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The IRS has provided guidance on two exceptions to the 10 percent additional tax under Code Sec. 72(t)(1) for emergency personal expense distributions and domestic abuse victim distributions. These exceptions were added by the SECURE 2.0 Act of 2022, P.L. 117-328, and became effective January 1, 2024. The Treasury Department and the IRS anticipate issuing regulations under Code Sec. 72(t) and request comments to be submitted on or before October 7, 2024.

The IRS has provided guidance on two exceptions to the 10 percent additional tax under Code Sec. 72(t)(1) for emergency personal expense distributions and domestic abuse victim distributions. These exceptions were added by the SECURE 2.0 Act of 2022, P.L. 117-328, and became effective January 1, 2024. The Treasury Department and the IRS anticipate issuing regulations under Code Sec. 72(t) and request comments to be submitted on or before October 7, 2024.

Distributions for Emergency Personal Expenses

Code Sec. 72(t)(2)(I) provides an exception to the 10 percent additional tax for a distribution from an applicable eligible retirement plan to an individual for emergency personal expenses. The term "emergency personal expense distribution" means any distribution made from an applicable eligible retirement plan to an individual for purposes of meeting unforeseeable or immediate financial needs relating to necessary personal or family emergency expenses. The IRS specifically noted that emergency expenses could be related to: medical care; accident or loss of property due to casualty; imminent foreclosure or eviction from a primary residence; the need to pay for burial or funeral expenses; auto repairs; or any other necessary emergency personal expenses.

The IRS provides that a plan administrator or IRA custodian may rely on a written certification from the employee or IRA owner that they are eligible for an emergency personal expense distribution. Furthermore, the IRS provides that an emergency personal expense distribution is not treated as a rollover distribution and thus is not subject to mandatory 20% withholding. However, the distribution is subject to withholding, the IRS said. If the emergency personal expense distribution is repaid, it is treated as if the individual received the distribution and transferred it to an eligible retirement plan within 60 days of distribution.

If an otherwise eligible retirement plan does not offer emergency personal expense distributions, the IRS indicated that an individual may still take an otherwise permissible distribution and treat it as such on their federal income tax return. The individual claims on Form 5329 that the distribution is an emergency personal expense distribution, in accordance with the form’s instructions. The individual has the option to repay the distribution to an IRA within 3 years.

Distributions to Domestic Abuse Victims

Code Sec. 72(t)(2)(K) provides an exception to the 10 percent additional tax for an eligible distribution to a domestic abuse victim (domestic abuse victim distribution). The guidance defines a"domesticabusevictimdistribution" as any distribution from an applicable eligible retirement plan to a domestic abuse victim if made during the 1-year period beginning on any date on which the individual is a victim of domestic abuse by a spouse or domestic partner. "Domesticabuse" is defined as physical, psychological, sexual, emotional, or economic abuse, including efforts to control, isolate, humiliate, or intimidate the victim, or to undermine the victim’s ability to reason independently, including by means of abuse of the victim’s child or another family member living in the household.

As with distributions for emergency personal expenses, a retirement plan may rely on an employee’s written certification that they qualify for a domestic abuse victim distribution. Similarly, if an otherwise eligible retirement plan does not offer domestic abuse victim distributions, the IRS indicated that an individual may still take an otherwise permissible distribution and treat it as such on their federal income tax return. The individual claims on Form 5329 that the distribution is a domestic abuse victim distribution, in accordance with the form’s instructions. The individual has the option to repay the distribution to an IRA within 3 years.

Request for Comments

The Treasury Department and the IRS invite comments on the guidance, and specifically on whether the Secretary should adopt regulations providing exceptions to the rule that a plan administrator may rely on an employee’s certification relating to emergency personal expense distributions and procedures to address cases of employee misrepresentation. Comments should be submitted in writing on or before October 7, 2024, and should include a reference to Notice 2024-55.

On June 17, 2024, the U.S. Department of the Treasury and the Internal Revenue Service announced a new regulatory initiative focused on closing tax loopholes and stopping abusive partnership transactions used by wealthy taxpayers to avoid paying taxes.

On June 17, 2024, the U.S. Department of the Treasury and the Internal Revenue Service announced a new regulatory initiative focused on closing tax loopholes and stopping abusive partnership transactions used by wealthy taxpayers to avoid paying taxes.

Specifically targeted by this new tax compliance effort are partnership basis shifting transactions. In these transactions, a single business that operates through many different legal entities (related parties) enters into a set of transactions that manipulate partnership tax rules to maximize tax deductions and minimize tax liability. These basis shifting transactions allow closely related parties to avoid taxes.

