

“silver” level of coverage.

• The credit is capped at the premium for the plan the family chooses (so no one receives a

credit that is larger than the amount he or she actually pays for their plan).

235 Notice 2014-23 236 IRC §151 237 §2110(c) 5 of the Social Security Act (42 U.S.C. 1397jj(c)(5) 238 IRC §36B(3)B, Second Lowest Cost Silver Plan

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Special Rules

The credit has advance payments made directly to the insurance company on the family’s behalf.

The advance payments are then reconciled against the amount of the family’s actual premium tax

credit, as calculated on the family’s Federal income tax return. Any repayment due from the

taxpayer is subject to a cap for taxpayers with incomes under 400% of FPL.

Poverty Thresholds

The poverty thresholds are the original version of the Federal poverty measure. They are updated

each year by the Census Bureau. The thresholds are used mainly for statistical purposes, for

instance, preparing estimates of the number of Americans in poverty each year. (In other words,

all official poverty population statistics are calculated using the poverty thresholds, not the

guidelines.)

The individual will use the Federal Poverty Level Guidelines239 to calculate the cost assistance

on the health insurance marketplace.

NOTE: The Federal Poverty Guidelines are issued in January of each year in the Federal

Register by the Department of Health and Human Services (HHS). Only use the chart from Form

8962 Instructions, other FPL charts used for other purposes may not be the same.

The taxpayer is not required to repay any portion of the advance payment if a family ends the

year with household income below 100% of FPL after having received advance payments based

on an initial Exchange determination of ineligibility for Medicaid.

It is very important that the taxpayer report change in income to the marketplace. The effects of

Covid-19 may change the amount a taxpayer may receive in assistance. If his or her salary is cut

or they have lost a source of income, they may be able to receive more assistance. It is equally

important if the taxpayer income increases they report this change to the exchange to avoid a

large tax bill. Be sure to remind the taxpayer that the premium assistance is limited according to

income.

Household Income

In general, the household income includes the adjusted gross income plus any tax-exempt Social

Security benefits, tax-exempt interest and tax-exempt foreign income. Supplemental Security

Income (SSI) does not count.

The income should include wages, salaries and tips; taxable interest; taxable amounts of pension,

annuity or IRA distributions and Social Security benefits. Other categories, such as business

income, farm income, capital gains, unemployment compensation; alimony received, royalties or

foreign earned income, also should be considered.

239 IRC §5000A (4) (d)

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Items not included are child support, worker’s compensation, veteran disability payments or

proceeds from student loans or home equity and bank loans.

For purposes of the Premium Tax Credit, the household income is the modified adjusted gross

income plus that of every other individual in the family for whom the taxpayer can properly

claim a deduction and who is required to file a Federal income tax return.

Modified adjusted gross income is the adjusted gross income the Federal income tax return plus:

Any excluded foreign income240

Nontaxable Social Security benefits (including tier 1 railroad retirement benefits), and

Tax-exempt interest received or accrued during the taxable year.

Example: David and Melinda are Married Filing Jointly taxpayers. They have one child,

Phil, age 17, whom they claim as a dependent. Phil works part time and has a filing

requirement. David and Melinda’s household income calculation would include their MAGI,

as well as Phil’s MAGI.

A taxpayer is allowed a premium tax credit only for months that a member of the taxpayers’ tax

family is (1) enrolled in a policy offered through the Marketplace and (2) not eligible for

minimum essential health coverage (other than individual market coverage). The taxpayers’ tax

family consists of the taxpayer, the taxpayers’ spouse if filing jointly, and all other individuals

for whom the taxpayer claims a personal exemption deduction. The family members who meet

the above two requirements are the taxpayers’ “coverage family.”

For any tax year, the taxpayer received advance credit payments in any amount or if the taxpayer

plans to claim the premium tax credit, he or she must file a Federal income tax return for that

year. This filing requirement applies whether or not the taxpayer would otherwise be required to

file a return.

If the taxpayer receives any advance credit payments, he or she will use their tax return to

reconcile the difference between the advance credit payments made on their behalf and the actual

amount of the credit that they may claim. Form 1095-A is issued by the Marketplace as an

information statement showing the amount of the premiums and advance credit payments by

January 31 of the year following the year of coverage. The taxpayer should receive the

information statement by Jan. 31, each year and can use this information to compute the

premium tax credit on the tax return and to reconcile the advance credit payments made with the

amount of the actual premium tax credit. The Marketplace also reports this information to the

IRS.

240 IRS §911

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Shared Policy Allocations

In cases where the taxpayer divorced or are legally separated during the tax year and are enrolled

in the same qualified health plan, the taxpayer and the former spouse must allocate the policy

amounts on their separate tax returns to figure their premium tax credit and reconcile any

advance payments made on their behalf.

The allocation can be between zero and 100% as agreed upon be each taxpayer. This is done by

dividing the number of enrollees claimed as a personal exemption by the total number

individuals enrolled in the health plan. If the taxpayers does not agree on an allocation then the

allocation percentage is equal (50%).

Example: Judy and her husband were divorced July 1. Their family of herself, her

husband and three children were enrolled in health care from an exchange. One of her

children is properly claimed by her ex-husband and the allocation percentage agreed upon

was 60% for Judy and 40% for her ex-husband of the premiums paid from Jan 1 through

June 30.

If Judy and her ex-husband had not agreed on an allocation Judy and her ex-husband

would have to split the cost of the health care so 50% of the Premium Tax Credit is

allocated to Judy and 50% to her ex-husband.

Coverage Reporting Requirements

The Affordable Care Act (ACA) imposes some new annual reporting requirements, the specific

objective of which is to inform the IRS and individuals about who has access to minimum

essential coverage (MEC), and when an employer shared responsibility assessment might be

owed. In addition, these requirements are intended to facilitate the determination about who is

eligible for premium assistance.

Under the ACA, both health insurance providers and large employers (50 or more full-time

employees) have new reporting requirements to ensure they are meeting health care coverage

obligations. The information reporting obligations are meant to provide policy details for each

person who is provided with coverage to the IRS. At the end of the year, taxpayers and their

dependents must be able to prove that they were participating in a qualified health plan, thereby

producing a need for third party tax information reporting.

Health insurance providers will have significantly increased responsibilities, requiring them to

organize and report information about each member and their corresponding coverage, to both

the insured individual and the IRS, or face penalties matching those of other non-wage forms.

Taxpayers in turn will receive two forms to include in their filing at the end of each year. They

will receive a 1095-B from their insurance provider as well as a 1095-C from their employer if

they work for a large company. They will continue to receive Form 1095-A if they purchase

coverage through the State exchange (Marketplace).

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Under Section 6055 of the ACA, health insurers, self-insuring employers and other health

coverage providers are required to provide information to the IRS about the entity providing

coverage and each enrolled individual. They must also provide individual coverage information

to each of their members.

Under Section 6056 of the ACA, large employers (50 or more full-time employees) are required

to provide information on health insurance offered and provided in the previous year to the IRS

as well as to each of their employees. This information reports on the employers’ compliance

with the employer mandate and play or pay rules. Failure to comply with these mandates results

in a penalty fee if required coverage is not offered to full-time employees and their dependents.

If employees are not offered health coverage under an employer-sponsored plan, they are eligible

to claim a premium tax credit to purchase health coverage through a qualified Health Care

Exchange.

Form 1095-B

Form 1095-B will be provided by the health insurance provider to the individual member in

order to report on the type of coverage provided, period of coverage, and for whom coverage was

provided– including each dependent.

1095-C

Form 1095-C will be provided by large employers to their employees in order to report on the

type of coverage provided as well as identification information for each employee and their

dependents.

Form 1095-A

This form is issued by Health Care Exchanges (web-based health insurance marketplaces). Form

1095-A provides information on each individual enrolled in the ‘qualified health plans’ (QHPs).

Every year the Health Care Exchanges will be required to provide Form 1095-A to the individual

by the end of January. This form will include information such as the level of coverage,

identifying information for the primary insured, monthly health insurance premiums paid to the

insurance company selected through the Marketplace. It will also list the amount of premium

assistance received in the form of advance payments of the premium tax credit that were paid

directly to the insurance company. Every month, marketplaces will be required to report this

information to the Department of Health and Human Services, he or she will in turn report to the

IRS.

If the taxpayer chose to have advance payments of the premium tax credit paid directly to their

insurance company in 2020 they must file a 2020 Federal income tax return. Even if the taxpayer

did not choose to receive advance payments, he or she must file a 2020 Federal income tax return

to claim the Premium Tax Credit.

If the taxpayer has questions regarding Form 1095-A, the IRS will not be able to answer

questions about the information on his or her Form 1095-A or about missing or lost forms. These

questions must be resolved by the taxpayer through their exchange or marketplace.

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The PTC will vary based on family income and the cost of health insurance in the exchange

available to the taxpayer. The credit will equal the difference between the premium for the

second-lowest-price silver plan (also known as the benchmark plan) and a specified percentage

of income. In 2019, the percentage ranges from 2.08 percent for those with incomes below 133

percent of poverty and scales up to 9.8 percent for those with incomes up to 400 percent of

poverty. The percentage will be adjusted in subsequent years to account for any excess in the rate

of premium growth over the rate of income growth241.

The PTC is only available to taxpayers who purchased health coverage through the Marketplace.

On Form 8962, a taxpayer must subtract the advance credit payments for the year from the

amount of the taxpayers’ premium tax credit calculated on the tax return. If the premium tax

credit computed on the return is more than the advance credit payments made on the taxpayers’

behalf during the year, the difference will increase the refund or lower the amount of tax owed.

This will be reported in the Payments section of Form 1040. If the advance credit payments are

more than the premium tax credit (an excess advance credit payment), the difference will

increase the amount owed and result in either a smaller refund or a balance due. This will be

entered in the Tax and Credits section of the return. There may be a limitation on the amount of

tax liability a taxpayer owes because of an excess advance credit payment. The limitation is

based on the taxpayers’ household income.

The Covered California income limits require consumers to have a household income that ranges

from 0% to 400% of the Federal Poverty Level (FPL) in order to qualify for assistance on a

government health insurance plan. According to Covered California income guidelines and

salary restrictions, if an individual makes less than $47,520 per year or if a family of four earns

wages less than $97,200 per year, then they qualify for government assistance based on their

income

Penalties

Personal information submitted for verification may be used to the extent necessary for the

verification purposes and may not be disclosed to anyone not identified in the law. Any person,

who submits false information due to negligence or disregard for any rule, and without

reasonable cause, is subject to civil penalty of not more than $25,000. Any person who

intentionally provides false information will be fined not more than $250,000. Any person who

knowingly and willfully uses or discloses confidential information will be fined not more than

$25,000. A fine imposed may not be collected through a lien or levy against property.

241 IRC§5000 (d)(2)

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Self-Employed Health Insurance Deduction

Generally, a self-employed242 individual—is allowed an above the line deduction for all or a

portion of the taxpayers’ premiums paid during the taxable year for health insurance for the

taxpayer, the taxpayers’ spouse, the taxpayers’ dependents, and any child of the taxpayer under

the age of 27. No deduction is allowed for the portion of premiums for a qualified health plan

equal to the amount of the Premium Tax Credit,243

For the premiums to be deductible, the insurance plan must be established with respect to the

taxpayers’ business. A sole proprietor who purchases health insurance in his or her individual

name has established a plan providing medical care coverage with respect to his or her trade or

business. Therefore, the sole proprietor may deduct the medical care insurance costs for himself,

his spouse and dependents, but only to the extent that the cost of the insurance does not exceed

the earned income from the business where the insurance was purchased.

SEHI can come from a partnership. The partnership pays the insurance premiums, and the

partnership reports the premium amounts on Schedule K-1 as guaranteed payments to be

included in the partner’s gross income if the premiums are paid for services rendered in the

capacity of a partner and to the extent, the premiums are determined without regard to

partnership income.

A 2-percent S shareholder can qualify for self-employed health insurance. The policy can be

either in the name of the S corporation or in the name of the shareholder. Either the 2-percent

shareholder can pay the premiums him or herself or the S corporation can pay them and report

the premium amounts on Form W-2 as wages to be included in the shareholder’s gross income.

A taxpayer cannot add the net profits from all his or her trades and businesses for purposes of

determining the deduction limitation. However, if a self-employed individual has more than one

trade or business, the medical care insurance costs of the self-employed individual and his or her

spouse and dependents are deductible under each specific health insurance plan established under

each specific business up to the net earnings of that specific trade or business. The SEHI

deduction cannot exceed the earned income from the business where the insurance was

purchased.

Medicare is considered health insurance, no matter what Part the taxpayer is paying.

242 IRC §162 (l) 243 IRC §280C(g)

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The self-employed person is allowed a deduction for specified premiums not to exceed the

amount to the lesser of

The specified premiums less the premium tax credit attributable to the specified

premiums, and

The sum of the specified premiums not paid through advance credit payments and the

additional tax imposed (if any) that is due the taxpayer receiving Advance Premium Tax

Credit in excess of the Premium Tax Credit allowed (if any) after applying the limitation

on the amount of the APTC that must be repaid.

Because the SEHI deduction244 is allowed in computing adjusted gross income and because

adjusted gross income is necessary for computing the PTC, the taxpayer must know the

allowable deduction to compute the premium tax credit. Thus, the amount of the deduction is

based on the amount of the PTC, and the amount of the credit is based on the amount of the

deduction – a circular relationship. Rev. Proc. 2014-41 provides calculation methods that resolve

the circular relationship between the deduction and the PTC. Using the calculations in Rev. Proc.

2014-41 is optional. A taxpayer may determine amounts of the deduction and the PTC using any

method, if the amounts claimed satisfy the requirements of applicable tax law.

When taxpayers determine their allowable self-employed health insurance deduction, they have

two options for the calculation:

(1) The calculation method, or

(2) The simplified method. The taxpayers’ self-employed health insurance deduction

cannot exceed the lessor of:245

• The taxpayer earned income derived by the taxpayer from the trade or business

with respect to which the health insurance is established.

• The sum of the Marketplace premiums not paid through advance credit

payments and the limitation on additional tax.

Rev. Proc. 2014-41 provides taxpayers with calculation methods that resolve this circular

relationship.

244 IRC §162 (l) 245 Rev. Proc 2014-41 §5.03

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What Do You Think?

Q1. Which of the following will qualify for a Premium Tax Credit?

A. The Smith’s have household income between 100% and 400% of the

Federal poverty level and maintain minimum essential coverage through

their workplace.

B. John Jones has household income of 103% of the Federal poverty level

and is eligible for Medicaid.

C. Peter King purchased his qualifying coverage from the Marketplace, he is a welder and

expected to earn $75,000; his business did not do well and his total income for the year fell

below 300% of the FPL, he paid all the premiums without assistance.


Q2. Which of the following is not a true statement regarding household income for the

computation of the Premium Tax Credit?

A. Modified adjusted gross income includes excludable foreign earned income when

computing household income for the Premium Tax Credit

B. Child support is included in household income.

C. Nontaxable Social Security Benefits are included in household income.

D. Household income includes income earned at McDonald’s by the taxpayers’ 16-year-old

son.

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Answer Q1. – C – Peter’s total income for the year was below 400% of the

FPL and he purchased his coverage through the marketplace. He is eligible for

the Premium Tax Credit.

A. The Smith’s do not qualify for the Premium Tax Credit because they had coverage through

their workplace.

B. John Jones did not qualify for the Premium Tax Credit because he is eligible for Medicaid.

Premium Tax Credit Eligibility

• Household income must be between 100% and 400% of the Federal poverty level.

• Covered individuals must be enrolled in a “qualified health plan” through an Affordable

Insurance Exchange.

• Covered individuals must be legally present in the United States and not incarcerated.

• Covered individuals must not be eligible for other qualifying coverage, such as Medicare,

Medicaid, or affordable employer-sponsored coverage.

• The taxpayer cannot file a Married Filing Separately tax return (unless the taxpayer meets

the criteria, which allows certain victims of domestic abuse to claim the premium tax

credit using the Married Filing Separately filing status for the calendar year); and

• Cannot be claimed as a dependent by another person,

Individuals who purchase their own coverage, however, are entitled only to the deduction

allowed for unreimbursed medical expenses, including any health insurance premium amounts,

to the extent that the expenses exceed 10 percent of their adjusted gross income (AGI)

Answer Q2. –B – Child support is not included in household income when figuring the Premium

Tax Credit.

For purposes of the Premium Tax Credit, the household income is the modified adjusted gross

income plus that of every other individual in the family for whom the taxpayer can properly

claim a deduction and who is required to file a Federal income tax return.

Modified adjusted gross income is the adjusted gross income the Federal income tax return plus:

Any excluded foreign income

Nontaxable Social Security benefits (including tier 1 railroad retirement benefits), and

Tax-exempt interest received or accrued during the taxable year.

In general, the household income includes the adjusted gross income plus any tax-exempt Social

Security benefits, tax-exempt interest and tax-exempt foreign income. Supplemental Security

Income (SSI) does not count.

The income should include wages, salaries and tips; taxable interest; taxable amounts of pension,

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TaxLaw

annuity or IRA distributions and Social Security benefits. Other categories, such as business

income, farm income, capital gains, unemployment compensation; alimony received, royalties or

foreign earned income, also should be considered.

Items not included are child support, worker’s compensation, veteran disability payments or

proceeds from student loans or home equity and bank loans.

1

Ethics

2020

TaxEase, LLC


2020 ETHICS – DUE DILIGENCE IRS COURSE NUMBER: B8FQK-E-00033-20-S CTEC COURSE NUMBER 3064-CE-0062





2

Ethics

Chapter One – Circular 230

PTIN

Anyone who prepares or assists in preparing

federal tax returns for compensation must have a

valid 2020 PTIN before preparing tax returns.

PTINs must be renewed annually.

Preparing all or substantially all of a tax return.

Any individual who for compensation prepares or assists with the preparation of all or

substantially all of a tax return or claim for refund must have a preparer tax identification

number. Except as otherwise prescribed in forms, instructions, or other appropriate guidance, an

individual must be an attorney, certified public accountant, enrolled agent, or registered tax

return preparer to obtain a preparer tax identification number. Any individual who for

compensation prepares or assists with the preparation of all or substantially all of a tax return or

claim for refund is subject to the duties and restrictions relating to practice in subpart B, as well

as subject to the sanctions for violation of the regulations in subpart C.246

In 2012, three tax preparers sued the IRS regarding PTINs, The IRS won the case and the courts

found PTINs were allowed to be required, but the IRS could not charge fees, The IRS was forced

to return over $175 million in fees.

The IRS appealed and the matter went back to court. In March of 2019, the U.S. Court of

Appeals for the District of Columbia Circuit overruled a lower court, finding that the IRS did

have the authority to charge PTIN fees. Specifically, the appeals court found that the IRS did

provide a service in exchange for the fee. Further, the court held that the service—the provision

of the PTIN—has value because it allows tax preparers to use those numbers instead of their

SSN on tax returns.

The IRS won at the appellate court level, which opened the door for the IRS to reinstate PTIN

fees. The plaintiffs next appealed to the Supreme Court. The Supreme Court allowed the

appellate court decision to stand. The IRS did not issue a public comment, but many tax

preparers expect to see fees return to the PTIN application in 2020.

Internal Revenue Code

Congress writes the tax laws, which become part of the Internal Revenue Code (IRC). The tax

code is amended every year.

246 Circular 230 §10.8(c)

Objective:

Understand the PTIN and AFSP

requirements for tax preparers

Understand the responsibility and

limitations of non-exempt tax preparers

Recognize the importance for the tax

preparer to use due diligence when

preparing a tax return.

https://www.bloomberglaw.com/document/X1Q6O2MTJN82?fmt=pdf

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3

Ethics

Congress has given the IRS the power to interpret the tax code through a series of IRS

Regulations. These regulations are expanded versions of some tax code provisions with

illustrations of how the law is applied in different situations. The regulations are about four times

the length of the tax code itself. The IRS also publishes revenue rulings, revenue procedures, and

letter rulings, as well as publications and instructions, which provide guidance in much the same

manner as the regulations.

The IRS does not have the final say on interpreting the tax code. The federal court system

composed of the U.S. Tax Court, Federal District Court, the U.S. Court of Federal Claims, and

U.S. Bankruptcy Court; all have the power to decide, on a case-by-case basis, how Congress

intends the tax laws to be applied. In addition, if more than $50,000 is at stake, a taxpayer can

appeal a Tax Court decision to a Circuit Court of Appeal and in rare cases to the U.S. Supreme

Court.

Our objective in this course is to provide practical examples and court case decisions, which will

show the practitioner a clear view of the ethics, discussed in these examples.

NOTE: Provisions of the CA Business and Profession Code referring to CA Registered Tax

Preparer are explained in the CA Section of this syllabus.

Circular 230

In order to help practitioners comply with the rules of professional conduct with regard to

representing taxpayers, Congress gave the Treasury Department the authority to regulate

representation before the Internal Revenue Service. Treasury Circular 230 was issued, which

contained tax regulations under Title 31, Title 26 contains the Internal Revenue Code. The

Treasury Department Circular 230 (Revised 6/2014) is the Regulations Governing Practice

before the Internal Revenue Service. A copy of these new regulations can be found on the IRS

website.

Circular 230 is published by the Treasury Department and prescribes regulations governing the

practice of attorneys, CPAs, Enrolled Agents, Enrolled Actuaries, appraisers, and others who

practice before the Internal Revenue Service. Circular 230 has been amended several times

recently, and more changes are proposed.

Tax advisors play an increasingly important role in the federal tax system, which is founded on

principles of voluntary compliance. The tax system is best served when the public has

confidence in the honesty and integrity of the professionals providing tax advice. To restore,

promote, and maintain the public’s confidence in those individuals and firms, Circular 230 sets

forth regulations and best practices applicable to all tax advisors. Circular 230 regulations are

limited to practice before the IRS and do not alter or supplant other ethical standards applicable

to practitioners.

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Office of Professional Responsibility

The mission of OPR is to interpret and apply the standards of practice for tax professionals in a

fair and equitable manner. OPR’s objective is to support effective tax administration by ensuring

all tax professionals and other third parties interacting with the tax administration system on

behalf of taxpayers adhere to the practice standards and ethics enumerated in Circular 230.

The Office of Professional Responsibility (OPR) is responsible for all matters related to

practitioner misconduct, discipline and practice before the Internal Revenue Service. The OPR

administers the law and regulations governing the practice of tax professionals and other

individuals who interact with the IRS on behalf of taxpayers. Tax practitioners include attorneys,

certified public accountants, enrolled agents, enrolled actuaries, enrolled retirement plan agents,

tax return preparers who represent clients before the IRS, and appraisers who provide valuations

contained in documents submitted to the IRS.

The role of the OPR is to evaluate a practitioner’s fitness to practice, and if a violation of

regulations is found, to propose and negotiate with the practitioner in an effort to gain consent

from the practitioner. If the OPR and the practitioner cannot agree on a sanction, the OPR refers

the case to an Administrative Law Judge for adjudication.

The Office of Professional Responsibility (OPR) announces recent disciplinary sanctions

involving attorneys, certified public accountants, enrolled agents, enrolled actuaries, enrolled

retirement plan agents, appraisers, and unenrolled/unlicensed return preparers,

Licensed or enrolled practitioners are subject to the regulations governing practice before the

Internal Revenue Service.247 The regulations prescribe the duties and restrictions relating to such

practice and prescribe the disciplinary sanctions for violating the regulations.

Annual Filing Season Program (AFSP)

The voluntary Annual Filing Season Program is intended to recognize and encourage unenrolled

tax return preparers who voluntarily increase their knowledge and improve their filing season

competency through continuing education (CE). An unenrolled or unlicensed tax preparer may

represent a tax client only if he successfully completes the AFSP course, has an active PTIN, and

consent to adhere to Circular 230 practice obligations.

247 Title 31, Subtitle A, Part 10

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How to Obtain an AFSP – Record of Completion

Successfully complete 18 hours of continuing education from IRS-Approved CE Providers,

including:

A six (6) hour Annual Federal Tax Refresher (AFTR) course that covers filing season

issues and tax law updates, as well as a knowledge-based comprehension test

administered at the end of the course by the CE Provider;

Ten (10) hours of other federal tax law topics; and

Two (2) hours of ethics.

Have an active preparer tax identification number (PTIN).

Consent to adhere to specific practice obligations outlined in Subpart B and section 10.51

of Treasury Department Circular No. 230.

Once an AFSP, Record of Completion is obtained the preparer can then represent a taxpayer if

he prepared the return. The AFSP holder can argue tax law; disagree with the IRS; represent the

taxpayer in an audit; request information regarding processing; provide missing information;

respond to math errors; and request notices and copies.

Record of Completion

After PTIN renewal season begins in October, a Record of Completion will be generated once all

requirements have been met, including renewal of the PTIN for the next year and consent to the

Circular 230 obligations. A PTIN that is not renewed for three consecutive years will be dropped

from the IRS PTIN database. Providers will no longer be able to enter CE credits for that

preparer.

The following are exempt return preparers who can obtain the AFTR – Record of Completion

without taking the AFTR course are:

Anyone who passed the Registered Tax Return Preparer test administered by the IRS

between November 2011 and January 2013

Established state-based return preparer program participants currently with testing

requirements: Return preparers who are active registrants of the Oregon Board of Tax

Practitioners, California Tax Education Council (CTEC), and/or Maryland State Board of

Individual Tax Preparers.

SEE Part I Test-Passers: Tax practitioners who have passed the Special Enrollment Exam

Part I within the past two years

VITA volunteers: Quality reviewers and instructors with active PTINs

Other accredited tax-focused credential-holders: The Accreditation Council for

Accountancy and Taxation’s Accredited Business Accountant/Advisor (ABA) and

Accredited Tax Preparer (ATP) programs

An exempt return preparer must also renew his or her preparer tax identification number (PTIN)

for the upcoming year and consent to adhere to the obligations in Circular 230, Subpart B

§10.517.

https://apps.irs.gov/app/scripts/exit.jsp?dest=https://ssl.kinsail.com/partners/irs/publicListing.asp

https://www.irs.gov/Tax-Professionals/PTIN-Requirements-for-Tax-Return-Preparers

https://www.irs.gov/pub/irs-pdf/pcir230.pdf

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The key difference between AFSP participants and PTIN holders with a checked box for “Third

Party Designee” is that an AFSP participant can discuss tax information, while the latter can only

request information regarding processing, provide missing information, respond to math errors

and request notices and copies. Checking the third-party designee box will not be enough to

allow a PTIN holder without AFSP to represent the taxpayer before the IRS.

Example: A taxpayer receives CP 2000 regarding an omitted Form 1099-B; the IRS

computes the tax on the sale amount without regard to the basis or the long-term

treatment, which should apply. The PTIN holder can provide the Form 1099-B to the IRS

but cannot argue for the lesser tax and the long-term treatment without being an AFSP

participant.

All participants in the program who receive an AFSP Record of Completion will be included in

the IRS public listing. In February 2015, the IRS launched a public listing on its website of all

attorneys, CPAs, enrolled agents, enrolled retirement plan agents and enrolled actuaries with a

valid PTIN, as well as all AFSP – Record of Completion holders. This will be a searchable,

sortable Directory of Federal Tax Return Preparers so that taxpayers can find a preparer that

carries his or her preferred credentials or qualification(s). http://irs.treasury.gov/rpo/rpo.jsf

The IRS has updated the Form Power of Attorney (POA) to include AFSP holders. When

completing Part II of the form enter “h” under the Designation. The Licensing jurisdiction is

“IRS.” Sign and date the POA and submit it to the IRS to receive client information and talk to

the IRS on behalf of their client.

UNLIMITED REPRESENTATION RIGHTS: Enrolled agents, certified public accountants,

and attorneys have unlimited representation rights before the IRS, this means they may represent

their clients on any matters including audits, payment/collection issues, and appeals.

Enrolled Agents (EA) – People with this credential are licensed by the IRS and specifically

trained in federal tax planning, preparation and representation. Enrolled agents hold the

most expansive license the IRS grants and must pass a suitability check, as well as a three-

part Special Enrollment Examination, a comprehensive exam that covers individual tax,

business tax and representation issues. An EA is required to complete 72 hours of

continuing education every 3 years. This must be done by obtaining a minimum of 16 hours

of continuing education (including 2 hours of ethics or professional conduct) each year. For

more information on enrolled agents, see Publication 4693-A, A Guide to the Enrolled

Agent Program.

Certified Public Accountants (CPA) are credentialed individuals (unlike Enrolled Agents)

licensed by state boards of accountancy, the District of Columbia, and U.S. territories, and

have passed the Uniform CPA Examination. They also must meet education, experience,

and good character requirements established by their boards of accountancy. In addition,

CPAs must comply with ethical requirements as well as complete specified levels of

continuing education in order to maintain an active CPA license. CPAs can offer a range of

services; some CPAs specialize in tax preparation and planning.

http://irs.treasury.gov/rpo/rpo.jsf

http://irs.treasury.gov/rpo/rpo.jsf

http://www.irs.gov/file_source/pub/irs-pdf/p4693a.pdf

http://www.irs.gov/file_source/pub/irs-pdf/p4693a.pdf

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Attorneys are individuals with credentials licensed by state courts or their designees, such

as the state bar. Generally, requirements include completion of a degree in law, passage of

an ethics and bar exam and on-going continuing education. Attorneys can offer a range of

services; some attorneys specialize in tax preparation and planning.

LIMITED REPRESENTATION RIGHTS: Preparers without any of the above credentials

have limited practice rights and may only represent clients whose returns they prepared and

signed only at the initial audit level. Under USC section 7701(a) (36), a tax return preparer is any

person who prepares for compensation, or employs others to prepare for compensation, all or a

substantial portion of any tax return or claim for refund under the IRC.

NOTE: Registered Tax Return Preparers (RTRP) – Certain preparers became RTRPs

under an IRS program that IRS is no longer able to enforce due to a District Court

injunction. RTRPs passed an IRS competency test based on Form 1040 tax preparation.

In April 2015, the Office of Professional Responsibility (OPR) issued Alert 2014-05 reminding

tax preparers that the Commissioner signed a delegation order that gives OPR the authority to

process referrals for misconduct by tax return preparers who engage in limited practice before

the IRS. OPR also has the authority to issue disciplinary actions in connection with the new

Annual Filing Season Program (AFSP).

Return Preparer Office Federal Tax Preparer Statistics as of April, 2020

The IRS mentioned that many PTIN holders, who completed their Annual Filing Season

Program Courses, did not complete their Record of Completion showing they met the

requirement to comply with Circular 230. Without the Record of Completion, the tax preparer

will not be able to represent clients even though they completed the course and the tax preparer’s

CE credits are in their PTIN account.

Data current as of 04/01/2020

Number of Individuals with Current Preparer Tax Identification Numbers

(PTINs) for 2020

768,015

Professional Credentials‡

Attorneys 28,568

Certified Public Accountants 208,921

Enrolled Actuaries 212

Enrolled Agents 56,867

Enrolled Retirement Plan Agents 630

Other Qualifications

Annual Filing Season Program

Records of Completion Issued 57,698

Cumulative number of individuals issued PTINs since 9/28/2010: 1,665,831

http://www.irs.gov/uac/IRS-Statement-on-Court-Ruling-Related-to-Return-Preparers

http://www.irs.gov/uac/IRS-Statement-on-Court-Ruling-Related-to-Return-Preparers

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§ 10.21 Knowledge of Client’s Omission

Example: A client comes for his 2019 tax appointment and brings a broker statement for

both 2018 and 2019. The preparer discusses the omission with the client. He says that he

opened the account in 2018 and noted he bought and sold some stock and had a gain on

the sales of $2,500.

The preparer advises the client to amend the 2018 return as soon as possible. After further

discussion, the client decides he would rather wait for the IRS to contact him and he does

not want to amend the prior year return.

The action taken in the above example is in accordance with §10.21 Knowledge of Client’s

Omission from Circular 230, it states that the preparer must advise the taxpayer immediately of

any error or omission discovered in a tax return. A discussion of the remedy, which in this case

would be amending the return and the interest and penalties that may occur should be completed

immediately. Amended returns are sometimes confusing to a taxpayer, it is important that the

taxpayer understands all income from all sources must be reported on a return and as a preparer

the best course of action is to amend the return.

It is the decision of the taxpayer how to proceed and not to amend this return. The preparer must

abide by that decision, even if he or she does not agree. Circular 230 does not require the

preparer to inform the IRS of the omission

NOTE: Although it is not required, if a taxpayer does not amend or correct an error or

omission, it is recommended that the preparer advises the client in a confidential writing

and notations be made in the file. In this example, it is the advice of the tax preparer that

the 2018 tax return be amended before completing the 2019 tax return. Notation should

be made that against the preparer’s advice the taxpayer did not amend the return.

Rules for Individuals Within A Firm

The rules under Circular 230 require that an individual who is subject to Circular 230 and has

principal authority for overseeing a firm’s federal tax practice must take reasonable steps to

ensure the firm have adequate procedures in place to comply with Circular 230. Section 10.36 of

Circular 230 requires both the existence and the implementation of adequate procedures. This

section deals with a firm’s responsibility for the actions of the tax practitioners while performing

services during employment.

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Section 10.36 is clear that there must be a responsible person or persons identified by the firm as

being responsible for compliance by members, associates, or employees. In the absence of a

responsible person or persons, the IRS has the explicit authority to identify the person

responsible.

Any individual who has principal authority for overseeing a firm’s tax practice is potentially

subject to discipline for the failure of others in the firm to comply with the procedures and

practices of the firm and ethical requirements of the law. Furthermore, it is the responsibility of

the principal authority to communicate the rules of compliance to all members of the firm.

Practitioner noncompliance is a common reason for the OPR to recommend sanctions. Failure to

file tax returns is a common form of noncompliance.

Firms as well as tax practitioners are required to follow “best practices” outlined in Circular 230.

It is important that the firm realize they must self-regulate, so the firm is protected from penalty.

Rules set by the firm, notifies the employee of their responsibility and will work to eliminate

miss communication of what is expected.

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What Do You Think?

Q1. Which of the following is not commonly considered part of “best practices”?

A. Communicating clearly with the client regarding the terms of the engagement

B. Verifying the information the taxpayer presents is correct

C. Advising the client regarding the importance of the conclusions reached.

D. Acting fairly and with integrity in practice before the IRS.

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A1: B is the correct answer.

Verifying the taxpayer information is not required of a tax preparer, the data and

amounts given to the tax preparer can be accepted without verification.

According to Circular 230 §10.33 Best Practices – tax preparers should provide clients with the

highest quality representation concerning Federal tax issues by adhering to best practices in

providing advice, as well as communicating clearly, establishing the relevant facts and advising

the taxpayer of the importance of the conclusions reached.

It is important that any questions asked of a tax preparer directly related to the tax return are

answered using current law and the best interest of the taxpayer. It is equally as important that

the preparer advise the client where additional information may be found, if applicable.

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Chapter Two – Due Diligence

Best Practices

According to Circular 230 §10.33, tax advisors should

provide clients with the highest quality representation

concerning federal tax issues by adhering to best practices in providing advice and in preparing

or assisting in the preparation of a submission to the IRS.

Communicating clearly with the client regarding the terms of the engagement

Establishing the facts, determining which facts are relevant, evaluating the

reasonableness of any assumptions or representations, relating the applicable law, to the

relevant facts, and arriving at a conclusion supported by the law and the facts.

Advising the client regarding the importance of the conclusions reached.

Acting fairly and with integrity in practice before the IRS.

Paid Preparer Due Diligence Requirement – Form 8867

For the following items Form 8867, Paid Preparer’s Earned Income Credit Checklist, or similar

document is required, along with computation of the credit form (if required), meeting the

knowledge requirement and retaining the necessary records.

Each failure to complete Form 8867 is a separate penalty. Form 8867 is required if any of the

following are included in the return in the following circumstances:

Head of Household filing status

Child Tax Credit

Advanced Child Tax Credit

Other Dependent Credit

Earned Income Credit

American Opportunity Tax Credit

The penalty for not including form 8867 is $520 per occurrence.

Example: Jack Jones is 42, he has one child Peter, age 18, who is attending a local college, and

Jack pays for his son’s college. He lived with Jack for the entire year. For tax year 2020, Jack

files Head of Household, he is eligible for to take the Other Dependent Credit. He also is

eligible for the American Opportunity Tax Credit.

In the example above, if the preparer did not include the Form 8867 the penalty would be $1,590

(3 X $530).

Objective: Define Due Diligence

Practical Applications of Due

Diligence

Rules regarding Form 8867

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There is no exact set of standards a tax preparer must apply in preparing a tax return. When a tax

return is completed and ready for submission to the IRS, the taxpayer and the preparer sign a

declaration. The declaration for the preparer includes the following “Declaration of preparer

(other than taxpayer) is based on all information of which preparer has any knowledge.248” This

statement is made under penalty of perjury that the return is, to the best of the knowledge and

belief, true, correct, and complete.

A fundamental portion of preparer regulations has to do with the concept of reliance by the

preparer. The general rule is that the preparer may rely in good faith and without verification

upon information furnished by the taxpayer. The preparer is not required to audit, examine, or

review books and records, business operations, documents, or other evidence to verify

information provided by the taxpayer; however, the preparer may not ignore the implications of

information furnished by the taxpayer. The preparer must make reasonable inquiries if the

information as furnished appears to be incorrect or incomplete.249

A definition of “due diligence250” for the purpose of tax preparation means the diligence or care

that a reasonable tax return preparer would use under the same circumstances. While court cases

relating to disciplinary or malpractice actions against preparers often refer to a preparer’s due

diligence, they do not appear to define the term in any manner that is unique to tax preparers. A

practitioner would have exercised due diligence if the practitioner used reasonable care in

evaluating another practitioner and the work product he or she supplied.

Requirement for Child Tax Credit

On federal returns in order for a child to be eligible for either, the $2,000 child tax credit or the

$500 other dependent credit they must have a Social Security Number.

This change was part of the Tax Cuts and Jobs Act that increased the child tax credit (for tax

years 2018 – 2025) to $2,000 for eligible children under 17 of which $1,400 may be refundable.

In addition, the earned income threshold will be $2,500 when calculating the refundable portion

of the child tax credit.

A $500 nonrefundable credit was also added for children who are age 17, 18, or for full time

students ages 19-24 and other eligible dependents.

Paid preparer due diligence requirement for Head of Household status

Beginning with 2018 federal returns the Tax Cuts and Jobs Act added a requirement that

preparer due diligence will apply to tax returns where the taxpayer uses the Head of Household

filing status.

248 IRS 2015 Form 1040 249 §6694 1(e)1 250 §10.22 Diligence as to Accuracy

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This means that additional questions were added to Form 8867 (Preparer’s Due Diligence

Checklist) to ensure that paid preparers are performing their due diligence in determining that the

taxpayer is eligible to file using the Head of Household filing status. A penalty of $530 will

apply if the IRS determines the tax preparer did not follow the due diligence requirement.

The tax return preparer must exercise due diligence to determine whether a taxpayer meets all of

the eligibility requirements to qualify for HOH filing status. Although line 14 of Form 8867 only

asks about substantiation that the taxpayer was unmarried (or considered unmarried) and

provided more than half of the cost of keeping up a home for the year for a qualifying person, the

taxpayer must meet all of the eligibility requirements for claiming HOH filing status. Your client

may not claim HOH filing status unless all of the eligibility requirements for HOH filing status

are satisfied, even if you answer “Yes” to the question on line 14. See the Tax Law section of

this syllabus for a discussion of Head of Household filing status.

Client Submissions

A practitioner can rely on an amount submitted by a client, but the practitioner cannot rely on the

client’s determination as a matter of law; or to allow the desire to help the client influence the

application of the law. The adherence to three key issues is important in the definition of “due

diligence”:

Discern all relevant facts (ask enough questions)

Know or research the law

Research the proper application of the facts to the law

Example: For tax year 2019, a client said they sold stocks resulting in capital gains of

$25,000. As the preparer, you requested the 2019 end of year statement to determine the tax

treatment of the capital gains. The client did not understand the reason to provide that

information since all the stock was purchased in 2018 and sold in 2019.

The preparer can accept the $25,000 amount without question, but the tax treatment of the stocks

must be determined by the preparer and explained to the taxpayer. Practitioners can rely on the

taxpayer for an amount, but cannot rely on the taxpayer for a matter of law. In this case, the

practitioner must determine that the stock was held for the correct period before determining the

tax.

Example: A taxpayer comes to the tax office when the preparer is unavailable; he has a

packet of documents, which he asks the receptionist to deliver. The receptionist asks the

taxpayer if she can make an appointment for him to come in for his tax interview. He

declines and says the packet of documents should be sufficient and to have the return

prepared with those documents.

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When the preparer reviews the documents, he notices the organizer is incomplete and he

did not have any interest or dividend statements in the package. The taxpayer had

reported those items in the previous year. The preparer contacts the taxpayer who

instructs him to prepare the return without that income. He fears he may owe tax and he

will amend the return later. After a discussion regarding reporting all income, the

taxpayer says he will make an appointment soon, but he would like to pick up his

documents.

According to Circular 230 §10.28, at the request of a client, a tax preparer must promptly return

any and all records of the client that are necessary for the client to comply with his or her Federal

tax obligations. The practitioner may retain copies of the records returned to a client.

Records of the client include:

All documents or written or electronic materials provided to the practitioner, or obtained

by the practitioner in the course of the practitioner’s representation of the client, that pre-

existed the retention of the practitioner by the client.

The documents include materials that were prepared by the client at any time and

provided to the practitioner for tax preparation.

Also included is any return, claim for refund, schedule, affidavit, appraisal or any other

document prepared by the practitioner, or his or her employee or agent, that was

presented to the client with respect to a prior representation if such document is necessary

for the taxpayer to comply with current Federal tax obligations.

