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6 Key Tax Questions for 2023

Right now, you may be more concerned about your 2022 tax bill than you are about how to handle your personal finances in the new year. However, as you deal with your annual tax filing, it’s a good idea to also familiarize yourself with pertinent amounts that may have changed for 2023.

Not all tax figures are adjusted for inflation. And even if they are, during times of low inflation the changes may be slight. When inflation is higher, as it currently is, the changes are generally more substantial. In addition, some tax amounts can change only with new tax legislation. Here are the answers to six commonly asked questions about 2023 tax-related figures:

1. How much can I contribute to an IRA for 2023? If you’re eligible, you can contribute up to $6,500 for 2023 to a traditional or Roth IRA (up from $6,000 for 2022). If you’re age 50 or older, you can make another $1,000 “catch-up” contribution.

2. I have a 401(k) plan through my job. How much can I contribute to it? For 2023, you can contribute up to $22,500 to a 401(k) or 403(b) plan. You can make an additional $7,500 catch-up contribution if you’re age 50 or older. (These figures for 2022 were $20,500 and $6,500, respectively).

3. I sometimes hire a babysitter and a cleaning person. Do I have to withhold and pay FICA tax on the amounts I pay them? The threshold for when a domestic employer must withhold and pay FICA for babysitters, house cleaners and other domestic employees has increased to $2,600 for 2023 (up from $2,400).

4. How much do I have to earn in 2023 before I can stop paying Social Security tax on my salary? The Social Security tax wage base is $160,200 for 2023, up from $147,000 for 2022. That means that you don’t owe Social Security tax on amounts earned above that. (You must pay Medicare tax on all amounts that you earn.)

5. On my last income tax return, my itemized deductions didn’t exceed my standard deduction. What’s my standard deduction for 2023? If the total amount of your itemized deductions (such as charitable gifts and mortgage interest) is less than your applicable standard deduction amount, itemizing won’t save you taxes. The Tax Cuts and Jobs Act eliminated the tax benefit of itemizing for many people by increasing the standard deduction and reducing or eliminating various itemized deductions. For 2023, the standard deduction amount is $27,700 for married couples filing jointly (up from $25,900 for 2022). For single filers, the amount is $13,850 (up from $12,950), and, for heads of households, it’s $20,800 (up from $19,400).

6. How much can I give to one person without having to file a gift tax return for 2023? The annual gift tax exclusion for 2023 is $17,000 (up from $16,000 in 2022). This amount is adjusted only in $1,000 increments, so it typically increases only every few years.

These are only some of the tax figures that may apply to you. For more information about your tax picture, or if you have questions, don’t hesitate to contact us.

What’s Your Taxpayer Filing Status?

For many people, December 31 means a New Year’s Eve celebration. However, from a tax perspective, it’s a key date in determining the filing status you’ll use when filing your tax return for the year. The one you’ll use depends partly on whether you’re married on that date.

The five statuses

When you file your federal tax return, you do so with one of five filing statuses. First, there’s “single” status, which is generally used if you’re unmarried, divorced or legally separated. A second status, “married filing jointly,” is for married couples who file a tax return together. If your spouse passes away, you can usually still file a joint return for that year. A third status, “married filing separately,” is for married couples who choose to file separate returns. In some cases, doing so may result in less tax owed.

“Head of household” is a fourth status. Certain unmarried taxpayers with dependents qualify to use it and potentially pay less tax. Finally, there’s a fifth status: “qualifying widow(er) with a dependent child.” It may be used if your spouse died during one of the previous two years and you have a dependent child. (Other conditions apply.)

Head of household

Let’s focus on head-of-household status because it’s often misunderstood and can be more favorable than filing as a single taxpayer. To qualify, you must “maintain a household” that, for more than half the year, is the principal home of a “qualifying child” or other relative that you can claim as a dependent.

A qualifying child is defined as someone who lives in your home for more than half the year and is your child, stepchild, foster child, sibling, stepsibling or a descendant of any of these. A qualifying child must also be under 19 years old (or a full-time student under age 24) and be unable to provide over half of his or her own support for the year.

Different rules may apply if a child’s parents are divorced. Also, a child isn’t a qualifying child if he or she is married and files jointly or isn’t a U.S. citizen or resident.

For head-of-household filing status, you’re considered to maintain a household if you live in it for the tax year and pay more than half the cost of running it. This includes property taxes, mortgage interest, rent, utilities, property insurance, repairs, upkeep and food consumed in the home. Medical care, clothing, education, life insurance and transportation aren’t included.

Under a special rule, you can qualify as head of household if you maintain a home for a parent even if you don’t live with the parent. To qualify, you must be able to claim the parent as your dependent.

You must generally be unmarried to claim head-of-household status. However, if you’ve lived apart from your spouse for the last six months of the year, you have a qualifying child living with you and you maintain the household, you’re typically considered unmarried. In this case, you may be able to qualify as head of household.

Not always obvious

Filing status may seem obvious, but there can be situations when it warrants careful consideration. If you have questions about yours, contact us.

When you think back on this spring, you may fondly recall a substantial deposit made to your bank account by the federal government (if you were eligible). Economic Impact Payments were a focal point of the American Rescue Plan Act (ARPA), signed into law in March, and the payments were even larger for parents with dependent children. But ARPA contains two other provisions that benefit parents:

1. Child credit expansion and advance payments. For 2021, this refundable tax credit has been increased from $2,000 to $3,000 per child — $3,600 for children under six years of age. In addition, qualifying children now include 17-year-olds.

The child credit is subject to modified adjusted gross income (AGI) phaseout rules and begins to phase out when MAGI exceeds:

• $400,000 for married couples who file a joint return, and
• $200,000 for other taxpayers.

The increased credit amount ($1,000 or $1,600) is subject to lower income phaseouts than the ones that apply to the first $2,000 of the credit. The increased amount begins to phase out when MAGI exceeds:

• $150,000 for joint filers,
• $112,500 for heads of household, and
• $75,000 for other taxpayers.

ARPA also calls for the IRS to make periodic advance payments of the child credit totaling 50% of the estimated 2021 credit amount. The IRS has announced the payments will begin on July 15, 2021. They’ll then be made on the 15th of each month (unless the 15th falls on a weekend or holiday).

Recipients will receive the monthly payments through direct deposit, paper check or debit cards. The IRS says that it is committed to maximizing the use of direct deposit.

2. Child and dependent care break increases. For 2021, the amount of qualifying expenses for the refundable child and dependent care credit has been increased to:

1. $8,000 (from $3,000) if there’s one qualifying care individual, and

2. $16,000 (from $6,000) if there are two or more such individuals.

The maximum percentage of qualifying expenses for which credit is allowed has been increased from 35% to 50%. So the credit ultimately is worth up to $4,000 or $8,000. But the credit is subject to an income-based phaseout beginning at household income levels exceeding $125,000.