The use of these abusive transactions grew during a period of severe underfunding for the IRS. As such, the audit rates for these increasingly complex structures fell significantly. It is estimated that these abusive transactions, which cut across a wide variety of industries and individuals, could potentially cost taxpayers more than $50 billion over a 10-year period, according to an IRS News Release.

"Using Inflation Reduction Act funding, we are working to reverse more than a decade of declining audits among the highest income taxpayers, as well as complex partnerships and corporations," IRS Commissioner Danny Werfel said during a press call discussing the new effort on June 14, 2024.

"This announcement signals the IRS is accelerating our work in the partnership arena, which has been overlooked for more than a decade and allowed tax abuse to go on for far too long," said IRS Commissioner Danny Werfel. "We are building teams and adding expertise inside the agency so we can reverse long-term compliance declines that have allowed high-income taxpayers and corporations to hide behind complexity to avoid paying taxes. Billions are at stake here".

This multi-stage regulatory effort announced by the Treasury and IRS includes the following guidance designed to stop the use of basis shifting transactions that use related-party partnerships to avoid taxes:

• proposed regulations under existing regulatory authority to stop related parties in complex partnership structures from shifting the tax basis of their assets amongst each other to take abusive deductions or reduce gains when the asset is sold;

• proposed regulation to require taxpayers and their material advisers to report if they and their clients are participating in abusive partnership basis shifting transactions; and

• a Revenue Rulingproviding that certain related-party partnership transactions involving basis shifting lack economic substance.

"Treasury and the IRS are focused on addressing high-end tax abuse from all angles, and the proposed rules released today will increase tax fairness and reduce the deficit," said U.S. Secretary of the Treasury Janet L. Yellen.

In the June 14, 2024, press call, Commissioner Danny Werfel also noted that there will be an increase in audits of large partnerships with average assets over $10 billion dollars and larger organizational changes taking place to support compliance efforts, including the creation of a new associate office that will focus exclusively on partnerships, S corporations, trusts, and estates.

By Catherine S. Agdeppa, Content Management Analyst

A savings account with the tax benefits of a health savings account or an educations savings account but without the singular restricted focus could be something that gains traction as Congress addresses the tax provision of the Tax Cuts and Jobs Act that expire in 2025.

A savings account with the tax benefits of a health savings account or an educations savings account but without the singular restricted focus could be something that gains traction as Congress addresses the tax provision of the Tax Cuts and Jobs Act that expire in 2025.

The concept was promoted by multiple witnesses testifying during a recent Senate Finance Committee hearing on the subject of child savings accounts and other tax advantaged accounts that would benefit children. It also is the subject of a recently released report from The Tax Foundation.

Rather than push new limited-use savings accounts, "policymakers may want to consider enacting a more comprehensive savings program such as a universalsavingsaccount," Veronique de Rugy, a research fellow at George Mason University, testified before the committee during the May 21, 2024, hearing. "Universalsavingsaccounts will allow workers to save in one simple account from which they would withdraw without penalty for any expected or unexpected events throughout their lifetime."

She noted that, like other more focused savings accounts, like health savings accounts, it would have "the benefit of sheltering some income from the punishing double taxation that our code imposes."

De Rugy added that universal savings accounts "have a benefit that they do not discourage savings for those who are concerned that the conditions for withdrawals would stop them from addressing an emergency in their family."

Adam Michel, director of tax policy studies at the Cato Institute, who also promoted the idea of universal savings accounts. He said these accounts "would allow families to save for their kids or any of life’s other priorities. The flexibility of these accounts make them best suited for lower and middle income Americans."

He also noted that they are promoting savings in countries that have implemented them, including Canada and United Kingdom.

"For example, almost 60 percent of Canadians own tax-free savingsaccounts," Michel said. "And more than half of those account holders earned the equivalent of about $37,000 a year. These accounts have helped increase savings and support the rest of the Canadian savings ecosystem."

De Rugy noted that in countries that have implemented it, they function like a Roth account in that money that has already been taxed can be put into it and not penalized or taxed upon withdrawal.

Michel also noted that the if the tax benefits extend to corporations as they do with deposits to employee health savings accounts, "to the extent that you lower the corporate income tax, you’re going to encourage a different additional investment into savings by those entities."

Simulating The Universal Savings Account Impact

The Tax Foundation in its report simulated how a universal savings account could work, based on how they are implemented in Canada. The simulation assumed the accounts could go active in 2025 for adults aged 18 years or older.

On a post-tax basis, individuals would be allowed to contribute up to $9,100 on a post-tax basis annually, with that cap indexed for inflation. Any unused "contribution room" would be allowed to be carried forward. Earnings would be allowed to grow tax-free and withdrawals would be allowed for any purpose without penalty or further taxation. Any withdrawal would be added back to that year’s contribution room and that would be eligible for carryover as well.

