The unprecedented global pandemic and record unemployment has resulted in a dramatic drop in interest rates. Many people focus on the Fed rate and mortgage rates, and rightfully so, but for some, the focal point should be on the historically low IRS interest rates.
The IRS posts various interest rates, generally on a monthly basis. The Applicable Federal Rate (“AFR”) and the Internal Revenue Code Section 7520 Rate (“7520 Rate”) are among the most important. Many tax strategies are a function of calculations driven by the AFR and 7520 rates. Some strategies work best in high rate environments while other work best in low rate environments. Accordingly, any time the IRS rates dramatically rise or fall, we should take notice and consider tax planning.
The May 2020 IRS Rates include:
Short-Term AFR: 0.25%
Mid-Term AFR: 0.58%
Long-Term AFR: 1.15%
7520 Rate: 0.80%
These rates are exceptionally low. To provide some context for comparison, the May 2019 Rates were: Short-Term AFR 2.39%, Mid-Term AFR 2.37%, and Long Term AFR 2.74%. Viewing this from a historical perspective, the May 2019 rates were low in their own right, but clearly the rates today, just one year later, are materially lower.
The remainder of this paper outlines three strategies that work particularly well in low interest rate environments. Although we have elected to highlight three strategies specifically, low interest rate tax strategies are not limited to just these three. Accordingly, we encourage you to contact our office to discuss your specific set of circumstances.
Charitable Lead Trusts
A Charitable Lead Trust (“CLT”) is a split interest trust, meaning there are two categories of beneficiaries: (1) a current beneficiary and (2) a remainder beneficiary. The current beneficiary receives distributions from the CLT for a period of time (the “Term”) and must be a charitable organization, such as a public charity, a church, most schools and universities, and even a private foundation operated by the donor. The remainder beneficiary receives all the assets remaining in the CLT after the Term expires and is generally the donor or the donor’s children. Depending on the design of the CLT, the donor may receive an income tax deduction in the tax year the CLT is established in an amount equal to the present value of all payments that will go to charity during the CLT’s term. Accordingly, it can generate a substantial income tax deduction for gifts that have not yet gone to the charity. This gives the donor the ability to continue investing and growing the CLT assets, thereby ultimately benefiting the donor who will receive the assets back upon expiration of the CLT term.
Why CLTs during low interest rates?
The donor’s income tax deduction is a present-value calculation. We take the sum of all scheduled future charitable distributions and discount that number to present value using a calculation based on the 7520 Rate. The lower the 7520 Rate, the lower the discount. The lower the discount, the greater the deduction. Accordingly, in today’s environment, all other factors being exactly the same (i.e. same growth rate, same amount to charity, etc.), a CLT today will generate a significantly higher income tax deduction, than the same CLT when interest rates are higher.
Grantor Retained Annuity Trusts
Grantor Retained Annuity Trusts (“GRATs”) are estate planning trusts that provide a tremendous opportunity to transfer wealth from one generation (“Generation 1”) to the next (“Generation 2”), often without incurring gift or estate taxes. GRATs are established with Generation 1 assets for a period of time (the “Term”). During the Term, the GRAT makes distributions to Generation 1. At the end of the Term, if designed properly, the assets remaining in the GRAT transfer to Generation 2 free of gift, estate, or transfer taxes. Many individuals will establish a series of GRATs in order to provide necessary lifetime cash flow to Generation 1.
Why GRATs during low interest rates?
Payments made from the GRAT to Generation 1 are based on the IRS rates. The donor makes the “bet” that the assets inside the GRAT will grow at a rate higher than the IRS rates. Lower rates mean a lower hurdle, a lower hurdle means more wealth can transfer to Generation 2 tax-free.
Sales to Intentionally Defective Grantor Trusts
Intentionally Defective Grantor Trusts (“IDGTs”), are irrevocable estate planning trusts that are generally utilized by high net worth business owners and those with assets likely to significantly increase in value (such as stock and real estate). The IDGT will purchase the asset from the individual primarily in exchange for a promissory note (there are no income taxes due on the sale because the IDGT is disregarded for income tax purposes). The IDGT will make installment payments to the individual for the term of the promissory note. The assets in the IDGT are outside of the individual’s estate, therefore any growth in the asset from the time it is sold remains outside of the individual’s estate for estate tax purposes.