The amount you can contribute to a child and dependent care Flexible Spending Account (FSA, also sometimes referred to as a “dependent care assistance program”) also has been increased. For 2021, it’s $10,500 (up from $5,000 for 2020). The FSA pays or reimburses you for these expenses. But you can’t claim a tax credit for expenses paid by or reimbursed through an FSA.

April 2020 – Special COVID-19 Update

Every Business Owner Needs an Exit Strategy

As a business owner, you have to keep your eye on your company’s income and expenses and applicable tax breaks. But you also must look out for your own financial future. And that includes creating an exit strategy.

Buy-sell agreement

When a business has more than one owner, a buy-sell agreement can be a powerful tool. The agreement controls what happens to the business if a specified event occurs, such as an owner’s retirement, disability or death. A well-drafted agreement provides a ready market for the departing owner’s interest in the business and prescribes a method for setting a price for that interest. It also allows business continuity by preventing disagreements caused by new owners.

A key issue with any buy-sell agreement is providing the buyer(s) with a means of funding the purchase. Life or disability insurance often helps fulfill this need and can give rise to several tax issues and opportunities. One of the biggest advantages of life insurance as a funding method is that proceeds generally are excluded from the beneficiary’s taxable income, provided certain conditions are met.

Succession within the family

You can pass your business on to family members by giving them interests, selling them interests or doing some of each. Be sure to consider your income needs, the tax consequences, and how family members will feel about your choice.

Under the annual gift tax exclusion, you can currently gift up to $15,000 of ownership interests without using up any of your lifetime gift and estate tax exemption. Valuation discounts may further reduce the taxable value of the gift.

With the gift and estate tax exemption approximately doubled through 2025 ($11.4 million for 2019), gift and estate taxes may be less of a concern for some business owners. But others may want to make substantial transfers now to take maximum advantage of the high exemption. What’s right for you will depend on the value of your business and your timeline for transferring ownership.

Get started now

To be successful, your exit strategy will require planning well in advance of retirement or any other reason for ownership transition. Please contact us for help.

Do You Know Your Tax Bracket?

Although the Tax Cuts and Jobs Act (TCJA) generally reduced individual tax rates through 2025, there’s no guarantee you’ll receive a refund or lower tax bill. Some taxpayers have actually seen their taxes go up because of reductions or eliminations of certain tax breaks. For this reason, it’s important to know your bracket.

Some single and head of household filers could be pushed into higher tax brackets more quickly than was the case pre-TCJA. For example, the beginning of the 32% bracket for singles for 2019 is $160,725, whereas it was $191,651 for 2017 (though the rate was 33% then). For heads of households, the beginning of this bracket has decreased even more significantly, to $160,700 for 2019 from $212,501 for 2017.

Married taxpayers, on the other hand, won’t be pushed into some middle brackets until much higher income levels through 2025. For example, the beginning of the 32% bracket for joint filers for 2019 is $321,450, whereas it was $233,351 for 2017. (Again, the rate was 33% then.)

As before the TCJA, the tax brackets are adjusted annually for inflation. Because there are so many variables under the law, it’s hard to say exactly how a specific taxpayer’s bracket might change from year to year. Contact us for help assessing what your tax rate likely will be for 2020 — and for help filing your 2019 tax return.

Year-End Tax and Financial To-Do List for Individuals

With the dawn of 2020 on the near horizon, here’s a quick list of tax and financial to-dos you should address before 2019 ends:

Check your Flexible Spending Account (FSA) balance. If you have an FSA for health care expenses, you need to incur qualifying expenses by December 31 to use up these funds or you’ll potentially lose them. (Some plans allow you to carry over up to $500 to the following year or give you a 2½-month grace period to incur qualifying expenses.) Use expiring FSA funds to pay for eyeglasses, dental work or eligible drugs or health products.

Max out tax-advantaged savings. Reduce your 2019 income by contributing to traditional IRAs, employer-sponsored retirement plans or Health Savings Accounts to the extent you’re eligible. (Certain vehicles, including traditional and SEP IRAs, allow you to deduct contributions on your 2019 return if they’re made by April 15, 2020.)

Take required minimum distributions (RMDs). If you’ve reached age 70½, you generally must take RMDs from IRAs or qualified employer-sponsored retirement plans before the end of the year to avoid a 50% penalty. If you turned 70½ this year, you have until April 1, 2020, to take your first RMD. But keep in mind that, if you defer your first distribution, you’ll have to take two next year.

Consider a qualified charitable distribution (QCD). If you’re 70½ or older and charitably inclined, a QCD allows you to transfer up to $100,000 tax-free directly from your IRA to a qualified charity and to apply the amount toward your RMD. This is a big advantage if you wouldn’t otherwise qualify for a charitable deduction (because you don’t itemize, for example).

Use it or lose it. Make the most of annual limits that don’t carry over from year to year, even if doing so won’t provide an income tax deduction. For example, if gift and estate taxes are a concern, make annual exclusion gifts up to $15,000 per recipient. If you have a Coverdell Education Savings Account, contribute the maximum amount you’re allowed.

Contribute to a Section 529 plan. Sec. 529 prepaid tuition or college savings plans aren’t subject to federal annual contribution limits and don’t provide a federal income tax deduction. But contributions may entitle you to a state income tax deduction (depending on your state and plan).

Review withholding. The IRS cautions that people with more complex tax situations face the possibility of having their income taxes underwithheld because of changes under the Tax Cuts and Jobs Act. Use its withholding estimator (available at https://www.irs.gov/individuals/tax-withholding-estimator) to review your situation.

If it looks like you could face underpayment penalties, increase withholding from your or your spouse’s wages for the remainder of the year. (Withholding, unlike estimated tax payments, is treated as if it were paid evenly over the year.)

For assistance with these and other year-end planning ideas, please contact us.

No Surprises: Why You Should Check Your Tax Bracket

Many taxpayers learned some tough lessons upon completing their 2018 tax returns regarding the changes brought forth by the Tax Cuts and Jobs Act (TCJA). If you were one of them, or even if you weren’t, now’s a good time to check your bracket to avoid any unpleasant surprises next April.

Under the TCJA, the top income tax rate is now 37% (down from 39.6%) for taxpayers with taxable income over $500,000 for 2018 (single and head-of-household filers) or $600,000 for 2018 (married couples filing jointly). These thresholds are higher than they were for the top rate in 2017 ($418,400, $444,550 and $470,700, respectively), so the top rate probably wasn’t too much of a concern for many upper-income filers.

But some singles and heads of households in the middle and upper brackets were likely pushed into a higher tax bracket much more quickly for the 2018 tax year. For example, for 2017 the threshold for the 33% tax bracket was $191,650 for singles and $212,500 for heads of households. For 2018, the rate for this bracket was reduced slightly to 32% — but the threshold for the bracket is now only $157,500 for both singles and heads of households.