"The fiscal cost of this USA policy would be offset by ending the tax advantage of contributions to HSAs beginning in 2025," the report states. "As such, future contributions to HSAs would be given normal tax treatment, i.e. included in taxable income and subject to payroll tax with subsequent returns on contributions also included in taxable income."

In this scenario, the Tax Foundation report estimates that "this policy change would on net raise tax revenue by about $110 billion over the 10-year budget window."

As for the impact on taxpayers, the "after-tax income would fall by about 0.1 percent in 2025 and by a smaller amount in 2034, reflecting the net tax increase in those years," the report states. "Over the long run, and accounting for economic impacts, taxpayers across every quintile would see a small increase in after-tax income on average, but the top 5 percent of earners would continue to see a small decrease in after-tax income on average."

By Gregory Twachtman, Washington News Editor

The Internal Revenue Service’s use of artificial intelligence in selecting tax returns for National Research Program audits that areused to estimate the tax gap needs more documentation and transparency, the U.S. Government Accountability Office stated.

The Internal Revenue Service’s use of artificial intelligence in selecting tax returns for National Research Program audits that areused to estimate the tax gap needs more documentation and transparency, the U.S. Government Accountability Office stated.

In a report issued June 5, 2024, the federal government watchdog noted that while the agency uses AI to improve the efficiency and selection of audit cases to help identify noncompliance, "IRS has not completed its documentation of several elements of its AI sample selection models, such as key components and technical specifications."

GAO noted that the IRS began using AI in a pilot in tax year 2019 for sampling tax returns for NRP audits. The current plan is to use AI to create a sample size of 4,000 returns to measure compliance and help inform tax gap estimates, although GAO expressed concerns about the accuracy of the estimates with that sample size.

"For example, NRP historically included more than 2,500 returns that claimed the Earned Income Tax Credit, but the redesigned sample has included less than 500 of these returns annually," the report stated.

IRS told GAO that it "is exploring ways to combine operational audit data with NRP audit data when developing its taxgapestimates. IRS officials also told us that if IRS can reliably combine these data for taxgap analysis, IRS might be better positioned to identify emerging trends in noncompliance and reduce the uncertainty of the estimates due to the small sample size."

The report also highlighted the fact that the agency "has multiple documents that collectively provide technical details and justifications for the design of the AI models. However, no set of documents contains complete information and IRS analyst could use to run or update the models, and several key documents are in draft form."

"Completing documentation would help IRS retain organizational knowledge, ensure the models are implemented consistently, and make the process more transparent to future users," the report stated.

By Gregory Twachtman, Washington News Editor

In many parts of the country, residential property has seen steady and strong appreciation for some time now. In an estate planning context, however, increasing property values could mean a potential increase in federal estate tax liability for the property owner's estate. Many homeowners, who desire to pass their appreciating residential property on to their children and save federal estate and gift taxes at the same time, have utilized qualified personal residence trusts.

In many parts of the country, residential property has seen steady and strong appreciation for some time now. In an estate planning context, however, increasing property values could mean a potential increase in federal estate tax liability for the property owner's estate. Many homeowners, who desire to pass their appreciating residential property on to their children and save federal estate and gift taxes at the same time, have utilized qualified personal residence trusts.

What is a QPRT?

The qualified personal residence trust, referred to as a "QPRT," is an estate planning technique used to transfer a personal residence from one generation to the next without incurring federal estate tax on the trust property. This type of irrevocable trust allows a homeowner to make a future gift of the family home or a vacation property to his or her children, while retaining the right to continue living in the home for a term of years that the homeowner selects.

Creating a QPRT

The homeowner transfers title to his or her residence into trust for a set time period (for example, 10 years), but retains the right to live in the house during the trust term. At the end of the term, the trust property is distributed to the donor's children without passing through the donor's estate, thereby avoiding federal estate tax on the trust assets. However, if the donor wishes to continue living in the residence after the end of the trust term, the donor must pay fair market rent to his or her children, the new owners of the residence.

Gift tax advantage

Through the use of a QPRT, the full value of your residence can be transferred to your children. However, for federal gift tax purposes, the property is valued at a discount. The actual value of the gift (and the gift tax savings) depends upon your age, the length of the QPRT term, and the federal interest rates in effect at the time you transfer the house to the trust. For example, the longer the trust term, the lower the gift value for gift tax purposes and the greater the gift tax savings. Also, the higher the applicable federal interest rate, the greater the potential gift tax savings.

If you would like to discuss how a QPRT might work for you as part of your overall estate plan, or if you currently have an established QPRT and you wish to review its effect in light of current interest rates and other factors, please do not hesitate to contact this office.