Why IDGTs during low interest rates?
Similar to any traditional lending arrangement, the IDGT promissory note must yield interest. Because this is a related-party transaction, the IRS mandates a certain minimum interest rate, which is based on the AFR. The lower the AFR, the lower the required monthly payments, and thus more taxable wealth remains outside of the Grantor’s estate.
Don’t let this exceptionally low interest rate environment get away. Please contact your Heritage financial advisor, CPA, or attorney to schedule a planning session.
This article has been edited by Hamilton Tharp LLP. This article originally appeared on the HWM newsletter.
As consumers become more conscious in their environmental footprint, and look for ways to save money, more and more electric vehicles can be seen on the roads today stretching from coast to coast. At this point, most taxpayers know or have heard of an electric vehicle tax credit program, but what they may not know is that there are specific conditions and limitations that must be met, and that some vehicles have actually phased out of the program. So, before you consider an electric vehicle for your next purchase, make sure it qualifies.
Here’s a rundown of what you need to know about the electric vehicle tax credit, how it works, and what qualifies.
What vehicles qualify for the electric vehicle tax credit?
The new car or truck must:
· Have at least four wheels and gross vehicle weight of less than 14,000 pounds
· Draw energy from a better with at least 4 kWh hours and recharged from an external source
· Purchased after 2010 and begun driving in the year claiming the credit
· Be primarily used in the U.S.
Two or three-wheeled vehicles purchased in 2012 or 2013 and used within that year may qualify under section 30D(g) if they draw from a batter with at least 25 kWh and charged from an external source.
How much is the electric vehicle tax credit?
The tax credit for an electric vehicle can range from $2,500 to $7,500 depending on the vehicle with higher credit amounts for specific battery capacities and vehicle sizes. For two or three-wheeled vehicles, the credit is 10% of the purchase price up to $2,500.
How is the tax credit applied to me?
The non-refundable tax credit is filed on your federal tax return (for individuals on your 1040), and your liability determines how much credit you qualify for. The non-refundable caveat means that in order to receive the full $7,500 credit, your tax liability must be at least that much. If your liability is only $3,000, you’ll only receive $3,000. You won’t receive the difference in a refund check.
Can I get a tax credit on a used or leased vehicle?
Unfortunately, the answer is no to both of those circumstances. The credit only applies to the new purchase and the person who actually owns it. Used vehicle purchases, even transfers to family members don’t qualify, and if you lease, the credit actually goes to the manufacturer
offering the lease. Some manufacturer dealers offer lower prices on leased electric vehicles as a result of the incentive, but are not forced to do so.
Does the tax credit run out?
As sales of electric vehicles increase, the tax credit will phase out. Once a manufacturer reaches 200,000 qualified vehicles, the credit begins to phase out with a step-down process over the course of a year. No tax credits are available for Tesla vehicles as they hit their mark in July 2018, and no credits are available for GM as they hit their mark as well. You can see a list of the vehicles available for credits at fueleconomy.gov.
Are there state tax credits available?
Some states and regions do offer tax credits for electric vehicles and alternative-fuel vehicles, but these often apply to businesses. Individuals may receive incentives such as carpool lane access or free parking. Some states offer rebates for retail buyers. The U.S. Department of Energy offers a chart of state incentives.
For Californians, a $2,000 or $1,000 rebate is available depending on which type of electric car you purchase. Fully electric cards usually receive the higher rebate with hybrids on the lower end. Hydrogen fuel vehicles are eligible for a $4,500 rebate in California. These rebates are in addition to the federal tax credit and can reduce the out of pocket cost for a car by close to $10,000. You can learn more about California’s Clean Vehicle Rebate Project on their website.
For assistance with the electric vehicle tax credit and determining any extra state or local incentives, reach out to us.
