Federal Tax News

Do you have a Flexible Spending Account (FSA) with your employer? Make sure to take full advantage of it this year and in the new year. For 2021, the contribution limit remains at $2,750 (unchanged from 2020). If an employer permits, employees can carry over up to $550 of unused funds into 2022 (the carryover amount for 2020 was $500). Otherwise, FSAs have a "use or lose" provision.

FSAs provide employees a way to use tax-free dollars to pay qualified medical expenses not covered by other health plans. Amounts contributed aren't subject to federal income tax, Social Security tax or Medicare tax. If the plan allows, an employer can contribute to an employee's FSA.

Taxpayer must pay the early withdrawal penalty. If you have a traditional IRA and take a distribution before age 59 ½, the amount is subject to income tax and you'll generally owe an additional 10% early withdrawal penalty tax. However, there are several exceptions when you can avoid the 10% penalty. In one case, a taxpayer who hadn't reached age 59 ½ took a $7,800 distribution from his IRA. He didn't report it on his tax return or pay the 10% penalty. He also didn't roll it over into another IRA or retirement account.

The U.S. Tax Court stated that he made "frivolous arguments" that didn't prove that any exception to the 10% penalty applied. Therefore, the court ruled he was liable for the penalty. (Lashua, TC Memo 2020-151)

The federal gift and estate tax exemption will be going up next year. It will be increasing by $120,000 to $11,700,000. The amount currently is $11,580,000. The Tax Cuts and Jobs Act doubled the exemption base amount from $5 million to $10 million, with the amount indexed for inflation. Be aware that although the doubled amount will continue to be adjusted annually for inflation, it expires after 2025. Without further legislation, the gift and estate tax exemption will return to an inflation-adjusted $5 million in 2026.

The annual gift tax exclusion remains at $15,000 per recipient for 2021. It's adjusted only in $1,000 increments, so it typically increases only every few years. It increased to $15,000 in 2018.

Business owner couldn't use an online review to prove he paid a refund. Business taxpayers may offset gross receipts with the amount of refunds, returns and allowances that they pay and can substantiate.

The owner of a driving school reported gross receipts of $29,000 in 2015, paid to him mostly by credit cards. Requests for refunds, however, he stated were paid in cash. He then offset his 2015 gross receipts by the amount of refunds, for which he produced no receipts or other records. His only proof was Yelp reviews, including one customer who said the owner "was going to refund the money and we are still waiting for this." Based on a lack of proof, the IRS denied the offset. The U.S. Tax Court agreed, finding the reviews didn't support the taxpayer's claims. (Lakew, TC Summary Opinion 2020-27)

IRS audit rates generally increase as income rises, but there are exceptions. According to the IRS, for 2015 (the most recent year for which the IRS provided data for this purpose), taxpayers with positive income between $100,000 and $200,000 were audited at a rate of 0.47%, while those with incomes between $1 million and $5 million were audited at a rate of 2.39%. Taxpayers with incomes above $10 million were audited at a rate of 8.16%.

An exception to audit rates increasing as income rises was taxpayers with positive income under $0. They were audited at a 4.47% rate due to high error rates on tax returns claiming the Earned Income Tax Credit. For more information: https://bit.ly/3mOA9Kc

Court case looks at where an individual's tax home was located. Taxpayers who live and work outside the U.S. may be able to exclude foreign-earned income. Generally, to qualify, a taxpayer must have a tax home (his or her regular place of business) in another country and not have an abode in the U.S.

An American pilot employed by a U.S. airline claimed this exclusion, stating that his international flying routes meant he had no regular place of business and that Thailand was his place of abode. But records showed his home base was California. He presented no evidence that he intended to be a Thailand resident, he paid no taxes there, and Thailand listed him as transient. So, the exclusion was denied. (Cutting, TC Memo 2020-158)

The IRS releases its fiscal year 2020 criminal investigation report. The report details cases involving fraudulent claims for Economic Impact Payments, Paycheck Protection Program (PPP) loans and refundable payroll tax credits from the CARES Act.

For example, a Florida man was charged with fraudulently obtaining $3.9 million in PPP loans and using those funds, in part, to purchase a Lamborghini sports car worth $318,000. At the time of his arrest, authorities seized the Lamborghini and $3.4 million in bank accounts. The report notes that in fiscal 2020, the IRS was able to identify over $10 billion in tax fraud and other financial crimes. Read the report: http://bit.ly/2VcC2ob

Taxpayer loses payroll tax penalty court case. Employers that withhold taxes from employee paychecks but don't pay them over to the IRS may face a harsh penalty. The Trust Fund Recovery Penalty (TFRP) equals 100% of the unpaid tax and can be assessed personally against responsible parties.

One taxpayer who owned a construction company stated that he also controlled the "entire operations on a daily basis" of a related subcontractor, including signing tax returns. When the subcontractor's taxes went unpaid, the IRS assessed the TFRP against the taxpayer as the responsible party. He argued that he wasn't responsible. The 3rd Circuit Court of Appeals said he acted in "reckless disregard of risk." It also added that the owner "has not rebutted the record showing that he willfully violated his duties as a responsible person." The TFRP was upheld. (Samango Jr., 10/29/20)

Be on the lookout for online scams, according to the IRS. Between COVID-19 and holiday shopping, there's increased time online, which raises the risk of cybercrime. That's why the IRS is urging taxpayers to step up their protection efforts.

For example, don't reveal more information about yourself than required, says the IRS, citing examples such as birthday and age. Ensure your firewall and anti-virus protections are turned on and updated. Learn to recognize and avoid scams. Don't click links or attachments from unknown sources. Shop only at reputable online retailers. Avoid public Wi-Fi unless you use a virtual private network. Here's more: https://bit.ly/3qirOkB

Non-itemizers can deduct up to $300 in charitable gifts this year. Taxpayers often want to donate to a charity around the holiday season. As an incentive for 2020, individuals can deduct up to $300 without itemizing deductions on their tax returns.

And an IRS tool, the "Tax Exempt Organization Search," can help you determine if giving to your favorite cause will allow for a tax deduction. It provides information about an organization's federal tax status and filings. You can locate organizations by legal name or a "doing business as" name. The search results are sortable by Employer Identification Number, name, state and country. You also can find out if an organization's tax-exempt status has been revoked. To use the tool, visit http://bit.ly/2Jlru3l


Categories: December2020, Monthly Bulletins

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