Possible changes on the tax front including Estate Taxes, 1031 Exchange limitations, and a SALT workaround for some Californians

September 1, 2021

We are pleased to bring you the next edition of Praetorian Advisors’ every so often tax musings direct from our national office in Corona del Mar; ok, our only office.  It is our hope that this edition finds you both happy and healthy.

So, what is the latest on the tax front?  Well, there has been a lot of talk but no action on the federal level (that is not a bad thing), and a recent welcome surprise for some of those impacted by California income taxes.  Here is the rundown:

Federal Income, Estate & Gift Changes

Since before the Biden administration took over in January, a wish list of income tax increases, and estate and gift exemption decreases has been much discussed.  We fielded questions from some of you in the spring about moves to make given this wish list.  Having been in this business for almost 20 years at Praetorian Advisors (anniversary gifts accepted in October), and in the tax business for another 7 (Patti) and 12 years (Paul, because it’s always fun to remind him he is older) prior to Praetorian’s inception, we have seen many proposals come and go over the years.  As a result, we typically do not advise drastic actions be taken based on the prospect of tax law changes and have felt the same way so far in 2021...although we continue to keep an eye on the landscape.  Our view on the Biden proposed tax increases is one of extreme positions in so many tax areas that the end game is to get a few of the proposals passed, allowing the administration to claim the “Great Compromise of 2021”.

Given the very narrow majorities in both the House and Senate, the differing goals of the moderate and extreme wings of the Democrats, and mid-terms being a mere 15 months away, less change is more likely than a lot of change.  When Afghanistan, inflation, rising gas prices, immigration and border issues, and Covid are considered, tax increases presumably will or at least should be a lower priority.  Here are some of the more impactful proposals:

Ordinary and capital gains tax rates – the Biden administration wants to restore the top ordinary tax rate to 39.6% and increase the top long term capital gains rate from 20% to the same 39.6% for those with over $1 million of income.  Add the Obamacare/net investment income tax of 3.8% on top of that and 43.4% is the new proposed top rate.  This would impact far too much of our client base.  Add another 13.3% for our California clients and 56.4% is your number.  That hardly inspires one to recognize any gains or motivate to build a business and provide jobs to many.

Perhaps our bias as your tax advisors that you should get to keep more of your money than the government is shining through.  When politicians and talking heads mention that the top tax rate was 70% decades ago, they dishonestly fail to mention that taxpayers could deduct just about anything they spent money on back then.  Today, the most impactful individual deductions are down to: $10,000 of state and local taxes (SALT) that includes real property taxes, mortgage and investment interest, and charitable contributions.

Section 1031 Exchanges – Also called the like-kind exchange, this provision of tax law dates back almost 100 years and allows the taxpayer to defer gain on the sale of trade or business assets (limited to real estate only by President Trump as of 2018) if the proceeds are reinvested into another piece of property.  President Biden wants to eliminate the Section 1031 exchange for those with income over $400,000.

Corporate Tax Rates – Proposed increase from 21% to 28% (was 35% in 2017).  Many, including us, feel this has a better chance to pass than the other proposals because it is still 7% lower than the rate before Trump cut them a few years ago.  What many fail to realize is that corporations pass along price increases, whether it be for product or taxes, onto the consumer which has an inflationary effect.  In our opinion it makes little sense to be pushing for a corporate tax increase at home while pushing for a global minimum tax rate of 15% abroad.  We will let the economists handle the rest of that one.

Estate and Gift Tax (Part 1) – The current estate and gift tax exemption is $11.7 million per person, meaning someone can gift up to this amount without having to pay a gift tax to the government.  To the extent the gift exemption is not fully utilized, each person can use the estate exemption against his or her assets before having to pay an estate or death tax at the end of life.  The current proposal is to reduce the estate exemption to $3.5 million and the gift exemption to $1 million.  Even Obama was good with a $5 million estate and gift exemption.

Planning Tip: Note that the current estate exemption (adjusted for inflation each year) is set to expire and return to approximately $6 million at the end of 2025.  Therefore, if you might otherwise be making substantial gifts by the end of 2025, DO IT NOW.  We advise this for those who can live at their accustomed lifestyle with remaining assets after the gifting, and those who are much closer to the end than the beginning (was that gentle enough?) who have enough assets to live out the remainder of their lives.  If you will be implementing a gifting plan, you need to consult with us or your estate attorney (or both) as some assets are better to gift than others.

