Do You Know Unemployment Benefits Are Taxable?

With the passage of the CARES Act stimulus package earlier this year, the federal government added $600 to the normal state weekly unemployment benefits and increased the number of benefit weeks to a total of 39.

In many cases, workers are receiving unemployment benefits for the first time in their lives, and they may not be aware that the benefits are fully taxable for federal purposes. Potentially making matters worse is that most states also tax unemployment benefits. This may come as a surprise with a potentially unpleasant outcome for many when it comes time to file their 2020 tax return next year.

Those who received unemployment benefits will be sent a Form 1099-G (Certain Government Payments) from the state that paid the benefits. This tax form shows the amount of unemployment benefits received and the amount of tax withheld, if any.

There are several states where unemployment benefits are not taxable. Seven states do not have a state income tax, so obviously, unemployment benefits are not taxable in those states, which are:

  • Alaska 
  • Florida 
  • Nevada 
  • South Dakota 
  • Texas 
  • Washington 
  • Wyoming

 Seven states have state income tax, but do not tax employment benefits. They include:

  • California 
  • Montana 
  • New Hampshire 
  • New Jersey 
  • Oregon 
  • Pennsylvania 
  • Tennessee 
  • Virginia 

Two states exempt 50% of amounts above $12,000 (single taxpayer) or $18,000 (married taxpayers). They are:

  • Indiana 
  • Wisconsin 

If you’ve collected unemployment compensation this year, your benefits’ impact on your tax bill will depend on a number of factors, including the amount of unemployment received, what other income you have, whether you are single or married (and, if married, whether you and your spouse are both receiving unemployment benefits), and whether you had or are having income tax withheld from benefit payments.

If you have questions about the taxation of unemployment compensation, please give our office a call.

 

© 2020

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Ready for the 1099-NEC?

The Internal Revenue Service has resurrected a form that has not been used since the early 1980s, Form 1099-NEC (the NEC stands for non-employee compensation). This form will be used to report non-employee compensation in place of the 1099-MISC, which has been used since 1983 to report payments to contract workers and freelancers. Form 1099-MISC has also been used to report rents, royalties, crop insurance proceeds and several other types of income unrelated to independent contractors.

The revival of the 1099-NEC was mandated by Congress with the passage of the PATH Act back in 2015. However, there have been some complications with implementing the form, so its use has been delayed. It will now make its return debut in 2021 for payments made in 2020.

The reason for the change is to control fraudulent credit claims—primarily for the earned income tax credit (EITC), which is based on earned income from working. Scammers were filing tax returns before the normal February 28 due date for 1099-MISC, which does not give the IRS the time to cross-check the earned income claimed in the returns. As a stopgap measure, 1099-MISC filings that included non-employee compensation were required to be filed by January 31, the same due date as W-2s, another source of earned income. By using the 1099-NEC for non-employee compensation, the IRS will be able to eliminate the problems created by having two filing dates for the 1099-MISC.

As a result, the 1099-MISC has also been revised, and Box 7—where non-employee compensation used to be entered—is now a checkbox for “Payer made direct sales of $5,000 or more of consumer products to a buyer (recipient) for resale.” Other boxes after Box 7 have also been reorganized.

The 1099-NEC is quite simple to use since it only deals with non-employee compensation, which is entered in Box 1, and there are entries for federal and state income tax withholding.1099 October 2020 1

If you operate a business and engage the services of an individual (independent contractor) other than one who meets the definition of an employee, and you pay him or her $600 or more for the calendar year, you are required to issue the individual a Form 1099-NEC soon after the end of the year to avoid penalties and the prospect of losing the deduction for his or her labor and expenses in an audit.

The due date for filing a 1099-NEC with the IRS and mailing the recipient a copy of the 1099-NEC that reports 2020 payments is February 1, 2021. (Normally the due date is January 31, but because that date falls on a weekend next year, the due date becomes the next business day, February 1, 2021.)