So, a lot more of these filers found themselves in this bracket and many more could so again in 2019. Fortunately for joint filers, their threshold for this bracket has increased from $233,350 for 2017 to $315,000 for 2018. The thresholds for these brackets have increased slightly for 2019, due to inflation adjustments. If you expect this year’s income to be near the threshold for a higher bracket, consider strategies for reducing your taxable income and staying out of the next bracket. For example, you could take steps to accelerate deductible expenses.

But carefully consider the changes the TCJA has made to deductions. For example, you might no longer benefit from itemizing because of the nearly doubled standard deduction and the reduction or elimination of certain itemized deductions. For 2019, the standard deduction is $12,200 for singles and married individuals filing separately, $18,350 for heads of households and $24,400 for joint filers.

Fewer Taxpayers to Qualify for Home Office Deduction

Working from home has become commonplace for people in many jobs. But just because you have a home office space doesn’t mean you can deduct expenses associated with it. Beginning with the 2018 tax year, fewer taxpayers will qualify for the home office deduction. Here’s why.

Changes under the TCJA

For employees, home office expenses used to be a miscellaneous itemized deduction. Way back in 2017, this meant one could enjoy a tax benefit only if these expenses plus other miscellaneous itemized expenses (such as unreimbursed work-related travel, certain professional fees and investment expenses) exceeded 2% of adjusted gross income.

Starting in 2018 and continuing through 2025, however, employees can’t deduct any home office expenses. Why? The Tax Cuts and Jobs Act (TCJA) suspends miscellaneous itemized deductions subject to the 2% floor for this period.

Note: If you’re self-employed, you can still deduct eligible home office expenses against your self-employment income during the 2018 through 2025 period.

Other eligibility requirements

If you’re self-employed, generally your home office must be your principal place of business, though there are exceptions.

Whether you’re an employee or self-employed, the space must be used regularly (not just occasionally) and exclusively for business purposes. If, for example, your home office is also a guest bedroom, or your children do their homework there, you can’t deduct the expenses associated with that space.

Deduction options

If eligible, you have two options for claiming the home office deduction. First, you can deduct a portion of your mortgage interest, property taxes, insurance, utilities and certain other expenses, as well as the depreciation allocable to the office space. This requires calculating, allocating and substantiating actual expenses.

A second approach is to use the simplified option. Here, only one simple calculation is necessary: $5 multiplied by the number of square feet of the office space. The simplified deduction is capped at $1,500 per year, based on a maximum of 300 square feet.

More rules and limits

Be aware that we’ve covered only a few of the rules and limits here. If you think you may qualify for the home office deduction on your 2018 return or would like to know if there’s anything additional you need to do to become eligible, contact us.

Laying the Groundwork for Your 2018 Tax Return & Installment Sales: A Viable Option for Transferring Assets

Taxable vs. Tax-advantaged: Where to Hold Investments & Is Now the Time for Some Life Insurance?

Are You a Member of the Sandwich Generation?

If you’re currently taking care of your children and elderly parents, count yourself among those in the “Sandwich Generation.” Although it may be personally gratifying to help your parents, it can be a financial burden and affect your own estate plan. Here are some critical steps to take to better manage the situation.

Identify key contacts

Just like you’ve done for yourself, compile the names and addresses of professionals important to your parents’ finances and medical conditions. These may include stockbrokers, financial advisors, attorneys, CPAs, insurance agents and physicians.

List and value their assets

If you’re going to be able to manage the financial affairs of your parents, having knowledge of their assets is vital. Keep a list of their investment holdings, IRA and retirement plan accounts, and life insurance policies, including current balances and account numbers. Be sure to add in projections for Social Security benefits.

Open the lines of communication

Before going any further, have a frank and honest discussion with your elderly relatives, as well as other family members who may be involved, such as your siblings. Make sure you understand your parents’ wishes and explain the objectives you hope to accomplish. Understandably, they may be hesitant or too proud to accept your help initially.

Execute the proper documents

Assuming you can agree on how to move forward, develop a plan incorporating several legal documents. If your parents have already created one or more of these documents, they may need to be revised or coordinated with new ones. Some elements commonly included in an estate plan are:

Wills. Your parents’ wills control the disposition of their possessions, such as cars, and tie up other loose ends. (Of course, jointly owned property with rights of survivorship automatically pass to the survivor.) Notably, a will also establishes the executor of your parents’ estates. If you’re the one providing financial assistance, you may be the optimal choice.

Living trusts. A living trust can supplement a will by providing for the disposition of selected assets. Unlike a will, a living trust doesn’t have to go through probate, so this might save time and money, while avoiding public disclosure.

Powers of attorney for health and finances. These documents authorize someone to legally act on behalf of another person. With a durable power of attorney, the most common version, the authorization continues after the person is disabled. This enables you to better handle your parents’ affairs.

Living wills or advance medical directives. These documents provide guidance for end-of-life decisions. Make sure that your parents’ physicians have copies, so they can act according to their wishes.

Beneficiary designations. Undoubtedly, your parents have completed beneficiary designations for retirement plans, IRAs and life insurance policies. These designations supersede references in a will, so it’s important to keep them up to date.

Spread the wealth

If you decide the best approach for helping your parents is to give them monetary gifts, it’s relatively easy to avoid gift tax liability. Under the annual gift tax exclusion, you can give each recipient up to $15,000 (for 2018) without paying any gift tax. Plus, payments to medical providers aren’t considered gifts, so you may make such payments on your parents’ behalf without using any of your annual exclusion or lifetime exemption amount.

Mind your needs

If you’re part of the Sandwich Generation, you already have a lot on your plate. But don’t overlook your own financial needs. Contact us to discuss the matter further.

Deducting Home Equity Interest Under the Tax Cuts and Jobs Act

Passage of the Tax Cuts and Jobs Act (TCJA) in December 2017 has led to confusion over some longstanding deductions. In response, the IRS recently issued a statement clarifying that the interest on home equity loans, home equity lines of credit and second mortgages will, in many cases, remain deductible.

How it used to be

Under prior tax law, a taxpayer could deduct “qualified residence interest” on a loan of up to $1 million secured by a qualified residence, plus interest on a home equity loan (other than debt used to acquire a home) up to $100,000. The home equity debt couldn’t exceed the fair market value of the home reduced by the debt used to acquire the home.

For tax purposes, a qualified residence is the taxpayer’s principal residence and a second residence, which can be a house, condominium, cooperative, mobile home, house trailer or boat. The principal residence is where the taxpayer resides most of the time; the second residence is any other residence the taxpayer owns and treats as a second home. Taxpayers aren’t required to use the second home during the year to claim the deduction. If the second home is rented to others, though, the taxpayer also must use it as a home during the year for the greater of 14 days or 10% of the number of days it’s rented.

In the past, interest on qualifying home equity debt was deductible regardless of how the loan proceeds were used. A taxpayer could, for example, use the proceeds to pay for medical bills, tuition, vacations, vehicles and other personal expenses and still claim the itemized interest deduction.