Employers can now defer payroll tax withholding on employee compensation for the last four months of 2020 and then withhold the deferred amounts in the first four months of 2021, confirms a recent update from the IRS. President Trump’s memorandum on Aug. 8 gave employers the ability to defer payroll taxes for employees affected by the COVID-19 pandemic in an effort to provide financial relief.
The guidance directs that employers can defer the withholding, deposit, and payment of the employee portion of the old-age, survivors, and disability insurance (OASDI) tax under Sec. 3102(a) and Railroad Retirement Act Tier 1 under Sec. 3201 from employee wages from Sept. 1 to Dec. 31, 2020.
Employers must then withhold and pay the deferred taxes from wages and compensation during the period from Jan. 1, 2021, and April 30, 2021, with interest, penalties, and additions to tax to begin accruing starting May 1, 2021. Included in the notice is a line that indicates, if necessary, employers can “make arrangements to otherwise collect the total Applicable Taxes from the employee,” such as if an employee leaves the company before the end of April 2021, but does not provide details on what that entails.
Employees with pretax wages or compensation during any biweekly pay period totally less than $4,000 qualify for the deferral. Amounts normally excluded from wages or compensation under Secs. 3121(a) or 3231(e) are not included in calculating the applicable wages. The determination of applicable wages should be made on a period-by-period basis.
Companies may choose whether or not to enact the payroll tax deferral. We are closely monitoring updates related this and other presidential executive orders and will communicate if more information becomes available. For questions or assistance with this payroll tax deferral, contact us.
In an effort to help businesses cope with the impact of COVID-19, the CARES Act passed by Congress in March of this year eliminated some of the restrictions on the business interest deduction set in place in 2017 by the Tax Cuts and Jobs Act (TCJA). Now, the IRS has released much-needed guidance and final regulations for business interest expense deductions.
Limiting the business interest deduction was originally a way of helping pay for the TCJA and began with tax years starting after Dec. 31, 2017. The deduction was limited to the sum of:
- The taxpayer’s business interest income
- 30% (or 50% if applicable) of the taxpayer’s adjusted taxable income, and
- the taxpayer’s floor plan financing interest expense
The final regulations state that the deduction does not apply to:
- Certain small businesses with gross receipts of $26 million or less (applies to 2020 tax year, adjusted annually for inflation)
- Electing real property trades or businesses (cannot claim additional first-year depreciation deduction on certain types of property held)
- Electing farming businesses (cannot claim additional first-year depreciation deduction on certain types of property held)
- Certain regulated public utilities
Taxpayers must use Form 8990 to calculate and report their deduction and the carry-forward amount of disallowed business interest expense.
Additional regulations released by the IRS cleared up some of the remaining questions including issues related to the CARES Act. These additional regulations can be used with limitations until the final regulations are published in the Federal Register.
Additionally, a safe harbor was created in Notice 2020-59 that allows taxpayers engaged in a trade or a business managing or operating qualified residential living facilities to treat that as a real property trade or businesses in order to qualify as an electing real property trade or business.
Reach out for assistance with understanding and reporting your business interest expense.
Economic downturns are an almost inevitable reality for nearly every business owner. Decisions made far away from your community, catastrophic and unpredictable weather events, and even global pandemics as we’ve seen this year can disrupt the health and viability of a business. During these challenging times, business owners have to make difficult decisions about the future of their business that not only affect them but also their employees, vendors, clients, and communities. It’s an enormous responsibility to bear, but you don’t have to go it alone.
Your CPA advisor is your best resource for tackling the challenges of an economic downturn. As an outside party, they can help you make smart business decisions that protect your vision and mission while remaining financially responsible. Your CPA can help you:
Optimize your books
Never underestimate the power of good bookkeeping. By keeping your books in order, your CPA can help you plan and project for the future at each stage of an economic downturn. This includes planning for temporary closures and tiered re-openings (and potentially a back-and-forth of both depending on the state of the country and market). When your books are clean and up to date, you can better project how events and decisions will impact your finances on a weekly, monthly, and quarterly basis. Your CPA can help you flex the numbers on fixed and variable expenses to account for increases in costs, decreases in income, and potential changes to payroll. Knowing your numbers intimately can help you make better-informed decisions.