Estate and Gift Tax (Part 2) – For many decades (Paul was 10 and Patti 4 at the time), people’s estates have received a “basis step up” upon death, adjusting the tax basis of assets left for a surviving spouse or heirs to the date of death value.  For example, you bought a home on Balboa Island in 1983 for $300,000 and today it is worth $6 million.  Assuming the home is part of your estate (not shifted/gifted to an irrevocable trust), there will be a step up in basis to $6 million at your death, meaning your surviving spouse or heirs can sell that home and not recognize a capital gain on sale.  How can this be you ask?  The idea is that because an estate tax exists that assesses a tax based on the value of your assets, an income tax on sale of the same asset should not apply.

The Biden administration has proposed not only an elimination on the basis step up rules, but also an immediate capital gains tax at death for someone not subject to the estate tax!  Assume you die before the end of 2025.  Your Balboa home combined with your investments total $9 million.  Under this proposal, your heirs would have to pay capital gains tax on the $5.7 million “gain” even though the home isn’t sold…yet…plus whatever gains exist in your investment portfolio.  At 43.4%, that’s almost $2.5 million of capital gains tax!  It sounds like the kids will have to sell the house after the funeral reception there.

Estate and Gift Tax (Part 3) – Biden wants to eliminate use of effective estate and gift planning trusts called Grantor Retained Annuity Trusts (GRATs) and dynasty (multi-generational) trusts, and has also proposed capital gains tax upon transfer of assets to a trust.  Yikes!

Retroactive Application - The administration also floated retroactive application to January 1, 2021 of any new tax law changes.  Isn’t that unconstitutional you ask?  We all thought so until the Clinton tax increases of 1993 which were retroactive, and it held up in court.  While retroactivity is a possibility, with each passing day it is less and less probable.  Given that we are already into the 8^th month of the year and so much is still up in the air, we expect any (if any) changes will be effective January 1, 2022. 

Another factor is the IRS still being months behind processing returns and correspondence due to what we call their Covid vacation.  It turns out the good people working at the IRS do not take kindly to the vacation comment, but the fact remains they are months behind where they should be.  Retroactive application of tax law changes at this juncture might be the end of them.  Now there is an idea!

Crystal Ball Predictions

If we had to guess, our prediction is the corporate tax rate hike is most likely to pass, the estate and gift tax provisions the least likely to pass, the income tax rate changes less likely to pass, and elimination of the 1031 exchange – your guess is as good as ours.

The SALT Workaround – Relief for some Californians

Are you tired of hearing about the rich and how they need to pay their fair share?  We sure are because we see how much you pay.  Not just the numbers, but the percentage of income paid in taxes by some of you is astounding.

Have you also been trained to think that you got completely hosed by the $10,000 state and local tax (SALT) limitation?  As we have shown to many of you that has not been the case…for some.  Significant changes to the Alternative Minimum Tax (AMT) structure and a lower tax rates have resulted in lower overall tax liability even though the SALT limit has created higher taxable income.  Now for those over $1 million of ordinary income (you know who you are), the sting of the SALT limitation is real. 

Relief is on the way due to a recent California law enacted, but only for those with income from partnership and S Corp K-1s, and even that is not as straightforward as it sounds.  Given that there are a multitude of questions to be answered by the state government given the newness of the law, here we provide a top-level overview here of how it is designed to work.

S Corporations and partnerships doing business in California may make an election on March 15, 2022 to remit California taxes at 9.3% of flow through income on behalf of its shareholders/partners, and get a federal tax deduction for the taxes remitted.  A quick example: you own a S Corp that reports $1,000,000 of income on your K-1.  Rather than you remitting quarterly individual estimated taxes to California on the expected K-1 income, the S Corp instead elects to remit $93,000 in March 2022 on your behalf.  Your K-1 from the S Corp will now reflect federal taxable income of $907,000 instead of $1,000,000.  State taxes have never been deductible for state purposes, so your California K-1 will still show $1,000,000 plus or minus other federal/California tax differences.  At the 37% tax rate, the $93,000 deduction saves $34,410 in federal taxes. That’s the concept in a nutshell.  Here is what else we know:

• If the S Corp or partnership fails to make the election and remit the tax by March 15, 2022 then it is an opportunity missed. However, to get the deduction on your 2021 federal K-1, the tax must be remitted before December 31, 2021 on a yet to be published estimate form.  You can already see that this is going to get confusing!
  
  
• To be eligible for the 2022 tax year, the greater of $1,000 or 50% of what was paid by March 15, 2022 for the 2021 tax year must be remitted by June 15, 2022. The balance owed for 2022 will be due March 15, 2023.  For each subsequent year, it is rinse, lather, repeat but only through 2025 when the SALT limitation is set to expire, or until (if) the SALT limitation is repealed by Congress.  If the proper June 15^th payment is not remitted, it’s an opportunity missed for that year.
  