What’s deductible now

The TCJA limits the amount of the mortgage interest deduction for taxpayers who itemize through 2025. Beginning in 2018, for new home purchases, a taxpayer can deduct interest only on acquisition mortgage debt of $750,000.

On February 21, the IRS issued a release (IR 2018-32) explaining that the law suspends the deduction only for interest on home equity loans and lines of credit that aren’t used to buy, build or substantially improve the taxpayer’s home that secures the loan. In other words, the interest isn’t deductible if the loan proceeds are used for certain personal expenses, but it is deductible if the proceeds go toward, for example, a new roof on the home that secures the loan. The IRS further stated that the deduction limits apply to the combined amount of mortgage and home equity acquisition loans — home equity debt is no longer capped at $100,000 for purposes of the deduction.

Further clarifications

As a relatively comprehensive new tax law, the TCJA will likely be subject to a variety of clarifications before it settles in. Please contact our firm for help better understanding this provision or any other.

Business Owners: Brush Up on Bonus Depreciation

Every company needs to upgrade its assets occasionally, whether desks and chairs or a huge piece of complex machinery. But before you go shopping this year, be sure to brush up on the enhanced bonus depreciation tax breaks created under the Tax Cuts and Jobs Act (TCJA) passed late last year.

Old law

Qualified new — not used — assets that your business placed in service before September 28, 2017, fall under pre-TCJA law. For these items, you can claim a 50% first-year bonus depreciation deduction. This tax break is available for the cost of new computer systems, purchased software, vehicles, machinery, equipment, office furniture and so forth.

In addition, 50% bonus depreciation can be claimed for qualified improvement property, which means any qualified improvement to the interior portion of a nonresidential building if the improvement is placed in service after the date the building is placed in service. But qualified improvement costs don’t include expenditures for the enlargement of a building, an elevator or escalator, or the internal structural framework of a building.

New law

Bonus depreciation improves significantly under the TCJA. For qualified property placed in service from September 28, 2017, through December 31, 2022 (or by December 31, 2023, for certain property with longer production periods), the first-year bonus depreciation percentage is increased to 100%. In addition, the 100% deduction is allowed for both new and used qualifying property.

The new law also allows 100% bonus depreciation for qualified film, television and live theatrical productions placed in service on or after September 28, 2017. Productions are considered placed in service at the time of the initial release, broadcast or live commercial performance.

In later years, bonus depreciation is scheduled to be reduced to 80% for property placed in service in 2023, 60% for property placed in service in 2024, 40% for property placed in service in 2025 and 20% for property placed in service in 2026.

Important: For certain property with longer production periods, the preceding reductions are delayed by one year. For example, 80% bonus depreciation will apply to long-production-period property placed in service in 2024.

More details

If bonus depreciation isn’t available to your company, a similar tax break — the Section 179 deduction — may be able to provide comparable benefits. Please contact our firm for more details on how either might help your business.

Making 2017 Retirement Plan Contributions in 2018

The clock is ticking down to the tax filing deadline. The good news is that you still may be able to save on your impending 2017 tax bill by making contributions to certain retirement plans.

For example, if you qualify, you can make a deductible contribution to a traditional IRA right up until the April 17, 2018, filing date and still benefit from the resulting tax savings on your 2017 return. You also have until April 17 to make a contribution to a Roth IRA.

And if you happen to be a small business owner, you can set up and contribute to a Simplified Employee Pension (SEP) plan up until the due date for your company’s tax return, including extensions.

Deadlines and limits

Let’s look at some specifics. For IRA and Roth IRA contributions, the maximum regular contribution is $5,500. Plus, if you were at least age 50 on December 31, 2017, you are eligible for an additional $1,000 “catch-up” contribution.

There are also age limits. You must have been under age 70½ on December 31, 2017, to contribute to a traditional IRA. Contributions to a Roth can be made regardless of age, if you meet the other requirements.

For a SEP, the maximum contribution is $54,000, and must be made by the April 17th date, or by the extended due date (up to Monday, October 15, 2018) if you file a valid extension. (There’s no SEP catch-up amount.)

Phase-out ranges

If not covered by an employer’s retirement plan, your contributions to a traditional IRA are not affected by your modified adjusted gross income (MAGI). Otherwise, when you (or a spouse, if married) are active in an employer’s plan, available contributions begin to phase out within certain MAGI ranges.

For married couples filing jointly, the MAGI range is $99,000 to $119,000. For singles or heads of household, it’s $62,000 to $72,000. For those married but filing separately, the MAGI range is $0 to $10,000, if you lived with your spouse at any time during the year. A phase-out occurs between AGI of $186,000 and $196,000 if a spouse participates in an employer-sponsored plan.

Contributions to Roth IRAs phase out at mostly different ranges. For married couples filing jointly, the MAGI range is $186,000 to $196,000. For singles or heads of household, it’s $118,000 to $133,000. But for those married but filing separately, the phase-out range is the same: $0 to $10,000, if you lived with your spouse at any time during the year.

Essential security

Saving for retirement is essential for financial security. What’s more, the federal government provides tax incentives for doing so. Best of all, as mentioned, you still have time to contribute to an IRA, Roth IRA or SEP plan for the 2017 tax year. Please contact our firm for further details and a personalized approach to determining how to best contribute to your retirement plan or plans.

Highlights of the New Tax Reform Law

The new tax reform law, commonly called the “Tax Cuts and Jobs Act” (TCJA), is the biggest federal tax law overhaul in 31 years, and it has both good and bad news for taxpayers.

Below are highlights of some of the most significant changes affecting individual and business taxpayers. Except where noted, these changes are effective for tax years beginning after December 31, 2017.

Individuals

• Drops of individual income tax rates ranging from 0 to 4 percentage points (depending on the bracket) to 10%, 12%, 22%, 24%, 32%, 35% and 37% — through 2025
• Near doubling of the standard deduction to $24,000 (married couples filing jointly), $18,000 (heads of households), and $12,000 (singles and married couples filing separately) — through 2025
• Elimination of personal exemptions — through 2025
• Doubling of the child tax credit to $2,000 and other modifications intended to help more taxpayers benefit from the credit — through 2025
• Elimination of the individual mandate under the Affordable Care Act requiring taxpayers not covered by a qualifying health plan to pay a penalty — effective for months beginning after December 31, 2018
• Reduction of the adjusted gross income (AGI) threshold for the medical expense deduction to 7.5% for regular and AMT purposes — for 2017 and 2018
• New $10,000 limit on the deduction for state and local taxes (on a combined basis for property and income taxes; $5,000 for separate filers) — through 2025
• Reduction of the mortgage debt limit for the home mortgage interest deduction to $750,000 ($375,000 for separate filers), with certain exceptions — through 2025
• Elimination of the deduction for interest on home equity debt — through 2025
• Elimination of the personal casualty and theft loss deduction (with an exception for federally declared disasters) — through 2025
• Elimination of miscellaneous itemized deductions subject to the 2% floor (such as certain investment expenses, professional fees and unreimbursed employee business expenses) — through 2025
• Elimination of the AGI-based reduction of certain itemized deductions — through 2025
• Elimination of the moving expense deduction (with an exception for members of the military in certain circumstances) — through 2025
• Expansion of tax-free Section 529 plan distributions to include those used to pay qualifying elementary and secondary school expenses, up to $10,000 per student per tax year
• AMT exemption increase, to $109,400 for joint filers, $70,300 for singles and heads of households, and $54,700 for separate filers — through 2025
• Doubling of the gift and estate tax exemptions, to $10 million (expected to be $11.2 million for 2018 with inflation indexing) — through 2025

