Planning For a Successful 2021 Tax Season

Date January 13, 2022
Categories
Article Authors
Shelly’Ann Soleyn
HBK CPAs & Consultants

January 24th, 2022 marks the start of the 2021 tax filing season. With another eventful year quickly coming to a close and the tax season rapidly approaching, preparation is key. Planning ahead and being prepared for the upcoming tax season can help ensure an accurately filed tax return and avoid unnecessary IRS processing issues or delays. Here are some steps that you can take to stay ahead of the game for the upcoming tax season. Gather and Organize All Tax Documents Take the time to collect and organize any 2021 tax documents and financial records you have already, and create a folder or other storage place for items arriving soon. This includes documents such as W-2s, K-1s, 1099s, 1095-A, and others. Having everything organized and together can make the filing process faster and more efficient for you and your accountant. If you’re a business owner with a Schedule C, a rental property owner with a Schedule E, or a farm owner with a Schedule F make sure you have all of your 2021 related data organized. This includes records of how much income you’ve made from your business during the year as well as any business expenses paid. Below is a list of common tax forms and records that you may receive for the filing of your 2021 tax return in the coming weeks.
Who Receives these Forms Tax Forms
Employees W-2
Self-employed 1099-NEC
Unemployed Individuals 1099-G
College Students and Graduates 1098-T and/or 1098-E
Investors 1099-Div, 1099-S, Schedule K-1, and/or 1099-MISC
Homeowners 1098-MIS
Retirees SSA-1099 and/or 1099-R
Do you think you have enough deductions to itemize for 2021? Make sure to include this information in the documents that you organize and provide to your accountant. Providing this information to the accountant that will be preparing your tax return will help the filing process run smoothly and ensure you receive the proper deductions for your situation. Some information you may want to gather, organize, and provide to your accountant if you plan on itemizing include:
  • Amounts paid for medical and dental expenses
  • Real estate taxes paid during the year
  • Personal property taxes paid during the year
  • State and local income taxes paid during the year
  • Mortgage Interest paid during the year (You will usually get a form 1098-MIS for this, but if it is an intrafamily loan you may not receive one in the mail.)
  • All cash and non-cash charitable contributions made during the year
Inform Your Accountant of Any Significant Changes Made Throughout the Year Did you move out of your old home and change your address in 2021? Did you get married during the year or change your name? Make sure to let your accountant know! Any significant changes made during the year 2021 must be reported on your 2021 tax return. Here are a few informational changes that may need to be discussed with your accountant:
  • Change of legal name
  • Change of address
  • Change in marital status
  • Any changes related to dependents claimed
  • Any birth or death in your immediate family (While adopting or losing a pet may not impact your tax return, we love pets too and want to know!)
You should also inform your accountant of any life events during the year that may have affected your income. Here are a few examples of financial changes that may affect your income:
  • Change in employment
  • Sale of primary residence or any property
  • Purchase of a home
  • Start of a new business
  • Working in another state (there may be some state filing requirements)
  • New investments
If you owed money on your 2020 income tax return, you may have made estimated tax payments for the 2021 tax year. These are quarterly payments that go towards your 2021 tax balance on your return. Make sure to let your accountant know if you made these payments, how much you paid, and when these payments were made. Changes Impacting the 2021 Tax Filing Season With the effects of Covid-19 still being prominent throughout the year, it’s important to make note of these covid relief items that may affect your 2021 tax return. Recovery Rebate Credit At the beginning of 2021, the IRS issued Economic Impact payments (also known as stimulus payments) to eligible individuals. Individuals were eligible for up to $1,400 plus $1,400 for each qualifying dependent. Make sure to let your accountant know if you received the third Economic Impact payment and exactly how much you received. The IRS will be issuing Letter 6475 in January of 2022, which will detail your eligibility for the recovery rebate credit and how much of the economic impact payments you received in 2021. If for some reason you did not receive the full amount of the third economic impact payment, you may be eligible to claim the recovery rebate credit on your 2021 federal tax return. This credit can reduce the amount of tax due and potentially increase your refund. Advance Child Tax Credit Payments   Individuals who were eligible to receive advance child tax credit payments in 2021 should be receiving a Letter 6419 issued by the IRS in January of 2022. This letter will detail the total amount of advanced child tax credit payments that you received in 2021. Make sure to inform your accountant of this information. If you received less than the total credit that you’re eligible for, then the remaining amount of the credit can be taken on your 2021 tax return. If you received more than what you’re eligible for, then you may need to pay the excess amount with the filing of your 2021 tax return. Above the line Charitable Contribution Deduction Individuals who aren’t itemizing on their 2021 tax return can still deduct certain cash donations to charity on their return. This deduction is limited to $300 for individual taxpayers and $600 for married individuals filing joint returns. If you don’t have enough deductions to itemize in 2021, but still made some cash donations to charities during the year make sure to let your accountant know about these donations made. Having a game plan and taking the right steps to prepare for the upcoming tax season can help tax season be less daunting. It can also help with making sure your return is accurate and processed without any issues or hiccups. It’s always a good thing to be one step ahead when it comes to your taxes. Make sure to consult with your HBK tax advisor about any questions or concerns you may have about the upcoming 2021 tax filing and plan accordingly.