Due Diligence Requirements for Paid Preparers who file Earned Income Tax Credit (EITC),

Child Tax Credit (CTC)/Additional Child Tax Credit (ACTC) or American Opportunity Tax

Credit (AOTC).

The Protecting Americans from Tax Hikes Act of 2015 (PATH) added the due diligence

requirements relating to the child tax credit and the AOTC, effective for tax years beginning after

2015.

The regulations implement changes made by the PATH Act that expand the application of the

due diligence penalty for paid preparers, who file EITC, CTC/ACTC or AOTC returns or claims

for refunds for clients. Preparers must meet four due diligence requirements251. Those who fail to

do so can be assessed a $530 penalty for each failure.

251 IRC §6695(g)

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1. Complete and Submit Form 8867

Complete Form 8867, Paid Preparer’s Due Diligence Checklist, for each EITC, CTC/ACTC,

AOTC claim or HOH filing status prepared. Meet the knowledge requirement by interviewing

the taxpayer, asking adequate questions, contemporaneously documenting the questions and the

taxpayers’ responses on the return or in your notes, reviewing adequate information to determine

if the taxpayer is eligible to claim the credit(s) and/or HOH filing status, and to determine the

amount(s) of the credit(s) claimed.

Complete the checklist-based compliance with due diligence requirements and

information provided by the client(s).

Submit the completed Form 8867 to the IRS with every electronic return prepared

claiming the EITC, the CTC/ACTC or the AOTC

Attach the completed Form 8867 to every paper return or claim for refund prepared for

the EITC, the CTC/ACTC or the AOTC and advise the client of the importance of

sending it with the return or claim for refund to the IRS.

2. Compute the Credits

Complete the appropriate refundable credit worksheets from the instructions for Form 1040

series or the Form 8863 instructions or complete alternative document(s) with the same

information. The worksheets show what to consider in the computation.

Keep the records supporting the computations or copies of each credit.

3. Knowledge

Under the third due diligence requirement, the signing tax return preparer must not know, or

have reason to know, that any information used in determining the taxpayers’ eligibility for, or

the amount of, the CTC, AOTC, or EITC is incorrect.

The tax return preparer may not ignore the implications of information furnished to, or

known by him or her. He or she must make reasonable inquiries if the information

furnished to him or her appears to be incorrect, inconsistent, or incomplete.

A tax return preparer must make reasonable inquiries if a reasonable and well-informed

tax return preparer knowledgeable in the law would conclude that the information

furnished to him or her appears to be incorrect, inconsistent, or incomplete.

The tax return preparer must also contemporaneously document in his files the reasonable

inquiries made and the responses to these inquiries.252

252 Reg. Sec. 1.6695-2(b)(3)

http://www.parkertaxpublishing.com/LinkDirector.aspx/C%5E~DataLocal~_Frequent~reg~HTML~6601_6696~380-4994398_6695~~0001-0002%5E%5E%5E1~~6695-2%5E%5E1~~6695-2(b)(3)

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4. Keep Records

Under the fourth due diligence requirement, the signing tax return preparer is required to retain: A. A copy of Form 8867.

B. The applicable worksheet(s) or the preparers own worksheet(s) for any credits claimed.

C. Copies of any taxpayer documents the preparer may have relied upon to determine

eligibility for the credit(s) and/or HOH filing status.

D. A record of how, when, and from whom the information used to prepare Form 8867 and

the applicable worksheet(s) was obtained.

E. A record of any additional questions asked regarding eligibility for the credit(s), the

amount of the credit(s), and/or eligibility for HOH filing status, and the taxpayers’

answers.

The materials referred to under the fourth due diligence requirement must be retained for three

years after June 30 following the date the return or claim for refund was presented to the

taxpayer for signature. These records may be retained on paper or electronically in the manner

prescribed in applicable regulations, revenue rulings, revenue procedures, or other appropriate

guidance.253

Preparers must include a Form 8867 with the initial filing of each return claiming one or more of

these credits. The IRS may send a letter to a preparer who is not meeting the due diligence

requirements when preparing EITC, AOTC or ACTC. Letter 4858 is sent to return preparers who

completed returns claiming one of these credits but who may not have met the required due

diligence requirements; and Letter 5364 to return preparers who completed two or more paper

returns claiming EITC, AOTC or ACTC without including Form 8867, Paid Preparer’s Due

Diligence Checklist.

The taxpayer must have a Social Security Number by the due date of his or her return (including

extensions). He or she cannot claim the EITC, CTC/ACTC or the AOTC on either an original or

an amended return, even if he or she later gets an SSN. If a dependent does not have an SSN by

the due date of the taxpayers’ return (including extensions), the taxpayer cannot count that child

as a qualifying child in figuring the EIC on either an original or an amended return, even if that

child later gets an SSN.

Questions on Form 8867

Form 8867 is for the tax preparer to complete to meet the due diligence requirements when

preparing any client’s return or claim for refund. As part of exercising due diligence, the preparer

must interview the client, ask adequate questions, and obtain appropriate and sufficient

information to determine the correct reporting of income, claiming of tax benefits (such as

deductions and credits), and compliance with the tax laws254.

253 Reg. Sec. 1.6695-2(b)(4)(ii)

254 §6695(g) and Regulation §1.6695-2(b).

http://www.parkertaxpublishing.com/LinkDirector.aspx/C%5E~DataLocal~_Frequent~reg~HTML~6601_6696~380-4994398_6695~~0001-0002%5E%5E%5E1~~6695-2%5E%5E1~~6695-2(b)(4)(ii)

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Form 8867 is for the tax preparer to verify the correct reporting of information, allowing your tax

software to fill in Form 8867 does not meet that requirement. The questions are designed to be

sure the preparer has asked the correct questions.

It is important that the Form 8867 columns for the credits are not completed unless the credit is

allowed. To meet due diligence the preparer must ask enough general questions to determine

whether the credits or filing status is allowed, as well as using tax knowledge.

NOTE: Question 15 on Form 8867. By checking the box and including this form in the clients

return, you are certifying that you have completed the form with all due diligence requirements.

The failure to exercise due diligence for the listed credits or head of household filing status is

$530 per item.

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Form 8867 – Due Diligence Checklist

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The Tax Cuts and Jobs Act added the due diligence requirement relating to the Head of

Household filing status, effective for tax years beginning after 2017.

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Fees

A practitioner’s fee must be reasonable in matters before the IRS. Contingent fees are only

allowed when the IRS is examining or challenging an original tax return; an amended return,

claim for a refund or credit where the amended return or claim was filed within 120 days of

taxpayer receipt of IRS examination notice. Contingent fees are also allowed for services to a

client in connection with the determination of interest or penalties assessed by the service and for

services provided with any judicial proceeding arising under the Internal Revenue Code.

According to Circular 230 §10.28 the existence of a dispute over fees generally does not relieve

the practitioner of his or her responsibility to return documents to the taxpayer. Nevertheless, if

applicable state law allows or permits the retention of a client’s records by a practitioner in the

case of a dispute over fees for services rendered, the practitioner need only return those records

that must be attached to the taxpayers’ current return. The practitioner, however, must provide

the client with reasonable access to review and copy any additional records belonging to the

client retained by the practitioner under state law that are necessary for the client to comply with

his or her Federal tax obligations.

NOTE: A tax organizer prepared by the preparer and completed by the client is considered material

prepared by the client; and must be returned to the client in a tax fee dispute.

Example: For many years Sue, an enrolled agent, has completed the joint tax return for

Mr. Gomez and Mrs. Gomez. They came to the office together, and told Sue they have not

lived together since May. They are not legally separated or divorced. They want to file as

Married Filing Separate. After a discussion with Mr. and Mrs. Gomez, Sue realized they

have some disagreements over their holdings. They are willing to waive any conflict of

interest, but Sue does not feel she can represent both of them to the best of her ability.

Mrs. Gomez decides to retain another preparer; Sue provides her with a copy of the prior

year return and completes the return with Mr. Gomez.

Conflict of Interest

According to Circular 230 §10.29 a conflict of interest exists if the representation of one client

will be directly adverse to another client (which in the circumstance above would be the case); or

The tax preparer could represent the taxpayer, if —

(1) The tax preparer reasonably believes that he or she will be able to provide competent

and diligent representation to each affected client,

(2) The representation is not prohibited by law; and

(3) Each affected client waives the conflict of interest and gives informed consent,

confirmed in writing by each affected client, at the time the existence of the conflict of

interest is known by the practitioner. The confirmation may be made within a reasonable

period after the informed consent, but no later than 30 days thereafter.

Copies of the written consents must be retained by the practitioner for at least 36 months from

the date of the conclusion of the representation of the affected clients, and the written consents

must be provided to any officer or employee of the Internal Revenue Service on request.

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Ethics

Example: A new client comes to Joe’s office to have his tax return prepared. After the

preparation of the return, the taxpayer tells Joe he has some stock he wants to sell in the

current year and wants to know about the tax he may have to pay. He anticipates a gain

of about $10,000. Joe had prepared his prior year return and correctly noted a $9,500

capital loss carryover. $3,000 of that loss was used on the return that was just prepared.

Joe explains to him that he can use this carryover loss to offset $6,500 of his gain and the

remainder would be taxed at 15% with his income. The taxpayer then tells Joe that he

would be willing to pay him for some advice on which stock he should buy and asks him

to do some research on three different stocks. Joe does not accept his offer and explains

that this kind of research is not directly related to the preparation of the tax return.

The clarification from the IRS, Circular 230 §10.3(f)(3) states that tax return preparers are

allowed to provide advice to a client that is reasonably necessary to prepare a document intended

to be submitted to the IRS. Preparation of a tax return, claim for refund, or other document sent

to the Internal Revenue Service for a current or future tax period would meet that qualification.

The taxpayer does not have to engage the preparer for the period in question, but the information

must be about a document intended to be submitted to the IRS. In the example above the advice

would not be related to a document intended to be submitted to the IRS.

NOTE: The IRS has released final regulations255that eliminate the overly complex covered

opinion rules in Circular 230 by replacing them with a new competence standard. Section 10.35

now requires practitioners to “possess the necessary competence to engage in practice before the

Internal Revenue Service” and states, “competent practice requires the appropriate level of

knowledge, skill, thoroughness, and preparation necessary for the matter for which the

practitioner is engaged.” The final rules also allow practitioners to remove the Circular 230

notices at the end of emails, which will make communications with clients less complex.

NOTE: According to the Office of Professional Responsibility the majority of sanctions

on preparers have been for failure to file their own tax returns

Circular 230 §10.50 and §10.51 state that incompetence and disreputable conduct for which a

practitioner may be sanctioned includes willfully not filing a Federal tax return and filing a

Federal income tax return in an untimely manner. This section pertains to tax preparers as well as

taxpayers. It is important that tax preparers understand and follow the tax rules as interpreted by

the IRS.

255 TD 9668 June 12, 2014

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Ethics

What Do You Think?

Q1. Form 8867 is required to be completed by the tax preparer when claiming

the following, except?

A. Head of Household Filing Status

B. Residential Energy Credit

C. Earned Income Credit

D. Other Dependent Credit

Q2. Which of the following is a true statement?

A. A taxpayer must not rely on a clients’ interpretation of tax law, but must

research the proper application of the law.

B. In accord with Circular 230 §10.28, a taxpayer must return to a client all

records necessary for the client to comply with his or her Federal tax

obligation.

C. The purpose of Form 8867 is that the tax preparer meets his or her due

diligence requirement.


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Ethics


Answer 1 - Correct answer is C

A1. Form 8867 is required to be completed by the tax preparer when claiming the

following, except?

A. Head of Household Filing Status

B. Residential Energy Credit

C. Earned Income Credit

D. Other Dependent Credit

Form 8867, Paid Preparer’s Due Diligence Checklist is prepared when the tax return

includes EITC, CTC/ACTC, AOTC claim or HOH filing status.

A2. Which of the following is a true statement? Answer 2- Correct answer is D

A. A taxpayer must not rely on a clients’ interpretation of tax law, but must

research the proper application of the law.

B. In accord with Circular 230 §10.28, a taxpayer must return to a client all

records necessary for the client to comply with his or her Federal tax

obligation.

C. The purpose of Form 8867 is that the tax preparer meets his or her due

diligence requirement.


Refer to pages 12 through 18 for a review of these items. Form 8867 is a

form that is used often. Take caution not to allow your software to answer

the questions. Be sure to ask the taxpayer the proper questions in your

interview or through an organizer.

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Ethics

Chapter Three – Disclosure, Document Protection and Rules

Internal Revenue Code §7216

On January 1, 2009, tax return preparers became

subject to many additional rules regarding the use

and disclosure of their clients’ tax return

information. These new rules and restrictions

create everyday problems by complicating a tax

preparer’s ability to use or disclose return

information.

These changes made it very difficult for any tax preparer to share tax return information with

anyone other than the IRS or state taxing authorities without obtaining a taxpayers’ consent.

Disclosure regulations under Internal Revenue Code §7216 became effective January 1, 2009.

The regulations give taxpayers greater control over their personal tax return information. The

statute limits tax return preparers’ use and disclosure of information obtained while preparing a

taxpayers’ return to activities directly related to the preparation. The regulations describe how

preparers, with the informed written consent of taxpayers, may use or disclose return information

for other purposes. The regulations also describe specific and limited exceptions that allow a

preparer to use or disclose return information without the consent of taxpayers.

The term “disclosure” in the context of tax return information casts a wide net, defined in

regulations as, “the act of making tax return information known to any person in any manner

whatsoever.”

The regulations authorize two types of disclosures:

• Certain permissible disclosures without client consent.

• Disclosures requiring client consent.

Consents to disclosure of a taxpayers’ tax return information – paper or electronic – must contain

certain specific information. Every consent form must include:

Tax preparer name and the taxpayers’ name

The nature and extent of the disclosure and the intended purpose

To whom the disclosures will be made

Details on the information being disclosed

The particular use authorized

The product or service for which the tax return information will be used.

Expansion of the definition of “return preparer”

Objective:

Identify when a consent for disclosure is

required.

Awareness that specific wording must be

included in a consent to use or disclose

form.

Recognize the importance of protecting

taxpayer data.

Adherence to the appropriate tax preparer

conduct

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Ethics

The new rules apply only to “return preparers.” Tax return preparers for this purpose are defined

as persons who participate in the preparation of tax returns for taxpayers. These include, but are

not limited to:

Return preparers who are in business or hold themselves out as preparers.

Casual preparers who are compensated for their services

E-file providers

Electronic return originators and electronic return transmitters

Intermediate service providers

Software developers

Reporting Agents

The definition of a “return preparer” also now extends to those who assist the tax preparer in

preparing returns, such as tax preparers’ employees who perform services in connection with the

preparation of a tax return, and those individuals outside the office who perform services in

connection with the preparation of return.

IRC § 7216 – Related to the Affordable Care Act

Internal Revenue Code § 7216 is a criminal provision enacted by the U.S. Congress in 1971 that,

except as provided in regulations, prohibits tax return preparers from knowingly or recklessly

disclosing tax return information or using tax return information for a purpose other than

preparing, or assisting in preparing, an income tax return. This provision applies to tax return

preparers who also offer services and education related to the Affordable Care Act. Violators are

subject to a $1,000 fine or a year in prison, or both.

The regulations under § 7216256, were issued as final regulations effective on Dec. 28, 2012.

In addition to criminal penalties, a civil penalty of $250 for each unauthorized disclosure or use

of tax return information by a tax return preparer may be imposed257. The total amount imposed

on any person shall not exceed $10,000 in any calendar year.

The IRS takes the privacy rights of America’s taxpayers very seriously and is committed to

protecting those rights. Section 7216 prohibits tax return preparers, including those who also

offer services and education related to the Affordable Care Act, from knowingly or recklessly

disclosing or using tax return information for unauthorized purposes.

The tax return information a tax return preparer can disclose or use depends on whether the

preparer obtains consent from the taxpayer, or whether Treas. Reg. § 301.7216-2 provides an

exception to the general prohibition on disclosure or use of tax return information without

taxpayer consent.

256 Treas. Reg. §§ 301.7216-1 to 301.7216-3 257 IRC §6713

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Ethics

The §7216 regulations permit tax return preparers to use a list of client names, addresses, email

addresses, phone numbers and each client’s income tax form number to provide clients general

educational information, including general educational information related to the Affordable

Care Act.

Example: A tax return preparer may mail general educational information regarding the

CA health care mandate.

Tax return preparers who use tax return information to solicit and facilitate health care

enrollment services must first obtain taxpayer consent to do so.

Example: Return Preparer Joe is also a health care “navigator” who would like to use

tax return information258, to solicit and facilitate enrollment of eligible clients into

qualified health plans available through the new health insurance marketplaces. Joe must

obtain taxpayer consent prior to using the tax return information in assisting taxpayers in

connection with the solicitation and facilitation of the enrollment of Joe’s eligible clients

into qualified health care plans. See Rev. Proc. 2013-14 (I.R.B. 2013-3, Jan.4, 2013 for

information regarding the qualification requirements for health care navigators, agents,

or brokers visit healthcare.gov.

Starting Jan.1, 2014, tax return preparers must use the mandatory language in Rev.

Proc. 2013-14. See Rev. Proc. 2013-19.

Revenue Procedure 2013-14259

This Rev. Proc supersedes and modifies the rules issued in 2008-35 (effective Jan 14, 2013) The

IRS has provided guidance to tax return preparers about the format and content of taxpayer

consents to disclose and consents to use tax return information and modified the mandatory

language required on each taxpayer consent. The guidelines apply to individuals filing a return in

the Form 1040 series. The revenue procedure also lists specific requirements for electronic

signatures when a taxpayer executes an electronic consent to the disclosure or consent to the use

of the taxpayers’ tax return information.

In the revenue procedure, the IRS says that some taxpayers have expressed confusion over

whether they must complete consent forms to engage a tax return preparer to perform tax return

preparation services. The modified mandatory language required in consent forms clarifies that a

taxpayer does not need to complete a consent form to engage a tax return preparer to perform

only tax return preparation services. One example in the revenue procedure provides that if a tax

return preparer makes provision of tax preparation services contingent on the taxpayers’ signing

a consent, the consent is not valid because it is not voluntary. However, a taxpayer must

complete a consent form as described in the revenue procedure to allow a tax return preparer to

disclose or use tax return information in providing services other than tax return preparation.

258 Treas. Reg. §301.7216-1(b)(3), 259 Appendix Rev Proc 2013-14

http://www.irs.gov/pub/irs-drop/rp-13-14.pdf

http://apps.irs.gov/app/scripts/exit.jsp?dest=http://www.healthcare.gov/news/factsheets/2011/07/exchanges07112011b.html

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Ethics

IRC §7216 prohibits a tax return preparer from “knowingly or recklessly” disclosing or using tax

return information. A violation could result in a preparer’s being charged with a criminal

misdemeanor, involving a maximum penalty of $1,000 or one year in prison, or both, plus costs

of prosecution.

Under the revenue procedure, each separate consent to disclosure or use of tax return information

must be contained on a separate written document (either paper or electronic). The separate

written document may be provided as an attachment to an engagement letter furnished to the

taxpayer.

The revenue procedure prescribes the required paper size and font size for consents on paper. For

electronic consents, the revenue procedures requires the consent to appear on its own screen,

prescribes the text size, and says there must be sufficient contrast between the text and

background colors.

The revenue procedure provides mandatory statements that must be included in a consent in

various circumstances, including:

1. Consent to disclose tax return information in a context other than tax return preparation

or auxiliary services;

2. Consent to disclose tax return information in the context of tax return preparation or

auxiliary services; and

3. Consent to use tax return information.

All consents must also contain the following statement:

If you believe your tax return information has been disclosed or used improperly in a

manner unauthorized by law or without your permission, you may contact the Treasury

Inspector General for Tax Administration (TIGTA) by telephone at 1-800-366-4484, or

by email at [email protected].

The revenue procedure also provides mandatory language to be included in any consent

to disclose tax return information to a tax return preparer located outside the United

States.

All consents must require the taxpayers’ affirmative consent to a tax return preparers’

disclosure or use of tax return information. An “opt-out” consent, which requires the

taxpayer to remove or deselect disclosures or uses that the taxpayer does not wish to be

made, is not permitted. For an electronic consent to be valid, it must be furnished in a

manner that ensures the taxpayers’ affirmative, knowing consent to each disclosure or

use.

All consents to disclose or use of tax return information must be signed by the taxpayer.

For consents on paper, the taxpayers’ consent to a disclosure or use must contain the

taxpayers’ handwritten signature. For electronic consents, a taxpayer must sign the

consent by any method prescribed in Rev. Proc. 2013-14.


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Ethics

A tax return preparer may not alter a consent form after the taxpayer has signed the document;

therefore, a tax return preparer cannot present a taxpayer with a consent form containing blank

spaces for completing the spaces after the taxpayer has signed the document.

Example: The tax preparer does not acquire a consent form from a taxpayer when a

draft of the taxpayers’ Schedule C is requested by the retirement administrator to

determine the amount of retirement contribution that can be contributed by the taxpayer.

In this case, the tax preparer did not meet any of the exceptions. Disclosure of tax return

information to a taxpayers’ retirement administrator does not fit within any of the exceptions

under the second revised Regulation (301.7216-2) to the requirement of prior written consent.

Accordingly, the taxpayer should have a signed consent form before the preparer made the

disclosure.

The following are the items listed in Reg. §301.7216-2 allowing a tax preparer to disclose tax

information without written consent:

A. Disclosure pursuant to other provisions of the Internal Revenue Code.

B. Disclosures to the IRS. NOTE: If doing a state return for the taxpayer, information may

be disclosed to a state taxing authority.

C. Disclosures or uses for preparation of a taxpayers’ return—

a) Updating Taxpayers’ Tax Return Preparation Software.

b) Tax return preparers located within the same firm in the United States.

Example: A taxpayer sent an email to his tax preparer, which read: “I’m in the process of

refinancing my home loan, and if the mortgage company calls, please provide them with

whatever they request”. The tax preparer prints the email and puts it in the client’s file. When

the mortgage lender calls a week, later the preparer gives the information the lender requests.

Again, the preparer did not meet the requirements of §7216 or Rev Proc. 2013-14. The preparer

should have sent the appropriate consent form to the taxpayer for signature. The preparer should

not provide any tax return information to the third party until the preparer received the signed

consent form from the taxpayer. A letter, email, or note is not sufficient.

Adequate data protection safeguards A tax return preparer located within the United States, including any U.S. territory or possession,

may disclose a taxpayers’ Social Security number to a tax return preparer located outside the

United States or any U.S. territory or possession with the taxpayers’ consent. Both the tax return

preparer located within the United States and the tax return preparer located outside the United

States must maintain an “adequate data protection safeguard”, at the time the taxpayers’ consent

is obtained and when making the disclosure.

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Ethics

The revenue procedure describes an “adequate data protection safeguard” as the following:

a) An implemented security program, which is explained to all employees and monitored by

management, and

b) A written policy put into practice and reviewed, and

c) It must include technical and physical safeguards to protect tax return information from

misuse, unauthorized access, or disclosure, and

d) It must follow and conform to one of the data security frameworks described in the

revenue procedure260.

Electronic signatures 1. For electronic consents, the tax return preparer must obtain the taxpayers’ signature on

the consent in one of the following ways:

a) Assign a personal identification number (PIN) that is at least five characters long

to the taxpayer.

b) Have the taxpayer type in the taxpayers’ name and then select “enter” to authorize

the consent. (The software must not automatically furnish the taxpayers’ name so

that the taxpayer only has to click a button to consent.)

c) Any other manner in which the taxpayer affirmatively enters five or more

characters unique to the taxpayer that the tax return preparer uses to verify the

taxpayers’ identity.

Document Rules261

The revenue procedure includes three examples showing the application of its rules.

A tax preparer cannot willfully sign a tax return or advise a taxpayer knowing that the

return, documentation, or other submitted papers lack a reasonable basis or if the tax

preparer should have known that the information lacks a reasonable basis.

The tax preparer cannot take an unreasonable position, or willfully attempt to understate

the tax liability or a recklessly disregard rules.

A tax preparer may not advise a client to take a frivolous tax position on any document,

affidavit or other submitted papers.

Example: The taxpayer is divorced and his child lives all year with his ex-wife. He instructs

his tax preparer to claim the child as his dependent because he pays child support.

This would be an unreasonable position and should be explained to the taxpayer. The tax

preparer should not take this position on the tax return because the child did not live with the

taxpayer during the year and there is no reasonable basis to take the child as a dependent.

260 IRS Publication 1075, Tax Information Security Guidelines for Federal, State and Local Agencies and Entities 261 IRC §6694

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Ethics

Any penalties that are likely to be applied must be communicated to the taxpayer by the tax

preparer if the tax preparer advised the taxpayer with respect to the position, prepared or signed

the tax return or any other document submitted to the IRS. The tax preparer can rely on

information provided by the taxpayer without verification, but the tax preparer may not ignore

implications of information furnished that appear to be incorrect or inconsistent with other

factual assumptions.

Example: Use the same facts as in the example above. Also, assume the taxpayer is not

satisfied with the answer and says he will do his own return, because the preparer will

not sign the return with an unreasonable position. The preparer tells the taxpayer that if

he knowingly claims a child that is not considered his dependent, the taxpayer will be

subject to penalty and his position will not be sustained.

A tax preparer advising a taxpayer to take a position on a tax return, document, affidavit or other

paper submitted to the Internal Revenue Service, or preparing or signing a tax return as a

preparer, generally may rely in good faith without verification upon information furnished by the

taxpayer. The tax preparer may not, however, ignore the implications of information furnished

to, or actually known by, the tax preparer, and must make reasonable inquiries if the information

as furnished appears to be incorrect, inconsistent with an important fact or another factual

assumption, or incomplete.

Penalties The new rules have criminal as well as civil penalties that may apply. Further, violations can be

sanctioned by restriction on a practitioner’s right to practice before the IRS.

A civil penalty is imposed under IRC §6713(a) for unauthorized disclosures or uses of

information furnished in connection with the preparation of an income tax return. The penalty for

violating IRC §6713 is $250 for each disclosure or use, not to exceed a total of $10,000 for a

calendar year. IRC §7216 imposes a criminal penalty on tax return preparers who knowingly or

recklessly make an unauthorized use or disclosure of tax return information provided to them in

connection with the preparation of an income tax return. A maximum $1,000 fine or

imprisonment of no more than one year, or both, may be imposed for each violation.

Federally Authorized Tax Practitioner-Client Privilege262

Generally, with respect to tax advice, the same common law protections of confidentiality apply.

The privilege which applies to a communication between a taxpayer and an attorney shall also

apply to a communication between a taxpayer and any federally authorized tax practitioner to the

extent the communication would be considered a privileged communication if it were between a

taxpayer and an attorney. The privilege may only be asserted in any noncriminal tax matter

before the Internal Revenue Service and any noncriminal tax proceeding in Federal Court

brought by or against the United States

262 IRC §7525

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Ethics

The term federally authorized tax practitioner means any individual who is authorized under

Federal law to practice before the Internal Revenue Service.263 The term tax advice means advice

given by an individual with respect to a matter, which is within the scope of the individual’s

authority to practice.

NOTE: Be cautious, this is an area where the IRS usually prevails; there is a difference between

tax preparation and tax advice. Items which are entered on a tax return and submitted to the IRS

cannot be considered privileged.

FBAR

A case heard by the United States Court of Federal Claims, Jarnagin v United States, Docket No.

15-1534-T, shows what can happen when an unsuspecting taxpayer fails to file FBAR forms.

Larry and Linda Jarnagin are a married couple. Larry owns and operates a farm and ranch in

British Columbia. He became a Canadian Citizen in 1989 and spends a significant part of each

year in the country. Because of his business there, Larry and Linda maintain bank accounts with

the Canadian bank CIBC, which had balances of $4 million on December 31, 2006, $3,500,000

in 2007, and $3,860,000 in 2008. Larry employed a Canadian accounting firm to handle all his

Canadian tax preparation.

Linda is a real estate broker and property owner in Oklahoma. She relied heavily on her

bookkeeper, Misty Fairchild. Every year, Fairchild would turn over the couple’s financial

statements, including the CIBC accounts and their balances to Mrs. Jarnagin’s CPA. Over time,

Ms. Fairchild went back to school to become an accountant, and eventually a CPA herself. Linda

eventually transferred her business to Fairchild and her brother Kyle Zybach, who was also a

licensed CPA.

However, neither Zybach nor Fairchild were aware of the Jarnagins’ FBAR reporting

requirements until 2010. Even though the Jarnagin’s financial statements had included the

foreign bank account, and their tax returns had disclosed the interest, no FBARs were ever filed.

In addition, Schedule B, which asks whether the taxpayer has control over foreign accounts was

incorrectly marked “No.”

In 2011, the IRS conducted an audit into the Jarnagins’ tax returns for 2008 and 2009. The IRS

issued non-willful FBAR penalties against both Larry and Linda for four years, a total of

$80,000.00.

The matter came before a federal judge to determine whether those penalties are appropriate.

Non-willful FBAR penalties may not be levied if the taxpayer properly reported the “amount of

the transaction or the balance of the account” and had “reasonable cause” for failing to file the

FBAR on time.

The Jarnagins argue that they did have reasonable cause: the advice (or lack thereof) of their

CPA.

263 USC §330

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Ethics

The Jarnagins say that by providing complete financial statements to licensed CPAs every year,

which included the CIBC account, and relying on those professionals to complete their tax

returns, they meet the requirements.

But, the government says a CPA’s advice is not automatically enough to raise a reasonable cause

defense. The IRS’s lawyers point to several facts to argue the Jarnagins were willfully negligent

in their tax reporting duties:

Zybach and Fairchild had no experience with foreign accounts

The Jarnagins didn’t inquire into their CPAs’ experience before hiring them

The Jarnagins didn’t specifically ask about FBAR reporting requirements or how the

international accounts would affect their tax returns

The Jarnagins did not carefully review the tax returns before signing them.

Taxpayers should be very careful in the delinquent filing of FBARs and the exceptions to

penalties for failing to timely file FBARs. The case creates doubt about the utility of the

reasonable cause exception to FBAR penalties. Taxpayers should get competent legal advice in

light of the new court ruling and should seriously explore voluntary disclosure options with

limited penalty exposure.

NOTE: FBAR filings are now due on the same date as Form 1040 (April 15th), if the return is

not filed there is an automatic extension until Oct. 15. When an extension is filed for Form

1040, the extension is also filed for Form 114.

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Ethics

What Do You Think?

Q1. Which of the following is a correct statement regarding a consent to disclose in Rev

Proc. 2013-14?

A. A tax return preparer makes provision of tax preparation services contingent

on the taxpayers’ signing a consent. The consent is not valid because it is not

voluntary.

B. A taxpayer must complete a consent form as described in the revenue

procedure to allow a tax return preparer to disclose or use tax return

information in providing services other than tax return preparation.

C. A taxpayer does not need to complete a consent form to engage a tax return

preparer to perform only tax return preparation services.

D. All of the above

Q2. Which of the following is a correct statement?

A. If the taxpayer insists, the tax preparer must sign the return even if the preparer has

reasonable knowledge that information supplied is incorrect.

B. If a taxpayer is self-employed, the tax preparer must audit the taxpayers’ books to

complete the tax return.

C. The tax preparer can rely on information provided by the taxpayer without verification.

D. The tax preparer does not have to advise a taxpayer of potential penalties on a position, if

the return is going to be filed with the IRS

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Ethics


A1: D All of the items are correct. In Rev Proc. 2013-14, the IRS says that some taxpayers have expressed confusion

over whether they must complete consent forms to engage a tax return preparer to perform tax

return preparation services.

The modified mandatory language required in consent forms clarifies that a taxpayer does

not need to complete a consent form to engage a tax return preparer to perform only tax

return preparation services.

The revenue procedure provides that if a tax return preparer makes provision of tax

preparation services contingent on the taxpayers’ signing a consent, the consent is not

valid because it is not voluntary.

A taxpayer must complete a consent form as described in the revenue procedure to allow a tax

return preparer to disclose or use tax return information in providing services other than tax

return preparation.

A2: C is the correct answer.

According to §6694, any penalties that are likely to be applied must be communicated to the

taxpayer by the tax preparer if the tax preparer advised the taxpayer with respect to the position,

prepared or signed the tax return or any other document submitted to the IRS. The tax preparer

can rely on information provided by the taxpayer without verification, but the tax preparer may

not ignore implications of information furnished that appear to be incorrect or inconsistent with

other factual assumptions.

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Ethics

Chapter Four – Sanctions for the Violation of Regulations

Circular 230 §10.50 Sanctions

Circular 230 §10.50 gives the OPR the authority to

censure (a public reprimand), suspend or disbar any

practitioner from practice before the IRS if he or she fail to comply with the conduct of

standards. Monetary penalties may also be assessed to individuals and/or firms who violate these

provisions.

Circular 230, Subchapter C §10.51- Incompetence and disreputable conduct.

The following is an overview of §10.51 Incompetence and disreputable conduct for which a

practitioner may be sanctioned includes but is not limited to —

Conviction of any criminal offense under the Federal tax laws.

Giving false or misleading information to the Department of the Treasury or any

officer or employee or facts or other matters contained in Federal tax returns,

financial statements and any other document or statement, written or oral, which

are included in the term “information.”

Failing to file a Federal tax return in violation of the Federal tax laws, or willfully

evading or attempting to evade any assessment or payment of any Federal tax.

Assisting, counseling, encouraging a client in violating, or suggesting to a client

or prospective client to violate, any Federal tax law; or knowingly counseling or

suggesting to a client or prospective client an illegal plan to evade Federal taxes

or payment.

Tax Law Case 10-243 – USA v. Mobley

Tax preparer Alice Mobley, paid $10 to $20 per person to a friend to gather social security

numbers to use fraudulently on tax returns. Those selling their information were paid $500 for

adult numbers and $600 for children’s numbers. Mobley’s Preyear Tax and Check Cashing in

Atmore, Mobley’s home, and other business locations were raided by federal agents on March 4,

2010. Investigators found complete identification information on 536 people, including Social

Security cards, Medicaid cards and other documents.

Mobley also “split” dependents, using the identity of some children on one return to obtain

Earned Income Credit, and on other returns to obtain Child Credit and Dependent Care Credits.

Mobley’s firm also prepared returns, which claimed business tax deductions for businesses,

which did not exist and farm tax deductions for clients who did not have farms.

Objective:

Recognize what constitutes

misconduct in a tax preparer

Understand the importance of being

an informed tax preparer.

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Accuracy Related Penalty

Many different circumstances can result in an accuracy related penalty for the taxpayer or for the

tax preparer. A common defense against the accuracy-related penalty is reliance on tax software

The IRS and court decisions have sustained accuracy related penalties where the taxpayer or

preparer relies on the software. Sixty-six percent of the time when the taxpayer or tax preparer

blamed software for inaccuracy, the penalty was sustained by the court. The court and the IRS

essentially followed the garbage-in and garbage-out philosophy. To blame the computer software

the taxpayer or preparer needs to show it was a software error and not the tax preparer or the

taxpayers’ failure to enter the information in the proper manner264.

Trade or Business Expenses Under IRC §162 and Related Sections

Internal Revenue Code §162 allows deductions for ordinary and necessary trade or business

expenses paid or incurred during the course of a taxable year. Rules regarding the practical

application of IRC §162 have largely come from case law. The IRS, the Department of the

Treasury, Congress, and the courts continue to provide guidance about whether a taxpayer is

entitled to claim certain deductions.265 In the following paragraphs, we show many court cases,

which demonstrate “ordinary” and “necessary” and some of the evolution of the term.

The majority of gross income cases this year involved taxpayers failing to report items of

income, including some specifically mentioned in IRC §61 such as wages, interest, dividends,

and annuities. Although “trade or business” is one of the most widely used terms in the IRC,

neither the Code nor the Treasury Regulations provide a definition. The definition of a “trade or

business” comes from common law, where the concepts have been developed and refined by the

courts. The Supreme Court has interpreted “trade or business” for purposes of IRC §162 to mean

an activity conducted with “continuity and regularity” and with the primary purpose of earning

income or making profit.266

IRC §162(a) requires a trade or business expense to be both “ordinary” and “necessary” in

relation to the taxpayers’ trade or business in order to be deductible.

Common law also requires that in addition to being ordinary and necessary, the amount of the

expense must be reasonable for the expense to be deductible.

The most prevalent issue was the substantiation of claimed trade or business expense deductions,

which appeared in 13 cases.

264 Brenda F Bartlett v. Commissioner TC Memo 2012-254 265 Taxpayer Advocate ARC 2012 266 Taxpayer Advocate ARC 2012

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For example: In Lyseng v. Commissioner267, the Tax Court denied several deductions for lack of

substantiation, including depreciation on a travel trailer, laundry services, vehicle permit costs,

and towing expenses. The taxpayer provided no evidence to substantiate the laundry, vehicle,

and towing expenses, and, therefore, the court disallowed the deductions. Concerning the

depreciation deduction, the taxpayer provided no evidence substantiating the trailer had a cost

basis — no bill of sale, canceled check, or third party corroborating testimony. The Tax Court

did find that the taxpayer substantiated the deductions for unreimbursed automobile expenses

and some union dues. The taxpayer kept a mileage record with the dates of travel and provided

credible testimony regarding the business purpose of each trip he took for his employer. A pay

stub from an employer, combined with credible taxpayer testimony, also convinced the court to

allow some of the union dues.

Even when the individual taxpayer maintains records to substantiate a deduction, he or she still

has to prove the expense is ordinary and necessary to a trade or business.

In Farias v. Commissioner268, the taxpayer was a teacher who claimed deductions for

unreimbursed employee expenses for the purchase of a specialty chair, an adjustable headrest, a

pillow, and ice/heat pads. The taxpayer claimed she purchased the items because she suffered a

back injury when she moved her classroom. The taxpayer also taught fitness classes and claimed

deductions for fitness items, including clothing. The IRS denied the deductions because the

purchases were not ordinary and necessary to her teaching position. The Tax Court also

disallowed the taxpayers’ deductions for fitness expenses because she failed to describe the items

purchased and to prove the clothing was ordinary and necessary in her trade or business. The

court further determined the clothing deduction was not allowable because the clothing was

suitable for general use

Kennedy v. Commissioner269 Shows the general rule that where business clothes are suitable for

general wear, a deduction for the clothes is not allowable. Refer to Donnelly v. Commissioner,270

in which such costs are not deductible even when it has been shown that the particular clothes

would not have been purchased but for the employment.

The tax preparer should assist the taxpayer in determining whether their business expenses are

ordinary and necessary under IRC § 162. The Internal Revenue Code defines business expenses

as the ordinary and necessary expenses of carrying on a trade or business. Generally, business

expenses are tax deductible. However, the IRS does not provide a compendium of general

business expenses, leaving it to the taxpayer to define from the criteria what is ordinary and

necessary. In fact, the terms ordinary and necessary were not defined in the original statute

establishing the Internal Revenue Code, leaving it to the tax courts to establish their meanings

through case law.

267 T.C. Memo. 2011-226. 268 T.C. Memo. 2011-248. 269 T.C. Memo. 1970-58, affd. 451F.2d 1023 (3d Cir. 1971) 270 262 F.2d 411 (2d Cir. 1959), affg. 28 T.C. 1278 (1957)

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In Welch v. Helvering, the court also stated that the term ordinary has some consistency but is

nonetheless a variable affected by time, place and circumstance” and does not mean it must be

habitual. There is not one standard that defines ordinary.

Example: A plumbing service ordered two cases of aftershave and new shirts for the 35

plumbers that worked for the service. Although the aftershave and shirts were not

required, the owner (and some customers) found it necessary. Since it was necessary it is

deductible.

In Deputy v. DuPont271 the Supreme Court defined ordinary as “normal, usual, or customary”,

reaffirming Welch V. Helvering by explaining, that though an expense happened but once in the

taxpayers’ lifetime, if the transaction giving rise to it is of “common or frequent occurrence in

the type of business involved”, it is ordinary.

To be deductible, a business expense must be both ordinary and necessary. An ordinary expense

is one that is common and accepted in that trade or business. A necessary expense is one that is

helpful and appropriate for that trade or business. An expense does not have to be indispensable

to be considered necessary.

From this definition and the tax court rulings, we can draw the following conclusions.

Both criteria, ordinary and necessary, need to be met for the expense to be deductible.

For an expenditure to be an ordinary expense, it must be a common or usual expense in

one’s business and an acceptable or customary expense for one’s business.

Example: If a plumber claims the purchase of window curtains as a deduction on his tax

return it would not be considered an ordinary and necessary expense.

However, if an interior decorator purchases window curtains, they may easily be a legitimate

business deduction. Their purchase would be both a common and an acceptable expenditure

in the conduct of their services.

271 Supreme Court 308 U.S. 488, 495 (1940),

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The term necessary for tax purposes has a wider definition than that found in common usage

today.

As the tax cases illustrated above, the expense does not have to be “absolutely necessary”

in the sense that it is “indispensable” to carrying on the business.

It only needs to be helpful to one’s business as well as appropriate for one’s business.

Example: Renting office space is certainly helpful to a tax preparer, providing a place for

the preparer to meet with clients and for employees to work. However, renting an office is

not necessary for a tax preparer to conduct his trade, since many sole proprietors, preparers

work out of their home, or provide their services at their clients’ homes or businesses. In

addition, an office is very appropriate for a tax preparer, providing a workplace for him and

his employees.

The best advice the tax preparer can give a taxpayer regarding “ordinary and necessary”

expenses is good record keeping. All taxpayers should have records and receipts. There are many

ways a business taxpayer can keep and substantiate his or her records. Any recordkeeping system

suited to his or her business that clearly shows the income and expense is acceptable. The books

must show the gross income, as well as deductions and credits. For most small businesses, the

business checkbook is the main source for entries in the business books.272

Damage Awards

The taxation of damage awards continues to generate litigation. Damage awards fall under IRC

§104(a) (2). This year, at least ten taxpayers challenged the inclusion of settlement proceeds or

arbitration awards in gross income, and the IRS won every case. The code specifies that damage

awards and settlement proceeds are taxable as gross income unless the award was received “on

account of personal physical injury or physical sickness.273” Congress added the “physical injury

or physical sickness” requirement in 1996; until then, the word “physical” did not appear in the

statute.