Businesses

• Replacement of graduated corporate tax rates ranging from 15% to 35% with a flat corporate rate of 21%
• Repeal of the 20% corporate AMT
• New 20% qualified business income deduction for owners of flow-through entities (such as partnerships, limited liability companies and S corporations) and sole proprietorships — through 2025
• Doubling of bonus depreciation to 100% and expansion of qualified assets to include used assets — effective for assets acquired and placed in service after September 27, 2017, and before January 1, 2023
• Doubling of the Section 179 expensing limit to $1 million and an increase of the expensing phaseout threshold to $2.5 million
• Other enhancements to depreciation-related deductions
• New disallowance of deductions for net interest expense in excess of 30% of the business’s adjusted taxable income (exceptions apply)
• New limits on net operating loss (NOL) deductions
• Elimination of the Section 199 deduction, also commonly referred to as the domestic production activities deduction or manufacturers’ deduction — effective for tax years beginning after December 31, 2017, for noncorporate taxpayers and for tax years beginning after December 31, 2018, for C corporation taxpayers
• New rule limiting like-kind exchanges to real property that is not held primarily for sale
• New tax credit for employer-paid family and medical leave — through 2019
• New limitations on excessive employee compensation
• New limitations on deductions for employee fringe benefits, such as entertainment and, in certain circumstances, meals and transportation

More to consider

This is just a brief overview of some of the most significant TCJA provisions. There are additional rules and limits that apply, and the law includes many additional provisions. Contact your tax advisor to learn more about how these and other tax law changes will affect you in 2018 and beyond.

Ensuring Your Year-End Donations Are Tax-Deductible

Many people make donations at the end of the year. To be deductible on your 2017 return, a charitable donation must be made by December 31, 2017. According to the IRS, a donation generally is “made” at the time of its “unconditional delivery.” But what does this mean?

Is it the date you write a check or charge an online gift to your credit card? Or is it the date the charity actually receives the funds? In practice, the delivery date depends in part on what you donate and how you donate it. Here are a few common examples:

Checks. The date you mail it.

Credit cards. The date you make the charge.

Pay-by-phone accounts. The date the financial institution pays the amount.

Stock certificates. The date you mail the properly endorsed stock certificate to the charity.

To be deductible, a donation must be made to a “qualified charity” — one that’s eligible to receive tax-deductible contributions. The IRS’s online search tool, “Exempt Organizations (EO) Select Check,” can help you more easily find out whether an organization is eligible to receive tax-deductible charitable contributions. You can access it at https://www.irs.gov/charities-non-profits/exempt-organizations-select-check. Information about organizations eligible to receive deductible contributions is updated monthly.

Many additional rules apply to the charitable donation deduction, so please contact us if you have questions about the deductibility of a gift you’ve made or are considering making. But act soon — you don’t have much time left to make donations that will reduce your 2017 tax bill.

Given the astronomical cost of college, even well-off parents should consider applying for financial aid. A single misstep, however, can harm your child’s eligibility. Here are five common mistakes to avoid:

1. Presuming you don’t qualify. It’s difficult to predict whether you’ll qualify for aid, so apply even if you think your net worth is too high. Keep in mind that, generally, the value of your principal residence or any qualified retirement assets isn’t included in your net worth for financial aid purposes.

2. Filing the wrong forms. Most colleges and universities, and many states, require you to submit the Free Application for Federal Student Aid (FAFSA) for need-based aid. Some schools also require it for merit-based aid. In addition, a number of institutions require the CSS/Financial Aid PROFILE®, and specific types of aid may have their own paperwork requirements.

3. Missing deadlines. Filing deadlines vary by state and institution, so note the requirements for each school to which your child applies. Some schools provide financial aid to eligible students on a first-come, first-served basis until funding runs out, so the earlier you apply, the better. This may require you to complete your income tax return early.

4. Picking favorites. The FAFSA allows you to designate up to 10 schools with which your application will be shared. Some families list these schools in order of preference, but there’s a risk that schools may use this information against you. Schools at the top of the list may conclude that they can offer less aid because your child is eager to attend. To avoid this result, consider listing schools in alphabetical order.

5. Mistaking who’s responsible. If you’re divorced or separated, the FAFSA should be completed by the parent with whom your child lived for the majority of the 12-month period ending on the date the application is filed. This is true regardless of which parent claims the child as a dependent on his or her tax return.

The rule provides a significant planning opportunity if one spouse is substantially wealthier than the other. For example, if the child lives with the less affluent spouse for 183 days and with the other spouse for 182 days, the less affluent spouse would file the FAFSA, improving eligibility for financial aid.

These are just a few examples of financial aid pitfalls. Let us help you navigate the process and explore other ways to finance college.

3 Strategies for Handling Estimated Tax Payments

In today’s economy, many individuals are self-employed. Others generate income from interest, rent or dividends. If these circumstances sound familiar, you might be at risk of penalties if you don’t pay enough tax during the year through estimated tax payments and withholding. Here are three strategies to help avoid underpayment penalties:

1. Know the minimum payment rules. For you to avoid penalties, your estimated payments and withholding must equal at least:

• 90% of your tax liability for the year,
• 110% of your tax for the previous year, or
• 100% of your tax for the previous year if your adjusted gross income for the previous year was $150,000 or less ($75,000 or less if married filing separately).

2. Use the annualized income installment method. This method often benefits taxpayers who have large variability in income by month due to bonuses, investment gains and losses, or seasonal income — especially if it’s skewed toward year end. Annualizing calculates the tax due based on income, gains, losses and deductions through each “quarterly” estimated tax period.

3. Estimate your tax liability and increase withholding. If, as year end approaches, you determine you’ve underpaid, consider having the tax shortfall withheld from your salary or year-end bonus by December 31. Because withholding is considered to have been paid ratably throughout the year, this is often a better strategy than making up the difference with an increased quarterly tax payment, which may trigger penalties for earlier quarters.

Finally, beware that you also could incur interest and penalties if you’re subject to the additional 0.9% Medicare tax and it isn’t withheld from your pay and you don’t make sufficient estimated tax payments. Please contact us for help with this tricky tax task.