Minimize your tax burden
During times of economic crisis, staying abreast of new and changing tax legislation will be essential to projecting tax burden and uncovering tax savings opportunities. Your CPA is the best person to handle this because they know your business and your industry inside and out and can help you uncover tax savings opportunities that are unique to your circumstances. They do all the research, and you reap the rewards. With a CPA’s assistance, you achieve deductions and credits you may not have realized were available and develop a plan to defer costs where allowed depending on your business, industry, and location. Taxes are not an area you should or need to face alone during an economic downturn. Your CPA has done the homework, so you don’t have to.
Rationalize your decision making
When markets are in flux and your business is facing unprecedented challenges, the decisions you make can make or break your business. But you don’t have to go it alone. Your accountant can help you make data-informed decisions whether that be how to pay vendors, when and how to apply lines of credit, and the best ways to use your capital. Negotiating contracts with vendors that meet your needs and theirs during a downturn will not only achieve cost savings but also preserve relationships – your CPA can help develop a plan that makes sense. Knowing when to engage lines of credit can help you make better moves that you can either afford to pay back later, or maybe prevent you from taking on credit you can’t handle – your CPA can guide you in this process. Knowing where to allocate capital will be key to maintaining operations, and you may need guidance on what expenses to cut and what to keep such as marketing and payroll – your CPA can help you project the ramifications. With your CPA by your side, you don’t have to operate in a silo of decision-making.
Maximize your sense of relief
Most of all, your CPA can provide perspective, alleviate business back-end burden, and help advise you on financially feasible and sound decisions when much of the world feels like it’s in chaos. You have a lot to focus on during a downturn including how to handle your customers and employees in a changing marketplace. Having someone who can help you stay fiscally viable as you work through tough times, and develop a plan for future success, provides a welcome peace of mind.
You don’t have to go through any economic downturn alone. Your CPA can help you shoulder the challenges and weather the storms so you can continue doing what you do best – running your business.
In the midst of the uncertainty and instability that the COVID-19 pandemic has created for businesses and individuals, some relief is available for taxpayers in the form of deductible losses thanks to the preexisting Internal Revenue Code (IRC) Section 165(i). While the CARES Act and FFCRA have received much of the attention, taxpayers may also find relief thanks to Section 165(i) which allows for losses sustained as a result of the pandemic in 2020 to be claimed on the taxpayer’s 2019 tax return.
This deduction is triggered by a federally declared disaster, like the pandemic which was declared a national emergency on March 13, 2020. In the case of this deduction, losses attributed to federally declared disasters can be deducted on the previous year’s return. While not often used, this deduction comes at the right time for businesses struggling during the pandemic.
In order to claim the Section 165(i) deduction, losses must:
- Be attributable to a federally declared disaster
- Occur in a disaster area
- Not be compensated by insurance or otherwise
While some taxpayers will fit into this deduction, the rules and procedures are complex.
Examples of deductible losses as a result of COVID-19 vary from costs related to running your business during a pandemic like investments in personal protective equipment and cleaning supplies and services, to the closure of stores and facilities and disposal of unsaleable inventory. Other eligible costs include certain termination payments, losses from property sales or exchanges, abandonment of leasehold improvements, and nonrefundable event payments, to name a few.
To make the Section 165(i) election, taxpayers must include Form 4684, “Casualties and Thefts,” with their return within six months from the due date for filing the taxpayer’s federal income tax return for the disaster year.
We can assist you with identifying your deductible expenses and following the complex rules and procedures for making this election. Reach out for assistance.
With personal income tax representing 61% of California’s total general fund revenue sources, it is no surprise that the California Franchise Tax Board in the last few years has become more aggressive in its enforcement and interpretation of California residency law, using residency audits to do so.
What is California Residency Audit?