It is not uncommon to have a repairman out early in the year, pay him less than $600, then use his services again later in the year and have the total for the year exceed the $599 limit. As a result, you may have overlooked getting the information from the individual needed to file a 1099 for the year. Therefore, it is good practice to always have individuals who are not incorporated complete and sign an IRS Form W-9 the first time you engage them and before you pay them. Having a properly completed and signed Form W-9 for all independent contractors and service providers eliminates any oversights and protects you against IRS penalties and conflicts. If you have been negligent in the past about having W-9s completed, it would be a good idea to establish a procedure for getting each non-corporate independent contractor and service provider to fill out a W-9 and return it to you going forward.

IRS Form W-9, Request for Taxpayer Identification Number and Certification, is provided by the government as a means for you to obtain the vendors’ data you’ll need to accurately file the 1099s. It also provides you with verification that you complied with the law in case a vendor gave you incorrect information. We highly recommend that you have potential vendors complete a Form W-9 prior to engaging in business with them. The W-9 is for your use only and is not submitted to the IRS.

The penalties for failure to file the required informational returns are $280 per informational return. The penalty is reduced to $50 if a correct but late information return is filed no later than 30 days after the required filing date or it is reduced to $110 for returns filed after the 30th day but no later than August 1, 2021. If you are required to file 250 or more information returns, you must file them electronically.

In order to avoid a penalty, copies of the 1099-NECs you’ve issued for 2020 need to be sent to the IRS by February 1, 2021. They must be submitted on magnetic media or on optically scannable forms (OCR forms).

This firm prepares 1099s for submission to the IRS. We provide recipient copies and file copies for your records. Use the 1099 worksheet to provide this office with the information needed to prepare your 1099s.

 

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What Happens if an Individual Can’t Pay Taxes

While you probably don’t have any problems paying your tax bills, you may wonder: What happens in the event you (or someone you know) can’t pay taxes on time? Here’s a look at the options.

Most importantly, don’t let the inability to pay your tax liability in full keep you from filing a tax return properly and on time. In addition, taking certain steps can keep the IRS from instituting punitive collection processes.

Common penalties

The “failure to file” penalty accrues at 5% per month or part of a month (to a maximum of 25%) on the amount of tax your return shows you owe. The “failure to pay” penalty accrues at only 0.5% per month or part of a month (to 25% maximum) on the amount due on the return. (If both apply, the failure to file penalty drops to 4.5% per month (or part) so the combined penalty remains at 5%.) The maximum combined penalty for the first five months is 25%. Thereafter, the failure to pay penalty can continue at 0.5% per month for 45 more months. The combined penalties can reach 47.5% over time in addition to any interest.

Undue hardship extensions

Keep in mind that an extension of time to file your return doesn’t mean an extension of time to pay your tax bill. A payment extension may be available, however, if you can show payment would cause “undue hardship.” You can avoid the failure to pay penalty if an extension is granted, but you’ll be charged interest. If you qualify, you’ll be given an extra six months to pay the tax due on your return. If the IRS determines a “deficiency,” the undue hardship extension can be up to 18 months and in exceptional cases another 12 months can be added.

Borrowing money

If you don’t think you can get an extension of time to pay your taxes, borrowing money to pay them should be considered. You may be able to get a loan from a relative, friend or commercial lender. You can also use credit or debit cards to pay a tax bill, but you’re likely to pay a relatively high interest rate and possibly a fee.

Installment agreement

Another way to defer tax payments is to request an installment payment agreement. This is done by filing a form and the IRS charges a fee for installment agreements. Even if a request is granted, you’ll be charged interest on any tax not paid by its due date. But the late payment penalty is half the usual rate (0.25% instead of 0.5%), if you file by the due date (including extensions).

The IRS may terminate an installment agreement if the information provided in applying is inaccurate or incomplete or the IRS believes the tax collection is in jeopardy. The IRS may also modify or terminate an installment agreement in certain cases, such as if you miss a payment or fail to pay another tax liability when it’s due.