Wills and Living Trusts: Estate Planning Imperatives

Well-crafted, up-to-date estate planning documents are an imperative for everyone. They also can help ease the burdens on your family during a difficult time. Two important examples: wills and living trusts.

The will

A will is a legal document that arranges for the distribution of your property after you die and allows you to designate a guardian for minor children or other dependents. It should name the executor or personal representative who’ll be responsible for overseeing your estate as it goes through probate. (Probate is the court-supervised process of paying any debts and taxes and distributing your property after you die.) To be valid, a will must meet the legal requirements in your state.

If you die without a will (that is, “intestate”), the state will appoint an administrator to determine how to distribute your property based on state law. The administrator also will decide who will assume guardianship of any minor children or other dependents. Bottom line? Your assets may be distributed — and your dependents provided for — in ways that differ from what you would have wanted.

The living trust

Because probate can be time-consuming, expensive and public, you may prefer to avoid it. A living trust can help. It’s a legal entity to which you, as the grantor, transfer title to your property. During your life, you can act as the trustee, maintaining control over the property in the trust. On your death, the person (such as a family member or advisor) or institution (such as a bank or trust company) you’ve named as the successor trustee distributes the trust assets to the beneficiaries you’ve named.

Assets held in a living trust avoid probate — with very limited exceptions. Another benefit is that the successor trustee can take over management of the trust assets should you become incapacitated.

Having a living trust doesn’t eliminate the need for a will. For example, you can’t name a guardian for minor children or other dependents in a trust. However, a “pour over” will can direct that assets you own outside the living trust be transferred to it on your death.

Other documents

There are other documents that can complement a will and living trust. A “letter of instruction,” for example, provides information that your family will need after your death. In it, you can express your desires for the memorial service, as well as the contact information for your employer, accountant and any other important advisors. (Note: It’s not a legal document.)

Also consider powers of attorney. A durable power of attorney for property allows you to appoint someone to act on your behalf on financial matters should you become incapacitated. A power of attorney for health care covers medical decisions and also takes effect if you become incapacitated. The person to whom you’ve transferred this power — your health care agent — can make medical decisions on your behalf.

Foundational elements

These are just a few of the foundational elements of a strong estate plan. We can work with you and your attorney to address the tax issues involved.

Understanding the Differences Between Health Care Accounts

Watch Out for IRD Issues When Inheriting Money

Once a relatively obscure concept, income in respect of a decedent (IRD) can create a surprisingly high tax bill for those who inherit certain types of property, such as IRAs or other retirement plans. Fortunately, there are ways to minimize or even eliminate the IRD tax bite.

How it works

Most inherited property is free from income taxes, but IRD assets are an exception. IRD is income a person was entitled to but hadn’t yet received at the time of his or her death. It includes:

• Distributions from tax-deferred retirement accounts, such as 401(k)s and IRAs,
• Deferred compensation benefits and stock option plans,
• Unpaid bonuses, fees and commissions, and
• Uncollected salaries, wages, and vacation and sick pay.

IRD isn’t reported on the deceased’s final income tax return, but it’s included in his or her taxable estate, which may generate estate tax liability if the deceased’s estate exceeds the $5.49 million (for 2017) estate tax exemption, less any gift tax exemption used during life. (Be aware that President Trump and congressional Republicans have proposed an estate tax repeal. It hasn’t been passed as of this writing, but check back with us for the latest information.)

Then it’s taxed — potentially a second time — as income to the beneficiaries who receive it. This income retains the character it would have had in the deceased’s hands. So, for example, income the deceased would have reported as long-term capital gains is taxed to the beneficiary as long-term capital gains.

What can be done

When IRD generates estate tax liability, the combination of estate and income taxes can devour an inheritance. The tax code alleviates this double taxation by allowing beneficiaries to claim an itemized deduction for estate taxes attributable to amounts reported as IRD. (The deduction isn’t subject to the 2% floor for miscellaneous itemized deductions.)

The estate tax attributable to IRD is equal to the difference between the actual estate tax paid by the estate and the estate tax that would have been payable if the IRD’s net value had been excluded from the estate.

Suppose, for instance, that you’re the beneficiary of an estate that includes a taxable IRA. If the estate tax is $150,000 with the retirement account and $100,000 without, the estate tax attributable to the IRD income is $50,000. But be careful, because any deductions in respect of a decedent must also be included when calculating the estate tax impact.

When multiple IRD assets and multiple beneficiaries are involved, complex calculations are necessary to properly allocate the income and deductions. Similarly, when a beneficiary receives IRD over a period of years — IRA distributions, for example — the deduction must be prorated based on the amounts distributed each year.

We can help

If you inherit property that could be considered IRD, please consult our firm for assistance in managing the tax consequences. With proper planning, you can keep the cost to a minimum.

RETIREMENT AND TAXES: SHOULD YOU PAY NOW OR LATER?

When saving for retirement, you have a number of options for how you’ll pay taxes: now, later or both. Just as you diversify your investments, diversifying how you save for retirement from a tax perspective is also important.

Here’s why: When you save in both taxable and non-taxable accounts, you set yourself up to have more money to spend when you’re actually in retirement. And you can better manage how you withdraw your money annually to avoid jumping into higher tax brackets.

What Are My Savings Options?

1. Pay no tax now, but pay in retirement. This includes savings options like employer-sponsored plans, such as 401(k)s and 403(b)s; simplified employee pensions (SEPs); and traditional individual retirement accounts (IRAs).
   
   These “qualified” accounts allow you to save pretax money now, which will grow tax deferred. However, you will pay tax on the money you take from your account (known as a distribution). In fact, when you retire (or turn 70½, depending on the type of account), you’ll be forced to take annual distributions known as Required Minimum Distributions (RMDs).
   
   There are limits to how much you can contribute to each of these types of accounts in a given year. In addition, unless an exception applies, you’ll pay a penalty if you take money out of these accounts prior to turning 59½.
2. Pay taxes now, not later. These types of accounts are frequently referred to as Roth accounts. Roth 401(k)s or Roth IRAs allow you to save with after-tax dollars now. You’re not taxed on the growth of your money; and when you take it in retirement, you won’t pay tax either.
   
   There are also limits to how much you can contribute to these accounts yearly, and if you make too much money, you can’t contribute to some. You also may pay a penalty if you take money out of these accounts prior to 59½.
3. Pay taxes now, as your money grows and later. Non-qualified investments—basically anything that’s not in a tax-qualified account like a 401(k)—are another option. You invest money that has already been taxed in non-qualified investments. Depending on the investment, you may be taxed on earnings or distributions along the way. And then when you sell those investments, you will pay tax on any increase in value. For instance, let’s say you invest $1,000 in a mutual fund today and then sell it 10 years from now for $1,700. The $700 you made will be treated as capital gain income the year you sell it, and the capital gains tax bracket is based on the ordinary income tax bracket you are currently in.
   
