Tag: IRS

Underestimated Tax Payments

July 23, 2024
Taxes

One of the items that I look at when I review an income tax return for our clients is whether the taxpayer was assessed an underpayment penalty. I have discovered that a lot of clients are not aware of how much these rates have increased and what they can do to reduce the penalty. Hopefully, the following will be helpful to you if you are subject to paying estimated income tax penalties.

First and foremost, remember that the payment of income taxes is a concept of “pay as you go” method. This refers to the system where taxpayers are required to pay their income taxes throughout the year as they earn income, rather than paying the entire amount owed at the end of the tax year.

The Internal Revenue Service imposes penalties for underpaying estimated income taxes throughout the year. These penalties, known as the “estimated tax penalty” or “underpayment penalty,” are calculated separately for each quarter based on the amount of unpaid tax for that period.

How the Penalty is Calculated:

The penalty equals the federal short-term interest rate (in the first month of the quarter in which taxes were not paid) plus 3 percent. As of mid-2024, the estimated tax penalty has reached a whopping 8% – the highest it has been since 2007. This penalty is not deductible, so the effective rate is even higher.

Avoiding the Penalty:

To avoid the underpayment penalty, individuals with an adjusted gross income (AGI) of $150,000 or less must pay by the due date of the tax return the lesser of:

90% of the current year’s tax liability (paid through withholdings or timely quarterly estimates)
100% of the previous year’s tax liability

For those with an AGI above $150,000, the threshold is higher at 110% of the previous year’s tax liability. These amounts can be paid through a combination of withholding from paychecks and timely quarterly estimated tax payments.

It’s important to note that meeting the safe harbor requirement (either 100% or 110% of the previous year’s tax liability) guarantees avoidance of underpayment penalties, regardless of your actual tax liability for the current year. However, if you expect your income to decrease, you may choose to pay 90% of your estimated current year tax liability instead, though this carries more risk of penalties if your estimate is too low

Safe Harbor Rules

The IRS provides “safe harbor” rules that allow taxpayers to avoid the penalty if certain conditions are met, such as:

Owing less than $1,000 in taxes (This is not after estimated or withheld taxes, it is the total tax owed)
Paying at least 90% of the current year’s tax liability through withholdings and timely estimated payments

Notice that taxes withheld from wages & other sources are treated as if they were withheld equally over the year.

- Withholding a large amount from an IRA distribution towards the end of the year does gives you credit for tax payments as if you made them equally throughout the year.
- When you take a taxable distribution from your traditional IRA, you have the option to have federal income tax withheld from the distribution amount. The default withholding rate is 10%, but you can elect to have a different percentage withheld using IRS Form W-4R. The withheld amount is credited against your total tax liability when you file your tax return for that year.
- However, the timing of the withholding does not affect how the payment is credited. Whether you withhold the entire amount in December or spread it out evenly throughout the year, the total withheld will be treated the same way – as a prepayment towards your tax liability for that year. There is no advantage or credit given for making withholding payments earlier in the year.
- The IRS does not consider when the withholding occurred – only the total amount withheld for the tax year. If too little tax is withheld compared to your actual tax liability, you may owe additional taxes plus potential underpayment penalties when you file your return.
- So in summary, while withholding from an IRA distribution can help cover your tax liability, the timing of when that withholding occurs within the tax year is irrelevant. The total amount withheld is simply credited as a prepayment when you file, regardless of whether it was withheld upfront or at the last minute

Quarterly Payment Deadlines

For those required to make estimated tax payments (e.g., self-employed individuals, business owners), the quarterly deadlines are typically:

April 15
June 15
September 15
January 15

However, these dates may be adjusted if they fall on a weekend or holiday. By understanding the estimated tax penalty rules and making timely payments through withholding or estimated payments, taxpayers can minimize or eliminate this costly penalty.

One effective way to minimize or avoid the estimated tax penalty is to use the annualized income installment method. This method allows you to pay estimated taxes based on your actual income earned during each period of the year, rather than having to project your entire year’s income upfront.