A court cannot consider damage awards for emotional distress to be excludible from income,

even if the emotional distress has resulted in “insomnia, headaches, or stomach disorders.” To

justify exclusion from income under IRC §104, the taxpayer must show that settlement proceeds

are in lieu of damages for physical injury or sickness.

Settlements and judgments are taxed according to the item for which the plaintiff was seeking

recovery (the “origin of the claim”). If the taxpayer is suing a competing business for lost profits,

a settlement will be lost profits, taxed as ordinary income. A taxpayer laid off from work and

sues for discrimination seeking wages and severance, the wages are taxed as any other wages.

272 IRS Publication 583 273 Pub. L. No. 104-188, § 1605(a), 110 Stat. 1755, 1838 (1996).

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If the taxpayer sues for damage to their condominium by a negligent building contractor, the

damages usually will not be income. Instead, the recovery will be treated as an expense to repair

the condominium and/or affect the basis of the condominium.

Legal Fees: If the taxpayer settles a suit for intentional infliction of emotional distress against a

neighbor for $100,000 and the lawyer fee is $40,000. The $100,000 would be taxable.

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What Do You Think?

Q1. Which of the following is not a true statement?

A. Trade or business is considered an activity that is conducted with

continuity and regularity with the primary purpose of earning income and

making a profit.

B. A damage award for emotional stress is excludable from income.

C. A business expense needs to be helpful and appropriate to the business.

D. In order to avoid accuracy penalties, a tax preparer must understand how

to correctly input data into their tax software.

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A1: B is the correct answer

The Supreme Court has interpreted “trade or business” for purpose of IRC §162

to mean an activity conducted with “continuity and regularity” with the primary

purpose of earning income or making a profit.

IRC §104(a) (2) specifies that damage awards and settlement proceeds are taxable in gross

income unless the award was received “on account of personal physical injury or physical

sickness”. A court cannot consider damage awards for emotional stress to be excludible from

income even if the plaintiff’s emotional stress resulted in “insomnia, headaches or some other

physical ailment”.

A business expense must be an ordinary and necessary expense to the business, although it does

not have to be a necessary expense in the sense that it is an indispensable expense in order to

carry out business. A business expense needs to be helpful and appropriate to one’s business.

The court and the IRS essentially follow the “garbage-in and garbage-out” philosophy. In order

to blame the computer software the taxpayer or tax preparer needs to show it was a software

error and not the failure of the tax payer or preparer to enter information in a proper manner.

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Ethics

Chapter Five – Identity Theft –Taxpayer First Act

HR 3151

The President signed into law the Taxpayer First Act, July 1, 2019, aimed at protecting taxpayers

from tax-related identity theft through several different measures. The Taxpayer First Act (TFA) (1) changes management and oversight of the IRS in order to improve customer service and the

process for assisting taxpayers with appeals; (2) restricts certain IRS enforcement activities,

including the use of private debt collectors in certain cases; and (3) modernizes departments

within the IRS.

Establishment of IRS Independent Office of Appeals

The Taxpayer First Act sets up an independent administrative appeals function at the IRS274.

This will ensure that generally all taxpayers are able to access the administrative review process,

allowing their cases to be heard by an independent decision maker. This independent

administrative appeal will have Congressional oversight and independence from the Office of

Chief Counsel.

TFA provides taxpayers access to the case against them. It would require the IRS to provide

certain individual and business taxpayers with their case files, if requested, no less than 10 days

prior to the start of any dispute resolution process.

Appeals employees will continue to work their cases. Although Appeals is not currently holding

in-person conferences with taxpayers, conferences may be held over the telephone or by

videoconference. Taxpayers are encouraged to promptly respond to any outstanding requests for

information for all cases in the Independent Office of Appeals

Comprehensive Customer Service Strategy

Within one year of enactment of TFA, the IRS is required to develop and submit to Congress a

comprehensive customer service strategy275. The strategy must address how the IRS intends to

assist taxpayers that is secure, designed to meet reasonable taxpayer expectations, and adopts

appropriate best practices of customer service provided in the private sector, including online

services, telephone call back services and training of employees providing customer services.

The IRS must also establish metrics and benchmarks for measuring the IRS success in

implementing this strategy.

Low-Income Exception for Offer in Compromise

The IRS is authorized to enter into an offer-in-compromise (OIC) agreement with a taxpayer to

settle a tax debt at a lower amount than what the taxpayer generally owes. Generally, when

274 IRC §7803 275 HR3151, Subtitle B

Objective:

Discussion of Taxpayers First Act

HR3151. Bill designed to deal with

the problems of identity theft.

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proposing an OIC to the IRS, the taxpayer must pay an application fee and provide an initial non-

refundable lump sum payment. The IRS has the authority to waive these payments. Typically,

the IRS does not require taxpayers certified as low-income, defined as those with incomes below

250 percent of the federal poverty level, to include the application fee and initial payment.

Relief from Joint Liability

In general, when married couples file joint tax returns, each spouse is jointly and severally liable

for the tax that should be reported on the return. However, under certain circumstances, the tax

code provides relief for certain innocent spouses from joint liability.

This provision clarifies the standard of review for such relief by the Tax Court shall take a fresh

look at the case without taking previous decisions into account. The review would be based on

the administrative record and any newly discovered or previously unavailable evidence. The

provision also clarifies the request for equitable relief for any portion of unpaid tax must be made

before the expiration of the 10-year collection period.276

Private Debt Collection

Congress directed the IRS to establish a program that refers certain inactive tax receivable

accounts to private collection agencies. The statute also specifies certain types of cases that are

not eligible for referral to private collection agencies; however, the IRS did not have a process in

place to exclude low-income individuals from being referred for private collection.

This provision creates two additional categories of cases not eligible for referral to private

collection agencies: (1) taxpayers whose income is substantially derived from supplemental

security income benefits or disability insurance benefit payments or (2) taxpayers with an

adjusted gross income of 200 percent of the applicable poverty level and below.

The provision also alters the definition of inactive tax receivables that can be assigned to private

debt collection agencies to those in which more than two years has passed since assessment of

the tax debt and limits installment agreements between the taxpayer and private debt collection

agencies to seven years.

Access to Tax Returns and Tax Return Information

Generally, returns and return information are confidential and cannot be disclosed unless

authorized by the Internal Revenue Code. TFA prohibits a person, other than an officer or

employee of the IRS, from examining books and records as part of an examination other than for

the sole purpose of serving as an expert. This provision also ensures that only IRS employees or

the Office of Chief Counsel are able to question a witness under oath.

Modernization of IRS Organizational Structure

The Restructuring and Reform Act of 1998 directed the IRS Commissioner to restructure the IRS

by eliminating or substantially modifying the three-tier geographic structure (national, regional,

276 IRC §6502

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and district) and replacing it with an organizational structure that features operating units serving

groups of taxpayers with similar needs.

This provision requires the Treasury Department to submit to Congress by Sept. 30, 2020, a

comprehensive written plan to redesign the organization of IRS.

TFA requires the plan to:

(a) Streamline the structure of the agency including minimizing the duplication of

services and responsibilities;

(b) Best position IRS to combat cybersecurity and other threats to IRS; and

(c) Address whether the Criminal Division of IRS should report directly to the

Commissioner.

Beginning one year after the date on which the plan is submitted to Congress, a requirement that

the IRS’s organizational structure feature operating units serving groups of taxpayers with

similar needs, will cease to apply.

VITA and Community Return Preparation Services

Through the Volunteer Income Tax Assistance (VITA) Program, the IRS partners with IRS-

certified volunteer organizations to provide free tax return filing assistance to low-income

populations, persons with disabilities, taxpayers with limited English proficiency and other

underserved communities.

TFA permanently authorizes the VITA program by matching grant program to support the

maintenance and expansion of VITA programs. Additionally, the provision allows the IRS to use

mass communications and other means to promote the benefits and encourage the use of the

program.

Low-Income Taxpayer Clinics

TFA will allow Treasury Department personnel to advise taxpayers of the availability of, and

eligibility requirements for receiving, advice and assistance from qualified low-income taxpayer

clinics that receive funding from the IRS, and to provide location and contact information for

such clinics.

Closure of Taxpayer Assistance Centers

The IRS is required to provide public notice, including by non-electronic means, to affected

taxpayers 90 days prior to the closure of a Taxpayer Assistance Center (TAC). The notice must

include information on alternative forms of assistance available for affected taxpayers and the

date of the proposed closure. The IRS also must notify Congress and provide the reasons for the

closure.

Whistleblower Reforms

Individuals who submit information leading to detection of underpayment of tax or to detection,

trial, and punishment of persons guilty of violating internal revenue laws, may file a claim for an

award.

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TFA allows the IRS to exchange information with whistleblowers where doing so would be

helpful to an investigation. It also requires IRS to notify whistleblowers of the status of their

claims at certain points in the review process and authorizes, but does not require, IRS to provide

status updates at other times upon written request of the whistleblower. To protect taxpayer

privacy, it would prohibit whistleblowers from disclosing public information they receive from

IRS under penalty of law. In addition, the provision amends the tax code to extend anti-

retaliation provisions to IRS whistleblowers similar to those that are provided to other

whistleblowers,

Customer Service Information

TFA instructs the IRS to provide the following information over the telephone, while taxpayers

are on hold with an IRS call center: information about common tax scams, direction to the

taxpayer on where and how to report such activity, and tips on how to protect against identity

theft and tax scams.

Tax Refund Deposits

TFA directs the IRS to establish procedures for taxpayers to report instances where they did not

receive an anticipated electronic fund transfer or a refund was erroneously delivered to the wrong

taxpayer and to ensure the IRS will recover the erroneous refunds and deliver them to the correct

taxpayer.

Cyber Security and Identity Protection

TFA approves recent efforts of the IRS, through the Security Summit, to foster a partnership

aimed at combatting identity theft tax refund fraud (IDTTRF) with public and private

stakeholders. Congress intends that these proactive efforts to protect taxpayers and combat

identity theft tax refund fraud to continue to be a priority of the IRS.

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Information Sharing

In 2016, the Security Summit, a partnership of the IRS, state tax agencies, and the private sector

tax industry to address tax refund fraud caused by identity theft, created an Identity Theft Tax

Refund Fraud Information Sharing and Analysis Center (ISAC). The ISAC enables the IRS and

the states to work together with external third parties to serve as an early warning system for tax

refund fraud, identity theft schemes, and cybersecurity issues.

TFA provides for the limited sharing of specified return information, such as IP address and the

speed at which the return was filed, with paid return preparers who are members of the ISAC.

The proposal also requires the Secretary of the Treasury to develop metrics for measuring the

success of the ISAC in detecting and preventing IDTTRF.

Identity Protection Personal Identification Numbers (IP PIN)

Currently, the IP PIN program fails to protect victims whose identities have been stolen but have

not yet had their tax account compromised. TFA requires the IRS to set up a program under

which any concerned taxpayer—regardless of state of residence—can request an IP PIN to use in

filing a return. The bill expands voluntary access to IP PINs nationwide over five years.

Single Point of Contact for Tax-Related Identity Theft Victims

TFA establishes a single point of contact within the IRS for any taxpayer who is a victim of

identity theft. The single point of contact will be responsible for tracking the taxpayer’s case to

completion and coordinating with other units to resolve the taxpayer’s issues as quickly as

possible. This provision is intended to address concerns over the lack of continuity of assistance

when taxpayers are victims of tax related identity theft.277

Notification of Suspected Identity Theft

Often identity theft and refund fraud victims may be unaware that their identity has been used

fraudulently or, when they are aware, may not be fully informed of the outcome of their case.

TFA requires the IRS to notify a taxpayer if there has been any suspected unauthorized use of a

taxpayer’s identity or that of the taxpayer’s dependents, if an investigation has been initiated and

its status, whether the investigation substantiated any unauthorized use of the taxpayer’s identity

and whether any action has been taken (such as a referral for prosecution). The unauthorized use

of the identity of an individual includes the unauthorized use of the individual’s identity to obtain

employment. Furthermore, when an individual is charged with a crime, the IRS must notify the

victim as soon as possible, giving such victims the ability to pursue civil action against the

perpetrators.

277

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Increased Penalty for Improper Disclosure or Use of Information by Return Preparers

TFA imposes an increased monetary penalty for the disclosure of taxpayer identity278

information by a return preparer in cases where such information is used in an identity theft

crime, whether or not related to the filing of a tax return. It is intended to provide a strong

incentive for tax preparers to secure client records, thereby decreasing the likelihood of those

records being stolen by identity theft criminals.

The civil penalty for the unauthorized disclosure or use of information by tax return preparers is

increased from $250 to $1,000 for cases in which the disclosure or use is made in connection

with a crime relating to the misappropriation of another person’s taxpayer identity. The calendar

year limitation is also increased from $10,000 to $50,000. The calendar year limitation is applied

separately with respect to disclosures or uses made in connection with taxpayer identity theft.

This provision also increases the criminal penalty for knowing or reckless conduct to $100,000

in the case of disclosures or uses in connection with taxpayer identity theft.

Internet Platform for Form 1099 Filings

The IRS is required to develop an internet portal that facilitates the filing of Forms 1099 with the

IRS by taxpayers. The internet portal is to be modeled after a Social Security Administration

(SSA) system that allows individuals to file Forms W-2 with SSA. The website will provide

taxpayers with access to resources and guidance provided by the IRS, and allow taxpayers to

prepare, file, and distribute Forms 1099, and create and maintain taxpayer records.

Electronic Filing of Returns

Currently, the IRS can only require individuals filing more than 250 returns to file them

electronically279. This is a different rule than the current rule under requiring tax return preparers

who reasonably expect to file more than 10 returns to file electronically.

TFA eventually would lower that 250-return threshold to 10 or more returns. This requirement

would be phased in between the years 2019 and 2021. For calendar years before 2021, the

threshold is 250 then drops to 100 in 2021 and to 10 for years after 2021.

In the case of a partnership, the applicable number is 200 in the case of calendar year 2018, 150

in the case of calendar year 2019, 100 in the case of calendar year 2020, then drops to 50 in

calendar year 2021.

TFA also authorizes the IRS to waive the requirement that a federal income tax return prepared

by a tax return preparer be filed electronically in cases where the tax return preparer applies for a

waiver. The preparer needs to and demonstrate the inability to file electronically is due to lack of

internet availability (other than dial-up or satellite service) in the geographic location in which

the return preparation business is operated.

278 IRC §6713 279 IRC §6011(e)(2)(A)

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Uniform Standards for the Use of Electronic Signatures

TFA requires the IRS to publish regulations and other guidelines that would allow for electronic

signatures to be used to request taxpayer return information for the purposes of disclosures to a

practitioner or to execute a power of attorney.

Payment of Taxes by Debit and Credit Cards

Currently, the IRS cannot accept credit and debit card payments for taxes directly due to a

restriction on the payment of fees charged by the card issuer. As a result, the IRS must use a

third-party processor to accept credit and debit card payments.

TFA allows the IRS to directly accept credit and debit card payments for taxes, provided that the

fee is paid by the taxpayer. The IRS is directed to seek to minimize these fees when entering into

contracts to process credit and debit cards.

Mandatory E-Filing by Exempt Organizations

Tax-exempt organizations that have assets of $10 million or more and that file at least 250

returns during a calendar year must electronically file their Form 990 information returns. Private

foundations and charitable trusts, regardless of asset size, that file at least 250 returns during a

calendar year are required to electronically file their Form 990-PF information returns.

Organizations that file Form 990-N also must electronically file.

TFA extends the requirement to file electronically to all tax-exempt organizations required to file

statements or returns in the Form 990 series or Form 8872, Political Organization Report of

Contributions and Expenditures. The provision also requires that the IRS make the information

provided on the forms available to the public as soon as practicable in a machine-readable

format.

Increased Penalty for Failure to File

TFA increased penalties on tax return preparers and taxpayers who fail to file tax returns280. This

penalty is imposed for the disclosure of taxpayer identity information by a return preparer in

cases where such information is used in an identity theft crime, whether or not related to the

filing of a tax return. TFA also increased the minimum penalty for failing to file a tax return to

the lesser of $330 (up from $205) (indexed for inflation) or 100 percent of the amount required

to be shown on the return for returns filed after December 31, 2019.

280 IRC §6713

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What Do You Think?

Q1. Which of the following was not established by the Taxpayer’s First Act?

A. Comprehensive Customer Service.

B. The Independent Office of Appeals.

C. Low income exception for Offer In Compromise.

D. The Tax Cuts and Jobs Act

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A1: D - The TCJA was established in 2017. Which of the following was not established by the Taxpayer’s First Act?

A. Comprehensive Customer Service.

B. The Independent Office of Appeals.

C. Low income exception for Offer In Compromise.

D. The Tax Cuts and Jobs Act

The following items are part of the Taxpayer First Act

Establishment of IRS Independent Office of Appeals

The Taxpayer First Act sets up an independent administrative appeals function at the IRS. This

will ensure that generally all taxpayers are able to access the administrative review process,

allowing their cases to be heard by an independent decision maker. This independent

administrative appeal will have Congressional oversight and independence from the Office of

Chief Counsel.

TFA provides taxpayers access to the case against them. It would require the IRS to provide

certain individual and business taxpayers with their case files, if requested, no less than 10 days

prior to the start of any dispute resolution process.

Comprehensive Customer Service Strategy

Within one year of enactment of TFA, the IRS is required to develop and submit to Congress a

comprehensive customer service strategy. The strategy must address how the IRS intends to

assist taxpayers that is secure, designed to meet reasonable taxpayer expectations, and adopts

appropriate best practices of customer service provided in the private sector, including online

services, telephone call back services and training of employees providing customer services.

The IRS must also establish metrics and benchmarks for measuring the IRS success in

implementing this strategy.

Low-Income Exception for Offer in Compromise

The IRS is authorized to enter into an offer-in-compromise (OIC) agreement with a taxpayer to

settle a tax debt at a lower amount than what the taxpayer generally owes. Generally, when

proposing an OIC to the IRS, the taxpayer must pay an application fee and provide an initial non-

refundable lump sum payment. The IRS has the authority to waive these payments. Typically,

the IRS does not require taxpayers certified as low-income, defined as those with incomes below

250 percent of the federal poverty level, to include the application fee and initial payment.

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1

California

2020

TaxEase, LLC


2020 CALIFORNIA TAX COURSE CTEC COURSE NUMBER - 3061-CE

California tax brackets, filing requirement thresholds, standard deductions, credits and other

items are indexed for inflation each year. California uses the inflation rate from July 1 through

June 30. This syllabus, completed prior to June 30, will be updated in July and sent to all

students who purchased this syllabus prior to the update.





2

California

Chapter 1 – CA Update

Covid 19 –

The Franchise Tax Board (FTB) announced updated special

tax relief for all California taxpayers due to the COVID-19 pandemic.

The FTB is postponing until July 15 the filing and payment deadlines for all individuals and

business entities for:

2019 tax returns

2019 tax return payments

2020 1st and 2nd quarter estimate payments

2020 LLC taxes and fees

2020 Non-wage withholding payments

2020 Real estate withholding payments are due when the real property is sold is not an additional

tax on the sale of real estate

“The COVID-19 pandemic is disrupting life for people and businesses statewide,” said State

Controller Betty T. Yee, who serves as chair of FTB. “We are further extending tax filing

deadlines for all Californians to July 15. Hopefully, this small measure of relief will help allow

people to focus on their health and safety during these challenging times.”

To give taxpayers a deadline consistent with that of the Internal Revenue Service (IRS) without

the federal dollar limitations, FTB is following the federal relief described in Notice 2020-17.

Since California conforms to the underlying code sections that grant tax postponements for

emergencies, FTB is extending the relief to all California taxpayers. Taxpayers do not need to

claim any special treatment or call FTB to qualify for this relief.

In line with Governor Newsom’s March 12 Executive Order7, FTB previously extended the due

dates for filing and payment last week for affected taxpayers until June 15, with the qualification

that the deadlines may be extended further if the IRS grants a longer relief period.

California’s conformity with Federal CARES Act

The FTB is currently analyzing and considering the impact of the Federal CARES Act on

California taxpayers. The following information has been released:

California generally conforms to the pension-related items such as early withdrawal penalty,

required minimum distribution rule changes, etc. However, California does not have automatic

conformity to the changes made with regard to loans from a qualified retirement account.

Objective

2019/2020 CA update, specifically

dealing with conformity to federal law

related to Covig-19.

Discuss and explain the new CA

Healthcare Mandate

3

California

Small Business Payment Plan for Sales and Use Tax

Effective April 2, 2020, small business taxpayers with less than $5 million in taxable annual

sales can take advantage of a 12-month, interest-free, payment plan for up to $50,000 of sales

and use tax liability only. All payment plans must be paid in full by July 31, 2021, to qualify for

zero interest. This relief only applies to sales and use tax liability.

Payment plan requests can be made through the online services system in the coming weeks.

California does not conform

California does not conform to some of the other changes made by the CARES Act including

those related to:

Loan forgiveness related to the Paycheck Protection program

NOL Carrybacks

Charitable contributions

Student loan forgiveness

Business interest limitations

Prior year alternative minimum tax liability (corporations)

Health-savings accounts changes (California does not conform to health-savings account

rules generally speaking)

The depreciation method for Qualified Improvement Property changed from 39-year

property to 15-years MACRS property. This change Qualified Improvement Property for

100-percent bonus depreciation for federal tax. California does not conform to the federal

treatment of bonus depreciation or the CARES Act changed related to QIP. For

California purposes, the useful like of QIP is generally 39 years.

CA excludes unemployment compensation, expanded unemployment compensation and paid

family leave from income.

Health Care Mandate

Effective January 1, 2020, a new state law requires California residents to maintain qualifying

health insurance throughout the year. The FTB has partnered with Covered California to ensure

the public is aware of the healthcare mandate. Covered California has already been running TV

and radio ads urging people to get coverage and take advantage of financial assistance. They also

have several other outreach efforts planned, including news releases, media interviews, social

media, etc. This requirement applies to each resident, his or her spouse or domestic partner, and

his or her dependents. The CA Healthcare Mandate is similar to Obama care.

https://www.cdtfa.ca.gov/news/20-07.htm

https://onlineservices.cdtfa.ca.gov/_/

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California

To reach uninsured individuals, Covered California will send letters to approximately 2.1 million

households beginning January 2, 2020. This letter let individuals know about the new state

Minimum Essential Coverage Individual Mandate and share that they can go to Covered

California to:

Shop for qualifying health insurance.

Get information about financial help to lower the cost of qualifying health insurance.

Get information about exemptions and the California Individual Shared Responsibility

Penalty for failure to have qualifying health insurance coverage or an exemption.

Individuals who fail to maintain qualifying health insurance will owe a penalty unless

they qualify for an exemption. Covered California and the Franchise Tax Board each

administer exemptions for qualifying individuals.

New penalty estimator The Franchise Tax Board has developed a new Individual Shared Responsibility Penalty

Estimator to help individuals estimate their penalty if they do not have qualifying health

insurance coverage or an exemption. The calculator is available at ftb.ca.gov/healthmandate.

For more information about the new health care law, exemptions, and financial assistance

available, go to CoveredCA.com.

Subsidies

Covered California will administer the subsidies. Taxpayers who obtain health insurance from

Covered California may qualify for state subsidies based on their projected annual income. They

will receive the subsidies in the form of reduced cost of monthly premiums, which will be

reconciled on their state tax returns. If a taxpayer’s employer is offering health coverage, they

may not be eligible for subsidies.

For the 2020 tax year, self-funded employers will need to report on the employees that had

health coverage throughout the year. The information must be furnished to employees by January

31, 2021 and filed with California’s Franchise Tax Board by March 31, 2021.

Another component of the mandate is the expansion of subsidies available to individuals and

families with incomes between 400% and 600% of the federal poverty level. Employers should

pay close attention to this as more individuals will now qualify for a Premium Tax Credit (PTC),

the trigger for letting the IRS know whether or not an organization is in compliance with the

ACA’s Employer Mandate.

Under the ACA’s Employer Mandate, Applicable Large Employers (ALEs) (organizations with

50 or more full-time employees and full-time equivalent employees) are required to offer

Minimum Essential Coverage (MEC) to at least 95% of their full-time workforce (and their

dependents). The coverage must meets Minimum Value (MV) and be Affordable for the

employee or be subject to Internal Revenue Code (IRC) Section 4980H penalties. The IRS is

issuing these penalties through Letter 226J.

5

California

Several other states including the District of Columbia, Massachusetts, New Jersey, Rhode

Island, and Vermont have also written into law statewide Individual Mandates. Many of them

also have penalties in place for employers and residents that fail to comply. You can read about

them here.

In addition to the statewide penalties, employers should know that the IRS is continuing to issue

penalty assessments to employers identified as having failed to comply with the ACA such as,

Letters 226J for the 2017 tax year. They are expected to begin penalty assessments for the 2018

tax year soon.

Organizations should elect to undergo an ACA Penalty Risk Assessment to learn their penalty

exposure and implement course-correction to avoid any future exposure

Penalties

California residents who do not have coverage for themselves and their dependents in 2020, and

who do not qualify for an exemption, will pay a penalty of $695/adult or more and

$347.50/minor, or 2.5% of their or gross income over the filing threshold for their filing status,

whichever is higher. The penalty for a married couple without coverage can be $1,390 and the

penalty for a family of four with two dependent children could be $2,085 or more. Draft tax

forms to reconcile the subsidies are due to be released by the FTB in June 2020.

A short gap coverage exemption will apply for taxpayers who did not have coverage for 3

consecutive months or less. (The federal short gap coverage exemption was for not having

coverage less than 3 consecutive months.)

The new state subsidies and the restoration of the individual mandate penalty are key reasons

why this year’s new plan selections are up 16 percent over last year compared to 114,306 for the

same time period a year ago. More than 486,000 individuals have been determined eligible for

the new state subsidy, including about 23,000 in the 400 to 600 percent range of the federal

poverty level, which could extend to an individual making up to $74,940 and family of four with

a household income of up to $154,500. Of those in this income range who have signed up

through Covered California, 44 percent have been found eligible for the state financial

assistance.

The increase in enrollment over last year is in stark contrast to what is being seen in the 38 states

served by the federally facilitated marketplace. The Centers for Medicare and Medicaid Services

report a drop of 4 percent from last year in those states.

California is the first state in the nation to offer subsidies to eligible middle-income consumers

who previously did not receive any financial assistance because they exceeded federal income

requirements.

On average, consumers between 200 and 400 percent of the federal poverty level will be

receiving $21 per household, per month on top of their federal tax credits. Consumers who earn

between 400 and 600 percent of the federal poverty level will be receiving an average of $460

per month, per household.

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California

In addition, California restored the individual mandate that was part of the Patient Protection and

Affordable Care Act from 2014 through 2018, meaning consumers who do not get covered could

face a penalty when they file their 2020 taxes in the spring of 2021.

For those facing a penalty, a family of four would pay at least $2,000, and potentially more, for

not having health insurance throughout 2020. Covered California is working with the Franchise

Tax Board, which will administer the penalty, to help alert Californians about the new law and

reduce the number of uninsured people in our state.

About Covered California

Covered California is the state’s health insurance marketplace, where Californians can find

affordable, high-quality insurance from top insurance companies. Covered California is the only

place where individuals who qualify can get financial assistance on a sliding scale to reduce

premium costs. Consumers can then compare health insurance plans and choose the plan that

works best for their health needs and budget. Depending on their income, some consumers may

qualify for the low-cost or no-cost Medi-Cal program.

Covered California is an independent part of the state government whose job is to make the

health insurance marketplace work for California’s consumers. It is overseen by a five-member

board appointed by the governor and the Legislature. For more information about Covered

California, please visit www.CoveredCA.com.

Extension for Filing Business/Personal Property Tax Statements

Governor Newsome signed an executive order281 on May 6, 2020, that:

Extends the May 7, 2020, deadline for deadline for filing business personal property tax

statements (Form 571-L) until May 31, 2020; and

Provides relief for some taxpayers who were unable to make their April 10, 2020,

property tax payments, by suspending penalties, costs, and interest for those late

payments until May 6, 2021.

Relief for the late April property tax payments is only available to taxpayers who

demonstrate they have experienced financial hardship due to the pandemic, for taxes paid

on:

o Residential real property occupied by the taxpayer; and

o Real property owned and operated by a small business.

The taxpayer must file a claim for relief (check with the local tax collector’s office for details).

Note: Relief is not available if the payments are made through an impound account

281

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California

What Do You Think?

Q1. CA conforms to which of the following?

A. Required Minimum Distributions

B. Charitable contributions

C. Student loan forgiveness

D. NOL Carrybacks

Q2. Effective January 1, 2020, a new state law requires California residents to maintain

qualifying health insurance throughout the year. Which of the following is correct?

A. The FTB has partnered with Covered California to ensure the public is aware of the

healthcare mandate.

B. Taxpayers may qualify for subsidies if they apply through Covered CA

C. The CA Health Mandate is similar to Obama care.

D. All of the above

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California

What Do You Think - Answers

A is the correct answer

A1. CA has conforms to which of the following?

A. Required Minimum Distributions

B. Charitable contributions

C. Student loan forgiveness

D. NOL Carrybacks

California does not conform to some of the other changes made by the CARES Act including

those related to:

Loan forgiveness related to the Paycheck Protection program

NOL Carrybacks

Charitable contributions

Student loan forgiveness

Business interest limitations

Prior year alternative minimum tax liability (corporations)

Health-savings accounts changes (California does not conform to health-savings account

rules generally speaking)

The depreciation method for Qualified Improvement Property changed from 39-year

property to 15-years MACRS property. This change Qualified Improvement Property for

100-percent bonus depreciation for federal tax. California does not conform to the federal

treatment of bonus depreciation or the CARES Act changed related to QIP. For

California purposes, the useful like of QIP is generally 39 years.

CA excludes unemployment compensation, expanded unemployment compensation and paid

family leave from income.

D is the correct answer

A2. Effective January 1, 2020, a new state law requires California residents to maintain

qualifying health insurance throughout the year. Which of the following is correct?

A. The FTB has partnered with Covered California to ensure the public is aware of the

healthcare mandate.

B. Taxpayers may qualify for subsidies if they apply through Covered CA

C. The CA Health Mandate is similar to Obama care.

D. All of the above

Effective January 1, 2020, a new state law requires California residents to maintain qualifying

health insurance throughout the year. The FTB has partnered with Covered California to ensure

the public is aware of the healthcare mandate. The CA Health Mandate is similar to Obama care.

9

California

Chapter 2 - Rates, Exemptions and Deductions

The Personal Income Tax Law (PITL) and the

Corporation Tax Law (CTL), in general, conform to the Internal Revenue Code (IRC); either, by

reference to federal law as of a “specified date” or by stand-alone language that mirrors the

federal provision. Currently, California law is conformed to the IRC as of January 1, 2015,

unless a specific provision provides otherwise.282 This specified date effectively freezes state law

and avoids unintended conformity. First, the Legislature must review the Federal changes and

modify the “specified date” before any Federal changes become effective. Before a bill is passed

changing the specified date and conforming to large parts of a Federal bill, they have the option

of passing a bill to conform to a specific provision within the Federal bill.

The CA Legislature has not passed a bill with respect to the “specified date” that would enact the

Tax Cuts and Jobs Act of 2017 (TCJA) for CA. TCJA has made significant changes to many

areas and CA has for the most part not conformed.

Who Must File? If the taxpayers’ gross income or adjusted gross income is more than the

amount shown in the chart below for the taxpayers’ filing status, age, and number of dependents,

then he or she has a filing requirement.

282 R&TC §§17024.5(d) and 23051.5

Objective: Discussion of filing

requirements, tax rates, and differences

from the federal regarding exemptions

and deductions.

https://www.ftb.ca.gov/individuals/FileRtn/7.shtml#1

https://www.ftb.ca.gov/individuals/FileRtn/7.shtml#2

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California

Filing Status

Age as of

December 31,

2019*

California Gross Income CA Adjusted Gross

Income

Dependents

0 1 2 or

more 0 1

2 or

more

Single or Head of

Household

Under 65 $18,241 $30,841 $40,291 $14,593 $27,193 $36,643

65 or older $24,341 $33,791 $41,351 $20,693 $30,143 $37,703

Married/RDP

filing jointly or

separately

Under 65 (both

spouses/RDPs)

$36,485 $49,085 $58,535 $29,190 $41,790 $51,240

65 or older (one

spouse)

$42,585 $52,035 $59,595 $35,290 $44,746 $52,300

65 or older

(both spouses/RDPs)

$48,685 $58,135 $68,695 $41,390 $50,840 $58,400

Qualifying

widow(er)

Under 65 N/A $30,841 $40,291 N/A $27,193 $36,643

65 or older N/A $33,791 $41,351 N/A 30,143 $37,703

Dependent of

another person

(Any filing status)

Under 65 More than the taxpayer’s standard deduction

65 or older More than the taxpayer’s standard deduction

* If the taxpayer turns 65 on January 1, 2019, he or she is considered to be age 65 at the end of

2019.

Dependents of any age and any filing status must file if California gross income or California

AGI is more than the standard deduction from the “California Standard Deduction Worksheet”

for dependents. In 2019, this amount is the greater of $1,100 or earned income not to exceed the

standard deduction.

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California

California Personal Income Tax

Personal income tax283 is levied by the Franchise Tax Board for the single largest California

revenue source. The personal income tax applies to both residents and nonresidents.

A resident is taxed on their entire income wherever derived; nonresidents and part-year

residents pay tax on California source income only. The personal income tax applies to

all sources of income unless specifically excluded. This source of income includes wages

and salaries, interest, dividends, business-related income and capital gains.

A nonresident must file if they have any California source income and income from all

sources is more than the amount for filing status in the chart above.

A part-year resident must file if the total CA income (income from all sources while a CA

resident and CA source income while a nonresident) is more than the amount for filing

status in the chart above.

Pension Source Tax Act of 1996. 284 This law specifically stipulates that, "No State may

impose an income tax on any retirement income of an individual who is not a resident or

domiciliary of such State." While the Source Tax law still allows individual states to

define residency on their own terms, it prohibits any state from taxing non-residents for

pensions earned within the state. If the taxpayer earns a pension in California, then retires

to Colorado, California may not tax his or her pension income.

Other Filing Situations

Taxpayers must file a CA return if they have a tax liability or owe:

Tax on lump-sum distribution

Tax on qualified retirement plan or IRA.

Tax on Children under age 19 or student under age 24 who have investment income

greater than $2,200.

Recapture taxes

Deferred tax on certain installment obligations

Tax on accumulated distribution of a trust.

NOTE: Even if a taxpayer does not have a filing requirement, he or she should file a return to get

refund of tax paid if any of the following applies:

Withholding from wages

Tax withheld on a California Real Estate sale

California estimated taxes paid.

283 R&TC §14071-§17061, Imposition of Tax 284 P.L.104-94, Jan. 10, 1996

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California

California personal income tax is based on Federal adjusted gross income. The Federal AGI is

the starting point; it consists of total income from all sources less exempt or excluded income,

plus certain Federal adjustments. The California Personal Income Tax Law conforms to the

Internal Revenue Code for taxable years beginning on or after January 1, 2015.285California does

not conform to all Federal regulations such as, a difference in tax rates, taxable income sources,

exemptions, deductions, tax credits. These differences are legislative and referred to as

conformity and nonconformity.

California Residency286

1. A resident is any individual that meets any of the following:

A. Present in California for other than a temporary or transitory purpose;

B. Domiciled in California, but outside California for a temporary or transitory

purpose.

2. A nonresident is any individual who is not a resident. Nonresidents must file if they have

California source income and meet the filing requirements.

3. A part-year resident is any individual who is a California resident for part of the year and

a nonresident for part of the year. Part-year residents must file if they have California

source income while a resident and/or acquires California source income while a

nonresident and meets the filing requirements.

Safe Harbor

Safe harbor is available for certain individuals leaving California under employment-related

contracts. The safe harbor provides that an individual domiciled in California who is outside

California under an employment-related contract for an uninterrupted period of at least 546

consecutive days will be considered a nonresident unless any of the following is met:

• The individual has intangible income exceeding $200,000 in any taxable year during

which the employment-related contract is in effect.

• The principal purpose of the absence from California is to avoid personal income tax.

The spouse/RDP of the individual covered by this safe harbor rule will also be considered a

nonresident while accompanying the individual outside California for at least 546 consecutive

days.

Return visits to California that do not exceed a total of 45 days during any taxable year covered

by the employment contract are considered temporary.

285 R&TC §17024.5 286 Form 540 Booklet, Personal Income Tax Booklet and Instructions

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California

Individuals not covered by the safe harbor determine their residency status based on facts and

circumstances. The determination of residency status cannot be solely based on an individual’s

occupation, business, or vocation. Instead, consider all activities to determine residency status.

For instance, students are residents of California if he or she leave the state to attend an out-of-

state school they do not automatically become nonresidents, nor do students who are

nonresidents of California coming to this state to attend a California school automatically

become residents.

Residency can be an important determining factor. In the court case California Franchise Tax

Board v. Hyatt, the Supreme Court in May 2019 overturned earlier decisions and decided in

favor of the FTB. The 26-year history of the case began as an audit procedure and evolved into a

constitutional issue.

Gilbert Hyatt, a tech inventor and entrepreneur, moved from California to Nevada in the early

1990s. Hyatt claimed he moved in September 1991, while California claimed he did not move

until April 1992. At stake was $7.2 million in patent royalties earned during that time. CA is a

high tax state. Nevada does not tax personal income.

Hyatt filed suit in a Nevada state court seeking damages for California’s alleged abusive audit

and investigation practices. A Nevada jury verdict awarded Hyatt over $400 million in damages

and fees. California appealed, arguing that the Constitution’s Full Faith and Credit Clause

required Nevada to limit the award to $50,000, the maximum that the state would permit in a

similar suit against its own agencies. The Nevada Supreme Court affirmed $1 million of the

award and ordered a retrial on another damages issue.

In the third ruling, the Supreme Court overruled a 41-year-old precedent in the case of Nevada v.

Hall. “The immediate practical implications of Hyatt’s holding that states are wholly immune

from suit in the courts of other states may open many residency cases.

Individual Tax Rates

The 2020 California marginal tax brackets have not been posted on the state’s website as of this

writing. California’s tax brackets are indexed for inflation each year, and this is based on the

observed rate of inflation from July 1 through June 30. Filing requirement thresholds, the

standard deduction, and certain credits are adjusted along with income tax brackets based on the

inflation rate. California’s tax rate for personal income tax of 12.3% with an additional 1%

Mental Health Tax is the highest state income tax in the nation.

TaxEase will publish an update as soon as the CA Individual Tax Rates are available.

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California

Progressive Tax: California personal income tax, like Federal personal income tax is a

progressive tax. The share of one’s income paid in taxes generally rises with income and the

average tax rate raises with income.

Mental Health Tax

The Mental Health Services Tax Rate287 is 1% for taxable income in excess of $1,000,000.

Effective January 2005 it applies to all filing status and without regard to credits. The funds

collected under the Mental Health Services Tax are transferred to the California Mental Health

Services Fund.

California imposes a surcharge of 1% on “a taxpayers’ taxable income in excess of $1

million”288

The additional tax:

o Is added after all taxes except withholding, estimated tax, and overpayment of

SDI;

o May not be reduced by tax credits, including the credit for taxes paid to another

state;

o Is in addition to alternative minimum tax;

o Must be included in estimated tax for purposes of the underpayment penalty; and

o Includes a marriage penalty.

The surcharge is imposed on, “a taxpayers’ taxable income in excess of $1 million.” In this case,

the Married Filing Joint couple is considered the taxpayer and pay the Mental Health Tax at $1

million. If the taxpayer and spouse filed separately, he or she would each start paying the Mental

Health Tax at $1 million. At 1%, that extra $1 million benefit can save the couple up to $10,000.

Example: Jack Jones and his wife Sally have an AGI $1,540,000 the amount of Mental

Health Services Tax on their joint return will be $5,400 or $540,000 x 1%. This amount

is reported on Line 62 of Form 540. In the same scenario, if Jack Jones and his wife file

Married Filing Separate and each of his or her AGI is $770,000, neither would owe

Mental Health Tax.

287 R&TC §17042 288 R&TC §17043

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California

Personal and Dependent Exemptions

California does not conform to the repeal of federal personal and dependent exemption

deductions. Instead of personal-exemption deductions, the PITL provides personal-exemption

tax credits. For, taxable year 2019, individual taxpayers are allowed personal-exemption tax

credits in the amounts shown below:

Exemption

Type Number of Exemptions

Exemption

Amount

Personal

Exemption

One exemption for themselves, and one for a

spouse, if married filing joint (MFJ - 118 x2) $244

Senior One additional exemption if 65 or older, and

one for a spouse 65 or older, if MFJ. $122

Blind One additional exemption if visually impaired

and one for a visually impaired spouse. $122

Dependent One exemption for each qualifying dependent. $378

The personal exemption tax credits are reduced when a taxpayers’ federal AGI exceeds a

threshold amount. For taxable year 2019, the exemption credits are reduced by $6 ($12 if

married filing joint) for each $2,500 ($1,250 if Married Filing Separately) of AGI or fraction

thereof, that exceeds the following threshold amounts:

Single or Married/RDP filing separate — $194,504

Married/RDP filing joint — $291,760

Head of Household — $389,013

Phase-out of exemption credits 2019289

Higher-income taxpayers’ exemption credits are reduced as follows:

Filing Status Reduce each Credit

by:

For Each Federal AGI exceeds

Single $6 $2,500 $200,534

Married/RDP filing

separately

$6 $1,250 $200,534

Head of Household $6 $2,500 $300,805

Married/RDP filing

jointly

$12 $2,500 $401,072

Qualifying widow(er) $12 $2,500 $401,072

289 R&TC §§17062, 17063

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California

When applying the phase-out amount, apply the $6/$12 amount to each exemption credit, but do

not reduce the credit below zero. If a personal exemption credit is less than the phase-out

amount, do not apply the excess against a dependent exemption credit.