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Benefiting from Non-Deductible IRC 280E Expenses in an S-Corp

Date December 12, 2019
Categories

Internal Revenue Code section 280E prevents businesses engaged in the trafficking of a Schedule I or II controlled substance* from taking federal income tax deductions for ordinary and necessary business expenses—allowing deductions only for costs of goods sold. However, in certain situations, S corporation shareholders may receive a tax benefit from these otherwise non-deductible expenses due to stock basis ordering rules.

Generally, losses may be deducted by a taxpayer only to the extent of their basis, that is, the amount invested. Basis is adjusted in the following order: (1) income, (2) non-dividend distributions, (3) non-deductible expenses, and (4) losses.

When a shareholder’s loss or deduction items are disallowed due to basis limitations, they are suspended and carried over to the succeeding taxable year. The suspended losses and deductions are treated as incurred in that succeeding year, are added to the shareholder’s loss and deduction items actually incurred during that year. Under Treas. Reg. 1.1367-1(g), however, a shareholder can elect to have basis adjusted in a different order: (1) income, (2) non-dividend distributions, (3) losses, and (4) non-deductible expenses. The effect of the election is that any unused non-deductible expenses are carried forward until they are used to reduce stock or debt basis. Once the election is made, the shareholder must continue to use that ordering rule unless the IRS approves a change back to the standard rule. The election may be made on an original return or an amended return.

Consider the following illustration:

George is the sole shareholder in an S corporation. At the beginning of the year, he has $100,000 in basis. The company has a taxable loss of $250,000 for the year, plus $600,000 of non-deductible expenses.

If the shareholder makes—or has previously established—a 1.1367-1(g) election, they can apply $100,000 of taxable loss to their basis first. The loss will be taken on their individual return and the remainder—$150,000 of losses and $600,000 of non-deductible expenses—carries forward to the next year.

If the shareholder has not made the election, the $100,000 of beginning basis will be reduced by $100,000 of the non-deductible expenses. The entire $250,000 loss is then carried forward to the next year. However, the $500,000 of non-deductible expenses exceeding the basis are not deductible and do not carry forward. By making the election, the shareholder receives a tax benefit even though the expenses are in theory non-deductible.

Election under 1.1367-1(g) Stock Basis Ordering Rules
Basis:
Beginning basis 100,000 100,000
Non-deductible expenses (600,000)
Non-deductible expenses in excess of basis – not carried forward 500,000
Stock basis before losses 100,000 0
Losses incurred (250,000) (250,000)
Suspended losses carried forward 150,000 250,000
Stock basis before non-deductible expenses 0
Non-deductible expenses (600,000)
Suspended non-deductible expenses carried forward 600,000
Ending stock basis 0 0
Suspended losses carried forward 150,000 250,000
Suspended non-deductible expenses carried forward 600,000

On the surface, the 1.1367-1(g) election seems like a good idea. It allows the use of a tax-deductible loss now instead of a future year. However, making the election could have negative consequences for S corporation shareholders, as any deductions for non-deductible expenses that aren’t used up due to basis limitations are lost.

These rules affect all S corporation shareholders, but it’s particularly important for cannabis companies because under the limitations of the Controlled Substances Act they tend to have large amounts of non-deductible expenses. Taking advantage of the stock basis ordering rules is an involved process requiring many considerations; it is critical to use a tax preparer familiar with these rules. Making a 1.1367-1(g) election without considering the consequences, or being unaware of the carryover rules and tracking non-deductibles incorrectly, could be extremely costly. Make sure you have a CPA who knows the rules and can apply them to your benefit.

* The Controlled Substances Act (CSA) is the statute establishing federal U.S. drug policy under which the manufacture, importation, possession, use, and distribution of certain substances is regulated. It was passed by the 91st United States Congress as Title II of the Comprehensive Drug Abuse Prevention and Control Act of 1970 and signed into law by President Richard Nixon.[1] The Act also served as the national implementing legislation for the Single Convention on Narcotic Drugs.