The annualized income installment method divides the tax year into four payment periods, with each period using a different income annualization factor:

Period 1 (Jan 1 – Mar 31): Annualize income for this period by multiplying by 4
Period 2 (Jan 1 – May 31): Annualize by multiplying by 2.4
Period 3 (Jan 1 – Aug 31): Annualize by multiplying by 1.5
Period 4 (Jan 1 – Dec 31): No annualization needed for full year

By annualizing your income for each period based on the actual amounts earned, you can make more accurate estimated tax payments that reflect your cash flow. This reduces the likelihood of underpaying and being subject to penalties.

To use this method, you need to complete IRS Form 2210 (Underpayment of Estimated Tax by Individuals) and attach it to your tax return. Be sure to check Box C for “Annualized Income Installment Method” under Part I.

While the annualized method involves more calculations, it provides flexibility for those with fluctuating or seasonal incomes. It ensures you pay the proper estimated taxes based on what you’ve actually earned, rather than an upfront projection.

So, if your income varies significantly throughout the year, strongly consider using the annualized income installment method. It can save you from costly underpayment penalties by aligning your estimated tax payments with your actual earnings pattern.

If you have your tax return prepared by a tax practitioner, be sure to provide them with the information that they will need to use this method. They can determine the amounts from the sale of assets where they have the dates sold. However, for income that you receive a 1099 for, you will have to provide the dates received to them.

Article by: Lewis Robinson, CPA

To further discuss this article, contact Lewis Robinson at LRobinson@capsouthpartners.com

To learn more about CapSouth and the services we provide, visit our website at capsouthwm.com/what-we-do/ or click here to schedule a Discovery Call.

Investment advisory services offered through CapSouth Partners, Inc., dba CapSouth Wealth Management, an independent Registered Investment Advisor. This material has been prepared for planning purposes only and is not intended as specific tax or legal advice. CapSouth Partners does not provide tax or legal advice. Please consult your tax or legal advisor prior to making decisions which may have tax or legal consequences. Information provided by sources deemed to be reliable. CapSouth does not guarantee the accuracy or completeness of the information.

Inflation Reduction Act: What You Should Know

October 5, 2022
Health Insurance, Healthcare, IRS, Life, Medicare, Taxes, Uncategorized

The Inflation Reduction Act, signed into law on August 16, 2022, includes health-care and energy-related provisions, a new corporate alternative minimum tax, and an excise tax on certain corporate stock buybacks. Additional funding is also provided to the IRS. Some significant provisions in the Act are discussed below.

Medicare

The legislation authorizes the Department of Health and Human Services to negotiate Medicare prices for certain high-priced, single-source drugs. However, only 10 of the most expensive drugs will be chosen initially, and the negotiated prices will not take effect until 2026. For each of the following years, more negotiated drugs will be added.

Starting in 2025, a $2,000 annual cap (adjusted for inflation) will apply to out-of-pocket costs for Medicare Part D prescription drugs.

Starting in 2023, deductibles will not apply to covered insulin products under Medicare Part D or under Part B for insulin furnished through durable medical equipment. Also, the applicable copayment amount for covered insulin products will be capped at $35 for a one-month supply.

Health Insurance

Starting in 2023, a high-deductible health plan can provide that the deductible does not apply to selected insulin products.

Affordable Care Act subsidies (scheduled to expire at the end of 2022) that improved affordability and reduced health insurance premiums have been extended through 2025. Indexing of percentage contribution rates used in determining a taxpayer’s required share of premiums is delayed until after 2025, preventing more significant premium increases. Additionally, those with household incomes higher than 400% of the federal poverty line remain eligible for the premium tax credit through 2025.

Energy-Related Tax Credits

Many current energy-related tax credits have been modified and extended, and a few new credits have been added. Many of the credits are available to businesses, and others are available to individuals. The following two credits are substantial revisions and extensions of an existing tax credit for electric vehicles.