Reduction in itemized deductions290 Itemized deductions must be reduced by the lesser of 6% of the excess of the taxpayers’ Federal

AGI over the threshold amount or 80% of the amount of itemized deductions otherwise allowed

for the taxable year.

Filing Status AGI Threshold 2019

Single or married/RDP filing separately $200,534

Head of Household $300,805

Married/RDP filing jointly or Qualifying Widow(er) $401,072

TCJA eliminated the phase-out of itemized deductions. California continues to phase-out

itemized deductions using 6% of Federal AGI. Generally, a taxpayers’ itemized deductions are

reduced by the lesser of:

6% of the excess AGI over the threshold amount; or

80% of the itemized deductions otherwise allowable

Depreciation differences create basis differences. California never conformed to the enhanced

IRC §179 deduction, but continues to have a maximum of $25,000 and $200,000 placed-in-

service threshold.291

California has never conformed to:

The ability to revoke the IRC §179 election; or

The ability to elect IRC §179 for off-the-shelf computer software292.

The expansion of the deduction to include portable heating and air conditioning units

under §179293.

California also does not conform to bonus depreciation, 15-year depreciation on qualified

leasehold improvement property, qualified restaurant property, or qualified retail improvement

property (which must be depreciated over 39 years).

290 R&TC §17077 291 R&TC §§17255, 24356 292 R&TC §§17255, 24356(b)(6) 293 R&TC §§17024.5(a), 23051

17

California

Other depreciation nonconformity

Seven-year depreciation for motorsports entertainment complexes;

Business property on an Indian reservation;

Advanced mine safety equipment; and

Expensing provisions for U.S. film and television production.

Special bonus depreciation for luxury autos.

Special treatment for leasehold improvement property and qualified restaurant property.

Expensing of energy efficient improvement to commercial buildings.

Treating certain farm business machinery as five-year property

Federal film and television cost expensing.

These depreciation differences have created a basis difference. Continuing depreciation will

differ because California does not conform to most of the enhanced bonus depreciation,

therefore, it is important to use the increased basis for computing California depreciation.

Business Income or Loss

Adjustments are generally necessary to Federal business income or loss reported on the Federal

return because of the difference between California and Federal law relating to depreciation

methods, special credits, and accelerated write-offs. As a result, the recovery period or basis used

to calculate California depreciation might be different from the amount used for Federal

purposes.

Nonresident business income. Gross income from the entire business, trade, or profession is

included in the nonresident’s adjusted gross income from all sources. If a nonresident owns a

business, trade, or profession carried on within California that is an integral part of a unitary

business carried on both within and outside of California, the amount of such income having its

source in California is determined by an apportionment formula. Key Fact

Adjustments to Basis or Business Deductions

California provides special credits and accelerated write-offs that effect the California basis of

qualifying assets.

18

California

Basis adjustments related to any of the following items:

• Property acquired prior to becoming a California resident.

• Sales or use tax credit for property used in an EZ, Local Agency Military Base

• Recovery Area (LAMBRA), Targeted Tax Area (TTA), or former LARZ.

• Amortization of pollution control facilities.

• Discharge of real property business indebtedness.

• Vehicles used in an employer-sponsored ridesharing program.

• An enhanced oil recovery system.

• Joint Strike Fighter property costs.

• The cost of making a business accessible to disabled individuals.

• Property for which a taxpayer received an energy conservation subsidy from a public

utility on or after January 1, 1995, and before January 1, 1997.

• Research and experimental expenditures.

• Business expense deductions related to any of the following items:

• Wages paid in an EZ, LAMBRA, Manufacturing Enhancement Area (MEA), or TTA.

• Certain employer costs for employees who are also enrolled members of Indian tribes.

• Business located in an EZ, LAMBRA, or TTA.

19

California

What Do You Think?

Q1. Which of the following is a correct statement regarding CA basis differences

from the Federal

A. California never conformed to the enhanced IRC §179 deduction, but

continues to have a maximum of $25,000 and $200,000 placed-in-

service threshold

B. California does not conform to bonus depreciation, bonus depreciation

in 2019 on the Federal return is 100%

C. CA has not conformed to the ability to elect IRC §179 for off-the-shelf computer

software.

D. All of the above are differences, which will effect basis.

20

California


D is the correct answer -

A1. Which of the following is a correct statement regarding CA basis differences

from the Federal

A. California never conformed to the enhanced IRC §179 deduction, but

continues to have a maximum of $25,000 and $200,000 placed-in-service threshold

B. California does not conform to bonus depreciation, bonus depreciation in 2019 on the

Federal return is 100%

C. CA has not conformed to the ability to elect IRC §179 for off-the-shelf computer

software.

D. All of the above are differences, which will effect basis.

CA starts with federal adjusted gross income, which will include the differences above. Use CA

Form CA to make the addition adjustments to CA for Schedule C, E or F.

21

California

Chapter 3 – California Conformity and Nonconformity

Common Income Adjustments for California

Active duty military pay Capital Gains

Sick pay Social Security benefits

Foreign income Railroad Retirement Benefits

CA Qualified Stock Options (COSO) Business/Farm/Rental Income

(if depreciation differences exist)

In-Home Supportive Services (IHSS) payments Gambling winnings

Native American Income State Income Tax Refund

Employer Contributions to an HSA Basis Adjustments for other gains

and losses

Capital Gains

Interest Reminder

Federal law requires interest earned on federal bonds (U.S. bonds and obligations) to be included

in gross income. CA does not include that interest in income. Federal law does not tax interest

from state and local bonds. CA does tax the interest from Non-California state and local bonds.

Both of these differences go on Line 2 of Schedule CA.

50-Percent Rule

Certain mutual funds pay “exempt-interest dividends.” If the mutual fund has at least 50% of its

assets invested in tax-exempt U.S. obligations and/or in California or its municipal obligations,

that amount of dividend is exempt from California tax. The proportion of dividends that are

tax-exempt will be shown on his or her annual statement or statement issued with Form 1099-

DIV, Dividends and Distributions. This is another Line 2, Schedule CA adjustment.

Retirement Plans

California automatically conformed to employees whose retirement plans terminate or who

separate from employment while they have outstanding plan loans that could contribute to the

loan balance to an IRA by the due date for filing their tax return, including extensions for that

year in order to avoid the loan being taxed as a distribution. Recharacterization cannot be used to

unwind a Roth conversion.294

294 R&TC §17501(b)

Objective:

List and explain items adjustments

between the federal return and CA.

Discuss AB91 and significant

changes.

22

California

Schedule C, Schedule E and Schedule F

Adjustments to federal businesses, rental property and farm income or loss reported in column A

generally are necessary because of the difference between California and federal law relating to

depreciation methods, special credits, and accelerated write-offs. As a result, the recovery period

or basis used to figure California depreciation may be different from the amount used for federal

purposes.

Adjustments are figured on form FTB 3885A, Depreciation and Amortization Adjustments, and

are most commonly necessary because of the following:

High federal limits on IRC §179 deductions,

100% Bonus Depreciation allowed under TCJA

Limitations of items on the Federal return

Differences in passive activities is the same as federal law concerning Passive Activity Loss

(PAL) limitations. However, special treatment for Real Estate Professionals and in the basis of

the passive activity may cause differences in passive activities. Form 3801, Passive Activity Loss

Limitations is used to report the differences.

Schedule E differences from a flow-through entity between Federal and CA also will cause an

adjustment on Schedule CA. Those differences will be computed and reported on the flow-

through entity.

AB91

This act is to be known as the “Loophole Closure and Small Business and Working Families Tax

Relief Act of 2019.”

AB91 expanded the state’s Earned Income Tax Credit (EITC) in modified federal conformity.

For the period January 1, 2019 to December 31, 2019, it sets the amount of the EITC. After

January 1, 2020, and until the state’s minimum wage hits $15 per hour, there are revised

calculation factors to be recomputed annually for eligible individuals.295

AB91 also allows a Refundable Young Child Tax Credit296 effective January 2, 2019 for

$1,176 times the earned income tax credit adjustment factor, capped at $1,000 for each qualified

taxpayer each tax year. It also states a public purpose and requires annual reporting by the FTB

and it allows FTB to adopt permanent regulations under emergency authority.

295 §1, R&TC §17052 296 §3, R&TC §17052.1

23

California

For taxable years beginning on or after January 1, 2019, the refundable Young Child Tax Credit

(YCTC) is available to taxpayers who also qualify for the California Earned Income Tax Credit

(EITC) and who have at least one qualifying child who is younger than six years old as of the

last day of the taxable year. The maximum amount of credit allowable for a qualified taxpayer is

$1,000. The credit amount phases out as earned income exceeds the "threshold amount" of

$25,000, and completely phases out at $30,000.

To qualify for the YCTC, the taxpayer must meet all of the following:

Have been allowed the California EITC on Form 3514.

Have at least one qualifying child for the California EITC.

The qualifying child is younger than six years old as of the last day of the taxable year.

Caution: If you do not meet all of the above requirements, you cannot take this credit.

If you meet all of the above requirements, complete Part VII, Young Child Tax Credit. If you are

a nonresident or part-year resident, also complete Part VIII, Nonresident or Part-Year Resident

Young Child Tax Credit.

Note: If the qualifying child is younger than six years old as of the last day of the taxable year,

list that child’s information under Part III, Qualifying Child Information, Child 1, Child 2 or

Child 3 column.

AB 91 amends the ABLE Act to exclude income distributions used for qualified disability

expenses by a beneficiary and conforms to changes relating to ABLE accounts made by the 2016

Act. It also allows Section 529 accounts to roll over to ABLE accounts.297

The bill excludes from an individual’s gross income the amount of student loan indebtedness

discharged after December 31, 2011 due to death or disability of a student.298

The bill also conforms to the federal TCJA to disallow or limit the amount that specified

taxpayers may deduct for the premiums paid for an assessment by the FDIC depending on

amount of total consolidated assets of the taxpayer.299

Effective January 1, 2019, the bill disallows net operating loss (NOL) carrybacks.[21]

AB91 conforms to the federal TCJA to allow a small business to use the cash method of

accounting if its average annual gross receipts for the 3 taxable years do not exceed $25 million.

Previously, California law previously allowed a small business to use the cash method of

accounting if its average annual gross receipts for the 3 taxable years do not exceed $5 million,

effective January 1, 2019 and taxpayers can elect to have conformity apply to tax years after

January 1, 2018300 and AB91 conforms to suspense allowances.

297 §3, R&TC §§ 17140, 17140.4 23711.4 298 R&TC §17144.8 299 R&TC §24343 300 R&TC §§17560.5, 24654

24

California

The AB91 bill conforms effective January 1, 2019 to the TCJA that exempts a taxpayer with

average annual gross receipts for the 3 taxable years ending with the prior taxable year of $25

million or less; from provisions that preclude the deduction of certain direct and indirect costs,

and determine whether those property costs are inventory costs or are capitalized (California law

provides a limit of $10 million). Taxpayers can elect to have conformity apply to tax years after

January 1, 2018.

In modified conformity to federal law effective January 1, 2019 (and with no sunset date), excess

business losses of a noncorporate taxpayer are not allowed as a deduction and instead those

losses must be carried forward and treated as a net operating loss in future taxable years.


California does not conform, under the PITL, to the new federal deduction for qualified business

income (QBI) of pass-through entities under IRC §199A, CA does conform to the definitions

below referenced in TCJA.

California conforms, under the PITL, to the definition of AGI, as of the specified date of January

1, 2015, with modifications, but does not conform to the federal change that does not allow the

deduction for qualified business income of pass-through entities in the computation of adjusted

gross income.

California conforms, under the PITL, to the definition of taxable income, as of the specified date

of January 1, 2015, with modifications. However, does not conform to the federal change that

excludes the deduction for qualified business income of pass-through entities from the definition

of itemized deductions, and allows the deduction in addition to the standard deduction in

determining taxable income.

California conforms, under the PITL and the CTL, to the tax treatment of S corporations and

their shareholders and the treatment of partners and partnerships, as of the specified date of

January 1, 2015, with modifications. California automatically conforms to federal law regarding

S corporation elections, revocations, and terminations and Partnerships.

California does not conform, under the PITL, to the new federal deduction for qualified business

income of pass-through entities under IRC §199A.301

Keep in mind: CA taxes start with Federal AGI, and the QBI deduction is a below the line

deduction. A taxpayer with QBI deduction does not need an adjustment on the CA return.

301 R&TC §§ 17072, 17073, 17073.5, 17087.5, 17851, 19164, and 23800-23813

25

California

Alimony

Alimony and separate maintenance payments are deductible by the payer spouse and includible

in income by the recipient spouse has been repealed under TCJA. CA does not conform to the

repeal of alimony deduction or inclusion.302 Either Line 11 or Line 31 of Schedule CA is used for

the CA income or deduction.

Moving Expense and Exclusion

TCJA repeals the exclusion from gross income and wages for qualified moving expense

reimbursements. The deduction for moving expenses is also repealed in TCJA. The exception to

this is in the case of a member of the Armed Forces of the United States on active duty who

moves pursuant to a military

order. CA has not

conformed to this

provision.303 Moving

expenses are allowed as an

adjustment to income.

Standard Deduction

California does not conform

to the federal standard

deduction, but instead has

stand-alone law allowing a

California standard

deduction in lieu of the

federal standard

deduction304. Amounts are

adjusted annually for

inflation based on the

California Consumer Price

Index. The taxpayer may

take the larger of the

standard deduction or

itemized deductions. (See

Chart)

302 R&TC §17071 303 R&TC §§17131, 17201 304 R&TC §17073.5

26

California

Itemized Deductions

Taxpayers who could not itemize deductions on the federal are allowed to file a Schedule A for

California. Filing a Schedule A for California may be necessary due to the increased federal

standard deduction. Some of the criteria for parts of Schedule A are based on Federal AGI, even

if Schedule A was not included in the Federal return.

Medical Expenses

California’s modified conformity allows a deduction for medical expenses unreimbursed by

insurance that exceed 7.5 percent of federal AGI. The SECURE Act changes the federal floor for

medical expenses to 7.5% for 2019 and 2020.

State and Local Taxes

Schedule CA does not allow a deduction for state and local taxes, no conformity to the federal

TCJA changes are required.

The federal deduction for state and local tax is limited to $10,000 ($5,000 for married filing

separate) for the aggregate of state and local income taxes and property taxes. California does not

conform. If the deduction was limited under federal law, enter an adjustment on line 5e, column

C for the amount over the federal limit.

Mortgage Interest – Personal Residence

Federal law (TCJA) limited the mortgage interest deduction acquisition debt maximum from

$1,000,000 ($500,000 for Married Filing Separately) to $750,000 ($375,000 for Married Filing

Separately). California does not conform. If the deduction was limited under federal law, enter

an adjustment on line 8, column C for the amount over the federal limit.

Federal law suspended the deduction on up to $100,000 ($50,000 for Married Filing Separately)

for interest on home equity indebtedness, unless the loan is used to buy, build, or substantially

improve the taxpayers’ home that secures the loan. California does not conform. If the deduction

was limited under the federal law, enter an adjustment on line 8, column C for the amount over

the federal limit.

Gambling Losses/CA Lottery

California lottery losses are not taxable to CA and are not deductible for California. Enter the

amount of California lottery losses included in line 16, column A on line 16, column B.

Federal Estate Tax

Federal estate tax paid on income in respect of a decedent is not deductible for California. Enter

the amount of federal estate tax included in line 16, column A on line 16, column B.

27

California

Federal Repeal of 2% Miscellaneous Deductions

Individuals may claim itemized deductions for certain miscellaneous expenses. Certain of these

expenses are not deductible unless, in aggregate, they exceed two percent of the taxpayers’

adjusted gross income (“AGI”)305. CA does not conform and still allows miscellaneous itemized

deductions subject to 2%. Report on Schedule CA, Side 3, Part III.

Itemized Deductions Limitation Amounts

TCJA repealed the limitations on itemized deductions California generally limits the amount

deducted by high-income taxpayers’.

305 R&TC §17076

28

California

California Itemized Deductions are limited for high-income taxpayers

Refer to Schedule CA Side. 3, Line 29 for the computation

Single or married/RDP filing separately $200,534

Head of Household $300,805

Married/RDP filing jointly or qualifying widow(er) $401,072

If married or an RDP and filing a separate tax return, the taxpayer and spouse/RDP must either

both itemize deductions (even if the itemized deductions of one spouse/RDP are less than the

standard deduction) or both take the standard deduction.

29

California

What Do You Think?

Q1. Which of the following are exempt from CA income tax?

A. A mutual fund with 43% of its assets invested in CA.

B. A CA Muni Bonds

C. Interest in a CA bank

D. None of the above.

Q2. Which of the following is not included on the CA return?

A. Qualified Business Income Deduction.

B. Qualified Mortgage Interest

C. Alimony Income and Deduction

D. Charitable Deductions

30

California

What Do You Think? Answers

Answer B is the correct answer

A1.Which of the following are exempt from CA income tax?

A. A mutual fund with 43% of its assets invested in CA. This is not exempt because it is

not at least 50% CA Muni Bonds.

B. A CA Muni Bonds – These are always exempt.

C. Interest in a CA bank – Interest on a bank account is not exempt


If the mutual fund has at least 50% of its assets invested in tax-exempt U.S. obligations and/or in

California or its municipal obligations, that amount of dividend is exempt from California tax.

A is the correct answer.

A2. Which of the following is not included on the CA return?

A. Qualified Business Income Deduction.

B. Qualified Mortgage Interest

C. Alimony Income and Deduction

D. Charitable Deductions

Qualified Business Income Deduction is not part of the CA return. Qualified business income is

reported on Form 1040 after the adjusted gross income, it is not an adjustment on CA.

Qualified Mortgage interest is allowed as an itemized deduction to CA,

Alimony

Alimony and separate maintenance payments are deductible by the payer spouse and

includible in income by the recipient spouse in CA. Alimony has been repealed under

TCJA starting Jan 1, 2019. CA does not conform to the repeal of alimony deduction or

inclusion


California does not conform, under the PITL, to the new federal deduction for qualified

business income (QBI) of pass-through entities under IRC §199A, CA does conform to

the definitions below referenced in TCJA. CA taxes start with Federal AGI, and the QBI

deduction is a below the line deduction. A taxpayer with QBI deduction does not need an

adjustment on the CA return.

31

California

Chapter 4 – Filing Status and Related Item

Filing Status

The taxpayer must use the same filing status for

California as was used on the Federal return, unless306

1. One spouse is a nonresident without California

source income; or

2. One spouse is a nonresident military service member; or

3. A registered domestic partner is not permitted to file a joint Federal tax return.

In the case of 1 or 2 above, the spouses may elect to file Married Filing Separate for California

and Married Filing Joint for Federal purposes.

If the taxpayer had no Federal filing requirement but must file in California, use the same filing

status for California that would have been used to file a Federal income tax return.

Same-sex married individuals must file using the same filing status for California as they used

for Federal. Same–sex married taxpayers must file married/RDP filing jointly or married/RDP

filing separately for California.

Registered Domestic Partners (RDP’s) must file as Single or Head of Household taxpayers for

Federal purposes and must file their California income tax returns as married taxpayers (either

Married/RDP filing jointly; or married/RDP filing separately.

Filing Requirements for RDP Residents, Nonresidents, and Part-Year Residents

Residents – File a California tax return if either of the items below are more than the amount in

the Filing Requirements Chart found in Chapter 1.

The gross income (which consists of all income received from all sources in the form of

money, goods, property, and services, that is not exempt from tax); or

The adjusted gross income (which consists of the Federal adjusted gross income from all

sources, reduced or increased by all California income adjustments)

Nonresidents and Part-Year Residents

File a California tax return if there is any income from:

California sources or income earned while a California resident: (which consists of all

income received from all sources in the form of money, goods, property, and services,

that is not exempt from tax) or

Adjusted gross income (which consists of the Federal adjusted gross income from all

sources, reduced or increased by all California income adjustments) is more than the

amounts shown on the chart in Chapter 1 for the taxpayers’ filing status, age, and number

of dependents.

306 R&TC §§18521(c)(1)(2), 18521(d)

Objective

Obtain an understanding of the

how the filing status affects CA

and differs from the Federal.

• Emphasis on the reporting of

Head of Household, and the

changes initiated by the FTB.

32

California

Keep in Mind: A California nonresident or part-year resident taxpayer is taxed on California

Source income and income while a resident of California.

Same-Sex Married Couples

Legally married same-sex couples generally must file his or her Federal income tax return using

either the Married Filing Jointly or Married Filing Separately filing status. California taxpayers

are generally required to use the same filing status that they used for Federal tax purposes. Since

SSMCs must file both Federal and California income tax returns using the same filing status, no

Federal/California differences exist for SSMCs.

The U.S. Department of the Treasury and the IRS ruled307 that same-sex couples, legally married

in jurisdictions that recognize their marriages, would be treated as married for Federal tax

purposes.

Revenue Ruling 2013-17 specifically states that it applies only to “legally married” same-sex

couples, and not to registered domestic partnerships, civil unions, or similar formal relationships

recognized under state law. However, it does apply regardless of whether the couple lives in a

jurisdiction that recognizes same-sex marriage or a jurisdiction that does not recognize same-sex

marriage.

Registered Domestic Partners

A domestic partnership is established in California when both persons file a Declaration of

Domestic Partnership with the California Secretary of State. At the time of filing, either both

persons are members of the same sex, or one or both of the persons is/are over the age of 62. If

they are over the age of 62, they must meet the eligibility criteria under Title II of the Social

Security Act as defined in 42 USC section 402(a) for old-age insurance benefits or Title XVI of

the Social Security Act as defined in 42 USC section 1381 for aged individuals

Under California law308, RDPs must file his or her California income tax returns using either the

married/RDP filing jointly or married/RDP filing separately filing status309. RDPs have the same

legal benefits, protections, and responsibilities as married couples unless otherwise specified.

If the taxpayer entered into in a same sex legal union in another state, other than a marriage, and

that union has been determined to be equivalent to a California registered domestic partnership,

he or she is required to file a California income tax return using either the married/RDP filing

jointly or married/RDP filing separately filing status.

For purposes of California income tax, references to a spouse, husband, or wife also refer to a

California RDP, unless otherwise specified.

307 Revenue Ruling 2013-17 308 § 297 of Family Code 309 R&TC §18521

33

California

California Adjustments for Registered Domestic Partners

Under California law, a RDP must file his or her California income tax returns using either the

married/RDP filing jointly or married/RDP filing separately filing status. RDPs are not allowed

to use a married filing status on his or her Federal tax returns. To apply the correct dollar limits

on the California tax return, a RDP might be required to reduce the amount of a deductions

reflected on a Federal tax return.

Another category of adjustment occurs when the substantive rule for a transaction is different for

a married person. For example, no gain or loss is recognized when spouses transfer property

among themselves. Since an RDP is treated as a spouse for California purposes, no gain or loss is

recognized for California purposes when one RDP transfers property to his or her domestic

partner. However, this transfer is not likely to get the same treatment for Federal purposes and

gain or loss might be recognized for Federal purposes.

RDP adjustments include, but are not limited to the following:

• Division of community property

• Capital losses

• Transactions between RDPs

• Sale of residence

• Dependent care assistance

• Investment interest

• Qualified residence acquisition loan & equity loan interest

• Expense depreciation property limitations

• Individual Retirement Account

• Education loan interest

• Rental real estate passive loss

• Rollover of publicly traded securities gains into specialized small business investment

companies.

Health coverage for spouse

If an employer provided health coverage for an employee’s same-sex spouse and included the

value of that coverage in the employee’s gross income, the employee may file an amended return

reflecting the employee’s status as a married individual to recover Federal income tax paid on

the value of the health coverage of the employee’s spouse.

Employer coverage

Employers are not required to offer health benefits to spouses, whether they are same-sex

married or opposite-sex married. Employers are required to offer benefits to same-sex spouses if

they offer benefits to opposite-sex spouses. It is common for an employer to pay for medical

coverage for the employee, with spousal or family coverage available at the employee’s expense.

34

California

The effect of the DOMA ruling are many. Tax-free reimbursement under a health or dependent-

care flexible spending account (FSA), health savings account (HSA), and health reimbursement

arrangement (HRA) are also now available to same-sex couples and their children. Same-sex

employees and their dependents are now covered under plans that make them eligible as

qualified beneficiaries under COBRA and in the instance of certain events open to HIPAA’s

special enrollment rules. The Family and Medical Leave Act now extends to same-sex

employees as well, and they will have the right to take FMLA leave to care for a same-sex

spouse. For businesses offering 401(k) plans, the guidance issued in the ruling applies and the

plan may recognize legally married couples.

Filing Status

Filing as an RDP, check the box next to the question in the Filing Status section of the tax return

that asks, “If the California filing status is different from the Federal status, check the box here.”

Use the following guidelines in determining the proper filing status for the California tax return.

Married/RDP Filing Jointly – If any of the following is true, the taxpayer may be able to file as

Married/RDP Filing Jointly:

The taxpayer was an RDP as of December 31, even if he or she did not live with his or

her RDP partner at the end of the year.

The taxpayers’ RDP partner died during the year and the taxpayer did not re-register

as an RDP or marry in by December 31 of that year.

The RDP died in the current year before the prior year tax return was filed.

Example: Sally lives in San Jose CA with her daughter and her partner Jane. Sally and

Jane are RDPs. Sally files Head of Household on her Federal return and married filing

joint on her CA return.

Married/RDP Filing Separately • Community property rules310 apply to the division of income if the taxpayer uses the

married/RDP filing separately status.

• The taxpayer cannot claim a personal exemption credit for the RDP even if the RDP had no

income, is not filing a tax return, and is not claimed as a dependent on another person’s tax

return.

• The taxpayer may be able to file as Head of Household if the taxpayers’ child lived with the

taxpayer and they lived apart from the RDP during the entire last six months of the year.

310 FTB Pub.1051A

35

California

Generally, in community property states, money earned by either spouse during marriage and all

property bought with those earnings are considered community property that is owned equally by

husband and wife. Likewise, debts incurred during marriage are generally debts of the couple

Under California's community property laws, assets and debts spouses acquire during marriage

belong equally to both of them, and they must divide them equally in divorce. ... determine

whether the property (or debt) is marital or separate. Agree on a value for marital property, and.

decide how to divide the property.

Head of Household311 (Head of Household) Qualification Requirements

TCJA now requires preparer due diligence for Head of Household. IRS Form 8867. FTB Form

3532 must be completed and attached to the tax return. The FTB will deny the Head of

Household filing if this form is omitted. This requirement started in tax year 2018.

The law allowing this filing status has very specific rules. The taxpayer must meet all of the

following requirements:

On the last day of the year, he or she must be either unmarried and not an RDP, or meet

the requirements to be considered unmarried or considered not in a registered domestic

partner.

The taxpayer must have paid more than one-half the cost of maintaining the home that

was, for more than one-half of the year, the main home for the taxpayer and one of the

specified qualifying persons.

The qualifying person must have been a citizen or national of the U.S. or a resident of the

U.S., Canada, or Mexico.

The qualifying person must not have filed a joint Federal or state return with his or her

spouse/RDP.

For Head of Household purposes, the taxpayer must be unmarried and not an RDP (on the last

day of the year) must meet one of the following:

Never married and never registered as a domestic partner.

By December 31, the taxpayer was divorced under a final decree or the registered

domestic partnership was legally terminated.

Legally separated under a final decree by December 31.

Marriage or registered domestic partnership annulled under a final decree.

Widowed (spouse/RDP died before January 1).

311 R&TC §17042; FTB Pub 1540

https://www.ftb.ca.gov/individuals/hoh/selftest/definitions.shtml#UnmarriedandnotRDP

https://www.ftb.ca.gov/individuals/hoh/selftest/definitions.shtml#ConsideredUnmarriedor


https://www.ftb.ca.gov/individuals/hoh/selftest/definitions.shtml#KeepingUpYourHome

https://www.ftb.ca.gov/individuals/hoh/selftest/definitions.shtml#MainHome

https://www.ftb.ca.gov/individuals/hoh/selftest/definitions.shtml#QualifyingPerson

https://www.ftb.ca.gov/individuals/hoh/selftest/definitions.shtml#National

https://www.ftb.ca.gov/individuals/hoh/selftest/definitions.shtml#Spouse

https://www.ftb.ca.gov/individuals/hoh/selftest/definitions.shtml#RegisteredDomesticPartner

https://www.ftb.ca.gov/individuals/hoh/selftest/definitions.shtml#UnmarriedandnotRDP

https://www.ftb.ca.gov/individuals/hoh/selftest/definitions.shtml#DivorcedorRDPTerminated

https://www.ftb.ca.gov/individuals/hoh/selftest/definitions.shtml#LegallySeparated

https://www.ftb.ca.gov/individuals/hoh/selftest/definitions.shtml#Annulment

36

California

Considered Unmarried or Considered Not in a Registered Domestic Partnership

For Head of Household purposes, considered unmarried means the taxpayer was legally

married as of December 31, but was ending the relationship and the taxpayer lived apart

from the spouse at all times during the last six months of the year.

Considered not in a registered domestic partnership means the taxpayer was still

registered as a domestic partner as of December 31, but was ending the relationship and

lived apart from the RDP at all times during the last six months of the year.

Qualifying Child312 for Head of Household Purposes:

Relationship: The child must be the taxpayers’ child (includes an adopted child),

stepchild, foster child, brother or sister, half-brother or half-sister, stepbrother or

stepsister, or decedents of any of these individuals. Cousins fall off the family tree. In

other words, cousins do not meet the relationship test.

Age: The child must be under age 19 or must be under age 24 and a full-time student. A

child who is permanently and totally disabled is allowed to be any age. Unless the child is

permanently and totally disabled, the taxpayer must be older than the child.

Support: The child must not have provided more than half of his or her own support.

Member of the Household: The child must have lived with the taxpayer over half the

year. (More than 183 days).

If the taxpayers’ qualifying child was married or a RDP, the taxpayer must be entitled to a

Dependent Exemption Credit for the qualifying child in order to qualify for Head of Household

filing status.

Qualifying Relative313 for Head of Household Purposes:

Relationship: The relative must be related to the taxpayer in one of the following ways:

o The taxpayers’ child (includes an adopted child), stepchild, foster child, or

descendant of any of these individuals.

o The taxpayers’ brother or sister, half-brother or half-sister, stepbrother or

stepsister, or the child (nephew or niece) of the taxpayers’ brother or sister, or

half-brother or half-sister.

o The taxpayers’ father, mother, or grandparents.

o The sibling of the taxpayers’ father or mother (uncle or aunt).

o The taxpayers’ stepfather or stepmother.

o The taxpayers’ father-in-law, mother-in-law, son-in-law, daughter-in-law,

brother-in-law, or sister-in-law.

Cousins fall off the family tree and do not meet the relationship test.

The relative cannot be the qualifying child of the taxpayer or another taxpayer.

The relative must have a gross income that is less than the personal exemption amount.

Gross income generally includes all income that is not exempt from tax.

The taxpayer must have paid more than half the support for the relative.

312 IRC§152(a), Regs. §1.2-2(b)(2) 313 IRC§152(c)(3)



37

California

Tax Law Cases

Appeal of William Tierney, 97-SBE-006-A, September 10, 1997.

A taxpayer who was married or an RDP during part of the year, but divorced, legally separated,

or their registered domestic partnership was legally terminated by the end of the year, must make

a special calculation to determine how many days their home was the main home for their child.

Add together the following:

• Half of the days, the taxpayer and the child lived in the taxpayers’ home with the

spouse/RDP (ex-spouse/ex-RDP).

• All of the days the taxpayer and the child lived in the taxpayers’ home without the

spouse/RDP (ex-spouse/ex-RDP).

Appeal of Barbara Godek, 98-SBE-006, November 19, 1998.

A taxpayer who meets the requirements to be considered unmarried or considered not in a

registered domestic partnership and lives with his or her spouse/RDP at any time during the first

six months of the year must also apply the above Tierney rules to determine the number of days

the taxpayers’ home was his or her child’s main home. However, if a taxpayer is married or an

RDP as of the last day of the year and lives with his or her spouse/RDP at any time during the

last six months of the year, he or she does not qualify for Head of Household filing status.

CA Head of Household Filing Status

The taxpayer is entitled to the HOH filing status only if all of the following apply:

The taxpayer was unmarried and not an RDP or met the requirements to be considered

unmarried or considered not in a registered domestic partnership as of the last day of the

year.

The taxpayer was never married and never entered into a registered domestic partnership.

The taxpayer received a final decree of divorce, dissolution of registered domestic

partnership, or filed a Notice of Termination of Domestic Partnership with the California

Secretary of State and the six-month waiting period for the notice to become final had

passed. A petition for divorce or dissolution of registered domestic partnership is not the

same as a final decree. Until the final decree is issued, a taxpayer who is married or an

RDP remains married or an RDP.

The taxpayer received a final decree of legal separation from their spouse/RDP. A

petition for legal separation, an informal separation agreement, or just living apart from

their spouse/RDP is not the same as being legally separated under a final decree.

The taxpayer received a final decree of annulment of their marriage or registered

domestic partnership and did not marry or enter into a registered domestic partnership

after the annulment,

The spouse/RDP died in a prior year and did not remarry or enter into another registered

domestic partnership

The taxpayer paid more than one-half the costs of keeping up the home for the year.

The taxpayers’ home was the main home for the taxpayer and a qualifying person who

lived with you for more than half the year.

The qualifying person was related to the taxpayer and met the requirements to be a

qualifying child or qualifying relative.

The taxpayer was entitled to a Dependent Exemption Credit for the qualifying person.

https://www.ftb.ca.gov/individuals/hoh/definitions.shtml#UnmarriedandnotRDP

https://www.ftb.ca.gov/individuals/hoh/definitions.shtml#ConsideredUnmarriedor

https://www.ftb.ca.gov/individuals/hoh/definitions.shtml#ConsideredUnmarriedor

https://www.ftb.ca.gov/individuals/hoh/definitions.shtml#MarriedorRDP

https://www.ftb.ca.gov/individuals/hoh/definitions.shtml#Annulment

https://www.ftb.ca.gov/individuals/hoh/definitions.shtml#Spouse

https://www.ftb.ca.gov/individuals/hoh/definitions.shtml#RegisteredDomesticPartner

https://www.ftb.ca.gov/individuals/hoh/definitions.shtml#KeepingUpYourHome

https://www.ftb.ca.gov/individuals/hoh/definitions.shtml#MainHome

https://www.ftb.ca.gov/individuals/hoh/definitions.shtml#QualifyingPerson

https://www.ftb.ca.gov/individuals/hoh/definitions.shtml#MoreThanHalftheYear

https://www.ftb.ca.gov/individuals/hoh/definitions.shtml#QualifyingChild

https://www.ftb.ca.gov/individuals/hoh/definitions.shtml#QualifyingRelative

https://www.ftb.ca.gov/individuals/hoh/definitions.shtml#DependentExemptionCredit

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However, the taxpayer did not have to be entitled to a Dependent Exemption Credit for a

qualifying child if the child was unmarried and not an RDP and the qualifying child was

also unmarried and not an RDP.

The taxpayer was not a nonresident alien at any time during the year.

The qualifying relative’s gross income must be less than $4,200 (form 3522, Part III,

Line 4). Generally, gross income for head of household purposes only includes income

that is taxable for federal income tax purposes. It does not include nontaxable income

such as welfare benefits or the nontaxable portion of social security benefits.

Time/Dates Qualifying Person Was in the Home314

To claim the Head of Household filing status, the child must have lived with the taxpayer for

more than half of the taxable year.

If the taxpayer was not married and not an RDP at any time during the year, count all of

the days that the qualifying person lived with in the home.

If the taxpayer was married or an RDP at any time during the year, and received a final

decree of divorce, legal separation or the registered domestic partnership was legally

terminated by the last day of the year, add together:

o Half the number of days that the taxpayer, the spouse/RDP, and the qualifying

person lived together in the home.

o All of the days that the taxpayer and the qualifying person lived together in the

home without the spouse/RDP (ex-spouse/ex-RDP).

If the taxpayer was married or an RDP as of the last day of the year, and did not live with

the spouse/RDP at any time during the last six months of the year, add together:





If the taxpayer was married or an RDP as of the last day of the year, and lived with the

spouse/RDP at any time during the last six months of the year, the taxpayer cannot

qualify for the Head of Household filing status.

When calculating the above, the taxpayer may include days when the qualifying person was

temporarily absent from your home. Temporary absences include vacations, illness, business,

school, or military service.

If the taxpayers’ child did not live in his home more than half of the taxable year, the taxpayer

may qualify for the Credit for Joint Custody Head of Household.

314 R&TC §17054.5

https://www.ftb.ca.gov/individuals/hoh/definitions.shtml#NonresidentAlien

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The taxpayer may qualify for this credit:

If unmarried and not an RDP at the end of the tax year, or

If married/or an RDP, that lived apart from his or her spouse/RDP for all of the year, and

Used the married/RDP filing separately filing status; and

If the taxpayer furnished more than one-half the household expenses for the home that

also served as the main home of the child, step-child, or grandchild for at least 146 days

but not more than 219 days of the taxable year.

In the past the FTB, sent an audit questionnaire, when the qualifying child is “permanently and

totally disabled.” This information is now requested on the new Form 3532 ( See Part III below)

Keeping a copy of substantiation of the condition in your files will assist the taxpayer in

answering any questions from the FTB regarding the “Head of Household” filing status.

Head of Household

Beginning with returns filed for tax year 2019, the FTB will be able to determine if a taxpayer

qualifies for Head of Household (HOH) when the return is processed. The FTB does this by

using the information provided on FTB Form 3532, which is required to be attached when

taxpayers file as the HOH. If a taxpayer does not qualify for HOH or did not provide FTB Form

3532, the FTB will issue a Notice of Tax Return Change (NTRC) to deny the HOH filing status.

This is a change from prior years, when the FTB would have issued a Notice of Proposed

Assessment (NPA).

NPA vs. NTRC

A Head of Household Notice of Proposed Assessment (HOH NPA) is a "proposed" change in tax

due with the return. If a taxpayer disagrees with an HOH NPA, they may file a protest. When a

Protest is filed, it is worked by a protest-hearing technician, which may delay the resolution of

the issue and often requires additional documentation from the taxpayer.

Alternatively, a Notice of Tax Return Change is a change to the tax due with the return. Refund

amounts are reduced, possibly resulting in a bill, or if there is a balance due, that amount may

increase. If a taxpayer believes it was issued in error, they may contact the Filing Contact Center

via phone, chat, or correspondence, without having to file a protest. The taxpayer also has the

option to pay the balance in full and submit a claim for refund. If the claim for refund denied, the

taxpayer can appeal with the OTA.

The FTB is making this change to avoid letters after the fact. The letter in past years came

months after the refund was issued or the amount due was paid. The Notice of Tax Return

Change we can dramatically shorten the process. If someone does not qualify, he or she will

know immediately why he or she does not qualify and what they need to do to resolve it. An

NTRC can be resolved by reaching out to our contact center and often can be resolved in one

contact.

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California

How to Resolve an Notice of Tax Return Change? If the NTRC is in error or needed information was omitted:

Phone: Filing Contact Center

Chat: through MyFTB

Correspondence: by mail or online

To ensure an accurate determination make sure a completed FTB Form 3532 is attached when

submitting 2019 tax returns claiming HOH filing status.

Examples of Head of Household Qualifications for California

Example 1: Dan Tryhard was legally married but did not live with his spouse at any time

during the tax year. Dan’s 12-year-old brother lived with him from January 1 to

September 1. Dan filed Form 3532 with his return.

Dan’s brother qualifies as his qualifying child and qualifies Dan for the Head of

Household filing status, if the child meets the other requirements.

Example 2: Joe Shmoe was still legally married as of the last day of the year, and he lived with

his spouse from January 1 to September 10. Joe’s teenage daughter lived with him all year. Joe

filed Form 3532.

Joe does not qualify for Head of Household filing status because he did not meet the

requirements to be considered unmarried. He was married as of the last day of the tax

year and lived with his spouse from January 1 to September 10, which is a portion of the

last six months of the year. One of the requirements to be considered unmarried is that

the taxpayer cannot reside with his spouse for any portion of the last six months of the

year.

A Notice of Tax Return Change was issued and Joe’s refund reduced. Joe chatted with the Filing

Contact Center and understood the change to his return.

Example 3: Jack Slick was unmarried and not an RDP. The taxpayer claimed his girlfriend’s 12-

year-old son as his qualifying person. His girlfriend and her son lived with the taxpayer for the

entire year. The taxpayer paid all of the costs of maintaining the home. The girlfriend had no

income. Jack filed Form 3532.

Jack does not qualify for the Head of Household filing status because his girlfriend’s

child is not one of the relatives who by law can qualify him for the status. His girlfriend’s

son is not related to him and does not qualify as his eligible foster child. Therefore, the

child cannot be his qualifying person. Jack checked Turbo Tax and realized he did not

answer the questions correctly and paid the additional tax.

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California

Example 4: Jenny Workerbee was divorced 15 years ago. Her 32-year-old son, who is

unmarried and not an RDP, lived with her for all of 2020, and had gross income of $2,000. The

taxpayer provided more than half of her son’s support and paid all of the costs of maintaining

their home. Jenny filed Form 3532.