  However, if you want the deduction to be reflected on your 2021 K-1 the entity will need to remit the tax before December 31, 2021 on a yet to be published tax form.
  
  
• The workaround applies to all types of income on a K-1, including ordinary income, rental income, and investment income (interest, dividends, capital gains, etc).
  
  
• If a partnership has another partnership as even one of its partners, the entire partnership, and hence all individual partners, are disqualified from participating in the SALT workaround. This will likely eliminate participation if you are in a large investment partnership with hundreds of partners.
  
  
• Each eligible partner or shareholder must make the election with the partnership or S Corporation.
  
  
• For those of you who earn your income solely from W-2 wages, this whole concept is not applicable. We have said before that we prefer tax law that avoids choosing winners and losers, but this idea only passes muster with the IRS when a flow through entity is involved, trusts excluded.
  
  
• Planning Alert! (emoji with red sirens here if I knew how to do that): many of you have single member LLCs (SMLLC) for operating businesses, rental properties, etc that provide legal liability protection without the hassle of filing a separate federal entity return. While they are great vehicles for simplification and protection, the SALT workaround does not apply to SMLLCs.  Depending on the amount of income generated by your SMLLC, converting to a multi-member LLC has the potential to save significant tax dollars even after paying for preparation of additional tax returns.  For 2021, whether the full year’s LLC activity or only the multi-member period can be counted for the SALT workaround is not known at this time.
  
  
• If you are in a higher California tax bracket (up to 13.3%) and/or have other sources of income from wages, investment income, etc, there likely will still be a need to remit quarterly estimated tax payments that are subject to the SALT limitation.
  
  
• Unrelated to the California law, many other states to date have SALT workaround laws in varying formats. The current list of states that have passed or have pending SALT workaround legislation are: Arizona, Connecticut, Georgia, Idaho, Illinois, Louisiana, Maryland, Massachusetts, New Jersey, New York, North Carolina, Oklahoma, Rhode Island, and Wisconsin (no doubt with more to come).  For those of you in these states, we can review your situation to ensure maximum tax savings are achieved as well.

There is the quick rundown on what we do know, but there is much to still be clarified.  As we learn more about application of the new law, we will contact you about your next planning move, but do expect that this could impact the third and fourth quarter estimated tax payments for some of you.

Five pages of updates is enough for now.  Stay tuned for more in the future, and we look forward to continuing to serve your tax and financial needs.

Tax preparation during a global pandemic

Latest Praetorian Advisors Tax Season Update – Please Read! 

Well, much has changed in the past several days.  We are on lockdown and can no longer work from our office.  While not a huge deal because we can get work done from our home offices, it is still disruptive to our normal tax season life.  There is an oxymoron: “normal tax season life” as there is nothing normal about the way we live during tax season!  In addition, the internet and the news is all virus, all the time. 

One minute it feels like this may all be a severe overreaction when the numbers are put into perspective.  The California governor predicts 22 million of the 40 million Golden State’s residents will get the virus (56%), while China claims (insert chuckle here) 81,000 cases with 1.6 billion people (billion with a B – less than 1/100^th of 1%), and Italy has 41,000 cases with 60 million people, well less than 1/10^th of 1%).  Virus deaths globally now total over 10,000, while the flu typically kills about 35,000 Americans annually.  Imagine if we got an e-mail or phone call from building management or a restaurant every time it was determined someone had been there with the flu; it would make us nuts.  The governor’s math seems quite fuzzy, and it sure feels like an overreaction…

…Until the next minute we hear of doctors in ICU, few test kits available, well respected Dr. Fauci sounding alarm bells, cases spiking, people rushing stores to potentially hunker down for months, the most populous state in the country on lockdown, while this ultimate Black Swan event crushes a thriving economy as we come to a grinding halt.  Unless you are a U.S. Senator, your stock portfolio has also been crushed.

Time will tell if the spring breakers in Florida or the toilet paper hoarders/preppers were correct. The truth most likely lies somewhere in the middle.

While we have additional thoughts, the Op-Ed is over; now to the tax season update:

• Finally, the federal tax deadline to file and pay remaining 2019 taxes was extended this morning to July 15^th. California is conforming as well, like many other states.  Some states have yet to extend deadlines, and we are keeping an eye on those states for you, if applicable to your filings.
  
  Note that for federal purposes, if you owe more than $1 million for 2019 you can only defer payment on the first $1 million, while the remainder must be paid by April 15^th.
  
  
• The extension of time to file and pay applies to all entities, including trusts.
  
  
• Federal first quarter 2020 estimated tax payments are now due June 15^th. The second quarter estimate is also due June 15^th.  The $1 million cap on deferral also applies to estimated tax payments.
  