Avoid serious consequences

Tax liabilities don’t go away if left unaddressed. It’s important to file a properly prepared return even if full payment can’t be made. Include as large a partial payment as you can with the return and work with the IRS as soon as possible. The alternative may include escalating penalties and having liens assessed against your assets and income. Down the road, the collection process may also include seizure and sale of your property. In many cases, these nightmares can be avoided by taking advantage of options offered by the IRS.

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The Tax Implications of Employer-Provided Life Insurance

Does your employer provide you with group term life insurance? If so, and if the coverage is higher than $50,000, this employee benefit may create undesirable income tax consequences for you.

“Phantom income”

The first $50,000 of group term life insurance coverage that your employer provides is excluded from taxable income and doesn’t add anything to your income tax bill. But the employer-paid cost of group term coverage in excess of $50,000 is taxable income to you. It’s included in the taxable wages reported on your Form W-2 — even though you never actually receive it. In other words, it’s “phantom income.”

What’s worse, the cost of group term insurance must be determined under a table prepared by IRS even if the employer’s actual cost is less than the cost figured under the table. Under these determinations, the amount of taxable phantom income attributed to an older employee is often higher than the premium the employee would pay for comparable coverage under an individual term policy. This tax trap gets worse as the employee gets older and as the amount of his or her compensation increases.

Check your W-2

What should you do if you think the tax cost of employer-provided group term life insurance is undesirably high? First, you should establish if this is actually the case. If a specific dollar amount appears in Box 12 of your Form W-2 (with code “C”), that dollar amount represents your employer’s cost of providing you with group-term life insurance coverage in excess of $50,000, less any amount you paid for the coverage. You’re responsible for federal, state and local taxes on the amount that appears in Box 12 and for the associated Social Security and Medicare taxes as well.

But keep in mind that the amount in Box 12 is already included as part of your total “Wages, tips and other compensation” in Box 1 of the W-2, and it’s the Box 1 amount that’s reported on your tax return

Consider some options

If you decide that the tax cost is too high for the benefit you’re getting in return, you should find out whether your employer has a “carve-out” plan (a plan that carves out selected employees from group term coverage) or, if not, whether it would be willing to create one. There are several different types of carve-out plans that employers can offer to their employees.

For example, the employer can continue to provide $50,000 of group term insurance (since there’s no tax cost for the first $50,000 of coverage). Then, the employer can either provide the employee with an individual policy for the balance of the coverage, or give the employee the amount the employer would have spent for the excess coverage as a cash bonus that the employee can use to pay the premiums on an individual policy.

Contact us if you have questions about group term coverage or how much it is adding to your tax bill.

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IRS Publishes New Release Regarding Business Interest Expense Limitations

The Internal Revenue Service (IRS) recently announced finalized guidance regarding business interest expense limitations. In a helpful article from the Journal of Accountancy, author Sally Schreiber offers an overview of the new rules.

Background

The business interest expense limitation was created by the Tax Cuts and Jobs Act (TCJA) of 2017 and subsequently modified by the Coronavirus Aid, Relief, and Economic Security Act (CARES Act) of 2020. The TCJA established that for tax years 2018 and beyond, deductions for business interest expenses are limited to the total of three items:

  1. Business interest income
  2. 30% of adjusted taxable income (ATI)
  3. The interest expense of the taxpayer’s floor plan financing

The CARES Act made two changes: it adjusted item number two to 50% for tax years 2019 and 2020 and made it allowable for taxpayers to calculate their 2020 limit using their 2019 ATI. 

New IRS Regulations

The recently released IRS regulations offer instructions in four areas:

  1. Determining the interest expense limitation
  2. The definition of interest, for the purposes of the limitation
  3. Who is subject to the limitation
  4. How the limitation applies in various special cases

The guidance will go into effect 60 days from the date of its publication in the Federal Register, which has yet to be announced.

Additional Proposed Regulations

In addition to the new final guidance, the IRS published additional proposed regulations regarding business interest expense deduction limitation issues, including how to allocate interest expense for passthrough entities and more. The release of this proposed guidance opens up a 60-day period for written and electronic comment submission, as well as requests for a public hearing regarding the guidance.

For full details on the recent IRS release, click here to read the article at the Journal of Accountancy.

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