Jenny qualifies for the HOH filing status because, although her son was too old to be her

qualifying child, he met the requirements to be her qualifying relative. She is entitled to a

dependent exemption credit for her qualifying relative because he lived with her more than half

of the year and was a resident of the U.S., so he met the citizenship test. His income of $2,000

was under the Federal exemption amount of $4,200 (for 2019). He was also unmarried and not

an RDP, so the joint return test does not apply.

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California

Qualifying Widow(er) with Dependent Child315 In 2020, RDPs qualify for this filing status if all five of the following apply:

• The taxpayers’ RDP died in 2018 or 2019 and the taxpayer did not marry or enter into

another registered domestic partnership.

• The taxpayer has a child, stepchild, adopted child, or foster child who the taxpayer claims

as a dependent.

• This child lived in the taxpayers’ home for all of 2020. Temporary absences, such as for

vacation or school, count as time lived in the home.

• The taxpayer paid over half the cost of maintaining the home for this child.

• The taxpayer was allowed to file a joint return with the RDP the year he or she died, even

if he or she did not do so.

315 R &TC §18521

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California

What Do You Think?

Q1. When filing as Head of Household in California, a taxpayer must meet

the California requirements. Which of the following will not meet the

requirements for Head of Household filing for the taxpayer?

A. The taxpayer was not married and not an RDP at any time during the

year, and a qualifying person lived in the home the entire year.

B. The taxpayer, who is single, furnished more than one-half the

household expenses for the home that also served as the main home of the taxpayers’

grandchild for 150 days.

C. The taxpayer received a final decree of divorce May 30; the qualifying person lived with

both parents until May 25 and lived with the taxpayer the rest of the year.

D. The taxpayer was married but did not live with her spouse any time during the year. The

qualifying person lived with the taxpayer 300 days of the year.

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Answer Q1: B – Is the correct answer

The taxpayer furnished more than one-half the household expenses for the home

that also served as the main home of the taxpayers’ grandchild for 150 days. This scenario

will qualify for the Joint Custody Head of Household Credit, but not the Head of Household

filing status. A, C and D above are all examples of taxpayers’ qualifying for Head of

Household filing status in CA.

To claim the Head of Household filing status, the child must have lived with the taxpayer for

more than half of the taxable year. In the answer above the child only lived in the household for

150 days.

If the taxpayer was not married and not an RDP at any time during the year, count all of

the days that the qualifying person lived in the home.

If the taxpayer was married or an RDP at any time during the year, and received a final

decree of divorce, legal separation or the registered domestic partnership was legally

terminated by the last day of the year, add together:





If the taxpayer was married or an RDP as of the last day of the year, and did not live with

the spouse/RDP at any time during the last six months of the year, add together:





If the taxpayer was married or an RDP as of the last day of the year, and lived with the

spouse/RDP at any time during the last six months of the year, the taxpayer cannot

qualify for the Head of Household filing status.

When calculating the above, the taxpayer may include days when the qualifying person was

temporarily absent from your home. Temporary absences include vacations, illness, business,

school, or military service.

If the taxpayers’ child did not live in his home more than half of the taxable year, the taxpayer

may qualify for the Credit for Joint Custody Head of Household.

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Chapter 5 – Miscellaneous Items

California Real Estate Withholding Since 2007, withholding on the sale of California real

estate has been required. Real estate withholding is a

prepayment of California state income tax for sellers of

California real property. Real estate withholding is not

an additional tax on the sale of real estate. It is a prepayment of the income (or franchise) tax due

on the gain from the sale of California real property. Withholding is required on sales or transfers

of California real property when the total sale price exceeds $100,000 and does not qualify for an

exemption.

The Real Estate Escrow Person plays an important role in the closing of the real estate

transaction. In addition to their own responsibilities described below, the real estate escrow

person may assist the buyer in complying with their withholding requirements by performing or

assisting in the withholding, completing the required withholding forms, or remitting the

required withholding. Tax preparer’s need Form 593 to properly report real estate withholding,

The governing withholding laws316were revised and are effective as of November 2019.

Beginning January 1, 2020, California real estate withholding has changed. There is only one

Form 593, Real Estate Withholding Statement, which is filed with FTB after every real estate

transaction.

Real estate withholding is a prepayment of income tax due from the selling of California land or

anything on it (real property).

Examples of real property:

Vacant land

Buildings

Homes

Withholding is required on sales or transfers of:

Real property (including exchanges).

Interest in land owned by someone else (Easements).

Withholding is required when California real estate is sold or transferred. The real estate escrow

person (REEP) is required to notify buyers of withholding requirements, unless the buyer is a

Qualified Intermediary (QI) in a deferred exchange. The amount withheld from the seller or

transferor is sent to the FTB as required. 317 The real estate withholding was not extended due to

Covid-19.

316 California Code of Regulations, Title 18, §§18662-0 through 18662-6, §18662-8 317 R&TC §18662

Objective:

Review CA Real Estate

Withholding, and the changes to

Form 593.

Review the Impact of the

Affordable Care Act on CA

Explain the new Form required

for Native Indians.

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California

Example: John, a California tax preparer, received a call from a longtime tax client who sold a

rental property he had owned for many years. The client was told at the closing of the sale that

California required withholding on the total sales price. John’s tax client asked how this works

and how he could get back the withholding if the tax was less than the 3 1/3%. He also asked if

there was any way to avoid the withholding, because his gain on the property was small and his

estimated tax should cover the tax. John instructed his client to bring all the closing statements

with him and any additional documents he received to his tax appointment. John informed him

that the amount of withholding is entered on Form 540 and is added to any other withholding

from the year. John went on to explain to the tax client that he had not met the requirements

listed on Form 593 to be exempt from the withholding.318

The buyer or transferor of the property is responsible for withholding (although this is normally

handled by the escrow company) and may become subject to penalty for failure to withhold an

amount equal to the greater of 10 percent of the amount required to be withheld or five hundred

dollars ($500).

The buyer is not required to withhold under the following conditions:

The sales price of the California real property does not exceed one hundred thousand

dollars ($100,000), or

The seller executes a written certificate, certifying that the seller is a corporation or a

partnership with a permanent place of business in California, or

The seller, executes a written certificate, of any of the following:

The California real property is the seller’s or decedents principal

residence, within the meaning of §121 of the Internal Revenue Code. The

taxpayer qualifies for this exemption if during the five-year period (ten-

year period for persons on qualified extended duty in the U.S. Armed

Services or the Foreign Service) ending on the date of the sale both of the

following are true.

o The taxpayer:

Owned the property for at least two years.

Lived on the property as his or her principal residence for any two years

during the five-year period

o There are exceptions to the two-year rule if the primary reason for the sale is due

to one of the following:

A change in place of employment.

Health.

Unforeseen circumstances such as death, divorce, loss of job, etc.

318 R&TC §18622

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California

o The principal residence may be any of the following:

House

Houseboat with sleeping, cooking, and restroom facilities.

Mobile home that is permanently fixed to a foundation or is subject to real

property taxes

Cooperative apartment

Condominium

If the California real property is a like kind exchange,319 which is not required to be

recognized for California income tax purposes.

The California real property has been involuntarily converted,320 and that the seller

intends to acquire property to be eligible for nonrecognition of gain for California income

tax purposes.

The California real property transaction will result in a loss or a net gain not required to

be recognized for California income tax purposes.

Seller’s Filing Requirements

Withholding does not relieve the taxpayer from the requirement to file a California income tax

return. To claim an amount withheld, he or she must file a California income tax return. If the

withholding is more than the actual tax liability, FTB will refund the overpayment after the tax

return has been filed and processed. If your withholding payment is more than your tax liability,

you cannot receive an early refund from FTB. The law does not provide for early refunds of

taxes withheld on sales of real estate. If withholding is less than the actual tax liability, additional

tax may be due.

If the taxpayer is filing a paper return, he or she must attach a copy of Form 593 to the front of

Form 540, Side 1. Be sure the California Real Estate Withholding Statement is completed

properly by the escrow company. Remind, the taxpayer that he or she will need the FEIN of the

escrow or withholding agent, the escrow number and all information on this form completed, or

it will slow the filing of the return.

2020 Form 593 – Real Estate Withholding Statement

Effective January 1, 2020, the following real estate withholding forms and instructions have been

consolidated into one new Form 593, Real Estate Withholding Statement:

Form 593, Real Estate Withholding Tax Statement

Form 593-C, Real Estate Withholding Certificate

Form 593-E, Real Estate Withholding – Computation of Estimated Gain or Loss

Form 593-I, Real Estate Withholding Installment Sale Acknowledgment

The person who will remit the withheld tax on any disposition from the sale or exchange of

California real estate (remitter) is required to complete the applicable part(s) of Form 593 and

submit Sides 1-3 to the Franchise Tax Board (FTB) regardless of real estate transaction.

319 IRC §1031 320 IRC §1033

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50

California

51

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52

California

Like-kind Exchange

CA, with the passage of AB91 generally conforms to the TCJA changes made to IRC Section

1031 that limit the like-kind exchange rules, but the California conformity applies starting with

exchanges completed after January 10, 2019. The bill eliminates like-kind exchange treatment

for exchanges of personal property by limiting like-kind exchange treatment only to real

property, except for individual taxpayers with adjusted gross income of less than $250,000 for a

single filer and $500,000 for a joint filer.

Taxpayers are required to file an annual information return for the taxable year of the like-kind

exchange321 of real or tangible property and in each subsequent taxable year in which the gain or

loss attributable to the exchange has not been recognized under IRC Section 1031. The new law

creates an annual information-reporting requirement for taxpayers that claim non-recognition of

gain or loss for a like-kind exchange pursuant to IRC Section 1031, when property located in

California property is exchanged for property located outside of California. If a taxpayer fails to

file the required information return, FTB can estimate the net income, from any available

information, including the amount of gain deferred, and propose to assess the amount of tax,

interest, and penalties due.

The information return must be filed for the year in which the exchange is completed and each

subsequent year until the gain is fully recognized, regardless of whether the seller/exchanger has

any other California franchise tax, income tax, or information return filing requirement.

The taxpayer files Form FTB 3840 with the income or franchise tax return for the year of the

exchange and for each subsequent year. If the taxpayer does not have a filing requirement, the

form may be filed as a stand-alone form, with the taxpayers’ signature, and mailed to the address

provided on the form. If the form is attached to the return and mailed, no signature is required.

Taxpayers who exchange only personal assets are not required to File Form 3540.

The form should be filed each year until the exchange is final. Complete both sides of form FTB

3840. Enter the same information as reported on the initial or most recently amended form FTB

3840.

Final FTB 3840 – Check this box if this is the last form FTB 3840 that will be filed because the

property received in the exchange was sold or it was otherwise disposed. Enter the taxable year

that the like-kind exchange occurred. Complete both sides of form FTB 3840 with same

information from the previously filed form(s) FTB 3840.

Attach a statement to the back of form FTB 3840 that explaining the disposition of the property.

321 R&TC §§18032, 24953; AB 92

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California

Installment sales filing instructions

If the sale includes an installment agreement, the buyer will withhold on the principal portion of

each payment made to the seller. The FTB requires that the taxpayer file the appropriate

California income tax return to report installment sale income and claim the related withholding

credit in each taxable year he or she receives installment payments.

Elect out of withholding on installment payments

If the taxpayer does not want withholding from payments made by the buyer following the close

of escrow, he or she can elect not to report the sale as an installment method.322 Here is how:

File a California tax return and report the entire sale on Schedule D-1, Sales of Business

Property, in the year of the sale.

After filing the tax return and reporting the entire gain, submit a written request to FTB to

release the buyer from withholding on the installment sale payments

Withholding must continue until you receive an approval.

Native Americans

Generally, California taxes the entire income of California residents, and the California source

income of nonresidents. However, an enrolled member of a federally recognized California Indian

tribe may be exempt from California tax323.

For the income to be exempt from California tax, he or she must meet all of the following

requirements:

He or she must be an enrolled tribal member of a federally recognized California Indian

tribe.

The enrolled tribal member must live in the tribe’s Indian country, which includes:

o Reservations.

o Dependent Indian communities.

o Indian trust allotments.

The enrolled tribal member must earn or receive reservation source income from the

same Indian Country in which he or she lives.

If the Indian Country or tribal reservation is located in California, the enrolled member is a

resident of California.

Residential source income: Income earned for services performed on the tribe’s reservation, by

tribal members, who live on the tribal reservation, whether it is paid by the tribe or a third party.

Gaming Activities on California Reservations

Indian tribes that conduct gaming activities in California are allowed to distribute gaming

income to each tribal member (per capita) after accounting for tribal obligations. The tribal

member’s residence determines whether California taxes the per capita payments.

322 IRC§453(d) 323 FTB Pub 674, FTB Form 3504

http://www.bia.gov/cs/groups/public/documents/text/idc-020700.pdf

http://www.bia.gov/cs/groups/public/documents/text/idc-020700.pdf

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California

Taxation of CA Tribal Member Income

Federal

Federal law taxes income received by tribal members from reservation sources no matter

where they live.

California Tax Exempt Income

Income earned by tribal members who live in Indian country affiliated with their tribe

and receive earnings from the same tribal source of which they are members.

Military compensation is considered income from tribal sources.

o A tribal member who is active duty U.S. military stationed in California with

orders to live outside Indian country.

o A retired military tribal member who receives a military pension while residing

on his or her tribe’s reservation.

Income earned by a tribal member who lives outside of California and receives per capita

income from California sources.

Income earned for services performed by tribal members living on the Indian reservation,

which are paid by a third party.

California Taxable Income

California taxes a tribal member’s income if the tribal member:

Earns or receives income outside of Indian country

Earns or receives income from tribes, which he or she is not a member.

Earns or receives income outside of California.

Adjustments for income taxable to Federal, but not taxable to CA must be shown on the

appropriate line of Schedule CA as a subtraction.

Form FTB 3504, Enrolled Tribal Member Certification is a required form for tax exemption.

Beginning January 2, 2017 this form is used to declare residency within the tribe’s Indian

country and claim the tribal income exemption for California tax. The form must be filed for

each tax year that the tribal member meets the exemption requirement.

If the tribal member has a filing requirement, he or she can file this form with Form 540 or Form

540NR. If all of the tribal member’s income is tax exempt, he or she does not have a California

filing requirement. Tribal members without a California filing requirement must file Form 3504

separately between January 1 and October 15 of the year following the exemption.

Example: John is a member of the Cabazon tribe and lives on the Cabazon reservation in

California. John receives per capita income from the tribe of $10,000. The income is

taxable on his Federal return and reported on Line 21 of Form 1040. John also owns

rental property in Palm Springs CA and has interest and dividend income. John is require

to file a California return.

John should include Schedule CA in his CA540 resident return, with a subtraction on

Line 21f.

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California

What Do You Think?

Q1. Betsy a single taxpayer is selling her condominium that she has lived in

for the past 5 years. She sold her home for a profit of $225,000. Which of the

following is correct?

A. Betsy must complete Form 593 and have withholding on the

$225,000.

B. The property qualifies as the seller’s or transferor’s principal

residence within the meaning of Internal Revenue Code §121. Betsy completed Form

593.

C. Since the gain on the property is not taxable, no other action is needed by Betsy.


Q2. Which if the following is correct regarding the filing of a like-kind exchange Form 3840?

A. Taxpayers are required to file an annual information return for the taxable year of the

like-kind exchange and in each subsequent taxable year in which the gain or loss

attributable to the exchange has not been recognized.

B. The new law applies only when property located in California is exchanged for property

located outside of California.

C. If a taxpayer fails to file the required information return, FTB can estimate the net

income, from any available information, including the amount of gain deferred, and

propose to assess the amount of tax, interest, and penalties

D. All of the above

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California


A1: B – Is the correct answer.

Betsy, a single taxpayer, is selling her condominium that she has lived in for the

past 5 years. She sold her home for a profit of $225,000. Which of the following is correct?

A. Betsy must complete Form 593 and have withholding on the $225,000.

B. The property qualifies as the seller’s or transferor’s principal residence within the

meaning of Internal Revenue Code §121. Betsy completed Form 593.

C. Since the gain on the property is not taxable, no other action is needed by Betsy.


The seller, executes a written certificate (Form 593) under the penalty of perjury, the California

real property is her principal residence, within the meaning of §121 of the Internal Revenue

Code.

The taxpayer qualifies for this exemption if during the five-year period (ten-year period for

persons on qualified extended duty in the U.S. Armed Services or the Foreign Service) ending on

the date of the sale both of the following are true.

The taxpayer:

Owned the property for at least two years.

Lived on the property as your principal residence for any two years during the

five-year period

There are exceptions to the two-year rule if the primary reason for the sale is due to

one of the following:

A change in place of employment.

Unforeseen circumstances such as death, divorce, loss of job, etc.

A – This is incorrect because withholding is not required on a personal residence that has no

taxable income.

C – This is incorrect because Betsy is required to select the appropriate exemption in Part II of

Form 593 and sign and date the form, which is filed.

A2: D – Is the correct answer all the items are correct.

Which if the following is correct regarding the filing of a like-kind exchange Form 3840?

A. Taxpayers are required to file an annual information return for the taxable year of the

like-kind exchange and in each subsequent taxable year in which the gain or loss

attributable to the exchange has not been recognized.

B. The new law applies only when property located in California is exchanged for property

located outside of California.

C. If a taxpayer fails to file the required information return, FTB can estimate the net

income, from any available information, including the amount of gain deferred, and

propose to assess the amount of tax, interest, and penalties

D. All of the above

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California

A-C are all correct because taxpayers are required to file an annual information return for the

taxable year of the like-kind exchange and in each subsequent taxable year in which the gain or

loss attributable to the exchange has not been recognized under IRC Section 1031. The new law

creates an annual information-reporting requirement for taxpayers that claim non-recognition of

gain or loss for a like-kind exchange pursuant to Internal Revenue Code (IRC) Section 1031,

when property located in California is exchanged for property located outside of California. If a

taxpayer fails to file the required information return, FTB can estimate the net income, from any

available information, including the amount of gain deferred, and propose to assess the amount

of tax, interest, and penalties.

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Chapter 6 - California NOL, Disaster Loss, California Estimates

Net Operating Loss

If the taxpayer deductions and losses are greater than his or her

income from all sources in a tax year, there may be a net

operating loss (NOL).

For losses incurred in tax years:

2019 and after, NOL can no longer be carried back to the past 2 years.

2013 through 2018, NOL can be carried back to each of the past 2 years

Claiming the NOL Carryback

On July 1, 2019, California enacted Assembly Bill 91 as part of the budget package for the fiscal

year 2020. Called the “Loophole Closure and Small Business and Working Families Tax Relief

Act of 2019,” AB91 affects both California personal income and corporate tax.

The bill selectively conforms to certain federal provisions from the TCJA. However, AB91 does

not conform to, or decouple from, several of the more significant federal tax reform provisions

affecting business and individual taxpayers.

The TJCA generally repealed the two-year carryback and special carryback provisions while

extending the carryforward period (subject to certain limitations) for taxable years ending after

December 31, 2017. Prior to AB91, California’s PIT Laws and CT Laws allowed taxpayers to

carryback NOLs attributable to taxable years beginning on or after January 1, 2013 to the

preceding two taxable years.

AB91 changes this rule by disallowing NOL carrybacks (with limited exceptions) for taxable

years beginning after December 31, 2018. The state still permits a two-year carryback for NOLs

attributable to taxable years beginning on or after January 1, 2013 and before January 1, 2019.

Under California law (similar to Federal law), the oldest NOL is applied first against the income

reported in the succeeding year. The carryover period on or after 01/01/2018 is 20 years, 100

percent of the NOL is allowed to be carried over.

TCJA made changes to NOL’s. The CA NOL’s are computed separately from the Federal.

Objective

Understand CA carrybacks and

carryovers for Individuals

Understand CA Disaster Loss,

carrybacks, and carryovers.

Recognize when estimated tax

payments are necessary to avoid

underpayment penalty.

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California Disasters

California automatically follows the IRS extended deadlines to file/pay taxes until the date

indicated for the specific disaster. Write the disaster name in blue or black ink at the top of

clients tax return to alert the FTB the return is disaster related, if filing by paper. If electronically

filing enter the disaster code. Search for Disaster Codes on the FTB website. www.ftb.gov

List of disasters

Disaster name Tax Year Extended deadline to file/pay taxes

Tropical Storm Imelda 2018 January 31, 2020

Texas Storms and Flooding 2018 October 31, 2019

Carr Fire 2017 November 30, 2018

Hurricane Florence 2017 January 31, 2019

Hurricane Michael 2017 February 28, 2019

Hurricane Harvey 2016 January 31, 2018

Hurricane Irma 2016 January 31, 2018

Hurricane Maria 2016 January 31, 2018

Types of losses that may qualify

Casualty loss

The taxpayer may claim a disaster loss that is not repaid for the damage to property that was lost

or damaged due to a sudden, unexpected, or unusual:

Earthquake

Fire

Flood

Similar event

The taxpayer may deduct a disaster loss suffered in California beginning on or after January 1,

2014, and before January 1, 2024. The disaster loss must be claimed in the taxable year the

disaster occurred or in the taxable year immediately before the disaster occurred.

Refer to CA Pub. 1034, How to Claim a State Tax Deduction for Your Disaster Loss

California Estimated Tax Requirements

The taxpayer does not have to make estimated tax payments324 if the California withholding in

each payment period totals 90% of the required annual payment. Also, the taxpayer does not

have to make estimated tax payments if the taxpayer will pay enough through withholding to

keep the amount owed with the tax return under $500 ($250 if married/registered domestic

partner (RDP) filing separately).

324 R&TC §19025

http://www.ftb.gov/

https://www.ftb.ca.gov/forms/misc/1034.pdf

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When figuring the required estimated tax payments for 2020, the taxpayer must pay the lesser of

100 percent of prior year’s tax or 90 percent of the current year’s tax. However, a high-income

individual must base his or her estimated tax payments on the following applicable percentages.

If adjusted gross income is more than $150,000 ($75,000 if married filing a separate return) in

the prior tax year:

The required payment is the lesser of 90 percent of his or her tax for 2020 or 110 percent

of his or her tax for 2019

If adjusted gross income is $1 million or more ($500,000 if married filing a separate return) in

the current tax year. The required payment is 100 percent of his or her tax for 2019.

This rule does not apply to farmers or fishermen. The taxpayer is considered a farmer or

fisherman if at least two-thirds (2/3) of his or her annual gross income for the current or prior

year is from farming or fishing. Farmers and fishermen are required to make one estimate

payment. For calendar year taxpayers, the due date is January 15. If the taxpayer pays the entire

tax due by March 1, they do not owe a penalty for underpaying estimated tax.

A taxpayer does not have to make estimated tax payments if he or she is nonresident or a new

resident to California in 2019 and did not have a California tax liability in the prior year.

To avoid the need to pay estimated vouchers the taxpayer could increase their withholding. If the

taxpayer indicates, increased income is anticipated the estimated vouchers can also be increased.

The taxpayer must complete the Employment Development Department ((EDD) Form DE-4,

Employee Withholding Allowance Certificate with their employer. If the taxpayer must increase

his or her Federal withholding, he or she must us Form DE4 for CA, Employee’s Withholding

Allowance Certificate.

In 2019, California continues to have front-loaded estimated tax payments. The required

payments include the 1% mental health surcharge for taxpayers with a taxable income

$1,000,000 or more and AMT. The required percentages are:

Quarter Percentage

1st 30%

2nd 40%

3rd 0%

4th 30%

If the taxpayer and spouse/RDP paid joint estimated tax payments, but are now filing separate

income tax returns, the taxpayer or spouse/RDP may claim the entire amount paid, or he or she

may each claim part of the joint estimated payments. If the taxpayer wants the estimated tax

payments to be divided, notify the FTB before he or she files the income tax returns so that the

payments can be applied to the proper account. The FTB will accept in writing, any divorce

agreement (or court ordered settlement) or a statement showing the allocation of the payments

along with a notarized signatures of both taxpayers.

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The statements should be sent to:

JOINT ESTIMATE CREDIT ALLOCATION MS F225,

TAXPAYER SERVICES CENTER,

FRANCHISE TAX BOARD,

PO BOX 942840,

SACRAMENTO CA 94240-0040

The taxpayer is required to remit all his or her payments electronically once he or she makes an

estimate or extension payment exceeding $20,000 or he or she file an original return with a total

tax liability over $80,000 for any taxable year that begins on or after January 1, 2009. Once the

threshold is met, subsequent payments regardless of amount, tax type, or taxable year must be

remitted electronically. Individuals who do not send the payment electronically will be subject to

a one percent noncompliance penalty. Electronic payments can be made using Web Pay on the

Franchise Tax Board’s (FTB’s) website, electronic funds withdrawal (EFW) as part of the e-file

return, or credit card.

Since January 2017, taxpayers and tax preparers can submit electronic funds withdrawal (EFW)

request for extension and estimated tax payments using tax preparation software. The payments

will be accepted as stand-alone transaction and can be submitted separate from an e-file tax

return. The tax return can be filed at a later date.

Payment methods for ES Vouchers

Web Pay – Make a payment online or schedule a future payment (up to one year in

advance), go to ftb.ca.gov/pay for more information. Do not send Forms 540-ES.

Electronic Funds Withdrawal (EFW) – Individuals can make an extension or estimated

tax payment using tax preparation software. Check with the software provider to

determine if they support EFW for extension or estimated tax payments.

Credit card – Pay by Discover, MasterCard, Visa, or American Express Card to pay

your tax. Call 800.272.9829 or go to officialpayments.com, use code 1555. Official

Payments Corp. charges a fee for this service. Do not mail Forms 540-ES if paying by

credit card.

Check or money order – There is a separate payment form for each due date. Be sure

the correct form is used, check the due date shown in the top margin of the form.

Fiscal year filers: Enter the month of your fiscal year end (located directly below the form’s

title).

The taxpayer must print their name, address, and social security number (SSN) or individual

taxpayer identification number (ITIN) in the space provided on Form 540-ES. If he or she has a

foreign address, enter the information in the following order: City, Country, Province/Region,

and Postal Code. Follow the country’s practice for entering the postal code. Do not abbreviate

the country name.

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Complete the amount of payment line of the form by entering the amount of the payment that

you are sending. Using black or blue ink, make your check or money order payable to the

“Franchise Tax Board.” Write your SSN or ITIN and “2020 Form 540-ES” on it and mail to the

address in Section F.

Make all checks and money orders payable in U.S. dollars and drawn against a U.S. financial

institution.

Mandatory e-Pay Requirements for Individual Taxpayers

Below are answers to frequently asked questions about the individual taxpayer e-Pay

requirements and penalty.

Individual taxpayers are required to pay electronically if the taxpayer:

Makes an estimated tax or extension payment exceeding $20,000

Files a tax return with a tax liability over $80,000325

Individual taxpayers who meet one or both of the specified threshold requirements must

make all payments to us electronically.

To request a discontinuance or waiver of the e-Pay requirement, the taxpayer must submit Form

FTB 4107, Mandatory e-Pay Election to Discontinue or Waiver Request. The FTB will grant the

request if the taxpayer has not met the thresholds in the previous taxable year or if the taxpayer

has established the amounts paid in excess of the threshold amounts were not representative of

the tax liability.326 The taxpayer must continue to make all payments electronically until they

receive a letter from us granting the discontinuance or waiver.

Failing to meet the e-Pay requirement will result in a penalty of one percent of the amount of

payment not paid electronically, and there is no maximum penalty limitation.

For example: If a taxpayer with an e-Pay requirement makes three separate estimated tax

payments by check in the amount of $100,000 each, the FTB will impose three e-Pay

penalties of $1,000 each, totaling $3,000.

The law allows an abatement of the e-Pay penalty only for reasonable cause and lack of willful

neglect. Being unaware of the e-Pay is not reasonable cause.

325

R&TC, Section 19011.5(a). 326

R&TC, Section 19011.5(b), (d).

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There are several ways for individuals to pay electronically:

Pay on the FTB website using FTB Web Pay

Request an electronic funds withdrawal with an e-filed tax return

Pay by credit card

Pay by phone

Create and pay through your MyFTB account and receive other online services (view

payments cancel payments, schedule future payments, view your tax returns and more)

Go to ftb.ca.gov and search for mandatory e-Pay for information on how to use each of

these options.

Underpayment of Estimated Tax

The Underpayment of Estimated Tax327 is reported on Form 5805.

The taxpayer may be subject to an estimated tax penalty if any of the following is true:

• The withholding and credits are less than 90% of the current tax year liability.

• The withholding and credits are less than 100% of the prior year tax liability (110% if

AGI is more than $150,000 or $75,000 if married/RDP filing separately).

• The taxpayer did not pay enough through withholding to keep the amount he or she owed

with the tax return under $500 ($250 if married/RDP filing separately).

The underpayment of estimated tax penalty shall not apply to the extent the underpayment of an

installment was created or increased by any provision of law that is new for the taxable year of

the underpayment.

The rates used to determine the amount of your penalty are established at various dates

throughout the year. If an installment of estimated tax for any quarter remained unpaid or

underpaid for more than one rate period, the penalty for that underpayment will be figured using

more than one rate when applicable.

Example: The taxpayer did not meet the estimated tax payments requirements. The

preparer had set up estimated tax vouchers based on the tax on the 2019 tax return

($17,200). The taxpayer did not pay all of the estimated vouchers for 2020. The taxpayer

reduced the estimated vouchers and only paid $10,000. He paid $10,000 in the second

quarter and had withholding of $5,250.

An underpayment penalty will be charged when taxes are not paid by the due date. The

penalty is 5 percent of the unpaid tax as of the due date plus ½ of 1 percent each month,

or part of a month the tax remains unpaid, not to exceed 40 months. The maximum

penalty is 25 percent of the total unpaid tax.

327 R&TC §19131

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What Do You Think?

Q1. Which of the following would not qualify as a CA disaster loss?

A. Ca Wild Fire

B. An Flooding due to a break in a dam

C. A Car Accident

D. An Earthquake

Q2. If the taxpayer and spouse paid joint estimated tax payments, but are now filing separate

income tax returns, which of the following is not correct?

A. Either of the taxpayer or spouse may claim the entire amount paid

B. The taxpayer and spouse may each claim part of the joint estimated payments.

C. If the taxpayer wants the estimated tax payments to be divided, he or she can write a note

and file with the return.

D. The FTB will accept court ordered settlement statement showing the allocation of the

estimated tax payments.

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C is the correct answer

Q1. Which of the following would not qualify as a CA disaster loss?

A. Ca Wild Fire

B. An Flooding due to a break in a dam

C. A Car Accident

D. An Earthquake

The taxpayer may claim a disaster loss that is not repaid for the damage to property that was lost

or damaged due to a sudden, unexpected, or unusual:

Earthquake

Fire

Flood

Similar event

Answer Q2: – C – Is the correct answer.

If the taxpayer and spouse paid joint estimated tax payments, but are now filing separate income

tax returns, either the taxpayer or spouse may claim the entire amount paid, or he or she may

each claim part of the joint estimated payments. If the taxpayers want the estimated tax payments

to be divided, notify the FTB before he or she file the income tax returns so that the payments

can be applied to the proper account. The FTB will accept in writing, any divorce agreement (or

court ordered settlement) or a statement showing the allocation of the payments along with a

notarized signature of both taxpayers. The statements should be sent to:

JOINT ESTIMATE CREDIT ALLOCATION MS F225,

TAXPAYER SERVICES CENTER,

FRANCHISE TAX BOARD,

PO BOX 942840,


66

California

Chapter 7 – Alternative Minimum Tax and Stock Options

California Alternative Minimum Tax – Schedule P328

California tax law gives special treatment to some items of income and allows deductions and

credits for some items of expense329. Many individuals who benefit from these provisions must

pay at least a minimum amount of tax and/or limit the amount of their credits.

Use Schedule P (540), Alternative Minimum Tax and Credit Limitations — Residents, to

determine if:

• The taxpayer owes AMT.

• The taxpayers’ credits must be reduced or eliminated. The credits may be limited even

if they do not owe AMT, so be sure to complete Side 1 and Side 2 of Schedule P (540).

2019 AMT Exemption – indexed annually for inflation

Filing Status Amount


Single or Head of Household $73,748

Married/RDP filing separately, estates, or trusts $49,163

AMT Exemption Phase-out – the California AMT exemption amount is reduced .25 for each

dollar the taxpayers’ AMTI exceeds the beginning phase-out amount ranges for 2019/2020.

Filing Status Phase-out




Like the calculation for Federal AMT, the alternative minimum tax base is calculated by adding

to and subtracting from taxable income certain adjustments and preferences, and subtracting an

AMT exemption allowance; this determines the alternative minimum taxable income (AMTI).

AMTI is multiplied by 7% tax rate to determine the tentative minimum tax. If the taxpayers’

regular tax is less than the tentative minimum tax, the taxpayer must pay the difference as AMT.

328 RT &C 329 Schedule P Instructions

Objectives:

Discussion of CA AMT and

conformity issues.

Recognize when and how stock

options are taxed by CA

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A qualified taxpayer must exclude income, positive and negative adjustments, and preference

items attributable to any trade or business when figuring AMTI. These adjustments and

preference items must also be excluded when calculating any deductions that may result in AMT

carryovers. The taxpayer is a qualified taxpayer if they meet both of the following:

• Own or have an ownership interest in a trade or business.

• Have aggregate gross receipts (less returns and allowances), during the taxable year, of

less than $1,000,000 from all trades or businesses for which you are the owner or have an

ownership interest.

Gross receipts may include, but are not limited to:

Items reported on Federal Schedules C, Profit or Loss from Business,

D, Capital Gains and Losses,

E, Supplemental Income and Loss, (other than income from a trust), or

F, Profit or Loss from Farming, and Fishing

Form 4797, Sales of Business Property (figured in accordance with California law), or

California Schedule D-1, Sales of Business Property, (if required to complete it) that are

associated with a trade or business.

In the case of an ownership interest, the taxpayer include only the proportional share of

gross receipts of any trade or business from a partnership, S corporation, regulated

investment company (RIC), a real estate investment trust (REIT), or real estate mortgage

investment conduit (REMIC) in accordance with their ownership interest in the

enterprise.

Apply the $1,000,000 test to the return regardless of filing status. The threshold does not

become $2,000,000 for married /RDP taxpayers filing jointly.

Common adjustments and preferences that are added to or subtracted from taxable income in

arriving at alternative minimum taxable income include (this is not a complete list):

• Certain medical and dental expense

• Personal property taxes and real property taxes

• Interest on a home mortgage not used to buy, build, or improve the home

• Miscellaneous itemized deductions

• Refunds of personal property taxes and real property taxes

• Investment interest expense adjustment

• Depreciation adjustment

• Incentive Stock Options

• Passive activity adjustment

• K-1 adjustments for beneficiaries of estates and trusts

• Installment sales

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Credit for Prior Year Minimum Tax

If a taxpayer paid AMT he or she may be able to claim the credit for prior year minimum tax. If

the taxpayer had an AMT credit carryover from the prior year; or paid AMT for the previous

year, and had adjustments and tax preference items other than exclusions use Form 3510, Credit

for Prior Year Alternative Minimum Tax, to see if the taxpayer qualifies.

The prior year alternative minimum tax credit must be applied before credits can reduce regular

tax.

Conformity

California generally conforms to the Federal AMT, except the following provisions:

• California imposes its own tax rate

• California has its own exemption amounts.

• California has its own phase-out amounts

• California allows certain credits to reduce the taxpayers’ regular tax below the tentative

minimum tax which include the following credits:

o Adoption Costs Credit

o California Competes Credit

o College Access Tax Credit

o Dependent Parent Credit

o Enterprise Zone Hiring and Sales or Use Tax Credit

o Joint Custody Head of Household Credit

o Low-Income Housing Credit

o Natural Heritage Preservation Credit

o Nonrefundable Renter’s Credit

o Orphan Drug Research Credit

o Other States Tax Credit

o Research Credit

o Senior Head of Household Credit

o Solar Energy Credit Carryovers

o Targeted Tax Area Hiring and Sales or Use Tax Credit

Stock Options

The favorable tax treatment afforded by Federal law to incentive and employee stock options

applies for California purposes to California qualified stock options. Accordingly, a taxpayer

who exercises a qualifying stock option may postpone paying tax until disposing of the option or

the underlying stock.

An employee stock option is the right or privilege granted by a corporation to purchase the

corporation’s stock at a specified price during a specified period, usually a bargain price.

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Stock option plans that meet the requirements of Internal Revenue Code §421-424 are referred to

as statutory stock options; those that do not, are referred to as nonstatutory stock options330.

Statutory stock options consist of incentive stock options and employee stock purchase plans.

Special rules apply to statutory options; special rules generally postpone the tax until the

employees sell the stock. Generally, if all requirements are met employees realize no income

when he or she receive options.

Nonstatutory stock options are all other options.331

California law conforms to Federal law concerning the taxation of statutory and nonstatutory

stock options.332

A “California qualified stock option” is a stock option

Designated by the corporation issuing the stock option as a California qualified

stock option at the time the option is granted,

Issued by a corporation to its employees after 1996 and before 2002, and

Exercised by a taxpayer either while employed by the issuing corporation or

within three months after leaving the employ of the issuing corporation.

A taxpayer who becomes permanently and totally disabled may exercise the option within one

year of leaving the employ of the issuing corporation.

Dates: The date the company grants the option to the taxpayer is the grant date. The price the

taxpayer will pay for the stock is the option price. The exercise date is the date the taxpayer

purchased the stock at the option price.

Disposition

A disposition that meets the following holding period requirements333 is a qualifying disposition:

• No sale of the stock within 2 years from the grant date of the option

• No sale of the stock within 1 year after the date the taxpayer exercise the option

Disqualifying dispositions

A disposition that does not meet the holding period requirements of IRC §422 or §423, is a

disqualifying disposition.

330 IRC §83 331 IRS Pub 525, R&TC §24602 332 FTB Pub1004 333 IRC §§422,423

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Nonstatutory Stock Options

Generally, the employee recognizes taxable wage income upon the exercise of a nonstatutory

stock option. The difference between the fair market value of the stock on the exercise date and

the option price is the taxable wage income. If the taxpayer exercises the nonstatutory stock

options while a California resident, California taxes the difference between the fair market value

of the shares on the exercise date and the option price because he or she is a resident of

California when the income is recognized.334

Example: On March 1, 2012, while a resident of Ohio, the taxpayers’ employer grants

the taxpayer nonstatutory stock options. On June 1, 2018, the taxpayer retires and

permanently moves to California. On September 1, 2018, the taxpayer exercises the

options.

The taxpayer is a California resident when the nonstatutory stock option income is

recognized; the difference between the fair market value of the shares on September 1,

2018, and the option price is wage income taxable by California. If the taxpayer also paid

tax to Ohio on the wage income, California allows a credit for taxes paid to Ohio on this

double-taxed income.

California Resident on Exercise Date

If the taxpayer exercises the nonstatutory stock options while a nonresident, the character of the

stock option income recognized is compensation for services rendered. California taxes the wage

income received to the extent the taxpayer performed services in this state. It does not matter

whether the taxpayer was always a nonresident or was formerly a California resident.

Example of all services performed within California

On February 1, 2011, while a resident of California, the taxpayers’ company grants the

taxpayer nonstatutory stock options. The taxpayer performs all of the services in

California from February 1, 2012 to May 1, 2017, the date the taxpayer left the company

and permanently moved to the state of Washington. On June 1, 2018, the taxpayer

exercised the nonstatutory stock options.

The difference between the fair market value of the shares on June 1, 2018, and the

option price is characterized as compensation for services having a source in California,

the state where the taxpayer performed all of the services. If the taxpayer performed

services for the corporation entirely within California, the difference between the fair

market value of the stock on the exercise date and the option price has a source in

California, the state where he performed the services.

334 Appeal of Earl R. and Alleene R. Barnett

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Services performed within and outside California

Example: On July 1, 2013, while a resident of Texas, the company grants the

nonstatutory stock options. On July 1, 2017, the company permanently transfers the

taxpayer to California. On July 1, 2018, the taxpayer leaves the company and

permanently moves to Florida. From July 1, 2013 through July 1, 2017, the taxpayer

worked for the company a total of 700 days in California and 300 days in other states. On

August 1, 2016, the taxpayer exercised the options.

The difference between the fair market value of the taxpayer shares on August 1, 2018,

and the option price is stock option income characterized as compensation for services.

The total workdays from grant date to exercise date equal 1,000 workdays (700

California workdays + 300 other state workdays). The allocation ratio is .70 (700

California workdays ÷ 1,000 total workdays). Therefore, California taxes 70 percent of

the total stock option income.

If the taxpayer-performed services for the corporation are both within and outside California he

must allocate to California that portion of total compensation reasonably attributed to services

performed in this state.335

One reasonable method is an allocation based on the time worked. The period of time the

taxpayer performed services includes the total amount of time from the grant date to the exercise

date (or the date employment ended, if earlier).

The allocation ratio is:

California workdays from grant date to exercise date

Total workdays from grant date to exercise date

Income taxable by California = Total stock option income x allocation ratio

Incentive Stock Options

Qualifying Disposition

The taxpayer does not include any amount in income when an incentive stock option is granted

to the taxpayer or when he exercises the option. The taxpayer recognizes a capital gain or loss

when he sells the stock if the holding period requirements 336are met.

Disqualifying Disposition

A disqualifying disposition results when the taxpayer sells the stock before meeting the holding

period requirements. The difference between the fair market value (FMV) of the stock on the

exercise date (or the sale price, if lower) and the option price is treated as ordinary income

(wages). The increase between the stock’s FMV on the exercise date and the sale date is a capital

gain.

335 R&TC §17951-5(b). 336 IRC §422

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If the taxpayer paid tax on the wage income to California and another state, California may allow

a credit for taxes paid on this double-taxed income.