   There is no limit on the amount of non-qualified investments you make in a year, and you can get your money anytime without paying a penalty.

Other Ways to Supplement Retirement Income

The primary purpose of life insurance is for the death benefit; however, because whole life insurance grows tax free and is guaranteed never to go down, the cash value that has grown in a life insurance policy can also be a great option to help supplement retirement income. This can give you added flexibility in years when the market is down or if you need to reduce your taxable income in a given year.

So What Option Is Best for You?

The answer to the question is different for everyone’s unique situation, but it’s a good idea to include a mix of different accounts to give yourself flexibility and greater spending power in the future. After all, you may not be in a lower tax bracket when you retire, and tax brackets are currently at historical lows. So while pretax retirement accounts can be a great start, they shouldn’t be your only savings.

Call us to have your specific situation analyzed and find the best solution.

FILING DEADLINES

Some  filing  due  dates  have  changed,  starting  with  2016  returns  filed  in  2017.

• Employers  are  required  to  file  W-2s  with  the  federal  government  by  Jan.  31

up  from  the  prior  deadlines  of  Feb.  28  for  paper  returns  and  .March  31  for  c-filings.

This  earlier  deadline  matches  the  date  for  sending  copies  of  the  forms  to  employees.

• The  Jan.  31  due  date  also  applies  to  1099s  reporting  nonemployee  compensation.

• Returns  of  partnerships  are  due  2%  months  after  year-end...March  15

for  calendar  year  firms.  Those  needing  more  time  can  request  a  six-month  extension.

The  due  date  for  most  regular  corporations  is  3 1/2  months  after  year-end...

generally  April  15  for  calendar  year  firms...but  they  can  request  a  five-month  extension.

• The  deadline  for  S corporations  with  a  June  30  fiscal  year  hasn't  changed.

• The  filing  date  for  owners  of  foreign  accounts  is  moved  up  to  April  15.

Also,  taxpayers  for  the  first  time  are  able  to  request  an  additional  six  months  to  file.

In  the  past,  U.S.  owners  of  these  accounts  had  until  June  80  to  file  FinCEN  Form  114

to  report  them  if  the  total  value  exceeded  $10,000  at  any  time  during  the  prior  year.

BUSINESS  TAXES    

• The  2017  standard  mileage  rate  for  business  driving  falls  to  53.5c  a  mile, a  0.50c  drop.
• The  rate  decreases  to  17c  a  mile  for  travel  for  medical  purposes

and  job-related  moves. 

• But  the  rate  for  charitable  driving  remains  at  14c  per  mile.

• $510,000  of  assets  can  be  expensed  in  2017,  and  this  figure  phases  out

dollar  for  dollar  once  over  $2,030,000  of  assets  are  put  into  service  during  the  year.

• Two  business  tax  breaks  first  apply  on  2016  returns  filed  in  2017:

1. Small  start-ups  can  opt  to  claim  $250J000  of  R&D  costs  to  offset  payroll  taxes

instead  of  their  regular  income  tax  liability.  The  election  is  available  to  companies

in  business  for  five  years  or  less  that  have  gross  receipts  under  $5  million.

Businesses  that  hire  the  long-term  unemployed  get  a  tax  credit.

2. The  work  opportunity  tax  credit  is  expanded  to  cover  employers  that  hire  people

who've  been  out  of  work  for  27  weeks  or  more  and  received  unemployment  benefits.

The  40%  credit  on  the  first  $6,000  in  wages  applies  for  those  beginning  work  after  2015.

IRS Announces that 2016 Filing Season Begins on January 23, 2017

The IRS notified taxpayers and practitioners that the 2017 individual income tax filing season (for 2016 Forms 1040) will open on January 23, 2017. Because Emancipation Day, a holiday in Washington, D.C., will be observed on Monday, April 17, the normal filing deadline will be pushed back to Tuesday, April 18, 2017.

The 2017 individual income tax filing season (for 2016 Forms 1040) will open on Monday, January 23, 2017 (News Release IR-2017-1). The IRS expects more than 153 million tax returns to be filed in 2017. More than four out of five returns are expected to be filed electronically, with a similar proportion of refunds issued through direct deposit.

While 2016 tax returns will not be processed before January 23, 2017, taxpayers who are e-filing can still submit returns to their software provider before that date, in which case the provider will hold the returns and transmit them to the IRS when the IRS's processing systems open. The IRS also reminds taxpayers that they don't have to wait until January 23 to contact their tax professional.

Observation: As a practical matter, most taxpayers will have to wait until they receive one or more Forms W-2 and/or 1099 before they can prepare and file their return. While the Protecting Americans from Tax Hikes Act of 2015 (PATH Act) revised the deadline for filing Form W-2 and certain types of Forms 1099 with the IRS, the revised deadline also affects the Form W-2 copy filed with the Social Security Administration. The deadline for providing electronic or paper Forms W-2 to employees, and for providing Forms 1099 to payees (including recipients of nonemployee compensation), remains January 31; specifically, Tuesday, January 31, 2017, for 2016 forms.

Filing Deadline Pushed back for Emancipation Day

According to Reg. Sec. 301.7503-1, when the deadline for filing tax returns or paying tax falls on a Saturday, Sunday, or legal holiday, the deadline is delayed until the next business day. For this purpose, the term "legal holiday" means legal holidays in the District of Columbia.

Paper tax returns are treated as timely filed if the envelope is properly addressed, postmarked, and deposited in the mail by the due date. Electronically filed tax returns are not considered filed until the IRS acknowledges acceptance of the electronic portion of the tax return for processing. The IRS accepts individual income tax returns electronically only if the taxpayer signs the return using a Personal Identification Number (PIN). If the provider transmits the electronic portion of a return on or shortly before the due date, and the IRS rejects it but the provider and the taxpayer comply with the requirements for timely resubmission of a correct return, the IRS considers the return timely filed.

April 15 falls on a Saturday in 2017, and while Emancipation Day in the District of Columbia is Sunday, April 16, 2017, it will be observed on Monday, April 17, 2017. This in means that taxpayers will have until Tuesday, April 18, 2017, to file their 2016 tax returns and pay any tax due.

Delayed Receipt of Some Tax Refunds

In 2016, the IRS issued 111 million individual tax refunds, and the IRS expects more than 70 percent of taxpayers to receive a refund in 2017. However, a new law requires the IRS to hold refunds claiming the Earned Income Tax Credit (EITC) or the Additional Child Tax Credit (ACTC) until February 15. This additional period is due to several factors, including banking and financial systems needing time to process deposits, as well as the IRS confirming the identities and wages and withholdings of those claiming the credit.