According to California’s residency laws, residents must pay state tax on their worldwide income, no matter the source of the income. Meanwhile, part-year residents are only required to pay taxes on income received while a resident of the state. Therefore, a person’s “residence” under California law is the key to understanding their state income tax liability. For this reason, the FTB conducts residency audits that will determine a person’s residency.
The 3 Types of “Residency” According to California Residence Law
When the FTB conducts a residency audit, the outcomes are generally broken down into three different categories. These are resident, nonresident, or part-year resident. The audit is simply meant to help determine which category taxpayers fall into.
- Resident: A taxpayer may be found to be a resident of California, in which case they are taxed on income from all sources, including income from sources outside of California.
- Nonresident: A taxpayer may be found to be a nonresident of California, in which case, they are taxed only on income from California sources.
- Part-year resident: A taxpayer may be found to be a part-year resident, and taxed on all income received while a resident and only from California sources while a nonresident.
According to California residency is defined as an individual who is in the state for anything else other than a temporary or transitory purpose or domiciled in California but physically outside the state for a temporary or transitory purpose. While the above definition might seem very straightforward, in reality the law is broadly written and leaves room for interpretation. As a result, if the FTB says you are a state resident, the burden now lies with you to prove them wrong.
How the FTB Determines Residency Status
California residency law defines the class of persons that are expected to contribute tax revenue to the state. California’s Revenue and Tax Code (R&TC) § 17014 includes every person in the state of California except for those in California for “a temporary or transitory purpose.”
It is important to note that this definition of residency is very broad, and includes everyone currently in the state except for those remaining in the state for a temporary or transitory purpose. It also includes those people domiciled in the state of California but currently outside the state for a temporary or transitory purpose.
Much of the residency determination depends upon the definition of “a temporary or transitory purpose.” California Code of Regulations (CCR) § 17014(b) defines in great detail what “temporary or transitory purpose” means. It states that those domiciled in the state who leave for a short period of time for both business and pleasure are outside the state for “a temporary or transitory purpose,” and as such are to be taxed as California residents.
Those domiciled outside the state, but staying within the state for business, medical or retirement purposes that are long-term and indefinite in time will not be considered in the state for “a temporary or transitory purpose,” and will be subject to the state tax.
- As you can see, there is a lot of room for the FTB to interpret your movement as they like. But in general, listed below are the factors that the FTB uses to determine an individual’s residence status:
- The amount of time the individual spent in California versus the amount of time spent outside of the state.
- The location of the individual’s spouse and children.
- The state where the individual’s principal residence is located.
- The state that issued the individual’s driver’s license.
- The state the individual’s vehicles are registered in.
- The state the individual’s professional licenses are maintained in.
- The state the individual is registered to vote in.
- The location of the individual’s bank accounts.
- The origination points of the individual’s financial transactions.
- The location of the individual’s medical professionals, as well as accountants and attorneys.
- The location of the individual’s social ties such as worship, country clubs and professional associations.
- The location of the individual’s real estate property and investments.
- The permanence of the individual’s work assignments in California.
Nothing is more important than the health and safety of you and your loved ones as you deal with the COVID-19 pandemic. The coronavirus crisis has had a wide-reaching effect on just about every aspect of our lives. We’ve all been asked to adjust our daily routines. Unfortunately, our health and wellbeing aren’t the only things of which we need to be concerned. The sudden downward shift in our economy has had a devastating effect on employment. The U.S. is currently experiencing a jobless rate unseen since the Great Depression. If you, or someone close to you, lost a job as a result of the economic shutdown caused by COVID-19, we’re sure you’ve got questions. In this article, we’ll address some of those questions, particularly with respect to unemployment benefits.
In March 2020, the Coronavirus Aid, Relief, and Economic Security (CARES) Act was signed into law. The CARES Act expands the states’ ability to provide Unemployment Insurance (UI) to those affected by COVID-19. You may be eligible for UI if you are unemployed through no fault of your own, meet certain work and wage requirements, and satisfy any additional state requirements. Under the new law, even self-employed individuals and independent contractors may qualify.