Incentive Stock Option Tax Treatment

Disposition Type Computation Character

Qualifying Disposition Sale price minus option price Capital Gain

Disqualifying Disposition:

Sales price > FMV on

exercise date

FMV on exercise date minus option price

Sales price minus FMV in exercise date

Ordinary gain

Capital gain

Disqualifying disposition:

Sales price < FMV on

exercise date

Sales price minus exercise date

Ordinary Income

Employee Stock Option Plan

This is a tax-qualified retirement plan, which invests primarily in the securities of the employer.

The shares of stock are allocated to the employee as of the end of the plan year. The

apportionment is made based on compensation paid to each to the total compensation paid to all

of those eligible. The employee must meet the vesting rules and the normal retirement age.337An

ESOP is a qualified stock bonus plan.

Distributions from ESOP’s are taxed like distributions from other retirement plans and reported

on Form 1099-R with a code U. The amount included is the FMV of the distribution minus the

amount of employee after-tax contributions. However, since the distribution from ESOP’s often

is made in the form of employer securities, the rules on net unrealized appreciation may apply.

The amount reported on Form 1099-R.

337 IRC §1042

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What Do You Think?

Q1. Which of the following is not correct regarding CA Alternative

Minimum Tax?

A. California has only one AMT tax rate.

B. California exemption amounts for AMT are not the same as

Federal.

C. California phase-out amounts are the same as Federal for AMT purposes.

D. The California AMT exemption amount is reduced 25 cents for each dollar the

taxpayers’ AMTI exceeds the beginning phase-out amount range.

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What Do You Think? –Answers

A1: C – Is the correct answer

C is not correct, California has different phase-out amounts

A, B and D are correct.

AMT Exemption Phase-out – the California AMT exemption amount is reduced .25 for each

dollar the taxpayers’ AMTI exceeds the beginning phase-out amount ranges for 2019/2020.

Filing Status Phase-out




Like the calculation for Federal AMT, the alternative minimum tax base is calculated by adding

to and subtracting from taxable income certain adjustments and preferences, and subtracting an

AMT exemption allowance; this determines the alternative minimum taxable income (AMTI).

AMTI is multiplied by 7% tax rate to determine the tentative minimum tax. If the taxpayers’

regular tax is less than the tentative minimum tax, the taxpayer must pay the difference as AMT.

A. California has only one AMT tax rate, which is 7%.

B. California exemption amounts for AMT are not the same as Federal.

D. The California AMT exemption amount is reduced 25 cents for each dollar the

taxpayers’ AMTI exceeds the beginning phase-out amount range.

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Chapter 8 – Power of Attorney, MyFTB, Identity Theft

Form FTB 3520, Power of Attorney (POA)

The Power of Attorney (POA) declaration is an FTB legal

document that allows taxpayers to grant a specific person or

tax professional/representative permission to obtain

information and/or represent a taxpayer on FTB matters.

The FTB has made the following changes to Form 3520, Power of Attorney:

Joint filers must now submit separate Forms 3520 for each spouse/registered domestic

partner (RDP) (joint designations filed prior to this change are still valid);

The taxpayer information section has been revised;

A client can now authorize his or her tax professional to represent him or her in all

matters, regardless of income or tax year, and the authority to do so automatically expires

four years from the date on the POA;

There are now checkboxes that clients can use to indicate which additional privileges are

extended to his or her representative; and the instructions on the form have been

expanded.

The FTB will still accept a durable power of attorney or military POA, however they do request

that the submission also include a filled out Form 3520 PIT to facilitate ease of processing.

All new POAs

Will expire six years from the date signed;

Will not revoke previously submitted POA declarations with overlapping privileges’

Will allow the designation of multiple representatives on one form so firms can include

multiple representatives when submitting a POA; and

Can be revoked using the new POA revocation forms.

KEY FACT

The new forms are supposed to result in faster processing because imputing an IRS or other non-

FTB POA via the online system results in many errors, since the information on the form does

not necessarily match the information entered in the system.

MyFTB

MyFTB provides tax account information and online services to individuals, business

representatives, and tax preparers. The enhanced MyFTB allows POA representatives to view

notices sent to clients.

Objective

Illustrate when it is best to have

a Power of Attorney as a

taxpayer and preparer.

Review how MyFTB can be a

useful tool

How to combat Identity Theft as

a taxpayer and as a tax preparer.

Review the rules of being a

California Register Tax Preparer

(CRTP).

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Individuals

An individual can use MyFTB to access:

Account information:

View account balance and tax year details.

View estimated payments and credits before filing a return.

View payment history.

View a list and images of tax returns.

View a list and images of notices and correspondence.

View and update contact information.

View proposed assessments.

View California wage and withholding information.

View FTB-issued 1099 information.

View a list of authorized representatives (tax preparer or a tax preparer with a

power of attorney) and manage who can access the account.

View a list of activities that occurred on the account, such as the last time the

individual or authorized representative accessed the account.

Online services:

Calculate a balance due for a date in the future.

File a power of attorney (POA).

File a nonresident withholding waiver request.

Protest a proposed assessment.

Communication with the FTB:

Chat with an FTB representative about confidential matters.

Send a secure message with attachments to FTB.

Choose to receive an email when we send you a notice or correspondence.

Businesses

A business representative can create one MyFTB account to access and manage all the

businesses he or she represents. For each business, a representative can access:


View account balance and account period details.


Verify the exact entity name before filing a return.


View a list and images of tax returns.

View a list and images of notices and correspondence.

View and update contact information.

View proposed assessments.

View a list of authorized representatives (tax preparer or a tax preparer with a power

of attorney) and manage who can access the account.

View a list of activities that occurred on the account, such as the last time the account

was accessed.

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Online services:

Add additional businesses.



File a nonresident withholding waiver request.

Protest a proposed assessment.

Options to communicate with the FTB:


Send a secure message with attachments to FTB.

Choose to receive an email when the FTB sends businesses represented a notice or

correspondence.

Tax Preparers

Tax preparers can use MyFTB to access tax account information and online services for

individual and business clients. On behalf of clients, the tax preparer can access:


View account balance and tax year details.


Verify the exact business entity name to use when filing a return.


View a list of tax returns.

View images of tax returns.*

View a list and images of notices and correspondence.*

Update contact information.*

View proposed assessments.*

View California wage and withholding information for individual clients

View FTB-issued 1099 information for individual clients only.

Online service



File a nonresident withholding waiver request (Form FTB 588).

Protest a proposed assessment.*

Options to communicate with the FTB:


Send a secure message with attachments to FTB.*

* Tax preparers must have an active POA declaration to access these services. To receive email

notifications when a client receives a notice, the POA declaration must contain the tax preparer’s

email address.

Client list.

In MyFTB, the homepage is the tax preparer’s client list. If the tax preparer has an active POA

declaration on file, that client may automatically appear on the client list. To add clients without

an active POA declaration, enter their information from a filed tax return for one of the last five

tax years. Before adding a client, the tax preparer must obtain the client’s permission.

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Form FTB 743, Online Account View Access Authorization, is used to gain client’s permission

when there is not a POA. Do not submit Form FTB 743 to the FTB, the signed form should be

kept in the tax preparer’s records. Clients will remain on the preparer’s client list for 13 months

or until an active POA expires or is revoked.

Client notices. The Client notices feature in MyFTB allows a representative to view the 200 most

recent notices the FTB has sent to clients in the last 60 days. The representative can sort and

filter by date, client name, or notice type. If the representative provided an email address on the

POA declaration, he or she will receive email notification when clients receive notices (for most

FTB notices).

California law requires individual income tax returns prepared by income tax preparers to be e-

filed unless the individual return cannot be electronically filed338 due to reasonable cause.

Reasonable cause includes a taxpayer's election to opt-out (choose not to e-file).

Note: The mandatory e-file law does not apply to the filing of business returns.

For the purposes of this law, an “Income Tax Preparer” is defined as a person who prepares, in

exchange for compensation, or who employs another person to prepare, in exchange for

compensation, any return for the tax imposed.

If the preparer resides or have an office outside California and he or she meet the requirements of

the mandate, all California individual returns prepared are required to be electronically filed.

Note: There is no provision in the law that allows for a preparer waiver from the mandate.

If the preparer prepares more than 100 California individual income tax returns in any calendar

year beginning January 1, 2003 or after, and in the following calendar year prepare one or more

using tax preparation software, then the taxpayer must e-file all acceptable individual returns in

that following year and all subsequent calendar years thereafter.

In order to be automatically enrolled in the e-file Program, the preparer needs to be an accepted

participant in the IRS e-file program. The FTB receives confirmation from the IRS after he or

she accept the preparer into their program.

The preparer uses the IRS-assigned Electronic Filer Identification Number (EFIN) to e-file with

FTB. If the preparer transmits returns, use the IRS-assigned Electronic Transmitter Identification

Number (ETIN) with FTB339.

The FTB e-file program will not shut down after October 15, but will continue year round and

support previous year electronic filing once the new production year is implemented in January.

338 R&TC §18621.9 339 FTB Pub. 1345 Handbook for Authorized e-file Providers

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e-file for Fiduciary Returns

Fiduciaries are able to e-file FTB Form 541, California Fiduciary Income Tax Return, for this

year and the past two tax years.

Forms you can e-file for fiduciary:

California Fiduciary Income Tax Return (Form 541)

Capital Gain of Loss (Schedule D-541)

Trust Allocation of an Accumulation Distribution (Schedule J)

Beneficiary's Share of Income, Deductions, Credits (Schedule K-1)

Alternative Minimum Tax and Credit Limitations – Fiduciaries (Schedule P)

Prior-year returns

Prior year returns can be electronically filed in the current year, plus two prior years (i.e., 2017,

2018, and 2019).

Amended returns

The FTB allows e-file for amended returns currently. The IRS is scheduled to implement their

amended e-file system in 2020. The FTB will coordinate with the IRS when they implement their

system.

New Payment Option in Web Pay for Individuals Individual taxpayers now have a new payment choice in Web Pay “Amended Return Payment”.

Taxpayers should select this payment type if he or she are filing an amended return, and

choosing to make a return payment electronically (instead of mailing a check). Go to ftb.ca.gov

and search for web pay. Mandatory Individual Electronic Funds Transfer (EFT).

Individuals are required to remit all payments electronically once he or she make an estimate or

extension payment exceeding $20,000 or the taxpayer files an original tax return with a total tax

liability over $80,000 for any taxable year that begins on or after January 1, 2009.

Once he or she meet this threshold, all subsequent payments regardless of amount, tax type, or

taxable year must be remitted electronically. The first payment that would trigger the mandatory

e-pay requirement does not have to be made electronically. Individuals that do not send the

payment electronically will be subject to a one percent noncompliance penalty.

https://www.ftb.ca.gov/forms/2019/2019-541.pdf

https://www.ftb.ca.gov/forms/2019/2019-541-d.pdf

https://www.ftb.ca.gov/forms/2019/2019-541-j.pdf

https://www.ftb.ca.gov/forms/2019/2019-541-k-1.pdf

https://www.ftb.ca.gov/forms/2019/2019-541-p.pdf

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Electronic payments can be made using Web Pay on Franchise Tax Board’s (FTB’s) website,

electronic funds withdrawal (EFW) as part of the electronic file return, or credit card. Web Pay

can be used for the following transactions:

Pay any personal income tax bill from us.

Pay the balance due on the current-year tax return.

Make an amended return payment (form FTB 540X).

Make an extension payment (form FTB 3519).

Pay any amount owed for prior years.

Pay any notice of proposed assessment.

Make a tax deposit for a pending audit payment

Refund Splitting

Taxpayers have the option of splitting their refund made by Direct Deposit (DDR) in up to two

accounts. Taxpayers requesting their refund be split must request the total refund amount be

electronically deposited between the two accounts. Taxpayers cannot receive part of their refund

by DDR and part by paper check.

Verifying Banking Information

To avoid DDRs or EFWs being returned by taxpayer’s banks, we encourage the use of double

entry or other techniques that require the taxpayer double check the entered bank account and

routing number information. This will help ensure the accuracy of the information.

MyFTB Account for Individuals340

This service allows taxpayers and their authorized representatives to change their address, view

current year payment activity, the total balance due on the account, up to 25 estimated payments,

and tax year summaries (tax computation) with payments applied. General Information Electronic filing ensures returns that are more accurate because electronic file software and the

FTB electronic file process verifies certain aspects of the return before it is accepted for

processing. These verifications ensure that electronically filed returns have the lowest error rate

of all returns filed. In addition, taxpayers and tax practitioners receive an acknowledgment for

each electronically filed return.

The FTB electronic file program checks the return information for completeness and accuracy, as

does the Federal program. When the electronic file program accepts the return, an

acknowledgement showing it is accepted is sent. If the FTB’s electronic file program rejects the

return, an ACK is sent identifying the problem(s) that caused the electronic file program to reject

the return. The return must be corrected and retransmitted for processing.

340 www.ftb.gov

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The following electronic returns may be filed:

Forms 540, 540NR Long, 540NR Short, 540 2EZ,

100, 100S, 100W, 100X,

199,

565, and

568

A participant in California’s electronic file program is an “Authorized FTB Electronic File

Provider.” The Authorized FTB Electronic file provider categories are:

An Electronic Return Originator (ERO) originates the electronic submission of income

tax returns. EROs may originate the electronic submission of income tax returns he or she

either prepared or collected from taxpayers. To be an ERO, the preparer must:

o Be an accepted participant in the IRS’s electronic file Program.

o Received an Electronic Filer Identification Number (EFIN) from the IRS.

o Passed the FTB suitability check.

Intermediate Service Providers receive tax return information from an ERO or a taxpayer,

process the tax return information or either forward the information to a transmitter and

send the information back to the ERO (or taxpayer).

Software Developers develop software for formatting electronic tax return information

according to FTB Publication 1346X, California Individual electronic file Guide for

Software Developers and Transmitters, or 1346B, Business Electronic file Guide for

Software Developers and Transmitters.

Transmitters transmit electronic tax return information directly to FTB.

Differences between the IRS and FTB electronic file Programs

The FTB follows the electronic file program requirements found in IRS Publication 1345341, to

the extent that he or she apply to FTB’s electronic file program.

Transmit all state tax returns and attachments directly to FTB in Sacramento, California.

Do not send paper documents to FTB.

Unlike the IRS, the FTB allows ERO’s and online filers to use a pen on paper signature

method (Form FTB 8453 series) in addition to electronic signature methods.

EROs and taxpayers must retain forms FTB 8453, FTB 8453-OL, FTB 8453-C, FTB 8453-

EO, FTB 8453-LLC, FTB 8453-P, or FTB 8879. Do not mail these to FTB.

Individual taxpayers must retain forms W-2, W-2G, 1099-R, 592-B, and 593, along with a

complete copy of the return.

The FTB does not have an “offset” indicator.

The FTB does not have an electronic signature option for business electronically filed

returns.

Electronic filing is mandatory for certain preparers of individual income tax returns.

341IRS Revenue Procedure 2007-40, 2007-26 I.R.B. 1488 (or the latest update) and Publication 3112

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Form 8454 – e-file Opt Out

For individual e-file returns, if the taxpayer chooses to file a paper return,

The FTB suggests that he or she sign the e-file Opt-Out Record for Individuals (FTB

8454).

The taxpayer must be allowed to review his or her completed tax return before signing

the return.

The preparer should always retain copies of all material furnished to the taxpayer.

Any material exchanged or retained by the taxpayer or preparer can be exchanged

electronically, provided copies of documents or information can be provided upon

request.

The preparer must comply with all the latest publications, forms, and notices governing

the e-file program individual e-file returns. If the taxpayer chooses to file a paper return,

the FTB suggests that he or she sign the electronic file Opt-Out Record for Individuals

(FTB 8454).

Suitability Check

The FTB may perform a suitability check on all applicants, or perform suitability checks on an

annual basis for continuing electronic file Program participants.

The purpose of the suitability check is to ensure that:

All business entities are valid and licensed.

All personal and business tax returns are timely filed.

All liabilities are paid or current

Fraud protection

The potential for fraud is a concern both at the federal and state level. The FTB is committed to

reducing the risk of fraudulent tax return filings. The tax preparer can help prevent and detect

fraud by:

Verifying the identity of new clients.

Informing clients that the FTB verifies W-2 and Child and Dependent Care Expenses Credit

information.

Verifying supporting information for the nonrefundable Child and Dependent Care Expense

Credit including:

o Visually inspecting the social security card to verify the child’s name and social

security number,

o Obtaining proof of care provided, such as copies of cancelled checks, and

o Reviewing taxpayer and spouse (if married) earned income to determine if he or she

meet the Child and Dependent Care Expenses Credit requirements.

Questioning Forms W-2 that appear altered or suspicious.

Identifying similar W-2 information between clients, such as employers, wages, and

withholding.

Identifying similar return information between clients, such as refund amounts, number of

dependents, and number of Forms W-2.

Questioning refunds on different returns directed to the same address or post office box.

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Asking taxpayers for social security cards and other documents to avoid incorrect social

security numbers (SSN’s) for taxpayers, spouses, and dependents on income tax returns.

Before preparing returns or accepting returns for electronic transmission, the tax preparer should

review two pieces of identification (picture identifications are preferable) from each new client.

One form of identification could include a picture reflecting at least the individual’s name

and the current address, such as:

Driver’s License

State Identification Card

Military Identification

Alien Registration Card

Passport

Veteran’s Identification Card

The second should include the same name and the SSN the individual is using to file the tax

return, such as:

o Social security card

o Work pay stub

Retention of this information is required for the later of four years from the due date of the

return; or four years from the date, the return is filed.

Suspension

The FTB reserves the right to suspend the electronic filing privilege of any Authorized FTB

electronic file provider who violates any provision of the requirements, specifications, and

procedures stated in the electronic filing procedures or who does not consistently transmit error-

free returns. The following reasons could lead to a warning letter and/or suspension of an

Authorized FTB Electronic File provider from the electronic file program. This list is not all-

inclusive:

Conviction of any criminal offense arising from a violation of California tax statutes or

revenue laws of the United States, or any offense involving dishonesty, or breach of trust

Non-compliance with the provisions of R&TC §§22250-22259 (Tax Preparer Act)

Failure to file timely and accurate returns, both business and personal

Failure to pay business or personal tax liabilities

Assessment of penalties under any of California’s tax statutes

Suspension/disbarment from practice before the IRS or local tax agency

Other facts or conduct of a disreputable nature that would adversely reflect on the

electronic file program

Misrepresentation on an enrollment form

Unacceptable format quality of individual transmissions

Unacceptable error rate

Violation of advertising standards

Unethical practices in return preparation

Stockpiling returns prior to official acceptance into California’s Eectronic File Program,

or at any time while participating in California’s Electronic File Program

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Failure of transmitters to provide taxpayers with acknowledgment files within 48 hours of

receipt from the FTB

Significant complaints about an Authorized FTB electronic file Provider

Misuse of an Authorized FTB electronic file Provider’s EFIN or ETIN

Practices inconsistent with the FTB’s recommendations revealed during site visits

Monitoring

The FTB staff site visits to tax practitioners, including Authorized FTB Electronic File Providers

who are participating in the electronic file program to monitor advertising and compliance with

mandatory electronic file law.

During the filing season to ensure that, the taxpayer is following the electronic file Program

requirements342. The FTB may ask the preparer to:

Produce a copy of the faxed or original signed form FTB 8453, FTB 8453-C, FTB 8453-

EO, FTB 8453-LLC, FTB 8453-P, FTB 8454, or FTB 8879 for all electronic filed

returns.

Demonstrate that copies of forms FTB 8453, FTB 8453-C, FTB 8453-EO, FTB 8453-

LLC, FTB 8453-P, FTB 8454 and FTB 8879 are being stored in a secure manner.

Produce any required electronic file documentation maintained for the entire filing

season.

Demonstrate that copies of taxpayer returns are maintained if the ERO is also the tax

preparer.

Produce a letter of acceptance into California’s Electronic File Program.

Produce a $5,000 surety bond and a Letter of Compliance from the California Tax

Education Council (CTEC) if the preparer is a registered tax preparer.

Produce record of clients who opted out of having their return electronic filed.

Disclosure of Electronic Return Information

An ERO shall not disclose or use any tax return information for a purpose other than preparing,

assisting in preparing, obtaining or providing services in connection with the preparation of tax

returns. Disclosure among accepted participants in California’s Electronic File Program for

preparing and transmitting the return information is permissible.

For example, it is permissible for an ERO to pass on tax return information to a Transmitter to

have an electronic return formatted and transmitted to the FTB. However, the return information

may not be disclosed or used in any other way.

Signing the Electronic Return

FTB offers pen-on-paper signature and electronic Signature options that will accept all signature

methods for all California individual electronic file return types (Forms 540, 540 2EZ, and

540NR Long and Short) throughout the duration of the electronic file season.

342 FTB Pub 1345

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Like the IRS, ERO’s may sign forms FTB 8453, 8454, 8455 and 8879 by rubber stamp,

mechanical device (such as signature pen) or computer software program343

Reminder: The taxpayer must be allowed to review his or her completed tax return before using

any of the signature options. In addition, the return must be signed before it is transmitted to the

FTB.

Individual electronic file Pen-on-Paper Signature Option – Form FTB 8453

Form FTB 8453, California electronic file Return Authorization for Individuals, is used when the

taxpayer and ERO sign using the pen on paper method.

Form FTB 8453 serves to:

Authenticate the return.

Authorize the ERO to file the return on the taxpayer’s behalf.

Authorize the ERO to either transmit the tax return electronically directly or through a

third party Transmitter.

Provide the taxpayer consented in writing to have his or her refund directly deposited or

his or her tax payment debited from their financial institution.

Authorize the FTB to inform the taxpayer’s ERO or Transmitter that the taxpayer’s return

has been accepted or rejected and when rejected, to identify the reason(s) for rejection.

Authorize the FTB to inform the taxpayer’s ERO or Transmitter of the reason(s) for

return processing delays or when the refund was sent.

Remind taxpayers who are filing balance due returns, of their liability for paying taxes,

and, if applicable, any interest and penalties.

Note: The ERO must provide the taxpayer with a copy of form FTB 8453, Forms W-2, W-2G,

and 1099-R and a copy of Form 540, Short Form 540NR, Long Form 540NR, or Form 540 2EZ

showing the electronic data transmitted to the FTB.

EROs must retain forms FTB 8453 at their place of business for four years from the due date of

the return or four years from the date the return was filed, whichever is later.

Failure to maintain forms FTB 8453 as required, or incomplete or erroneous forms may result in

immediate suspension from California’s Electronic File Program.

Electronic Signature Options- Individual Only

The FTB offers most of the same PIN methods as the IRS: the Self-Select PIN method, the

Practitioner PIN method, and the ERO PIN.

Practitioner PIN Method

Form FTB 8879, California e-file Signature Authorization for Individuals, is used when the

taxpayer signs using the Practitioner PIN Method. The Practitioner PIN method is an option only

available for taxpayers who use an ERO to e-file returns.

343 IRS Notice 2007-79

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Form FTB 8879 serves to:

Authenticate the return.

Authorize the ERO to file the return on the taxpayer’s behalf.

Authorize the ERO to enter the taxpayer’s PIN on the return on the taxpayer’s behalf.

Authorize the ERO to transmit the tax return either electronically directly or through a

third party transmitter.

Provide the taxpayer has written consent to have his or her refund directly deposited or

their tax payment debited from their financial institution.

Authorize the FTB to inform the taxpayer’s ERO or transmitter that the taxpayer’s return

has been accepted or rejected and when rejected, to identify the reason(s) for rejection.

Authorize the FTB to inform the taxpayer’s ERO or transmitter of the reason for return

processing delays or when the refund was sent.

Remind taxpayers who are filing balance due returns, of their liability for paying taxes,

and if applicable, any interest and penalties.

Note: The ERO must provide the taxpayer with a copy of Forms W-2, W-2G, and 1099-R and a

copy of Form 540, Short Form 540NR, Long Form 540NR, or Form 540 2EZ showing the

electronic data transmitted to us.

EROs must retain forms FTB 8879 at their place of business for four years from the due date of

the return or four years from the date the return is filed, whichever is later.

Failure to maintain forms FTB 8879 as required, or incomplete or erroneous forms may result in

immediate suspension from California’s e-file Program.

To sign using this method, the taxpayer(s) must:

Review the appropriate disclosure statements for their filing situation.

Select a PIN consisting of any five numbers (except all zeros).

Review and sign the California e-file Signature Authorization for Individuals (FTB

8879).

When taxpayers are Married Filing Jointly, each taxpayer must complete these steps.

By signing form FTB 8879, the taxpayer(s) gives the ERO a one-time authorization to enter their

PIN for their individual e-file return.

The ERO PIN

The ERO must use the ERO PIN when the taxpayer uses either the Self-Select PIN or

Practitioner PIN method to electronically sign their individual e-file return.

The ERO PIN is made up of two components:

1. The ERO’s six-digit electronic filer identification number (EFIN).

2. Any five numbers (except all zeros).

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Differences between the IRS & FTB e-Signature Programs

The FTB follows the IRS electronic signature specifications to the extent that he or she apply to

the Individual e-file Program. Key differences include:

Shared secret – The FTB requires the original California AGI, rather than the federal

AGI.

Prior-year nonresidents – Taxpayers who filed a Form 540NR in the previous year may

use any of the electronic signature methods for their current year return.

Prior-year non-filers – Taxpayers who did not file (or did not need to file) a California

individual income tax return in the previous year cannot sign their current year return

using the Self-Select PIN method. These taxpayers must sign the California e-file Return

Authorization for Individuals (FTB 8453) or use the Practitioner PIN method.

Extension of time to file – there is an automatic six-month extension of time to file

California individual income tax returns. No form or signature is required to receive this

extension.

Returns filed after cut-off – Taxpayers who filed their previous year’s California tax

return after November 15th cannot sign their current California tax return using the Self-

Select PIN method.

Electronic Signature Taxpayer Eligibility Requirements Practitioner PIN: All taxpayers are eligible to sign electronically using the Practitioner PIN

method, provided the ERO follows the fraud prevention procedures.

Self-Select PIN Method: Only taxpayers who filed a California individual income tax return

(Form 540, 540A, 540 2EZ, or 540NR) on or before November 15 are eligible to use the Self-

Select PIN method in the current year.

Note: If a taxpayer is ineligible to sign electronically using the self-select PIN method, he or she

may still e-file by signing the California e-file Return Authorization for Individuals (FTB 8453)

or by using the Practitioner PIN method.

Treasury Offset Program

An offset is when the federal tax refund is used to pay all or a portion of a state income tax debt

owed. If the full amount owed is not collected in one year, the FTB may offset future federal

payments to satisfy the tax debt.

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The United States Tax Code344 allows federal tax refunds to be offset to collect delinquent state

income tax obligations. The taxpayer will receive FTB Notice 1102PC, Intent to Offset Federal

Payments, which will provide a 60-day timeframe. During the timeframe if not all tax liabilities

listed in the notice, including ongoing interest are resolved; the FTB will send a request to the

Financial Management Service (FMS), a bureau of the U.S. Department of Treasury to offset any

federal income tax refund the taxpayer may be entitled to receive. Any payments sent to pay the

tax liability must be posted before the offset has been requested. The FTB 1102PC, Intent to

Offset Federal Payments will include a payment coupon to send in a check or money order

within 60 days. The FTB will continue to pursue federal offset activity even though the taxpayer

has an installment agreement with the FTB and is meeting the installment agreement terms. In

addition, any California state tax refund will be used as an offset until the amount is paid in full.

The U.S. Department of Treasury cannot issue any refunds after the offset has occurred, the FTB

will issue a refund of any overpayment after the offset is posted to the taxpayers’ account. If the

federal offset was from a jointly filed return, the FTB will issue the refund in both names.

If the taxpayer receives FTB 1102PC but believes he has paid the amount due the FTB, the

taxpayer should contact the FTB regarding the balance information.

Fraud protection and Identity Theft

The potential for fraud is a concern both at the federal and state level. The FTB is committed to

reducing the risk of fraudulent tax return filings. The tax preparer can help prevent and detect

fraud by:



information.


Credit including:


security number,






withholding.






344 §6402e

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Before preparing returns or accepting returns for electronic transmission, the tax preparer should

review two pieces of identification (picture identifications are preferable) from each new client.

One form of identification could include a picture reflecting at least the individual’s name

and the current address, such as:

o Driver’s License

o State Identification Card

o Military Identification

o Alien Registration Card

o Passport

o Veteran’s Identification Card

The second should include the same name and the SSN the individual is using to file the tax

return, such as:

o Social security card

o Work pay stub

Retention of this information is required for the later of four years from the due date of the

return; or four years from the date, the return is filed.

Identity theft occurs when a person knowingly transfers or uses, without lawful authority, the

identification of another person with the intent to commit any unlawful activity. The Better

Business Bureau estimates that more than 11.6 million Americans were victims of identity theft.

Identity theft costs a staggering $54 billion a year to businesses and consumers.

IRS and FTB use a comprehensive strategy to prevent, detect, and resolve identity theft cases

timely. Furthermore, they never collect confidential taxpayer information through email or phone

solicitation. The taxpayer should never provide personal information by phone or email to

persons who cannot verify their government employee status.

An indication that the taxpayer was victimized is when more than one tax return filed in the

taxpayers’ name or documentation that he or she received wages from an unknown employer. If

he or she believe identity theft affected their tax records, he or she should contact the FTB

Identity Theft Team.

• Website: Go to ftb.ca.gov and search for identity theft resolution

• Phone: 916.845.3669

• Mail:

IDENTITY THEFT TEAM MS A462

FRANCHISE TAX BOARD

PO BOX 2952


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Phishing

Phishing is typically carried out with the help of unsolicited email or a fake website to lure and

prompt potential victims to surrender valuable personal and financial information. Armed with

this information, a criminal can commit identity theft or financial theft. They never collect

confidential taxpayer information through email or phone solicitation. If you receive an

unsolicited email from the FTB or an organization linked to the FTB, call 916.845.7057, or email

[email protected].

California Registered Tax Preparers

All California Registered Tax Preparers must be 18 years of age and:

First complete 60 hours of qualifying tax education345

o 45 hours of Federal instruction and 15 hours CA instruction of basic personal

income tax law, theory, and practice tax education from a CTEC approved

curriculum provider is required

o A “Certificate of Completion” will be issued by CTEC upon registration

Then complete 20 hours of continuing tax education each year

o 15 hours in Federal taxation (2 Hours of Ethics, 3 Hours of Tax Update and 10

Hours of Tax Law) and 5 hours in California taxation from a CTEC approved

curriculum provider

Obtain a Preparer Tax Identification Number (PTIN) from the IRS

o Refer to Chapter One of the Ethics Section of this course

Always maintain a $5,000 tax preparer bond346 payable to the State of California

o The bond must be maintained with current information

o A tax preparer may not make a deposit in lieu of a bond.

o The preparer must furnish evidence of the bond required by this section upon the

request of any state, Federal agency or any law enforcement agency or the

California Tax Education Council.

NOTE: CTEC registration now requires a preparer to upload a copy of their bond policy while

registering or renewing. Please make sure to scan the bond certificate before the tax preparer

starts the registration and renewal process. Uploading the bond certificate was new during

registration in 2019. CTEC shall issue annually a “statement of compliance” when the tax

preparer completes the registration.

Refer to the Appendix in this section for the CRTP “Code of Conduct”

CTEC is authorized to consider “a minimum of two recent years’ experience in the preparation

of personal income tax returns” to determine if an individual has achieved “the equivalent of the

required qualifying education”. Those who prepared taxes in violation of the statute may not use

such time to qualify for this exception. Call CTEC to receive an Experience In Lieu of Education

Application.

345 CA B&PC §22255, Tax Education 346 CA B&PC §22250


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Anyone who has had a CPA, EA, or Attorney License for the last two years; anyone who was

employed by one of those three for the last two years; or anyone moving to California from out

of state with 2 years’ experience, may apply to receive an exemption from having to take the full

60-hr qualifying course.

Continuing Education

If an individual takes, a continuing education course before registering with CTEC, those CE

hours cannot be used toward the annual CE requirement. CE courses must be taken after an

initial CTEC registration. Providers need to be sure that individuals signing up to comply with

CTEC’s annual CE requirements are currently CTEC registered and have a valid CTEC ID

number.

CTEC Registration347

The following individuals must register with CTEC:

An individual who takes income tax data from a client and/or enters the data into the

computer and/or prepares the income tax return for compensation

An inactive CPA or a CPA from another state who prepares income tax returns for a fee.

A tax preparer who works for an exempt tax preparer but signs the return.

A tax preparer working for a CRTP who takes income tax data from a client and enters

that data in a computer.

A nonexempt tax preparer who prepares income tax returns that are bundled or included

with other services and receives a fee for the bundle of services, which include the

preparation of the income tax return.

The following individuals are not required to register with CTEC

Employees working for a CRTP who have no contact with clients and perform the

clerical function of inputting tax information into the computer for the employer.

An employee of a business unrelated to income tax preparation who prepare the

company’s tax return.

An employee of a business unrelated to income tax preparation compile the company’s

business income tax information for submission to a paid tax preparer who will prepare

the income tax return.

Online Registration Required

Online registration will be required each registration cycle year.

The registration must be completed by tax preparer after the education is completed and

the bond obtained.

The registration fee is $33

CTEC registration now requires you to upload a copy of your bond policy while

registering or renewing. Please make sure to scan the bond certificate before starting the

registration/renewal process.

Mail-in applications will be accepted only on a case-by-case basis.

347 CA B&PC §22258

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Late Fees and Registrations

Registration with CTEC is required by October 31 annually. CTEC allows a grace period of 10

weeks for registration with the payment of the late fee of $55. CRTPs who do not renew their

registration by January 15, and each year thereafter, will have to re-take the 60-hour qualifying

education course, pass a competency exam from an approved education provider and register as

a new CRTP.

Tax Preparation Services348 and Refund Anticipation Loans

Prior to rendering any tax preparation services, a tax preparer shall provide the customer in

writing with the tax preparer’s name, address, telephone number, and evidence of compliance

with the bonding requirement of Section 22250, including the bond number, if any.

A “Refund anticipation loan” is a loan, whether provided by the tax preparer or another entity,

such as a financial institution, in anticipation of a client’s Federal or state income tax refund or

both. A fee schedule must be given and explained to the taxpayer before entering into the

agreement.

Failure to Register 349

The California Franchise Tax Board (FTB) has the authority to identify and penalize

unregistered tax preparers. Failure to register as a tax preparer with CTEC, unless it is shown that

the failure was due to reasonable cause and not due to willful neglect, may result in the following

penalties:

The amount of the penalty under this subdivision for the first failure to register is $2,500.

This penalty shall be waived if proof of registration is provided to the Franchise Tax

Board within 90 days from the date notice of the penalty is mailed to the tax preparer.

The amount of the penalty under this subdivision for a failure to register, other than the

first failure to register, is $5,000.

NOTE: Every year there are students who complete their education, but do not complete their

registration with CTEC. Until the preparer registers online with CTEC they are not a CRTP and

can be subject to a late fee or fine.

Violations 350

The California Franchise Tax Board (FTB) is required to notify the California Tax Education

Council (CTEC) when it identifies an individual who has violated specific provisions regulating

tax preparers. CTEC is required to notify the Attorney General, a district attorney, or a city

attorney of the violation, and the entity so notified may do any of the following:

Cite individuals preparing tax returns in violation of provisions governing tax preparers.

Levy a fine on such individuals not to exceed $5,000 per violation.

Issue a cease and desist order effective until the tax preparer complies with the

registration requirement.

348 CA B&PC §22252 349 CA B&PC §22253 350 CA B&PC §22253.2

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Violators of other sections of the California Business & Professions Code, and California

Revenue & Taxation Code §19167 may be guilty of a misdemeanor, which offense is punishable

by a fine not exceeding $1,000, or by imprisonment in a county jail for not more than one year,

or by both. If a CRTP fails to perform a duty specifically imposed upon him or her pursuant to

this statute, any person may maintain an action for enforcement of those duties; or to recover a

civil penalty for $1,000, or for both enforcement and recovery.

Disclosures

The disclosure rules discussed in Circular 230 (Ethics Course, Chapter Two) are very similar to

those is the California Business and Profession Code §22252.1.

No confidential information obtained by a tax preparer, in his or her professional capacity,

concerning a client or a prospective client shall be disclosed by the tax preparer without the

written permission of the client or prospective client. Using the disclosure form with the wording

supplied in Circular 230 will apply to both the Federal and California.

Code Section 22252.1 allows the following exceptions:

Disclosures made by a tax preparer in compliance with a subpoena or a summons

enforceable by order of a court.

Disclosures made by a tax preparer regarding a client or prospective client to the extent

the tax preparer reasonably believes it is necessary to maintain or defend himself or

herself in a legal proceeding initiated by the client or prospective client.

Disclosures made by a tax preparer in response to an official inquiry from a Federal or

state government regulatory agency.

Disclosures made by a tax preparer or to a tax preparers’ duly authorized representative

to another tax preparer in connection with a proposed sale or merger of the tax preparer’s

professional practice.

Disclosures made when specifically required by law.

Disclosures made by a tax preparer to either of the following:

o Another tax preparer to the extent necessary for purposes of professional

consultation.

o Organizations that provide professional standards review and ethics or

quality control peer review.

Keep in Mind: Although it is allowed under Code §22252.1 to disclose to another preparer and

for peer review. It is always a good idea to have a signed disclosure form in your file. Taxpayers

often have varying ideas regarding the use of their personal information.

Refer to the Appendix for this section for a copy of the “Tax Preparer Code of Conduct”.

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Tax Preparer Penalties351

• Understatement by return preparer - $250 per return; $1,000 if noncompliance with

reportable transaction requirements, listed transaction, or gross misstatement; $5,000 if

willful or reckless.

• Failure of tax preparer to give taxpayer copy of return, furnish identifying number, or

retain copy or list - $50 for each failure up to $25,000 per return period.

• Negotiation or endorsement of client’s refund check by tax preparer - $250 per check

plus criminal penalty (misdemeanor) of up to $1,000 and/or up to 1 year in jail, and costs

of prosecution.

• Failure to file mandatory electronic return, except when failure is due to reasonable

cause, which may include a taxpayer-client electing not to e-file - $50 per non-electronic

return.

• Failure of tax preparer to register with California Tax Education Council - $5,000

($2,500 for first offense)

• Failure of tax preparer to exercise due diligence in determining eligibility for Earned

Income Tax Credit - $500 per failure

351 R&TC §§19166, 19167,19170, 19172

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.

What Do You Think?

Q1. The potential for fraud is a concern at both the Federal and state level. The

FTB is committed to reducing the risk of fraudulent tax return filings. The tax

preparer can help prevent and detect fraud by doing all of the following,

except

A. Verifying the identity of new clients.

B. Identifying similar W-2 information between clients, such as

employers, wages, and withholding.

C. Respecting the privacy of similar return information between clients, such as refund

amounts, number of dependents, and number of Forms W-2.

D. Asking taxpayers for social security cards and other documents to avoid incorrect social


Q2. Which of the following is not correct regarding California Registered Tax Preparers?

A. CTEC is authorized to consider a minimum of two recent years’ experience in the

preparation of personal income tax returns to determine if an individual has achieved the

equivalent of the required qualifying education.

B. All California Registered Tax preparers must have a PTIN.

C. The FTB is not required to notify CTEC when it identifies an individual who has violated

specific provisions regulating tax preparers.

D. All CTEC registered tax preparers must maintain a $5,000 bond.

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A1 – C – Is the correct answer

The potential for fraud is a concern both at the Federal and state level. The

FTB is committed to reducing the risk of fraudulent tax return filings. The

tax preparer can help prevent and detect fraud by:



information.


Credit including:


security number,






withholding.






A2: C – Is the correct answer The FTB is required to notify CTEC .The California Franchise Tax Board (FTB) is required to

notify the California Tax Education Council (CTEC) when it identifies an individual who has

violated specific provisions regulating tax preparers. CTEC is required to notify the Attorney

General, a district attorney, or a city attorney of the violation, and the entity so notified may do

any of the following:

Cite individuals preparing tax returns in violation of provisions governing tax preparers.

Levy a fine on such individuals not to exceed $5,000 per violation.

Issue a cease and desist order effective until the tax preparer complies with the registration

requirement,

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Chapter 9 – Nonresident Returns

The underlying theory of residency is that the taxpayer is

a resident of the place where he or she have the closest

connections. Any individual, who is not a resident, is a

nonresident. Nonresidents must file a state return, if they have California source income and

meet the filing requirements.

The following list shows some of the factors the taxpayer can use to help determine residency

status. Since the residence is usually the place where the taxpayer has the closest ties, he or she

should compare his or her ties to California with his or her ties elsewhere. In using these factors,

it is the strength of their ties, not just the number of ties, which determines residency. This is

only a partial list of the factors to consider. No one factor is determinative. Consider all the facts

of the particular situation to determine the residency status.

Factors to consider are as follows:

Amount of time spent in California versus amount of time spent outside California.

Location of the spouse/RDP and children.

Location of the principal residence.

State that issued the taxpayer a driver’s license.

State where taxpayers’ vehicles are registered.

State in which the taxpayer maintain their professional licenses.

State in which the taxpayer is registered to vote.

Location of the banks where the taxpayer maintains accounts.

The origination point of the financial transactions.

Location of medical professionals and other healthcare providers (doctors, dentists

etc.), accountants, and attorneys.

Location of social tie, such as, place of worship, professional associations, or social

and country clubs of which the taxpayer is a member.

Location of the taxpayers’ real property and investments.

Permanence of work assignments in California

Objective

Understand who is a nonresident

Compare regulations regarding

CA residents versus nonresidents

Understand and review FTB

Form 540 (NR)

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Safe Harbor Safe harbor is available for certain individuals leaving California under an employment related

contract. The safe-harbor provides that an individual domiciled in California who is outside

California under an employment related contract for an uninterrupted period of at least 546

consecutive days will be considered a nonresident unless either of the following are met:

The individual has intangible income exceeding $200,000 in any taxable year during

which the employment related contract is in effect.