While the IRS will begin releasing EITC and ACTC refunds on February 15, it cautions taxpayers that these refunds likely will not start arriving in bank accounts or on debit cards until the week of February 27. The IRS wants taxpayers to know it will take additional time for their refunds to be processed and for financial institutions to accept and deposit the refunds to their bank account. Furthermore, many financial institutions do not process payments on weekends or holidays, which can affect when refunds reach taxpayers. For example, the President's Day holiday weekend may affect the receipt of the taxpayer's refund.

Where's My Refund? irs.gov and the IRS2Go phone app will be updated with projected deposit dates for early EITC and ACTC refund filers a few days after February 15. Taxpayers will not see a refund date on Where's My Refund? through their software packages until then. The IRS, return preparers, and software providers will not have additional information on refund dates, so Where's My Refund? remains the best way to check on the status of a refund.

Form 1065 Filing Deadline One Month Earlier in 2017

The Surface Transportation and Veterans Health Care Choice Improvement Act of 2015 made an important change to the due date for partnership tax returns, effective for tax years beginning after 2015. Now, partnerships are required to file their returns by the 15th day of the third month following the close of a tax year. For calendar year partnerships, the due date for the 2016 Form 1065 will be March 15, 2017, instead of April 15. The Act did not change the filing deadlines for S corporation returns, which means that partnership and S corporation returns share the same due date.

The March 15 deadline for calendar year partnerships and multi-member LLCs taxed as partnerships should make it a little easier for individuals who are partners or LLC members to file their tax return by (or soon after) the April 18, 2017, filing deadline.

While Sympathetic, Tax Court Finds No Financial Hardship Exception to IRA Early Withdrawal Penalty

The Tax Court held that distributions from a taxpayer's IRA in 2011 to support herself and her children, after she was laid off from her long-time job and was unable to find another one, were subject to the Code Sec. 72(t) early withdrawal penalty tax. While "sympathetic to her financial straits," the court found that that none of the statutory exceptions were available to the taxpayer, and thus the distributions were subject to the Code Sec. 72(t) penalty tax. Elaine v. Comm'r, T.C. Memo. 2017-3.

Background

In June 2009, Candace Elaine was laid off from her job of 23 years as a call center manager with a mutual fund company. At that time and during the year in issue, she was a single mother, raising two daughters on her own without support from anyone else. On account of the economic downturn, she was unable to find another job, and remained unemployed for several years.

To provide for her own subsistence and that of her daughters, Elaine made a series of withdrawals from her individual retirement account (IRA). During 2011, at which time she was not yet age 59she received four distributions totaling $119,000 from that account. For each distribution, the bank issued Elaine a Form 1099-R, Distributions From Pensions, Annuities, Retirement or Profit-Sharing Plans, IRAs, Insurance Contracts, etc. According to the IRS's wage and income transcript for Elaine's 2011 tax year, each Form 1099-R reported that the entire distribution was taxable and was an early distribution with "no known exception." Each Form 1099-R also reflected federal income tax withheld.

Elaine prepared and filed timely her Form 1040 for 2011. She reported taxable IRA distributions of $119,675, among other items of income (including unemployment compensation) and loss. After itemized deductions totaling $45,148 and exemptions totaling $11,100 (for herself and her daughters), Elaine reported taxable income of $33,184 and total tax of $4,119. She did not report the additional tax on early distributions from her IRAs, and did not attach Form 5329, Additional Taxes on Qualified Plans (Including IRAs) and Other Tax-Favored Accounts, to the return. After reporting her federal income tax withheld, Elaine claimed an overpayment of $4,849, which was refunded to her in May 2012.

On June 3, 2013, the IRS proposed changes to Elaine's 2011 return attributable to her not reporting any additional tax on her IRA distributions. Elaine timely responded to the IRS and explained that, because the IRA was her only means of income to pay bills and support herself and her daughters, she thought that the distributions from her IRA would fall under a financial hardship exception. In subsequent correspondence to the IRS, Elaine continued to plead financial hardship.

The IRS subsequently issued a notice of deficiency which assessed a Code Sec. 72(t) 10 percent penalty tax on the 2011 distributions from Elaine's IRA, as well as a substantial understatement of tax penalty. Elaine timely petitioned the Tax Court. She stated that she believed that the amounts withheld from her IRA distributions included a "10% federal and a 10% state penalty," and asked that she not be held liable for the tax and the penalty on the ground that, during 2011, she was experiencing financial hardship.

Analysis

Taxpayers can withdraw assets from their traditional IRA at any time. However, distributions before age 59are considered early distributions. Generally, an individual who takes an early distribution from a traditional IRA must pay a 10 percent additional penalty tax. Under Code Sec. 72(t)(1), the 10 percent penalty tax applies only to the part of the distribution that the individual must include in gross income, and is in addition to any regular income tax on the amount.

However, an individual who receives a distribution before age 59may not be subject to the penalty tax under several circumstances, such as if:

• The individual has unreimbursed medical expenses that are more than 10% of his/her AGI.
• The distribution is not more than the cost of medical insurance due to a period of unemployment.
• The individual is totally and permanently disabled.
• The individual is the beneficiary of a deceased IRA owner.
• The individual is receiving distributions in the form of an annuity.
• The distribution is used for qualified higher education expenses.
• The distribution is used to buy, build, or rebuild a first home.
• The distribution is due to an IRS levy on the plan.

Before the Tax Court, Elaine testified that the distributions were essentially her only means of income to pay bills and to support herself and her daughters. She indicated that she used a portion of the distributions to pay monthly medical insurance premiums and her student loan debt. While the court noted that the relevant statutory exceptions to the 10 percent penalty tax include distributions to an unemployed individual for health insurance premiums, as well as distributions for qualified higher education expenses, it found Elaine's testimony regarding the insurance premiums and student loan debt to be too general, and noted that she was unable to produce any documentation substantiating her testimony.

After concluding that Elaine took withdrawals from her IRA because of financial hardship, the Tax Court repeated what it has held on many other occasionsthat there is no exception under Code Sec. 72(t) for financial hardship (e.g., see Dollander v. Comm'r, T.C. Memo. 2009-187; Milner v. Comm'r, T.C. Memo. 2004-111; and Gallagher v. Comm'r , T.C. Memo. 2001-34). While "sympathetic to taxpayer's financial straits," the Tax Court stated that it could not disregard the express and unambiguous wording of the statute. Since none of the enumerated statutory exceptions applied to Elaine, all distributions from her IRA in 2011 were subject to the Code Sec. 72(t) additional penalty tax.

However, the Tax Court also held that Elaine was not liable for the substantial understatement of tax penalty under Code Sec. 6662. This was based on the (1) common misunderstanding among taxpayers that financial hardship is an exception to the Code Sec. 72(t) penalty tax; and (2) the fact that, "for whatever reason," the IRS closed an examination of Elaine's 2010 tax return for the same Code Sec. 72(t) issue without change. Because of that, Elaine "proceeded under that misunderstanding not only with respect to 2011 but apparently with respect to 2012 as well."