  
• California has made everything simpler. Any payments, including balances due, the $800 minimum tax for entities, 2020 estimated taxes, etc, are due July 15^th.  This includes first and second quarter 2020 estimates.  For those of you filing in other states, we will be in touch to discuss your filing and payment deadlines.

Our approach to the lengthened tax season is to continue working hard but get a little more sleep than we normally do this time of year to try to stay healthy, while dealing with the challenges to our lives that we all face right now.  We are prioritizing completion of returns as follows, being mindful of the disruption in cash flow this has all caused for many people:

• Partnership and S Corporation returns with K-1s that are to be distributed to investors in the entities, so we are not delaying someone’s ability to claim a refund.
  
  
• Individual and trust returns expecting a refund that will not be applied to 2020.
  
  
• Returns for which we had all information in early.
  
  
• Returns for which we have all information that came in later. This includes returns that may have been extended at April 15^th in the past, but we will be able to complete before the extended deadline this year.
  
  
• For those of you who file in the Fall because you are waiting on K-1s well into the Summer, we will work on your extension calculations after April 15^th, except for those who may owe over $1 million who need to know the figures sooner.

Given all that is going on, as a firm we welcome the extension this year.  However, we have no desire to be in busy season mode for the next four months.  As hectic as the April 15^th deadline is, we also look forward to tax season being over every year so we can get back to our lives and families, and take a little time off.  To that end, we ask you to continue getting us information so we can continue working diligently on your behalf.  If you normally get us information right about now, stick with it rather than thinking you can show up on July 1^st with a stack of information and expect that we will get it done by the July 15^th deadline.  That would be misguided thinking on your part.  There are only so many closets you can clean or movies you can watch while in lockdown, so spend some time getting that tax information together, too.

Once we get more clarity on this lockdown, hopefully we can get back into the office for at least a limited time and have some drop off hours.  Stay tuned.

Lastly, we encourage you to consider that this is not the end of the world; many of us may have already had the virus and not even known it; don’t beat your spouse or kick the dog while having all of this together time; watch some old classic movies or newer ones you have been meaning to get to; do a puzzle or play a board game with your family; drink that special bottle of wine you have been saving, just live your life while taking prudent precautions to be safe.  In the meantime, we will be doing taxes.

Tax change possibilities following the election

Great News! Only one more month to go and 2020 will finally be behind us! Turning back the clock one hour in November wasn’t worth the extra sleep, and 2020 even managed to slip in an extra day on us back in February – cruel, cruel, cruel.

Although there is much to say about 2020 with liberal use of four letter  words a big part of it, our purpose here is to look forward at some thoughts and ideas as we look forward to turning the page on 2020. Here we focus on your wealth matters… because your wealth matters. See what we did there? Not bad for CPAs, huh?

Over the past 10 or so years, there have been several significant tax law changes signed into law in mid to late December creating year end planning chaos crammed into a few short days, during the holidays. Lumps of coal for all our “friends” in D.C. This year we won’t have that, it’s worse! The never-ending election still hasn’t ended, and we won’t know the color of the Senate majority until January. Why does this matter?

As it relates to your taxes and wealth, we aren’t 100% certain. There seem to be a few schools of thought, both of which assume President Trump’s multiple legal appeals fall short and Joe Biden becomes President. Note that if President Trump miraculously was successful in the appeals, then most of this letter was mostly a waste of time because nothing will change on the tax front.

School One – The Senate is blue, along with the House and Presidency. Bring on the Green New Deal and more regulations, back in the Iran nuclear deal and Paris accord, higher income taxes, and lower gift and estate tax exemptions, just to name a few.

School Two – The Senate, House, and Presidency are all blue but the moderate Democrats, sleeping with one eye open and knowing the 2022 midterms are just around the  corner, push back against the far left of the party and vote Republicans on major legislation in the name of their own political survival. Don’t even forget it’s not about you, but about politician’s political survival. A case in point: Joe Manchin, Democrat Senator from West Virginia, has already announced he won’t have any part in a Supreme Court packing scheme (his words, not ours). If the Dems do get control of Congress and the White House, it will be by the slimiest of majorities, and not the mandate Nancy Pelosi likes to claim. In fact, if both Georgia Senate seats go blue, it will be a 50-50 tie, with Kamala Harris as the tiebreaking vote.

School Three – At least one of the Georgia Senate seats goes red, Mitch McConnell maintains his leadership position, and he advances to the Senate floor what he wants, albeit with a tad more pressure to compromise than he has faced the past four years. This is what we call gridlock, a dirty word when trying to get home on the 405 on a Friday afternoon. In politics however (and down on Wall St.), gridlock is viewed as a positive by the 70% or so in the middle (center-left to center-right).