Starting in 2023, a tax credit of up to $7,500 is available for the purchase of new clean electric vehicles meeting certain requirements. The credit is not available for vehicles with a manufacturer’s suggested retail price higher than $80,000 for sports utility vehicles and pickups, $55,000 for other vehicles. The credit is not available if the modified adjusted gross income (MAGI) of the purchaser exceeds $150,000 ($300,000 for joint filers and surviving spouses, $225,000 for heads of household). Starting in 2024, an individual can elect to transfer the credit to the dealer as payment for the vehicle.

Similarly, a tax credit of up to $4,000 is available for the purchase of certain previously owned clean electric vehicles from a dealer. The credit is not available for vehicles with a sales price exceeding $25,000. The credit is not available if the purchaser’s MAGI exceeds $75,000 ($150,000 for joint filers and surviving spouses, $75,000 for heads of household). An individual can elect to transfer the credit to the dealer as payment for the vehicle.

Corporate Alternative Minimum Tax

For taxable years beginning after December 31, 2022, a new 15% alternative minimum tax (AMT) will apply to corporations (other than an S corporation, regulated investment company, or a real estate investment trust) with an average annual adjusted financial statement income in excess of $1 billion.

Adjusted financial statement income means the net income or loss of the taxpayer set forth in the corporation’s financial statement (often referred to as book income), with certain adjustments. If regular tax exceeds the tentative AMT, the excess amount can be carried forward as a credit against the AMT in future years.

Excise Tax on Repurchase of Stock

For corporate stock repurchases after December 31, 2022, a new 1% excise tax will be imposed on the value of a covered corporation’s stock repurchases during the taxable year.

A covered corporation means any domestic corporation whose stock is traded on an established securities market. However, the excise tax does not apply: (1) to a repurchase that is part of a nontaxable reorganization, (2) with respect to certain contributions of stock to an employer-sponsored retirement plan or employee stock ownership plan, (3) if the total value of stock repurchased during the year does not exceed $1 million, (4) to a repurchase by a securities dealer in the ordinary course of business, (5) to repurchases by a regulated investment company or a real estate investment trust, or (6) to the extent the repurchase is treated as a dividend for income tax purposes.

Increased Funding for the IRS

Substantial additional funds are provided to the IRS to help fund operations and business systems modernization and to improve enforcement of tax laws.

If you like to further discuss the provisions of the Inflation Reduction Act, contact an advisor at CapSouth Wealth Management.

To learn more about CapSouth Wealth Management, visit our website at www.capsouthwm.com or https://capsouthwm.com/what-we-do/ or call 800.929.1001. Click to Schedule a Discovery Call.

CapSouth Partners, Inc, dba CapSouth Wealth Management, is an independent registered Investment Advisory firm. This material is from an unaffiliated, third-party and is used by permission. Any opinions expressed in the material are those of the author and/or contributors to the material; they are not necessarily the opinions of CapSouth. Information provided by sources deemed to be reliable. CapSouth does not guarantee the accuracy or completeness of the information. CapSouth does not offer tax, accounting or legal advice. Consult your tax or legal advisors for all issues that may have tax or legal consequences. This information has been prepared solely for informational purposes, is general in nature and is not intended as specific advice. Any performance data quoted represents past performance; past performance is no guarantee of future results.

Qualifying for the Home Office Deduction

March 2, 2022
Uncategorized

Working from home can certainly provide you with personal benefits, such as a flexible schedule and more family time. But increasing numbers of people are discovering the tax advantages for the home office deduction as well. It’s no secret that you generally can’t deduct certain personal expenses (e.g., homeowners insurance, utilities, and home repairs) on your federal income tax return. But if you’re using part of your home as a home office, you may be able to write off part of these expenses. To qualify for the home office deduction, you must first understand the IRS requirements.

The home office deduction is really a group of deductions

First of all, what is a home office? A home office is a room in your home, a portion of a room in your home, or a separate building next to your home (such as a converted garage or barn) that you use exclusively and regularly to conduct business activities.