Normally, UI benefits are available for up to 26 weeks. The CARES Act allows states to extend that coverage up to 13 additional weeks. To help provide a little more support, states also are able to increase UI benefits by $600 per week. These extended benefits are available through 12/31/20.
UI benefits are administered at the state level, so each state sets its own eligibility guidelines. To find state-specific information regarding eligibility, benefits, and applications, go to: www.careeronestop.org/LocalHelp/UnemploymentBenefits/Find-Unemployment-Benefits.aspx
One very important thing to remember is that UI benefits are taxable income. In order to avoid an unexpected tax bill next April, you may need to make estimated tax payments or have federal income tax withheld from your UI payments. You’ll need to complete Form W-4V to have tax withheld. We can help you determine the best course of action.
Note: By 1/31/21, you should receive Form 1099-G from your state showing the amount of taxable UI benefits paid in 2020. This form will help us prepare your 2020 Form 1040.
Obviously, this information barely scratches the surface of unemployment benefits and how to best handle your exact situation. These are challenging times, to say the least. If you find yourself in the unfortunate position of being unemployed right now, please know we are here for you. If you’d like to discuss this issue further, please give us a call. We’d love the opportunity to speak with you over the phone, via an online meeting, or in-person if you are comfortable doing so. We can address this issue or anything else you want to discuss. We are here to help!
The COVID-19 pandemic has thrown a wrench into many employer-sponsored health, flexible health, and dependent care plans as employees are seeing increased or decreased need, depending on the impact of the pandemic on their families. In response, the IRS is granting employees the ability to make midyear changes to some employer-sponsored health coverage, health flexible spending arrangements (FSAs), and dependent care assistance programs under Notice 2020-29.
Normally, changes are only allowed at the beginning of the plan year or from a qualifying event like marriage, childbirth, or a drastic change in plan cost. Now, employees can make the following changes according to the notice:
- If employer-sponsored health coverage was initially declined, employees can make a new election on a prospective basis.
- Employees can make changes to existing health coverage such as individual to family, or one plan type to another.
- Employees may revoke coverage on a prospective basis with written confirmation the employee will obtain coverage elsewhere.
- For healthcare FSAs, employees may revoke an election, make a new election, or increase or decrease existing election on a prospective basis.
- For dependent care accounts, employees may revoke an election, make a new election, or increase or decrease existing election on a prospective basis.
The notice also extends grace periods and carry-overs through year-end. Employees can cover medical expenses incurred through December 31, 2020, using unused funds in health FSAs, and dependent care expenses can be covered for the same period using dependent care assistance funds. Unused FSA or childcare funds as of the end of plan year or grace period may be applied to reimburse medical or dependent care expenses. Additionally, Notice 2020-33 increased the $500 carry-over amount allowed in most plans to $550.
Unlike other changes to employer-related programs and benefits in the FFCRA and CARES Act, employers may make these changes at their discretion, though the IRS encourages implementing them.
Employees should note these changes cannot be applied retroactively, however the notice did clarify that reimbursements for telehealth services for high deductible health plans may be applied retroactively to January 1, 2020.
The CARES Act allows employers to delay the payment of the employer’s share of Social Security payroll tax, which is 6.2% of wages up to the annual wage base ($137,700 in 2020). The deferral also applies to 50% of the equivalent taxes incurred by self-employed persons. This only applies to taxes incurred from March 27, 2020, through December 31, 2020. Employers who opt to delay payment would need to deposit half of that delayed amount by December 31, 2021, and the other half by December 31, 2022. This payment deferral does not apply to the employee’s share of Social Security tax, the employee or employer’s share of Medicare tax, or to the Additional Medicare tax imposed on employees with Medicare wages in excess of $200K.
In addition, filing deadlines for reporting the employee and employer portions of Social Security and Medicare taxes have not been delayed by the Act.
Please note, an employer is ineligible for this payment deferral if it acquires a loan through the Paycheck Protection Program, for which all or part of the loan was or will be forgiven.