The principal purpose of the absence is to avoid personal income tax.

The spouse or registered domestic partner of the individual covered by the safe harbor rule will

also be considered a nonresident while accompanying the individual outside California for at

least 546 consecutive days.

Return visits that do not exceed 45 days during any taxable year covered by the employment

contract are considered temporary.

Example: Frank is a California resident. He agreed to work in Guatemala for one year.

He returned to California after the employment contract expired and stayed for two

months. Then, he signed another contract with the same employer to work in Guatemala

for another year. He cannot be considered a nonresident under the safe harbor rule

because his absence from California for employment reasons was not for an uninterrupted

period of at least 546 consecutive days. He cannot combine the days he was overseas

from the two separate contracts.

Leaving California

Any individual who is a resident of California continues to be a resident when absent from the

state for a temporary or transitory purpose. An absence from California under an employment-

related contract for a period of at least 546 days may be considered an absence for other than a

temporary or transitory purpose.

Example: Karen was a resident of California, until September. At that time, she declared

herself a resident of Oregon, where she has a summer home. She continues to spend six

or seven months each year at her home in California, which she has retained. She spends

only three to four months in Oregon and the rest of the time traveling in other states or

countries. She transferred her bank accounts to Oregon. However, she continues to

maintain her social club and business connections in California.

Karen’s declaration of residency in another state does not establish residency in that state.

Her closest connections are to California and her absence from California is for

temporary or transitory purposes. She is, therefore, a resident of California and is taxed

on her income from all sources.

Coming into California.

When a taxpayer is present in California for temporary purposes, he or she is a nonresident of

California. For instance, if a taxpayer comes to California, for a vacation; or to complete a

transaction; or are simply passing through, the taxpayers’ purpose is temporary. As a

nonresident, a taxpayer is taxed only on income from California sources.

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When a taxpayer is in California for other than a temporary or transitory purpose, he or she is

considered a California resident. For instance, a taxpayers’ stay is other than temporary or

transitory if:

• A taxpayers’ employer assigns him to an office in California for a long or indefinite

period.

• A taxpayer retires and comes to California with no specific plans to leave.

• A taxpayer is ill and is in California for an indefinite recuperation period.

As a resident, a taxpayer is taxed on income from all sources.

If a taxpayer spends more than nine months in the state, he or she will be presumed to be a

California resident for that taxable year.

Determining California Tax as a Nonresident352

California computes taxable income353 for part-year or nonresident taxpayers as the income and

deductions regardless of the source while a resident of California and income and deductions

from a California source income while a nonresident.

Residency is not the same as domicile, which is an individual’s permanent home, the place to

which the individual, whenever absent, intends to return. California law specifically provides

that an individual whose permanent home is in California, but who is absent from the state for an

uninterrupted period of at least 546 days354 under an employment-related contract; will generally

be considered to be outside the state for other than a temporary or transitory purpose. The

taxpayer is considered a nonresident subject to California tax. A return to California for not more

than 45 days during a taxable year will not affect the nonresident status of such an individual.

The same rules will apply to a spouse who accompanies such an individual.

Domicile is defined for tax purposes as the place:

• Where a taxpayer and family voluntarily establishes with a present intention of making it

his or her true, fixed, and permanent home.

• To which he or she intends to return whenever he or she is absent.

Taxpayers can only have one domicile at a time. Once a taxpayer acquires a domicile, he or she

retains that domicile until acquiring another. A change of domicile requires all of the following:

• Abandonment of prior domicile.

• Physically moving to and residing in the new locality.

• Intent to remain in the new locality permanently or indefinitely as demonstrated by the

taxpayers’ actions.

352 R&TC §17014-§17016 353 R&TC §17041(h) 354 R&TC §17041

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A person may be domiciled outside California and still, by remaining in the state for other than

temporary or transitory purposes, be considered a California resident. A person domiciled in

California may not be considered a California resident if he or she remains outside the state for

purposes that are not temporary or transitory. It is not necessary to demonstrate residency in any

particular foreign state or country to avoid being considered a California resident.

For taxable years beginning on or after January 1 2002, if the taxpayer is a nonresident or a part-

year resident, the taxpayer determines the California tax by multiplying his or her California

taxable income by an effective tax rate. The effective tax rate is the California tax on all income

as if the taxpayer were a California resident for the current taxable year and for all prior taxable

years for any carryover items, deferred income, suspended losses, or suspended deductions,

divided by that income.

Use the following formula355

Prorated tax = California taxable income x Tax on total taxable income

Total taxable income

Schedule CA (540NR), California Adjustments –Nonresidents

The line numbers below refer to CA 540NR

Determines California taxable income by doing the following356:

Identify the domiciles and current and past residency information.

o Use Part I

Enter the amounts of income and deductions reported on the Federal tax return.

o Column A, Part II in the example shows all the income from the Federal return.

Adjust the income and deductions reported on the Federal tax return for differences in

California and Federal law.

o In the example the only law difference is for the business income, Line 12

Column C. California law adjustments (subtractions and additions), are shown in

Part II column B and C.

Determine the portion of income reported on the Federal tax return that was earned or

received while the taxpayer was an AZ resident in the example below.

o The taxpayer was a nonresident of CA for the entire year.

Example: John Sample, the taxpayer has lived in AZ since 2010. The taxpayer

came to California to do a security job 6 weeks. John is a shareholder in ABC

Corp, an S-Corporation. His wages from ABC Corp for the year is $79,500, of

which $19,500 are CA earnings, Line 1 column E, and received a CA K-1 from

the ABC Corp. for $10,000 of CA ordinary income, Line 17, Column E.

Determine the portion of income reported on the Federal tax return that was earned or

received from California sources while the taxpayer was a nonresident (shown in Column

E).

o Column D shows the income as if the taxpayer was California residents. Column

E shows the California source income earned in California. In this case, AZ the

resident state has a credit for taxes paid to other states, so the taxpayer is not

double taxed.

355 R&TC §17041(b) 356 Schedule CA (540NR) Instructions

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102

California

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The deduction percentage is computed by dividing the California Source income (Line 37,

Column E by the amount of California income under California law (line 37, column D). See

Below. Determine the allowable standard deduction or itemized deductions.

Important: If the taxpayer did not itemize deductions on his or her Federal tax return but will

itemize deductions on the California tax return, first complete Federal Schedule A (Form 1040).

Then complete Schedule CA (540NR), Part III and Part IV, Lines 1 through 5. Attach a copy of

Federal Schedule A (Form 1040) to your Long Form 540NR.

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Schedule CA Part IV

Line 1 – California AGI

Enter your California AGI from Part III, Line 23, Column E.

Line 3 – Deduction Percentage

Divide the CA Source Amount (line 23, column E) by (line 23, column D) the total

amount of CA income using CA law as if the taxpayer was a CA resident.

Carry the decimal to four places.

This number may not be greater than 1.0000. If the result is greater than 1.0000, enter

1.0000.

Line 4 – CA Itemized/Standard Deduction

Greater of itemized deductions or standard deduction multiplied by the deduction

percentage.

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Line 5 – California Taxable Income

(CA AGI minus the applicable percentage of CA itemized deductions equals the CA

Taxable Income), subtract line 4 from line 1.

If less than zero -0-. Transfer this amount to Form 540NR, line 35.

Multiple Scenarios of a Full Year Nonresident Return In all the following situations, the taxpayer is a full year nonresident. A nonresident is only taxed

on income derived from California sources.

California tax installment gains are received by a nonresident from the sale of tangible property

and intangible property on a source basis. California taxes real property based upon where the

property is located. Installment gains from the sale of intangible property are generally sourced

to the recipient’s state of residence at the time of the sale. California taxes residents on all

income regardless of source.

California taxes the installment proceeds received by a nonresident to the extent the income from

the sale was from a California source asset.

Example: The taxpayer has always been a nonresident of California but has owned rental

property in California for many years. On March 1, 2014, the taxpayer sold a California

rental property in an installment sale. The installment proceeds were comprised of capital

gain income and interest income.

The capital gain income is taxable by California, because the property was located in California.

The interest income is not taxable by California and has a source in the state of residence.

Example: The taxpayer is a nonresident of California. A parcel of land located in Idaho

was sold on an installment basis. The installment proceeds were comprised of capital gain

income and interest income.

The capital gain income is not taxable by California because the source of the gain is Idaho. The

interest income is not taxable by California and has a source in the state of residence.

IRA Deductions When a Nonresident Working in California

If the taxpayer files a Long Form 540NR, the IRA deduction on Schedule CA (540NR), line 32,

column E, is limited to the lesser of:

• The IRA deduction allowed on the Federal return.

• The compensation reported on Schedule CA (540NR), column E.

Example: The taxpayer is a nonresident of California who is under 50 years of age.

During the year, he worked temporarily in California. California compensation is $1,000,

which is reported on Schedule CA (540NR), column E. The Federal compensation is

$10,000. The allowable IRA deduction on the Federal return is $5,000 in 2019.

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The allowable California IRA deduction that is report on Schedule CA (540NR), column E, is

$1,000. This is the lesser of (1) the $5,000 IRA deduction allowed on the Federal return, or (2)

the $1,000 of compensation reported on Schedule CA (540NR), column E.

California does not impose tax on retirement income357 received by a nonresident after

December 31, 1995. For this purpose, retirement income means any income from any of the

following:

A qualified plan described in IRC Section 401.

A qualified annuity plan described in IRC Section 403(a).

A tax-sheltered annuity described in IRC Section 403(b).

A governmental plan described in IRC Section 414(d).

A deferred compensation plan maintained by a state or local government or an exempt

organization described in IRC Section 457.

An IRA described in IRC Section 7701(a)(37), including Roth IRA and SIMPLE.

A simplified employee pension described in IRC Section 408(k).

A trust described in IRC Section 501(c)(18).

A military pension, even if the military service was performed in California

A private deferred compensation plan program or arrangement described in IRC Section

3121(v)(2)(C) only if the income is either of the following:

1. Part of a series of substantially equal periodic payments (not less than annually)

made over the life or life expectancy of the participant or those of the participant

and the designated beneficiary for a period of not less than 10 years.

2. A payment received after termination of employment under a plan program or

arrangement maintained solely to provide retirement benefits for employees in

excess of the limitations on contributions or benefits imposed by the IRC.

• Any retirement or retainer pay received by a member or former member of a uniform

service computed under Chapter 71 of Title 10, United States Code.

Stock Options

Whether the taxpayer was always a nonresident or was formerly a California resident, California

taxes the wage income received by a nonresident from employee stock options on a source

basis,358

Example: While a California resident, the taxpayer was granted nonstatutory stock

options. He performed all of the services in California from February 1, 2013 to May 1,

2016, the date he left the company and permanently moved to Texas. On Jan 12, 2019,

the taxpayer exercised the nonstatutory stock options.

The income resulting from the exercise of the nonstatutory stock options is taxable by California

because the income is compensation for services having a source in California, the state where

all of the services were performed.

357 R&TC §17041(h) 358 FTB Pub 1100

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California Property Exchange for Property Out of State359

The taxpayer is a nonresident and exchanged real or tangible property located within California

for real or tangible property located outside California, the realized gain or loss will be sourced

to California. Taxation will not occur until the gain or loss is recognized. This requires the

preparer and the taxpayer to keep track of the deferred California sourced gains and losses to

report them to California in the year of sale or otherwise dispose of the property received in the

exchange.

Example: As a resident of Texas, the taxpayer exchanged a condominium located in

California for like-kind property located in Texas. The taxpayer realized a gain of

$15,000 on the exchange that was properly deferred under IRC Section 1031. Then the

taxpayer sells the Texas property in a nondeferred transaction and recognizes a gain of

$20,000.

The $15,000 deferred gain (the lesser of the deferred gain or the gain recognized at the

time the taxpayer disposed of the Texas property) has a source in California and is

taxable by California.

Property from Out of State Exchanged for California Property

The taxpayer exchanged real or tangible property located outside California for real or tangible

property located within California, the gain recognized when he sells or otherwise disposes of

the California property in a nondeferred transaction has a California source and is taxable by

California.

As a resident of Nevada, the taxpayer exchanged Nevada business property for like-kind

California business property. The taxpayer realized a $10,000 gain on the exchange that was

properly deferred.360 The taxpayer then sold the California business property in a nondeferred

transaction and recognized a gain of $50,000.

Since the property is located in California, the $50,000 gain has a California source and is

taxable by California.

359 FTB Pub 1100 360 IRC §1031

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CA Group Nonresident Tax Return

A group nonresident tax return is a single tax return that is for a group of individuals, also known

as a composite tax return that meets the California individual income tax return requirements.

Each individual in the group must determine if they must file a tax return. Each individual

follows the basic CA filing requirements (See Chapter 2 of this CA Tax Course); if they have

income over a certain amount and have income, which is source income to CA. Source income is

income, from a business, trade, or profession that conducts business both within and outside

California. The income generated from business conducted within California is California

source-income and is taxable in the state. Sourced income also includes rent from real property

located in California and the sale of real California property.

The business files the group nonresident return on behalf of its qualified nonresident individuals

to report their loss or pay tax on their share of state income. A qualified nonresident individual

must meet all the following:

Be an individual or a grantor trust

Be a full-year nonresident of California

The income or loss from the business is the only California source income or loss, unless

the other California source income or loss is being reported on another group nonresident

return.

A qualified nonresident individual does not file Form 540NR if they are part of the Group

Nonresident Tax Return.

Election to File a Group Nonresident Return

The business must make an annual election to file a group nonresident return. Once made, the

election is irrevocable for the tax year. Each year the business entity/corporation will allow each

nonresident individual the election to be included in the group nonresident return. Only a

qualified nonresident individual may elect to be included in the group nonresident return. Once

the group nonresident return is filed for the year, the individual’s election is irrevocable.

The business makes the election by attaching a completed and signed Group Nonresident Return

Election (FTB 3864) with the group nonresident return. On the group nonresident return, only

the California source income or loss from the business is reported. Individuals included in a

California Group Nonresident Return are taxed at the highest marginal personal income tax rate

for single taxpayers on California sourced income.

The business uses California Nonresident Tax Return (Form 540NR) for the group nonresident

return. A group nonresident return is required to file by the personal due dates of the individuals

in the group. The group nonresident return must be filed and any estimated payments must be

paid on a calendar year basis. A fiscal year end is not allowed, even if the business has a fiscal

year end. The business is required to make payments electronically.

For additional information, see FTB Pub 1067.

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What Do You Think?

Q1. Which of the following is not considered retirement income?

A. An interest bearing certificate of deposit in a local bank.

B. A tax-sheltered annuity described in IRC Section 403(b).

C. A governmental plan described in IRC Section 414(d).

D. An IRA described in IRC Section 7701(a)(37), including Roth IRA

and SIMPLE.

Q2. California taxes the wage income received by a nonresident from employee stock options

_________________, whether the taxpayer was always a nonresident or was formerly a

California resident.

A. On Form 1099-R

B. On a source basis

C. As a nontaxable distribution


Q3. If real property owned in California in 2016 is exchanged in a like-kind exchange for like

property in NY, what is the tax effect on the California return?

A. The CA return is not affected because the gain is recognized when the exchange is

completed.

B. The gain recognized will be reported on the California return when the property sells or is

otherwise disposed

C. Both A and B above

D. Neither A nor B above

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A1: – A – Is the correct answer

California does not impose tax on retirement income received by a

nonresident after December 31, 1995. For this purpose, retirement income

means any income from any of the following:

A qualified plan described in IRC Section 401.

A qualified annuity plan described in IRC Section 403(a).

A tax-sheltered annuity described in IRC Section 403(b).

A governmental plan described in IRC Section 414(d).

A deferred compensation plan maintained by a state or local government or an exempt

organization described in IRC Section 457.

An IRA described in IRC Section 7701(a)(37), including Roth IRA and SIMPLE.

A simplified employee pension described in IRC Section 408(k).

A trust described in IRC Section 501(c)(18).

A military pension, even if the military service was performed in California

A2: -B – Is the correct answer

Stock Options

California taxes the wage income received by a nonresident from employee stock options on a

source basis. Source income is taxable whether the taxpayer was always a nonresident or was

formerly a California resident.

The income resulting from the exercise of the nonstatutory stock options is taxable by California

because the income is compensation for services having a source in California, the state where

all of the services were performed.

A3: B – Is the correct answer

If real property owned in California in 2016 is exchanged in a like-kind exchange for like

property in NY, what is the tax effect on the California return?

A. The CA return is not affected because the gain is recognized when the exchange is

completed.

B. The gain recognized will be reported on the California return when the property sells or is

otherwise disposed

C. Both A and B above

D. Neither A nor B above

The taxpayer is a nonresident and exchanged real or tangible property located within California

for real or tangible property located outside California, the realized gain or loss will be sourced

to California. Taxation will not occur until the gain or loss is recognized. This requires the

preparer and the taxpayer to keep track of the deferred California sourced gains and losses to

report them to California in the year of sale or other disposition of the property received in the

exchange.

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Chapter 10 – California Credits

Ordering of Credits

Net tax (the regular tax plus the tax on lump-sum distributions less exemption credits, but in no

event less than the tax on lump-sum distributions) is the basic figure against which credits are

applied. These rules are necessary because of the variety of provisions for carryovers, refundable

rules, etc., in the various credits. Credits are allowed against the net tax in the following order361:

A. Credits, which do not contain a carryover or refundable provision, except for credits,

allowed reducing net tax below the tentative minimum tax.362 Form 540 Schedule P, Part

III, Section B.

B. Credits, which contain carryover provisions but do not contain refundable provisions

except after 2001 credits that may reduce net tax below the tentative minimum tax.363

C. Credits, which contain both carryover and refundable provisions.

D. The minimum tax credit allowed.

E. Credits that are allowed to reduce net tax below the tentative minimum tax.

F. Credits for taxes paid to another state.

G. Credits, which contain refundable provisions but do not contain carryover provisions.

Revisions to Credit Carryovers

If a taxpayer discovers that, a credit carryover on a personal income tax return was understated

or overstated due to the original credit not having been calculated properly, revisions must be

made to the carryover. When a credit carryover amount is revised, the tax return for the year the

credit was generated does not need to be amended if the tax liability remains the same for that

year. If the revision to the credit increases the tax liability for the credit year, an amended return

should be filed reporting the increase in tax due for that year and for any subsequent tax years

with an open statute of limitations where the eliminated credit carryover was used to reduce tax.

Conversely, if there is no change in tax liability for the credit year and subsequent years, no

amended return is required; instead, the change may be reflected on the current year’s tax return.

To correct a credit carryover amount on the current year’s return, the taxpayer should provide the

original credit form as filed; the amended credit form to show the revised credit generated;

supporting schedules, if any; a revised credit carryover schedule; and a detailed statement

explaining the changes.

361 CA Rev & Tax Code § 17039 362 CA Rev & Tax Code § 17063 363 CA Rev & Tax Code § 17062

Objective

Identify the new and expiring

CA tax credits

Understand the importance of the

order of CA credits.

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California Competes Credit

The sunset date for the California Competes Tax Credit (CCC) is extended until taxable years

beginning before January 1, 2030. For more information, go to the GO-Biz website at

business.ca.gov or ftb.ca.gov and search for ca competes or get form FTB 3531, California

Competes Tax Credit. The credit is not refundable. However, in the case where the credit

allowed exceeds the tax, the excess may be carried over to reduce the tax in the following year,

and the succeeding five years, if necessary, until exhausted.

The California Competes Credit is an income tax credit available to businesses that want to come

to California or stay and grow in California. Tax credit agreements are negotiated by GO-Biz and

approved by a newly created “California Competes Tax Credit Committee”.

In each fiscal year, no more than 20% may be allocated to any one taxpayer. Small businesses

will be able to apply for the credit. 25% of the amount of the credits, available each year will be

specifically reserved for small businesses (gross receipts of less than $2 million).

College Access Credit

The College Access Credit is a nonrefundable tax credit and is available after January 1, 2014

and before January 1, 2022, The College Access Tax Credit Program provides a tax credit to

taxpayers and businesses who contribute to Cal Grants, the State of California's largest source of

educational financial aid. The credit can be used to offset or reduce taxes. These grants help

California students achieve their higher education goals. The credit is based on a percentage of

taxpayers’ contribution to the College Access Tax Credit Fund.364

The College Access Tax Credit (CATC) is a credit available to individuals and business entities

that contribute to the CATC Fund. The California Educational Facilities Authority (CEFA)

administers the fund. The credit is a percentage of the amount the taxpayer contributed each

taxable year, 50 percent for 2016 through 2022.

The College Access Tax Credit, retroactive back to 2014, can reduce individuals and businesses’

regular tax below tentative minimum tax.365 Taxpayers whose credit was limited by tentative

minimum tax in the past can file amended returns.

The taxpayer must receive a certificate from CEFA before he or she can claim the credit on his

or her state income tax return. He or she may also be able to claim a charitable deduction on his

or her Federal tax return. If this credit is taken, the taxpayers must add back the amount of the

charitable deduction taken on your Federal return as a state adjustment on the California tax

return. He or she cannot claim a deduction and a credit for the same contribution.

For an application and more information about how to contribute go to the CEFA’s website.

The taxpayer is eligible to claim the credit for the taxable year he or she submits the application

364 R&TC §17053.86 365 AB 81

http://www.treasurer.ca.gov/cefa/catc/index.asp

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if all of the following occur:

CEFA received a completed application by their deadline

CEFA issued a Notice of Allocation Reservation.

The taxpayer provided CEFA a Contribution Submittal Form and contribution by the due

date listed on the Notice of Allocation Reservation.

CEFA provided you with a signed College Access Tax Credit Certification

Child and Dependent Care Credit366 - Form 3506

The differences between California and Federal law are as follows:

• California allows this credit only for care provided in California.

• If the taxpayer was a nonresident, the taxpayer must have earned wages from working in

California or earned self-employment income from California business activities.

• The California credit is a percentage of the Federal credit.

• RDPs may file a joint California return and claim this credit.

A qualifying person is:

1. A child under age 13 who meets the requirements to be the taxpayers’ dependent as a

Qualifying Child. A child who turned 13 during the year qualifies only for the part of the year

when he or she was 12 years old.

2. The spouse/RDP who was physically or mentally incapable of self-care.

3. Any person who was physically or mentally incapable of self-care and either:

a. Was the taxpayers’ dependent.

b. Would have been the dependent except that:

• He or she received gross income of $4,200 or more in 2019.

• He or she filed a joint tax return.

• The taxpayer or spouse/RDP if filing a joint tax return could be claimed as a dependent

on someone else’s 2019 tax return.

The Child and Dependent Care Expenses Credit is a non-refundable tax credit. The credit is

applied against the net tax liability. If the credit exceeds the net tax liability, the excess credit

cannot be refunded. The credit is allowed for household and dependent care expenses incurred

during the year that allowed the taxpayer to seek or maintain gainful employment.

The taxpayer qualifies to claim this credit if he or she meet all of the following for the tax year:

The Adjusted Gross Income is less than $100,000.

He or she had earned income equal to or exceeding the amount paid for child or

dependent care.

The taxpayer has a qualifying individual.

366 R&TC §17052.6, FTB Pub 737

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A qualifying individual is one of the following:

A dependent of the taxpayer who is under 13 years of age and for whom the taxpayer is

entitled to a dependent exemption credit.

The spouse of the taxpayer, if he or she is physically or mentally unable to care for him

or herself.

A dependent of the taxpayer who is physically or mentally unable to care for him or

herself and for whom the taxpayer was entitled to a dependent exemption credit without

regard to the gross income limitation.

The taxpayer may take the credit if all eight of the following apply.

1. If the taxpayer is married or an RDP, he or she must file a joint tax return.

2. Care must be provided in California for one or more qualifying persons.

3. The taxpayer paid for the care so the taxpayer and spouse could work or look for work.

4. The taxpayer (and spouse/RDP) must have earned income (wages or self-employment income)

during the year.

5. The taxpayer and the qualifying person(s) live in the same home for more than half the year.

6. The person who provided care was not the spouse/RDP, the parent of the qualifying child, or a

person for whom the taxpayer can claim a dependent exemption.

7. The taxpayer reported the required information about the care provider(s) in Part II, line 1, and

the information about the qualifying person(s) in Part III, line 2.

8. The Federal adjusted gross income is $100,000 or less.

Other State Tax Credit

California allows a credit for taxes paid to another state. The other state’s taxes must have been

imposed on income derived from sources within the other state. California considers the source

of compensation for services is in California or in the other state only to the extent, that the

services are actually rendered.

The majority of the time the credit is taken on the resident return.

A California resident with income from Arizona, Guam, Indiana, Oregon and Virginia

takes the credit on the other state nonresident return. A California resident takes any

income from any other state or U.S. possession on the California resident tax return.

A California nonresident where the taxpayer is a resident for Arizona, Guam, Indiana,

Oregon and Virginia takes the credit on the California nonresident return. A California

nonresident takes any income from any other state or U.S. possession on the other state

resident tax return.

Nonresidents and part-year residents are allowed all credits except the renter’s credit, and a

nonresident’s credit for taxes paid in the state of residence, in the same proportion as the ratio

used to determine the basis for tax under California law.

When a joint return is filed in California, the entire amount of tax paid to the other state may be

used in figuring the credit, regardless of which spouse/RDP paid the other state tax or whether a

joint or separate return is filed in the other state.

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When a joint return is filed in the other state and separate California returns are filed, the credit is

allowed in proportion to the income reported on each California return.

The definition of double-taxed367 income is for resident taxpayers claiming the credit to reflect

only income that would be sourced to California to a nonresident. In other words, the taxpayer

cannot take the credit if the other state taxes the nonresident on the income, but California would

not tax a nonresident on the same income.

Calculation of Credit:

Step 1: Calculate the amount of income taxable by both California and the other state.

Typically, it will be the same, although it may vary because of depreciation or other laws.

Step 2: Calculate a percentage of the double-taxed income taxable by California divided

by the California adjusted gross income. The percentage cannot exceed 100%. This

percentage is multiplied by the California tax liability.

Step 3: Calculate a percentage of the double-taxed income taxable by the other state

divided by the other state’s adjusted gross income. The percentage cannot exceed 100%.

This percentage is multiplied by the income tax paid to the other state for the same year

the income is taxed by California.

The credit is the lesser of the results of Step 2 or Step 3.

Items excluded from the computation:

• Taxes paid to any local government, such as a city or county.

• Taxes paid to the Federal government.

• Taxes paid to any foreign country.

• Any tax comparable to California’s alternative minimum tax paid to another state.

• Tax on net passive income, built in gains tax, gross income tax, and any special tax paid

to another state (S corporation).

Credit is allowed only if the other State does not allow California residents a credit for California

taxes. The purpose is to prevent the allowance of credits by both States at the same time. Under

this rule, credit is allowable only for taxes paid to the following States and possessions:

Alabama, American Samoa, Arkansas, Colorado, Connecticut, Delaware, Georgia,

Hawaii, Idaho, Illinois, Iowa, Kansas, Kentucky, Louisiana, Maine, Maryland,

Massachusetts, Michigan, Minnesota, Mississippi, Missouri, Montana, Nebraska, New

Hampshire (business profits tax), New Jersey, New Mexico, New York, North Carolina,

North Dakota, Ohio, Oklahoma, Pennsylvania, Puerto Rico, Rhode Island, South

Carolina, Utah, Vermont, Virginia (dual residents*), Virgin Islands, West Virginia,

Wisconsin, and the District of Columbia (unincorporated business tax and income tax, the

latter for dual residents only).

367 R&TC §18001

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California residents who are included in a group nonresident partnership368 return, filed with the

states listed above as well as Arizona, Indiana, Oregon, or Virginia may also claim a credit for

his or her share of income taxes paid to these states, unless any of these states allow a credit for

taxes paid to California on the group nonresident return.

Example: Jack Perk went to Connecticut for four months to work. He is a resident of

California. He earned $38,000 in Connecticut. Jack’s California adjusted gross income is

$111,790. The $38,000 earned in CT is also taxable to California since Jack is a resident

and California taxes all income from all sources. The $38,000 is double taxed income; all

the tax paid in CT will be a credit in Jack’s California return.

Joint Custody Head of Household Credit/Dependent Parent Credit

For the 2019 tax year, the California joint custody Head of Household/dependent parent credits

equal the lesser of 30% of the net tax or $484. The credits cover both dependent children and

dependent parents. The credits are subject to the same annual inflation adjustment as the

exemption credits. However, neither may be claimed if the taxpayer used either the Head of

Household or Qualifying Widow(er) filing status.

If, under a joint custody arrangement, a child lives with the custodial parent for more than half

the year, the noncustodial parent may be entitled to claim the Joint Custody Head of Household

Credit. The noncustodial parent may claim the Joint Custody Head of Household Credit if he or

she:

Is unmarried and not an RDP on the last day of the tax year; or files a separate return and

lives apart from his or her spouse/RDP for the entire year.

Maintains his or her home as the main home for a birth child, stepchild, adopted child, or

grandchild.

Lives with the child for at least 146 days, but not more than 219 days of the tax year.

Pays more than half the costs of maintaining his or her home for the year.

Possesses one of the following documents that indicates the taxpayers’ home was the

child’s main home for the above period:

o A decree of dissolution of marriage or registered domestic partnership.

o A decree of legal separation.

o A written agreement entered into after a divorce, dissolution of registered

domestic partnership, or legal separation proceeding began, but before the final

decree was issued.

368 R&TC §18535

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Dependent Parent Credit 369

The taxpayer may NOT claim this credit if he or she used the Single, Head of Household,

Qualifying Widow(er), or Married/RDP Filing Jointly filing status. Claim this credit only if all of

the following apply:

Was married/or an RDP at the end of the year and he or she used the married/RDP filing

separately filing status.

The taxpayers’ spouse/RDP was not a member of the taxpayers’ household during the

last six months of the year.

The taxpayer furnished over one-half the household expenses for his or her dependent

mother’s or father’s home, whether or not she or he lived in the taxpayers’ home

If the taxpayer qualifies for the Credit for Joint Custody Head of Household and the Credit for

Dependent Parent, claim only one. The maximum amount of both credits is $484. Select the

credit that will allow the maximum benefit.

Credit for Senior Head of Household 370

California allows a senior Head of Household to claim a credit equal to 2% of taxable income,

with a maximum California AGI of $78,441, and a maximum credit of $1,478 in tax year 2019.

The taxpayer may claim this credit if:

The taxpayer was 65 years of age or older on December 31, 2019.*

Qualified as a Head of Household in 2017 or 2018 by providing a household for a

qualifying individual who died during 2017 or 2018.

Did not have AGI over $78,441 for 2019.

* If the 65th birthday is on January 1, 2020, the taxpayer is considered to be age 65 on December

31, 2019.

If the taxpayer meets all the conditions listed above, they do not need to qualify to use the Head

of Household filing status for 2019 in order to claim this credit.

Use this worksheet to figure this credit using whole dollars only.

Credit for Child Adoption Costs 371

For the year in which an adoption decree or an order of adoption is entered (e.g., adoption is

final), claim a credit for 50% of the cost of adopting a child who was both:

• A citizen or legal resident of the United States.

• In the custody of a California public agency or a California political subdivision.

369 R&TC §17042.6 370 R&TC §17054.7 371R&TC §17052.25

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Treat a prior unsuccessful attempt to adopt a child (even when the costs were incurred in a prior

year) and a later successful adoption of a different child as one effort when computing the cost of

adopting the child. Include the following costs if directly related to the adoption process:

• Fees for Department of Social Services or a licensed adoption agency.

• Medical expenses not reimbursed by insurance.

• Travel expenses for the adoptive family.

Note:

• This credit does not apply when a child is adopted from another country or another state,

or was not in the custody of a California public agency or a California political

subdivision.

• Any deduction for the expenses used to claim this credit must be reduced by the amount

of the child adoption costs credit claimed.

Use the worksheet below to figure this credit using whole dollars only. If more than one adoption

qualifies for this credit, complete a separate worksheet for each adoption. The maximum credit is

limited to $2,500 per minor child.

1. Enter qualifying costs for the child ………………………………………1. ___________

2. Credit percentage — 50% ………………………………………...............2. ____x .50___

3. Credit amount. Multiply line 1 by line 2. Do not enter more than $2,500 .3. ___________

The allowable credit is limited to $2,500 for 2019. Carryover the excess credit to future years

until the credit is used.

Credit for Prior Year Alternative Minimum Tax

Individuals or Fiduciaries, compute the 2019 California credit for prior year alternative minimum

tax (AMT) incurred in a taxable year beginning after 1986.

To claim the credit for prior year AMT, individuals and fiduciaries must complete form FTB

3510. Individuals and fiduciaries qualify for the credit if one of following applies:

• Had an AMT credit carryover from 2018.

• Paid AMT for 2018, and had 2018 adjustments and tax preference items other than

exclusions.

Corporations must use Schedule P (100 or 100W), Alternative Minimum Tax and Credit

Limitations – Corporations, Part III to claim the credit for prior year AMT.

Young Child Tax Credit – For taxable years beginning on or after January 1, 2019, the

refundable Young Child Tax Credit (YCTC) is available to taxpayers who also qualify for the

California Earned Income Tax Credit (EITC) and who have at least one qualifying child who is

younger than six years old as of the last day of the taxable year. The maximum amount of credit

allowable for a qualified taxpayer is $1,000. The credit amount phases out as earned income

exceeds the "threshold amount" of $25,000, and completely phases out at $30,000. For more

information, see Step 8, Qualifications for Young Child Tax Credit FTB 3514 (YCTC) in the

instructions.

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New Young Child Tax Credit

Available to families making less than $30,000

Family that qualifies for CalEITC and has at least one child under age 6 will qualify for YCTC

Up to $1,000

Like CalEITC, YCTC phases out as income rises

An estimated 400,000 families may be eligible to claim the YCTC

California Earned Income Tax Credit

For taxable years beginning on or after January 1, 2015, the refundable California Earned

Income Tax Credit (EITC) is available to taxpayers who earned wage income in California. This

credit is similar to the Federal Earned Income Tax Credit (EITC) but with different income

limitations. EITC reduces the California tax obligation, or allows a refund if no California tax is

due. The taxpayer may qualify if he or she earned income of less than $14,162. The taxpayer

does not need a child to qualify, but must file a California tax return to claim the credit and

attach a completed form FTB 3514.

AB91 expanded the state’s Earned Income Tax Credit (EITC) in modified federal conformity.

For the period January 1, 2019 to December 31, 2019, it sets the amount of the EITC. After

January 1, 2020, and until the state’s minimum wage hits $15 per hour, there are revised

calculation factors to be recomputed annually for eligible individuals.372

Earned Income Tax Credit

A worksheet and tax tables for determining the amount of the California EITC allowed are

provided in the instructions for FTB 3514 (California Earned Income Tax Credit).

The differences between California and federal law are as follows:

California allows this credit for wage income (wages, salaries, tips and other employee

compensation) that is subject to California withholding.

If the taxpayer is a nonresident, he or she must have earned wage income that is subject

to California withholding.

Both the taxpayers’ earned income and federal adjusted gross income (AGI) must be less

than $55,952 to qualify for the federal credit, and less than $30,001 to qualify for the

California credit.

An eligible individual without a qualifying child is 18 years or older for the California

credit.

The taxpayer may elect to include all of their (and/or all of their spouse/RDP’s if filing

jointly) nontaxable military combat pay in earned income for California purposes,

whether or not he or she elects to include it for federal purposes. Get FTB Pub. 1032, Tax

Information for Military Personnel, for special rules that apply to military personnel

claiming the EITC.

372 §1, R&TC §17052

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EITC Instructions

If certain requirements are met, the taxpayer may claim the EITC even if they do not have a

qualifying child. The amount of the credit is greater if there is a qualifying child, and increases

with each child that qualifies, up to a maximum of three children.

Investment income is limited to less than $3,600 in 2019 to qualify for CA EITC. Investment

income includes interest, dividends, capital gain net income including gains from Form 4797,

and net income from passive activities (rental and pass-through activity)

Attach the completed form FTB 3514 to Form 540 or 540 2EZ, California Resident Income Tax

Return; or Long or Short Form 540NR, California Nonresident or Part-Year Resident Income

Tax Return, if you claim the California EITC.

Paid Preparer’s CA Earned Income Tax Credit Checklist

Paid preparers are required to complete FTB Form 3596 and file it with the tax return whenever

EITC is included. Paid preparers of California income tax returns or claims for refund involving

the California earned income tax credit (EITC) must meet due diligence requirements in

determining the taxpayers’ eligibility for, and the amount of, the EITC. Failure to do so could

result in a $500 penalty for each failure373.

Only paid preparers have to complete this form. If you were paid to complete a tax return for any

taxpayer claiming the EITC, attach the completed form FTB 3596, Paid Preparer's Due Diligence

Checklist for California Earned Income Tax Credit to the original or amended Form 540 or Form

540 2EZ, California Resident Income Tax Return, or Long or Short Form 540NR, California

Nonresident or Part-Year Resident Income Tax Return.

Additional information can be found in FTB Pub. 1001, Supplemental Guidelines to California

Adjustments, the instructions for California Schedule CA (540 or 540NR), and the Business

Entity tax booklets.

The CA due diligence form shown below is similar to the Federal return. Most software includes

it, but each circumstance is different and should be thoroughly reviewed and completed with

each return claiming CA EITC.

373 CA R&TC §19167(a)(5)

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What Do You Think?

Q1. Which of the following filing status may the taxpayer use to claim the Credit

for Dependent Parent?

A. Single

B. Head of Household

C. Married/RDP filing jointly

D. Married Filing Separately filing status.

Q2.The College Access Tax Credit is a credit available to individuals and business entities that

contribute to the CATC Fund. Which of the following is not correct?

A. The California Educational Facilities Authority (CEFA) administers the fund.

B. Taxpayers whose credit was limited by tentative minimum tax in the past can file

amended returns.

C. A taxpayer may take a charitable deduction on their Federal return and the College

Access Credit on the California return for the same contribution.


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A1 – D – Is the correct answer

Which of the following filing status may the taxpayer use to claim the Credit for

Dependent Parent?

A. Single

B. Head of Household

C. Married/RDP filing jointly

D. Married Filing Separately filing status

The taxpayer must meet all of the following criteria for the credit for Dependent Parent:

The taxpayer is married/registered domestic partner (RDP) but filed separately

The taxpayer’s spouse/RDP did not live with you the last 6 months of the year

The taxpayer paid over 1/2 of the household expenses for his or her parent

A2. The correct answer is C. The College Access Tax Credit is a credit available to individuals

and business entities that contribute to the CATC Fund. Which of the following is not correct?

A. The California Educational Facilities Authority (CEFA) administers the fund.

B. Taxpayers whose credit was limited by tentative minimum tax in the past can file

amended returns.

C. A taxpayer may take a charitable deduction on their Federal return and the College

Access Credit on the California return for the same contribution.


The College Access Tax Credit (CATC) is a credit available to individuals and business entities

that contribute to the CATC Fund. The California Educational Facilities Authority (CEFA)

administers the fund. The credit is a percentage of the amount the taxpayer contributed each

taxable year 50 percent for 2016 and 2022.

The College Access Tax Credit retroactive back to 2014 can reduce individuals and businesses’

regular tax below tentative minimum tax.374 Taxpayers whose credit was limited by tentative

minimum tax in the past can file amended returns.

The taxpayer must receive a certificate from CEFA before he or she can claim the credit on his

or her state income tax return. He or she may also be able to claim a charitable deduction on his

or her Federal tax return. If this credit is taken, the taxpayers must add back the amount of the

charitable deduction taken on your Federal return as a state adjustment on the California tax

return. He or she cannot claim a deduction and a credit for the same contribution.

374 AB 81

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California Appendix

Preparer Code of Conduct

It is the policy of CTEC to be sure CTEC Registered Tax Preparers (CRTPs) are aware of the

Tax Preparer Code of Conduct and Responsibilities.

Background: In 1996, the California Legislature passed the Tax Preparers Act, Business and

Professions Code 22250-22259, which regulates tax preparers. Those sections of the statute

pertaining to tax preparer ethics, professional conduct, conduct regarding bonding and penalties

for breaking the law are listed below.

A tax preparer is defined as "a person who, for a fee, assists with or prepares tax returns for

another person or who assumes final responsibility for completed work on a return on which

preliminary work has been done by another person, or who holds himself or herself out as

offering those services."

A tax return is defined as "a return, declaration, statement, refund claim, or other document

required be making or filing in connection with state or federal income taxes or state bank and

corporation franchise taxes."

The statute exempts the following:

An individual with a current valid license issued by the California Board of

Accountancy (and his or her employees while functioning within the scope of his or her

employment).

An individual who is an active member of the State Bar of California (and his or her

employees while functioning within the scope of his or her employment).

Some employees of a trust company or business as defined in the statute, a financial

institution and employees thereof who are regulated as defined in the statute.

Enrolled Agents (and their employees while functioning within the scope of their

employment).

CTEC Registered Tax Preparers (CRTPs): Must register as a tax preparer with the California Tax Education Council (CTEC).

Must maintain a $5,000 tax preparer bond issued by a surety company admitted to do business in

California. A tax preparer shall provide to the surety company proof that he or she is at least 18

years of age before a bond can be issued.

Must identify to the surety company all preparers employed or associated with the tax preparer

securing the bond.

Must file an amendment to the bond within 30 days of any change in the information provided in

the bond.

http://www.dca.ca.gov/cba/

http://www.dca.ca.gov/cba/

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Must not conduct business without having a current surety bond in effect.

Must cease doing business as a tax preparer upon cancellation or termination of bond until a new

bond is obtained.

Must furnish evidence of a current bond upon the request of any state or federal agency or law

enforcement agency.