This definition is important, because you may be able to deduct part of your housing expenses (such as rent, utilities, and insurance) on your federal income tax return if you have a home office. This deduction (or group of deductions) is known as a home office deduction. To take the deduction, you’ll need to file Form 8829 with the IRS. To even consider the home office deduction, though, your at-home business activities must involve a trade or business — a hobby won’t do.

Now let’s consider the IRS requirements. To qualify for a home office deduction, you must meet two threshold tests — the place of business test, and the regular and exclusive use test.

The place of business test is somewhat flexible

To pass this test, you must show that you use part of your home as:

The principal place of business for your trade or business, or
A place where you regularly meet with clients, customers, or patients

In some cases, you can also meet the principal place of business requirement if you conduct substantial administrative and management tasks for your outside business at home and have no other fixed location where you conduct these activities. These tasks might include billing customers, keeping books and records, ordering supplies, setting up appointments, or writing reports. For example, assume you’re a doctor at a local HMO who’s been given examination space but no office space. You use a room in your home regularly and exclusively to correspond with insurance companies, bill patients, and read medical journals. You have no other fixed location for conducting these types of activities. In such a case, your space would likely pass the place of business test for a home office deduction.

What if your home office is in a separate structure next to your home, like a shed or garage? In that case, it needn’t be your principal place of business. However, you must use that office regularly and exclusively in connection with your trade or business. Be sure you use this structure only for business purposes — you can’t store your car there.

You must also meet the regular and exclusive use test

In general, you must also pass the regular and exclusive use test before you can take a home office deduction (exceptions apply for taxpayers who run day-care facilities from home and for sellers who use part of their homes for storing inventory). As you might expect, this test requires you to show that you exclusively use a portion of your home for business purposes on a regular basis.

For example, assume you set aside one room in your home as your home office. You also use this room as a playroom for your children. Here, you wouldn’t meet the exclusive use test. Now assume that you use one room in your home exclusively for your side business of selling insurance. You engage in this business only occasionally. Because you don’t use the office on a regular basis, you still won’t qualify for the home office deduction.

Telecommuters might also qualify for the home office deduction

Note: For 2018 to 2025, the deduction for miscellaneous itemized deductions subject to the 2 percent floor (including unreimbursed employee expenses) is suspended.

If you telecommute or are an employee who works at home, you may also qualify for the home office deduction. You’d have to meet the above requirements. In addition, though, your home office must be for the convenience of your employer. In plain English, this means that your employer must ask you to work out of your home. The arrangement must serve your employer’s business needs, not vice versa.

The home office deduction for an employee who works at home is taken as a miscellaneous itemized deduction on Schedule A of Federal Form 1040. This deduction is subject to the 2 percent limit for miscellaneous itemized deductions. However, as noted, this deduction is not currently available.

If you qualify for the deduction, you can deduct all direct expenses and part of your indirect expenses

You can deduct both your direct and indirect expenses regarding your home office. Direct expenses are costs that apply only to your home office. You can deduct these costs in full against your business income. Some examples include the cost of a business telephone line and the cost of painting your home office. However, no deduction is allowed for basic local telephone charges on the first line in your home, even if that line is used for the home office.

Indirect expenses are costs that benefit your entire home. You can deduct only the business portion of your indirect expenses. Some examples of indirect costs include rent, deductible mortgage interest, real estate taxes, and homeowners insurance. The business percentage of your home is determined by dividing the area exclusively used for business by the total area of the home. For example, assume your home is 2,000 square feet and your home office is 200 square feet. Your business percentage is 10 percent (200 divided by 2,000). In such a case, if you rent your home, you can deduct 10 percent of your rent as part of your home office deduction.

Even if you don’t qualify for the home office deduction and are unable to deduct home-related expenses (e.g., homeowners insurance), you can still take a deduction for your regular business expenses, such as the purchase of file cabinets, business equipment, and supplies.