So what does all this uncertainty mean to you? With your thumb holding your pinky, hold up your other three fingers on your right hand together – try again, not just the one finger but all three – that’s better, and do as the Boy Scouts do – Be Prepared!

Wagering on Schools Two or Three may very well be a solid bet, which we think are more likely then School One… but be prepared for School One just in case.

Income Taxes

Assuming School One wins out, advice here is trickier than you might think depending on your income. We have a secret shared with some of you over the past two years. The 2017 Tax Cuts and Jobs Act (TCJA) was the biggest federal tax overhaul since 1986. That’s not the secret though. The secret is that most of the tax benefits were in fact for the “middle” class (middle in quotes as we have seen taxes go down for those earners up to roughly $800,000, not your classic definition of middle class). Yes, this is true even with the limitations on state tax and property tax deductions. (SALT). Lower tax rates, an overhaul to the good of Alternative Minimum Tax (AMT), and a deduction for certain Qualified Business income have all contributed to these lower taxes.

            Although the media and certain politicians have been saying otherwise, the people paying more taxes under the TCJA are those with ordinary income in the seven figure and up range. Why? Without getting into great detail here, those of you in this income neighborhood were previously getting SALT benefit from the deduction. Those below $800,000 weren’t reaping full benefit due to the dreaded AMT. The million plus earners are now capped b y SALT and paying higher total federal income taxes.

Our advice is not one size fits all, but here are general guidelines. We can work with you specifically on your situation.

• If income acceleration or deferral is possible, maximize taxes paid at the 24% income tax bracket (and maybe higher).
• For the seven figure earners, do not pay your fourth quarter 2020 estimate until it is due in January 2021. This is president in the event Biden and company restore the SALT deduction, something Pelosi and Schumer have both been wanting for their high state income tax constituents.

Capital Gains

            Joe Biden has talked about increasing the long term capital gains rate from 20% to a person’s marginal tax rate which is currently as high as 37% (and going higher?? BE PREPARED!) Slap the 3.8% Obamacare tax on there and you are looking at a long term rate of almost 41% (or higher – BE PREPARED!)

            You already have the easy answer to that, right? Sell your long term gains before year end and take “advantage” of the lower rates. Not so fast my friend. Other factors need to be considered:

• Cost opportunity. Assuming California residency and a 11% income tax at the state level, you will pay roughly 35% tax on those gains (24% fed including Obamacare tax and 11% Cal). Paying tax on a $100,000, or $35,000 less working for you.

2020 Filing deadline extended and lingering questions about estimated tax due dates...

Praetorian Advisors Brief Tax Update
Spring 2021

Greetings from Praetorian Advisors!

As you may have heard, the individual tax deadline has been extended for the second straight year, this time to May 17^th (the 15^th is a Saturday so it bumps to Monday).  This means that no remaining tax payments are due for the 2020 tax year until that date as well.  All states except Arizona and New Hampshire have complied with the extended due date.  Given the sheer volume of information and ever-expanding disclosure requirements of the government, we would welcome a permanent due date change to May, but they haven’t asked us yet.

The IRS left the April 15^th due date unchanged for corporations and trusts.  That’s simple enough and reasonable.  What isn’t simple and is unreasonable is the IRS did not change the first quarter due date for estimated taxes, which was kept at April 15^th. 

Originally, the IRS commissioner resisted changing any due dates in spite of the IRS’ 6 month backlog, claiming that extending any due dates would be confusing.  So he agreed to extend some due dates but not others, which is…what’s the word…oh yes, confusing!

We held off sending this update, awaiting further guidance from the IRS on one key issue.  The so-called guidance came out a few days ago and only reiterated what was originally announced, leaving out the answer to the following question:

What if a taxpayer includes Q1 2021 payments in an extension payment not remitted until May 17^th?  Will the overpayment be applied as if made on April 15^th or May 17^th?

This is an obvious question to be answered yet we wait.

As those of you who extend every year know, building a Q1 payment into your extension is standard operating procedure here, as it serves two purposes: 1) it allows you to remit one payment rather than two, and 2) it provides cushion if the extension amount is short of what was needed, and we can make up for it in a subsequent quarter’s payment.

Because of the IRS’ lack of clarity, we will go the “safe” route and provide a Q1 2021 estimate for payment on April 15^th, with the 2020 extension payments happening by May 17^th unless better guidance is announced.  Those of you who do not typically remit estimates can ignore all of this!

In the meantime, we continue to grind away at a busy season pace even with the individual extended due date.  We appreciate you and appreciate your patience as we work through another tax season.

Patti, Paul, and your team at Praetorian Advisors.