Must prior to rendering any tax preparation services, provide the customer, in writing, with the

tax preparer's name, address, telephone number, evidence of compliance with the bonding

requirement including the name of your bond company and the bond policy number and the

address of the CTEC website, www.ctec.org. NOTE: CTEC registration now requires you to

upload a copy of your bond policy while registering or renewing. Please make sure to scan your

bond certificate before you start the registration/renewal process

Must not make fraudulent, untrue, or misleading statements or representations that are intended

to induce a person to use their tax preparation services.

Must not obtain the signature of a customer on a tax return or authorizing document that

contains blank spaces to be filled in after it has been signed.

Must not fail or refuse to give a customer, a copy of any document requiring the customer's

signature, within a reasonable time after the customer signs.

Must not fail to maintain a copy of any tax return prepared for a customer for four years from

the later of the due date of the return or the completion date of the return.

Must not engage in advertising practices that are fraudulent, untrue, or misleading, including

assertions that the tax preparer bond in any way implies licensure or endorsement of a tax

preparer by the State of California.

Must not violate provisions of Section 17530.5 or 7216 of Title 26 of the United States Code

prohibiting tax preparers from disclosing any information obtained in the business of preparing

federal or state income tax returns unless (1) consented to, in writing, by the taxpayer in a

separate document; (2) expressly authorized by law; (3) necessary for the preparation of the

return; and, (4) pursuant to court order.

Must not fail to sign a customer's tax return when payment for services rendered has been made.

Must not fail to return, upon demand by or on behalf of a customer, records or other data

provided to the tax preparer by the customer.

Must not give false or misleading bond information to a consumer or give false or misleading

information to a surety company in obtaining their tax preparer bond.

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California

Must apply for their Certificate of Completion within 18 months after completing their 60 hours

of qualifying education from an approved provider.

Must complete, on an annual basis, not less then 20 hours of continuing education from an

approved curriculum provider (10 hours federal tax law, 2 hours ethics, 3 hours federal tax

update and 5 hours California).

According to California Business & Professions Code Section 22253.2, and California Revenue

& Taxation Code Section 19167, when a person prepares a tax return, for a fee, without the

appropriate lawful designation, the Franchise Tax Board, pursuant to an agreement with the

California Tax Education Council, will do the following: (1) The amount of the penalty under the

subdivision for the first failure to register is two thousand five hundred dollars ($2,500). This

penalty shall be waived if proof of registration is provided to the Franchise Tax Board within 90

days from the date of notice of the penalty which is mailed to the tax preparer. (2) The amount of

the penalty for a failure to register, other than the first failure to register, is five thousand dollars

($5,000).

Violators of other sections of the statute are guilty of a misdemeanor, which offense is

punishable by a fine not exceeding $1,000, or by imprisonment in a county jail for not more than

one year, or by both. If a CRTP fails to perform a duty specifically imposed upon him or her

pursuant to this statute, any person may maintain an action for enforcement of those duties or to

recover a civil penalty in the amount of $1,000, or for both enforcement and recovery.

The Superior Court, in and for the county in which any person acts as a tax preparer in violation

of the provisions of this statute, may, upon a petition by any person, issue an injunction or other

appropriate order restraining the conduct.

1

2020

TaxEase, LLC

EXAM QUESTIONS

2

2020

TaxEase, LLC

3-HOUR TAX UPDATE

EXAM QUESTIONS

3

Final Exam – Tax Update

1. The filing deadline for tax returns has been extended from April 15 to July 15, 2020. Which

of the following will be timely filed if filed by July 15, 2020?

A. Elections that are made or required to be made on a timely filed form.

B. The first two 4/15 and 6/15 estimated payments due are required to be made in 2020.

C. Calendar year or fiscal year corporate income tax payments and return filings on Form

1120.

D. All of the above

2. The Emergency Paid Sick Leave Act (EPSLA) requires certain employers to provide an

employee with paid sick time. Which of the following is not correct regarding EPSLA?

A. An employee who has been advised by a health care provider to self-quarantine due to

concerns related to COVID-19 is eligible for EPSLA.

B. Paid sick time under EPSLA carries over from one year to the next.

C. The employee is experiencing symptoms of Covid-19 and is waiting to be tested is

eligible for ESPLA.

D. Length of employment does not stop the paid sick time from being available for

immediate use by employees.

3. Sam and Sally had an AGI of $130,000 in 2019 and received an economic impact payment of

$2,400. In June 2020, they had a baby; their AGI for the year was $102,000. What amount of

recovery rebate credit will they receive on their 2020 return?

A. $2,900

B. $500

C. -0-

D. $1,000

4. Peter, age 40 was laid off from his job due to Covid-19; he decided to take a $45,000

distribution from his IRA in June, 2020 to meet expenses for his family. Which of the

following statements is correct?

A. Peter includes the full $45,000 in income in 2020 to avoid the 10% penalty for early

withdrawal.

B. Peter may include in income $5,000 in 2020, $20,000 in 2021 and $20,000 in 2022 to

avoid the 10% penalty.

C. Peter must be 59 ½ to avoid the 10% penalty.

D. None of the above are correct.

5. Which of the following does not qualify as a qualifying individual of the Coronavirus-

Related Distribution Provision of the CARES Act?

A. An individual unable to work because his or her children were out of school and did not

have care.

B. An individual unable to work because he or she was quarantined due to exposure to the

virus.

C. An individual who had to reduce their work hours.

D. An individual who must work from home because his or her office was closed.

4

6. All of the following are correct regarding modifications to business interest in the CARES

Act, except?

A. The TCJA imposed the 30% limitation of interest expense deductions of adjusted

taxable income.

B. The CARES Act changes the limitation of interest expense deductions of adjusted

taxable income to 50%.

C. The 50% limitation applies to partnerships for any taxable year beginning in 2019.


7. Which of the following is not a correct statement regarding the Employee Retention Credit?

A. Under the CARES Act, eligible employers can take a credit against applicable

employment taxes for each calendar quarter.

B. The employee retention credit applies to wages paid after March 12, 2020, and before

January 1, 2021.

C. Qualified wages for each employee is limited to $10,000 for all quarters.


8. Which of the following items cannot be used from the PPP loan proceeds?

A. Salary, wages and commissions

B. Rent payments

C. Qualified sick leave wages for which a credit is allowed

D. Payment of any retirement benefit

9. Which of the following is an adjustment to income in 2020?

A. Food donations under $300.

B. Securities donation to a 501(c) charitable organization.

C. An above the line $300 charitable contribution to income.


10. Which of the following is a true statement regarding PPP loans?

A. The formula used to determine a loan applicant's maximum loan amount depends on

whether or not the applicant's business is seasonal.

B. The applicant must have been in business during a specified reference period.

C. In all scenarios, the maximum loan amount is determined by the applicant's payroll

costs, but cannot be more than $10 million.

D. All of the above

https://www.parkertaxpublishing.com/PDFs_Citable_ForAnalysis/CARES%20Act.pdf

5

11. Which of the following is a change to retirement accounts as part of the SECURE Act?

A. Penalty-free withdrawals from retirement plans for individuals in case of birth or


support. Distributions shall not exceed $5,000

B. Increase in age for required minimum distributions from 70½ to 72. Effective for



C. Taxpayers can elect to treat excluded difficulty of care payments as compensation for

determining retirement contribution limitations.

D. All of the above

12. Which of the following is not earned income for the Earned Income Credit?

A. Self-employment income;

B. Gross income received as a statutory employee;

C. Taxable disability benefits received under an employer's disability retirement plan

before reaching minimum retirement age.

D. Taxable social security income

13. Which of the following is not a correct statement?

A. The maximum wages subject to withholding for Social Security is $137,700.

B. The maximum charitable contribution to an IRA is $100,000.

C. The Saver’s Credit can be taken for a single taxpayer with AGI of $35,000.

D. The traditional IRA can be recharacterized from an IRA to a ROTH IRA.

14. All of the following is correct regarding the 2020 W-4, Employee Withholding Certificate,

except?

A. Employees will no longer be able to request adjustments to their withholding using

withholding allowances.

B. Employers are required to withhold federal income tax from each wage payment

according to the employee’s Form W-4 at the correct withholding rate.

C. The IRS may notify the employer to increase withholding if withholding reported on

the W-2 is not enough to cover the tax liability reported on the tax return.

D. The IRS recommends the use of the online W-4 calculator if the taxpayer works only

half of the year.

15. Which of the following is reported on Form 1099-NEC?

A. Payments are made in the course of a trade or business.

B. Personal payments

C. Direct sales of $5,000 or more.

D. All of the above

6

2020

TaxEase, LLC

10-HOUR TAX LAW

EXAM QUESTIONS

7

Final Exam – Tax Law

1. Which of the following qualifies for an Economic Impact Payment?

A. A dependent on another return.

B. An individual with no taxable income.

C. A Single taxpayer with $102,000 AGI.

D. A nonresident alien.

2. Which of the following is true regarding inflation increases to tax brackets in 2019?

A. The chained consumer price index results in lower inflation adjustments, which

means smaller annual increases than with the current tax.

B. Unlike tax brackets prior to TCJA (which uses a measure of the consumer price index

(CPI) for all-urban consumers), the inflation adjustment uses the chained consumer

price index for all-urban consumers (C-CPI-U).

C. The income tax bracket thresholds are all adjusted for inflation after December 31,

2018, and then rounded to the next lowest multiple of $100 in future years.


3. Which of the following is not correct regarding student loans under the CARES Act?

A. This includes automatic suspension of principal and interest payments on federally

held student loans from March 13, 2020 through September 30, 2020.

B. All payments of student loans to a private lender from March 13 through September

30 will apply directly to principal.

C. The CARES Act amends the existing code section to provide an exclusion from

income for payments of interest or principal made by an employer on any qualified

education loan incurred by an employee for the education of the employee.

D. Payments of student loan principal and/or interest by the employer is allowed up to

$5,250 in employer-paid educational assistance.

4. Which of the following is not correct regarding an IRA in 2020?

A. The taxpayer can convert the entire balance of a traditional IRA account to a Roth

account tax-free.

B. Tax Cuts and Jobs Act of 2017 banned recharacterization of a Roth back to a

traditional IRA.

C. To recharacterize a regular IRA contribution, the taxpayer must tell the trustee of the

financial institution holding the IRA to transfer the amount of the contribution plus

earnings to a different type of IRA (either a Roth or traditional) in a trustee-to-trustee

transfer or to a different type of IRA with the same trustee.

D. All of the items above are correct regarding IRS accounts in 2020.

8

5. Howard installs an elevator in his home because of his wife’s physical handicap. The

elevator costs $16,000 to install. The increase in the basis of the house is $10,000. How

much can Howard deduct as a medical deduction in the year of installation?

A. $5,000.

B. $6,000

C. $7,000

D. $25,000

6. In 2020, Peter paid real estate taxes on his personal residence of $5,950; $11,050 CA

income tax was withheld. How much is he allowed to deduct on Schedule A?

A. $5,950

B. $11,050

C. $10,000

D. $17,000

7. Which of the following is not a true statement regarding a Qualified Charitable

Deduction of an IRA?

A. A charitable deduction is allowed on a QCD that is excluded from income.

B. The taxpayer must be 70 ½ or older at the time of the QCD.

C. QCD’s are limited to $100,000 per taxpayer.

D. All or part of the taxpayers RMD may be included in the QCD.

8. Which of the following is correct when describing the temporary postponement or

reduction of mortgage payments?

A. Forbearance of mortgage payments.

B. Mortgage payment forgiveness. C. Borrower loan repayment. D. None of the above.

9. Many changes were made to charitable contributions for 2020. Which of the following is

not a change due to the CARES Act?

A. The adjusted gross income limit for cash contributions was increased for individual

donors. For cash contributions made in 2020, the taxpayer can elect to deduct up to

100 percent of their AGI.

B. The CARES Act changed the AGI limit for cash contributions for corporate donors.

Corporations can now deduct up to 75 percent of taxable income.

C. The CARES Act allows for an additional, “above-the-line” deduction for charitable

gifts made in cash of up to $300.

D. A Qualified Charitable Distribution (QCD) is a direct transfer of funds from an IRA

trustee to a qualified charity.

9

10. The Economic Impact Payment is considered an advanced refund for tax year 2020, which of

the following is considered a true statement? A. The taxpayer received more money based on his or her 2019 return than he or she

should have; if the payment was based on tax year 2020. The taxpayer must increase

his or her tax liability on the 2020 tax return by the excess amount of EIP received.

B. The EIP is included in gross income on the taxpayer’s 2020 return.

C. The EIP is excludable from income in 2020.

D. Taxpayers whose only income is Social Security are not required to file a tax return

and are not eligible for the EIP.

11. In 2020, which of the following is deductible subject to 2% of adjusted gross income?

A. Tax Preparer fees.

B. Union Dues.

C. Job search expenses for a new job in the same field.


12. In 2020, which of the following is correct regarding gambling income under TCJA?

A. Taxpayers must report the full amount of their gambling winnings (with no reduction

for gambling losses) for the year as income on Form 1040.

B. The taxpayer can deduct gambling losses (up to the amount reported as gambling

winnings) for the year separately on Schedule A (Form 1040) as a miscellaneous

itemized deduction not subject to the 2 percent floor.

C. When spouses file a joint return for the tax year, their combined gambling losses are

deductible to the extent of their combined winnings.


13. Which of the following is correct regarding a casualty loss in 2020?

A. Personal casualty losses, which include theft losses, are temporarily limited under the

Tax Cuts and Jobs Act of 2017.

B. The casualty loss must be federally declared, identifiable, unexpected, and unusual.

C. Any allowable casualty loss deductions are deductible as an itemized deduction and

subject to $100 per casualty and 10% of AGI limitations.


14. Which of the following will substantiate a charitable donation of less than $250?

A. Canceled check, bank or credit card statement.

B. Written communication from the donee showing the donations and the amount

contributed.

C. A written record of the date of the contribution, where it was contributed and the

amount of the gift.

D. All of the above

10

15. Which of the following does not apply to a professional gambler?

A. Professional gamblers can deduct business expenses as an itemized deduction.

B. A professional gambler can deduct his or her gambling business expenses on

Schedule C.

C. Professional gamblers’ losses are limited to winnings.

D. A written record of income and expenses are required as any other business.

16. Which items below are not found on Form 1098T?

A. The number of years the student has attended college.

B. Whether the student is a graduate student.

C. Scholarships or grants received

D. The employer identification number of college where the tuition was paid.

17. TCJA increases the contribution limitation to Achieving a Better Life Experience

(ABLE) accounts under certain circumstances. Which of the following is correct?

A. Contributions per-donee is the annual gift tax exclusion ($15,000 for 2020).

B. An ABLE account’s designated beneficiary can contribute an additional amount,

up to the lesser of (1) the federal poverty line for a one-person household; or (2)

the individual’s compensation for the tax year.

C. The beneficiary can claim the saver’s credit for contributions made to his or her

ABLE account.


18. Which of the qualified higher education expenses is not allowed for the Exclusion of US

Savings Bonds?

A. The costs of books or room and board.

B. Qualified expenses reduced by scholarships received.

C. Expenses paid for sports, games, or hobbies qualify only if part of a certificate

program are qualified expenses.

D. Expenses paid for a niece who is a dependent of the taxpayer are qualified

expenses.

19. Student Loans Discharged because of death or disability have been modified by TCJA.

Which of the following are qualifying loans?

A. The United States (or an instrumentality or agency thereof).

B. A state (or any political subdivision).

C. An educational organization that originally received the funds from which the

loan was made from the United States, a State, or a tax-exempt public benefit

corporation.


11

20. In reference to safe harbor being treated as a trade or business, rental services include all

of the items below, except?

A. Collection of rent.

B. Financial Services

C. Maintenance

D. Supervision of Employees

21. Which of the items listed pertaining to a Schedule E rental is true?

A. The taxpayer can depreciate the property from the time it is available to rent.

B. The taxpayer can deduct traveling expense to collect rent.

C. Repairs are considered an expense and deductible in the year they are paid.


22. Of the statements below, which is false regarding qualified business income related to

relevant pass-through entities (RPE)?

A. The entity must meet Code Sec. 162(a) “trade or business” requirements.

B. The QBI of an RPE is determined at the shareholder/partner level.

C. The QBI deduction will reduce or increase the adjusted basis of a partner’s

interest in the partnership or a shareholder’s basis in S corporation stock.


23. Which of the following is a correct qualification for Qualified Business Income?

A. Qualified business income does not include any amount paid by an S corporation

that is treated as reasonable compensation of the taxpayer.

B. The IRS can recharacterize “dividends” that are paid in lieu of reasonable

compensation to a S-Corp shareholder.

C. Guaranteed payments paid to a partner is not qualified business income.


24. Which of the following is correct regarding the QBI carryforward?

A. Sec 199A regulations clarify that QBI cannot be less than zero.

B. The carryforward of QBI does not affect the current-year deduction for purposes

of other sections of the code.

C. An overall loss after adding qualified REIT dividends and PTP income, the loss

from the REIT or PTP is carried forward and used to offset REIT/PTP income in

the succeeding year or years for Sec. 199A purposes.


12

25. Which of the following is not true regarding QBI?

A. The business income deduction applies at the partner and shareholders level.

B. SSTBs are not considered qualified businesses for individuals whose taxable

income exceeds certain thresholds.

C. Guaranteed payments paid to a partner in a partnership meet the definition of W-2

wages.

D. The taxpayer QBI amounts are calculated separately for each Qualified Business

and then combined to determine the taxpayers QBI deduction.

26. In 2019, which of the following is the correct answer regarding Qualified Business

Income?

A. A deduction for one-half of the self-employment tax, is subtracted from the

ordinary business income to determine the QBI amount.

B. Excess QBI deductions cannot be carried over to 2020.

C. Guaranteed payments from a partnership are included in QBI.

D. The QBI of a relevant pass-through entity is figured at the individual level.

27. Linus is an accountant and earned $85,000 of profit from his sole proprietorship. Linus is

married and his wife Lucy is an employee of ABC Corp. and earns wages of $198,000.

They have capital gain distributions of $65,400 and interest income of $12,000. Which

item will not be entered on Form 8995 to compute QBI?

A. Profit from sole proprietorship

B. Interest income

C. Lucy’s employee wages

D. All of the above

28. Of the professions below which is not a “Specified Service Business” for the computation

of the QBI deduction?

A. Lawyer

B. Financial advisor

C. Engineer

D. Professional basketball player

29. In regards to QBI, rental activity is defined and a safe harbor exists. With that in mind,

which of the following statements is correct?

A. A record of income and expenses must be kept separately for all rental activity.

B. Contemporaneous records are include hours of services performed.

C. Arranging financing for the rental is not considered a rental service.

D. All of these above are true statements.

13

30. Select the correct acquisition requirement for bonus deprecation.

A. The original use of the property must meet the requirements of IRC §§179(d)(2)(A),

179(d)(2)(B), 179(d)(2)(C) and 179(d)(3).

B. The property must not have been used by the taxpayer any time prior to acquisition.

C. The property can be new or used.


31. Under TCJA, which of the following is a component qualifying property for bonus

depreciation?

A. MACRS property that has a recovery period, regardless of any election made by

the taxpayer under the alternative depreciation system, of 20 years or less.

B. Computer software for which a deduction is allowable without regard to the bonus

depreciation rules.

C. The property meets either an original use requirement or acquisition requirement;

and was placed in service by the taxpayer before January 1, 2027.


32. Which of the statements below is not correct regarding vehicle expense for a vehicle used for

business?

A. A taxpayer can use either the standard mileage rate or the actual expense amount

when figuring the vehicle expense deduction. However, if the taxpayer wants to

use the standard mileage rate in future years, he or she must use the standard

mileage rate in the first year the vehicle is put in service.

B. An employee can take the standard mile rate if a vehicle is used for business; it is

reported as an itemized unreimbursed employee business expense deduction in

2020.

C. Beginning January 2020, the standard mileage rate lowers to 57.5 cents.

D. The standard mileage rate is figured using the total business miles multiplied by

the standard mileage rate.

33. Which of the following is a true statement regarding Section 179?

A. 2020 Section 179 deduction applies to new and used equipment, as well as off-

the-shelf software.

B. To take the deduction for tax year 2020, the equipment must be financed or

purchased and put into service between January 1, 2020 and the end of the day on

December 31, 2020.

C. 2020 Spending Cap on equipment purchases is the maximum amount that can be

spent on equipment before the Section 179. Deduction available to his or her

company begins to be reduced on a dollar for dollar basis.


14

34. When qualifying property is placed in service between September 28, 2017, and December

31, 2022, what is the maximum amount of bonus depreciation allowed?

A. 100%

B. 90%

C. 50%


35. When constructing a building which of the following is added to the land value?

A. Demolition costs

B. Building permit charges

C. Payments to contractors


36. Which item below is not added to the cost of an intangible asset?

A. The cost to buy the asset.

B. The cost to create the asset.

C. The time invested by the creator.


37. Which of the adjustments decreases the adjusted basis?

A. Capital improvements (having a useful life of more than one year).


C. Section 179 expense

D. Zoning costs

38. Which of the following categories of people do not qualify as ministers?

A. Those in traditional clergy roles (e.g., priests, pastors, rabbis) who typically

perform sacerdotal functions and conduct worship.

B. Those who work for secular organizations to the extent they perform sacerdotal

functions and conduct worship.

C. Those who control and maintain religious organizations at the local church or

denomination level.

D. Teachers at the day care associated with the church.

39. Which of the following is correct regarding a minister’ housing allowance?

A. The housing allowance is included in taxable income and subject to self-

employment tax.

B. The housing allowance is excluded from gross income, but subject to self-

employment tax.

C. The employer can leave the amount of the housing allowance to the minister.

D. None of the above are incorrect.

15

40. Which of the following is The Estate Tax exclusion for a married couple in 2020?

A. The exclusion for a married couple in 2020 is $11,580,000.

B. The exclusion is $23,160,000 for a married couple.

C. The exclusion for a married couple in 2020 is double the exclusion for a married

couple in 2019.


41. AMT is owed when the tentative minimum tax is _____________.

A. Higher than the regular tax

B. Below the AMT exclusion

C. Lower than the regular tax


42. Which of the following accounts is not reportable on Form 114?

A. Securities

B. Brokerage

C. U.S. Savings Bonds

D. Insurance policy with a cash value

43. The CARES Act, amended section 461(l) regarding the restrictions on excess business losses.

Which of the following is not correct?

A. The CARES Act repealed the limitation for tax years 2018, 2019, and 2020.

B. Form 461, Limitation of Business Losses, has been eliminated for those years.

C. A taxpayer who filed a 2016 or a 2017 return with the limitation, can file an

amended return.


44. The CARES Act expands taxpayer’s ability to deduct NOLs arising before the 2021 taxable

year. Which of the following is a true statement?

A. Temporary Lifting of 80% Limitation on NOLs.

B. A taxpayer that is a real estate investment trust for a given tax year may not carry

back NOLs incurred during that tax year to any preceding tax year.

C. NOLs carried forward from 2018, 2019 or 2020 to taxable years beginning after

December 31, 2020 will be subject to the 80% limitation.


16

45. As part of its ongoing security, the IRS has changed some of the requirements for applying

for an EIN. Which of the following is true?

A. Only individuals with tax identification numbers may request an Employer

Identification Number (EIN) as the “responsible party” on the application.

B. An EIN is a nine-digit tax identification number assigned to sole proprietors,

corporations, partnerships, estates, trusts, employee retirement plans and other

entities for tax filing and reporting purposes.

C. The change will prohibit entities from using their own EINs to obtain additional

EINs.


46. To have an NOL, a loss must generally be caused by deductions from which of the

following?

A. A trade or business

B. Casualty and theft losses resulting from a federally declared disaster,

C. Rental property


47. FinCen Form 114 is an informational reporting document reporting the ownership interest or

signature authority over a foreign bank or financial account of $10,000 or more. Which of the

following persons must file Form 114?

A. An agent, nominee, attorney, or a person acting in some other capacity on behalf

of the U.S. person with respect to the account.

B. A trust of which the U.S. person has an ownership percentage in the trust for U.S.

federal tax purposes.

C. A taxpayer who owns shares in a mutual fund located in France.


48. Which of the following is required to file Form 8938, Statement of Financial Assets?

A. A U.S. citizen, filing single, living in the U.S with a custodial financial account of

$75,000 in a foreign country.

B. A U.S. resident alien filing jointly with a foreign account of $80,000.

C. Both A and B are required to file.

D. Neither A nor B are required to file.

49. Which of the following statements is correct regarding virtual currency?

A. Virtual currency is a digital representation of value, other than a representation of

the U.S. dollar or a foreign currency that functions as a unit of account, a store of


B. Bitcoin is the most common type of virtual currency.

C. According to the IRS virtual currency is other income.


17

50. The insolvency exclusion of income is allowed when __________________.

A. He or she has declared bankruptcy under Title 11.

B. His or her total liabilities exceed his or her total assets.

C. The taxpayer gets a cancellation of debt form from a creditor.


18

2020

TaxEase, LLC

2-HOUR ETHICS

EXAM QUESTIONS

Final Exam - Ethics

1. Which of the following is correct regarding a preparer’s response to a client’s omission?

A. The tax preparer must advise the taxpayer immediately of the omission.

B. The preparer should amend the return and send it to the client.

C. The preparer can wait until the next tax season and discuss the omission with the

taxpayer at the tax appointment.


2. Which of the following would qualify as “best practices” as described in Circular 230

§10.33?

A. Advise the client clearly regarding withholding if they under withheld on his or

her 2019 tax return. Be sure the taxpayer understands your advice is based on the

return already prepared and not the following year information.

B. Represent the taxpayer fairly and reasonably before the IRS. Advise and assist the

taxpayer in preparation for an audit.

C. Be sure the taxpayer clearly answers all questions regarding Form 8867 and the

requirements for all refundable credits and head of household filing.

D. Establish the relevant facts presented making sure they are supported by the code

and law.

3. The Annual Filing Season Program is intended to recognize and encourage unenrolled tax

return preparers to voluntarily increase their knowledge and improve their filing season

competency through continuing education. Which of the following is not correct?

A. Enrolled Agents must complete the AFSP program to prepare tax returns for

payment

B. An unenrolled or unlicensed tax preparer may represent a tax client only if they

successfully complete the AFSP course.

C. All tax professionals who receive payment for preparation of a tax return must

have a PTIN.

D. A CA (CTEC) registered tax preparer can obtain a record of completion without

taking the AFTR exam.

4. Which of the following preparer’s do not need a PTIN?

A. The tax preparer who completes only Corporate returns for her bookkeeping

clients.

B. An individual who assists with the interview and preparation of tax returns for a

local preparer.

C. A professor who teaches tax preparation, an Enrolled Agent course at the local

college, but does not complete any returns except for his family.

D. A tax preparer who files tax returns in Oregon and passed all the requirements for

the Oregon Board of Tax Practitioners.

5. Which of the following is not a true statement regarding Form 8867?

A. Form 8867 must be included with any return claiming the Earned Income Credit.

B. A preparer must make reasonable inquiries of the taxpayer and keep notes on the

questions and responses.

C. Form 8867 must be completed for a taxpayer filing Married Filing Separately.

D. The tax preparer must retain a copy of Form 8867 for 3 years after June 30

following the date the return was presented to the taxpayer for signature.

6. Which of the following may be referred to Private Debt Collection?

A. A married filing joint return with AGI of $200,000.

B. A taxpayer whose income is substantially from social security benefits.

C. A taxpayer with income under 200 percent of poverty levels.


7. The general rule is that the preparer may rely in good faith and without verification upon

information furnished by the taxpayer. In reference to the term “due diligence,” which of

the following statements is not correct?

A. A practitioner can rely on the client’s determination on the application of the law

if the practitioner has discussed the law with his or her client.

B. A tax preparer must make reasonable inquiries if the information furnished by a

taxpayer seems incorrect .

C. A tax preparer may be judged to have met their due diligence if he or she applied

the same level of intenseness and care in preparation of the return as other tax

professionals would deem appropriate.

D. A preparer is not required to audit, examine, or review books and records,

business operations, documents, or other evidence to verify information provided

by the taxpayer.

8. Which of the following is correct regarding Circular 230, Section 10.35 new

competence standard?

A. The section no longer requires the notices at the end of emails making

communications with clients less complex.

B. The section eliminates the overly complex covered opinion rules.

C. The section requires practitioners to “possess the necessary competence to

engage in practice before the Internal Revenue Service”.


9. Which of the following is not an ordinary and necessary business expense that would be

deductible?

A. John drives an Uber 5 days a week. John gets four car washes a month.

B. Pete is a painter. He purchased 3 putty knives to scrape the windowsill

C. Don is a realtor. He buys new dress suits to wear to show houses.

D. Leslie is a caterer. She buys her own knife set to do the last minute prep work.

10. Which of the following is a correct statement regarding The Taxpayer First Act (TFA)?

A. TFA changes management and oversight of the IRS in order to improve customer

service.

B. TFA restricts certain IRS enforcement activities.

C. TFA authorizes modernization of departments within the IRS

D. All of the above are correct statements.

2020

TaxEase, LLC

5-HOUR CALIFORNIA

EXAM QUESTIONS

Final Exam - California

1. Which of the following is not correct regarding the CA response to the Covid-19 virus?

A. CA postponed tax return filing and payment deadline to July 15, 2020.

B. CA postponed real estate withholding on the sale of real property.

C. California does not have automatic conformity to the changes made with regard to

loans from a qualified retirement accounts.

D. CA does not conform to the federal changes to charitable contributions in the CARES

Act.

2. Which of the following is excluded from CA income in 2020?

A. Unemployment compensation

B. Expanded or additional unemployment compensation

C. Paid family leave compensation

D. All of the above are excluded.

3. Which of the following is part of the CA Small Business Plan created in response to Covid -

19?

A. Small business taxpayers with less than $5 million in taxable annual sales can take

advantage of a payment plan for sales and use tax.

B. The plan is a 12-month, interest-free, payment plan for up to $50,000 of sales and use

tax liability only.

C. All payment plans must be paid in full by July 31, 2021, to qualify for zero interest.


4. Which of the following is not a requirement of the new CA Healthcare Mandate?

A. This requirement applies to each resident, his or her spouse or domestic partner, and

his or her dependents.

B. A gap in coverage of 4 months is allowed and will not result in a penalty.

C. Covered California and the Franchise Tax Board each administer exemptions for

qualifying individuals.

D. The CA healthcare mandate has increased the residents who will be eligible for the

state financial subsidies.

5. California is the first state in the nation to offer subsidies to eligible middle-income

consumers who previously did not receive any financial assistance because they exceeded

federal income requirements. Which of the following is not correct regarding this new

program?

A. Covered CA is the states health insurance marketplace.

B. CA residents may meet their individual shared responsibility if they are on the Medi-

Cal program.

C. Covered CA is working with the FTB to alert all Californians to the new law.


https://www.cdtfa.ca.gov/news/20-07.htm

6. Which of the following would be the total amount a couple would have to pay in Mental

Health Tax if they were filing Married Filing Jointly with total income of $2,150,000.

A. $1,150

B. $21,500

C. $11,500

D. $2,150

7. Which of the following is not correct regarding California Personal Income Tax?

A. Residents are taxed on their entire income wherever derived.

B. The California Personal Income Tax Law conforms to the Tax Cuts and Jobs Act for

taxable years beginning on or after January 1, 2020.

C. The personal income tax applies to all sources of income unless specifically excluded.

D. California source income includes wages and salaries, interest, dividends, business-

related income and capital gains.

8. Which of the following does not have to file a CA Nonresident return?

A. The taxpayer who lives in NV with his family but works in CA.

B. The taxpayer comes to CA to work for six months at a branch of office of his

employer.

C. The taxpayer who lives in Colorado but receives a pension from his employment

as a CA firefighter.

D. All of the above must file a CA Nonresident tax return

9. Which of the following is correct regarding Assembly Bill 91 (AB91)?

A. AB91 is known as the “Loophole Closure and Small Business and Working

Families Tax Relief Act of 2019.”

B. Expanded CA Earned Income Tax Credit. C. Allowed limited conformity to TCJA.


10. Which of the following will reduce the taxpayers’ regular tax below the tentative minimum

tax?

A. California Competes Credit

B. College Access Tax Credit

C. Nonrefundable Renter’s Credit


11. Which of the following is not taxable to CA?

A. Interest on US obligations.

B. Muni bonds that have at least fifty percent invested in CA.

C. Lottery winnings.


12. Which of the following is correct regarding the processing of Head of Household tax retuns

starting in 2019?

A. The FTB will be able to determine if the taxpayer qualifies for Head of Household

filing status when the return is processed.

B. A Notice of Tax Return Change can be issued at the time of filing.

C. A Notice of Proposed Assessment can be issued at the time of filing.


13. Which of the following is correct regarding Form 593, Real Estate Withholding Tax

Statement?

A. The person who will remit the withheld tax on any disposition from the sale or

exchange of California real estate (remitter) is required to complete the applicable

part(s) of Form 593 and submit Sides 1-3 to the Franchise Tax Board (FTB)

regardless of real estate transaction.

B. Form 593, Real Estate Withholding Tax Statement, Form 593-C, Real Estate

Withholding Certificate, Form 593-E, Real Estate Withholding – Computation of

Estimated Gain or Loss and Form 593-I, Real Estate Withholding Installment Sale

Acknowledgment are part of 2020 Form 593.

C. The buyer or transferor of the property is responsible for withholding (although

this is normally handled by the escrow company) and may become subject to

penalty for failure to withhold.


14. Which of the following transactions require the taxpayer to file Form 593?

A. Land located in California sold for $185,000.

B. The sale of rental property held 7 years.

C. A like-kind exchange of CA rental property

D. All of the sales require the filing of CA Form 593

15. Which of the following is not correct regarding California, Like-Kind Exchange?

A. CA does not conform to the Federal limiting of like-kind exchange to real

property.

B. A taxpayer must file FTB 3840 when CA property is exchanged for out of state

property.

C. A taxpayer who is required to file FTB 3840 must continue to do so each

subsequent year until the exchange is final.


16. Which of the following California taxpayers’ is required to remit all of their payments

electronically in 2020?

A. A taxpayer who paid the following 2020 estimated vouchers – Voucher 1 - $18,000,

Voucher 2- $24,000, Voucher 3 -0-, Voucher $ $18,000.

B. A taxpayer that paid taxes each year of over $1,000 for the last three years.

C. A taxpayer who is subject to the Mental Health Tax.


17. If the taxpayers’ ____________________________, the taxpayer does not owe Alternative

Minimum Tax.

A. Regular tax is less than the tentative minimum tax

B. Tentative minimum tax is less than the regular tax

C. Alternative minimum tax is less than regular tax


18. Which of the following is required to register with CTEC?

A. An EA

B. An employee who works for an exempt tax preparer but signs the return.

C. Employees working for a CRTP who have no contact with clients and perform the

clerical function of inputting tax information into the computer for the employer.

D. All of the above

19. What are the consequences if a tax preparer is identified as an individual who has violated

specific provisions regulating tax preparers?

A. Issue a cease and desist order effective until the tax preparer complies.

B. Levy a fine on such individuals not to exceed $5,000 per violation.

C. Cite individuals preparing tax returns in violation of provisions.


20. Sam lived in Las Vegas; he owned his home and had his bank account there. In December

2019, Sam came to Los Angeles for an indefinite time-period to work. In January 2020, he

sold his home in Las Vegas, and purchased a home in Los Angeles. Which of the following

is correct?

A. Sam is a part-year resident of CA in 2019.

B. Sam became a resident of CA in December 2019.

C. Sam became a resident of CA in January 2020.

D. Sam became a resident when he sold his home in Las Vegas.

21. Net tax is the basic figure against which credits are applied. Credits are allowed against the

net tax in a specific order. Which of the following would be applied first?

A. Credits, which do not contain carryover provisions or refundable provisions.

B. Credits, which contain both carryover and refundable provisions.

C. The minimum tax credit allowed.

D. Credits for taxes paid to another state.

22. In reference to the Child and Dependent Care Expense Credit all of the following statements

are correct, except?

A. The Child and Dependent Care Expenses Credit is a non-refundable tax credit.

B. If the credit exceeds the net tax liability, the excess credit cannot be refunded.

C. The credit is allowed for household and dependent care expenses incurred during the

year that allowed the taxpayer to seek or maintain gainful employment.

D. A taxpayer whose AGI is $105,000 is allowed to claim the Child and Dependent Care

Credit.

23. On January 25, 2019, Joe donated $15,000 to the College Access Tax Benefit Fund. Joe

received a certificate for the donation from the College Access Tax Credit Fund. How is the

donation reported on Joe’s 2019 CA tax return?

A. Joe took a $15,000 charitable donation deduction on both his Federal and CA return.

B. Joe took a $15,000 refundable credit on his CA return.

C. Joe took a $7,500 charitable donation deduction on both his Federal and CA return.

D. Joe took a $7,500 nonrefundable credit on his CA return.

24. Which of the following statements is not correct regarding the Young Child Tax Credit?

A. The taxpayer must qualify for the CA Earned Income Tax Credit.

B. The YCTC has no income phase-out

C. The maximum YCTC credit is $1,000.

D. The qualifying child must be younger than six years old as of the last day of the

taxable year.

25. Which of the following is not correct regarding CA EITC Due Diligence?

A. The tax preparer does not have to complete CA Form 3596, if the federal due

diligence form was completed and included in the return,

B. Form 3596 must be filed with the taxpayer’s original or amended tax return,

C. The tax preparer must keep the due diligence checklist for four years.

D. Only paid preparers are required to complete FTB 3596.

E.

Fed. Tax Law Fed. Tax Update

Ethics

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1 A B C D 26 A B C D 1 A B C D 1 A B C D










11 A B C D 36 A B C D 11 A B C D

12 A B C D 37 A B C D 12 A B C D

13 A B C D 38 A B C D 13 A B C D

14 A B C D 39 A B C D 14 A B C D

15 A B C D 40 A B C D 15 A B C D

16 A B C D 41 A B C D California Tax

17 A B C D 42 A B C D A B C D A B C D









9 A B C D 22 A B C D

10 A B C D 23 A B C D

11 A B C D 24 A B C D

12 A B C D 25 A B C D

13 A B C D

Answer Sheet Instructions

Using ink mark an X in the column that reflects

the correct answer.

Example: Question 1 – How many inches are

in a foot?

A. 9 B. 6 C. 3 D. 12

Question A B C D

1 A B C X

2 A B C D

3 A B C D

Name: ______________________

Date: _______________________

TaxEase, LLC

2020 Answer Sheet 20 Hour Continuing Education

2020 PERSONAL INFORMATION FORM

This form must be completed and returned to TaxEase with your Answer Sheet in

order for us to complete our grading process.

ORDER NUMBER: Locate this number on your Confirmation Email from TaxEase. If you

do not have your Confirmation Email, TaxEase will enter the order number upon submission.

NAME* (AS IT SHOULD APPEAR ON THE CERTIFICATE):

PLEASE PRINT CLEARLY

EMAIL ADDRESS* (ALL CERTIFICATES ARE EMAILED):

PLEASE PRINT CLEARLY

DAYTIME PHONE NUMBER* CTEC NUMBER* PTIN

HOW DID YOU HEAR ABOUT TAXEASE?

USED PREVOUSLY INTERNET IRS WEBSITE CTEC WEBSITE

OTHER

PLEASE COMPLETE THE SECTION BELOW IF YOU WISH TO PURCHASE A PAPER

CERTIFICATE FOR $15.00:

CREDIT CARD NUMBER:

CARD EXPIRATION DATE:

NAME ON CARD:

SIGNATURE OF THE CARD HOLDER:

MAILING ADDRESS FOR THE CERTIFICATE:

SUBMISSION INSTRUCTIONS:

Be sure that your name and the date of submission are on the answer sheet.

Complete the Personal Information Form above and the Evaluation Form

EMAIL or FAX the Answer Sheet, Personal Information Form, and Evaluation Form to:

Email – [email protected] Fax – (510) 779-5251

All paper answer sheets must be emailed or faxed.

*Required Information: All required information must be completed in order for TaxEase to grade the exam.

TAXEASE REPORTS EDUCATION TO CTEC. IT IS

THE STUDENT’S RESPONSIBILITY TO COMPLETE

THEIR REGISTRATION RENEWAL WITH CTEC

ANNUALLY.

THE IRS REQUIRES THAT TAXEASE REPORT

THE STUDENTS CONTINUING EDUCATION

TO THE IRS IF THE STUDENT PROVIDES US

WITH THEIR PTIN.


2020 TaxEase Course Evaluation

2020 TAX UPDATE COURSE

IRS COURSE NUMBER: B8FQK-U-00036-20-S CTEC COURSE NUMBER: 3064-CE-0060

2020 TAX LAW COURSE

IRS COURSE NUMBER: B8FQK-T-00035-20-S CTEC COURSE NUMBER: 3064-CE-0063

2020 ETHICS COURSE

IRS COURSE NUMBER: B8FQK-E-00033-20-S CTEC COURSE NUMBER: 3064-CE-0062

2020 CALIFORNIA TAX COURSE

CTEC COURSE NUMBER: 3064-CE-0061

Student’s Name: ____________________________ Date: ___________________

Tax

Update

Tax

Law

Ethics CA

Date Program Completed

Hours Spent to Complete

Instructions: Please comment on all the following evaluation points on the programs and

assign a number grade, using 1-5 scale, with 5 being the highest.

Tax

Update

Tax

Law Ethics CA

Were the stated learning objectives met?

Were the course materials accurate and relevant,

and did they contribute to the achievement of the

learning objectives?

Was the time allocated to learning adequate?

Was the course syllabus satisfactory?

Part of the course you found most beneficial:

Part of the course you found least beneficial:

Additional Comments:

Please return with your completed answer sheet

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