Some of your home office expenses may be limited

If the gross income from your business (the one associated with the home office) equals or exceeds your regular business expenses (including depreciation), all expenses for the business use of your home can be deducted. But if your gross income is less than your total business expenses, certain expense deductions for the business use of your home are limited. The deduction isn’t lost forever, though. It’s simply carried forward to the next year.

Can you spell “audit”?

Historically, the IRS has closely scrutinized home office deductions. Here are some steps you can take to substantiate the existence of your home office:

Use your home address on your business cards, stationery, and advertisements
Install a separate telephone line for your business
Instruct clients or customers to visit your home office, and keep a log of those visits
Log the dates, hours spent, and type of work performed in your home office
Have business mail sent to your home

Having a home office can be a factor when you sell your home

Unless you’re careful, deductions today can cost you money when you sell your home. Homeowners who meet all requirements can generally exclude from federal income tax up to $250,000 of capital gain (up to $500,000 if you’re married and file a joint return) when a principal residence is sold. You may end up paying some taxes, though, if you have a home office. That’s because when you sell your principal residence, an amount of capital gain equal to certain depreciation deductions you were entitled to (as a result of having your home office) won’t qualify for the exclusion. Specifically, the exclusion won’t cover an amount equal to depreciation deductions attributable to the business use of your home after May 6, 1997.

Note: In addition, where the business portion of the home is separate from the dwelling unit (e.g., an office in a converted detached garage) any capital gain on the sale of the house has to be apportioned; only the part of the gain allocable to the residential portion is eligible for exclusion.

For example, assume a self-employed accountant bought a home in 1998 and sells the home several years later at a $20,000 gain. Although the house was always used as his principal residence, the accountant used one room within the house as his business office. Over the years, the accountant claimed $2,000 of depreciation deductions for his office. Under IRS regulations, $18,000 of the capital gain will be tax free. Only the $2,000 of the gain equal to the depreciation deductions will be taxable.

If the accountant’s office had been located in a converted detached garage on his property, he would have to treat the sale as two separate transactions and pay tax on any gain allocable to the converted garage.

Because this area is complex, you should consult a tax professional. Also, you might want to read IRS Publication 587, Business Use of Your Home.

Optional simplified method of calculation available

For tax years beginning on or after January 1, 2013, you’re able to use an optional simplified method of calculating your home office deduction. The simplified method doesn’t change the requirements for claiming the deduction, it simply changes the way the deduction is calculated. Instead of determining and allocating actual expenses, under the simplified method you calculate the home office deduction by multiplying the square footage of the home office (up to a maximum of 300 square feet) by $5. Since square footage is capped at 300, the maximum deduction available under the simplified method is $1,500. You cannot use the simplified method if you are an employee with a home office, and you receive advances, allowances, or reimbursements for expenses related to the business use of your home under an expense or reimbursement allowance with your employer.

Each year, you can choose whether to use the simplified method of calculating the deduction or to use actual expenses. There are two things to keep in mind, though:

If you use the simplified method in one year, and in a later year use actual expenses, special rules will apply in calculating depreciation
If you are carrying forward an unused deduction (because your business deduction exceeded your business income in a prior year), you will not be able to claim the deduction in any year in which you use the simplified method — you’ll have to wait for the next year you use actual expenses to claim the unused deduction

To discuss this article further or to learn more about CapSouth Wealth Management, visit our website at www.capsouthwm.com or call 800.929.1001 to schedule an appointment to speak with an advisor.

Investment advisory services are offered through CapSouth Partners, Inc, dba CapSouth Wealth Management, an independent registered Investment Advisory firm. Information provided by sources deemed to be reliable. CapSouth does not guarantee the accuracy or completeness of the information. CapSouth does not offer tax, accounting, or legal advice. Consult your tax or legal advisors for all issues that may have tax or legal consequences. This information has been prepared solely for informational purposes, is general in nature and is not intended as specific advice. Any performance data quoted represents past performance; past performance is no guarantee of future results.