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Another Taxpayer Loss – But There is Hope

Date November 20, 2019
Categories
Article Authors
HBK CPAs & Consultants

In an October 2019 U.S. Tax Court ruling, the IRS denied federal tax deductions proposed by the petitioner in the case, Northern California Small Business Assistants Inc. (NCSBA) v. Commissioner of Internal Revenue, 153 T.C. No. 4 (October 23, 2019).

NCSBA, a California corporation that operates a medical-marijuana dispensary legally under California law, argued the following points:

(1) Internal Revenue Code (“IRC”) Section 280E (“280E”) violates the Eighth Amendment to the US Constitution;
(2) Only ordinary and necessary business expense deductions (under IRC Section 162) are disallowed and does not apply to other sections of the IRC; and
(3) NCSBA was operating legally under state law and therefore is not subject to 280E.

The Eighth Amendment states that, “excessive bail shall not be required, nor excessive fines imposed, nor cruel and unusual punishments inflicted.” If it was determined that 280E violates the Eighth Amendment, the following would be viewed as facts: the Eighth Amendment applies to corporations; 280E functions as a penalty; and the penalty is excessive.

The Court ruled that 280E is not a penalty because the denial of a tax deduction is not a punishment or penalty. Further, the Court stated 280E was meant to limit or deter certain actions of a taxpayer (selling controlled substances).

NCSBA argued that 280E only disallowed ordinary and necessary business expenses (under Section 162). The Court determined Congress “could not have been clearer” when it stated, “No deduction or credit should be allowed.”

Finally, the petitioner argued that 280E applies only to businesses that engage in illegal or disreputable sales of controlled substances. They contend that the word “trafficking” in 280E implies some illicit purpose in the business’ operations. The Judge pointed to case law such as Canna Care Inc v. Commissioner, which set the precedent that the sale of medical cannabis pursuant to California law constitutes trafficking within the context of 280E.

In its conclusion, the Court stated that it is limited in its powers based on the law, and that the proper avenue to redress petitioner’s grievances is through Congress because changing tax laws is a legislative process that must originate with Congress. The fight to allow tax deductions for dispensaries operating legally under state law is a legislative fight not a judicial one.

To contact a member of HBK’s Cannabis Industry Group about this or related tax issues, please call 330-758-8613.

EDITOR’S NOTE: This article was written by HBK Senior Associate Dominic Pinina and reviewed by HBKVG Director Stacey Udell.

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PA Dept of Revenue Releases Tax Bulletins Impacting Certain Deductions

Date May 6, 2019
Categories
Article Authors
HBK CPAs & Consultants

The Pennsylvania Department of Revenue (DOR) has issued tax bulletins that impact the way hedging transactions and those associate with certain intangible income are taxed. This article was compiled to give Pennsylvania business owners and operators important information on how these changes may impact the ways they deduct certain types of income and the ability to file for some types of tax deductions.

Background Information: Corporate Tax Bulletins #1 & #2
Corporation Tax Bulletin 2019-01 – Corporate Net Income Tax Hedging and Foreign Currency Transactions
This bulletin addresses the apportionment factor for PA Corporate Net Income Tax. It states that receipts from hedging transactions are to be excluded from the numerator and denominator when calculating the apportionment fraction.

Corporation Tax Bulletin 2019-02 – Pennsylvania Corporate Net Income Tax Treatment of Global Intangible Low-Taxed Income and Foreign-Derived Intangible Income This much awaited bulletin addresses how Global Intangible Low-Taxed Income (GILTI) and Foreign-Derived Intangible Income (FDII) is treated for PA Corporate Net Income (CNI) and Personal Income Tax (PIT) purposes.

What are the GILTI & FDII Deductions?
For federal tax purposes GILTI is treated in a manner similar to Subpart F income as it is deemed to be repatriated in the year it is earned. The GILTI and FDII deductions are considered special deductions for federal income tax purposes and are not allowed in the calculation of PA CNI tax. Pennsylvania treats Subpart F income as dividend income for CNI tax. Therefore, GILTI income will also be treated as dividend income. CNI taxpayers should include GILTI in their tax base in the year it is recognized.

A deduction is allowed for corporations receiving dividends from foreign corporations for CNI tax. The GILTI income will fall into this definition. However, the deduction may be less than 100% depending on the ownership interest in the entity generating the GILTI.

The bulletin also discussed the treatment of GILTI for PIT purposes. Because the GILTI is a “deemed dividend” and not an actual cash distribution, it is not a dividend subject to tax under PA PIT. When an actual distribution of cash out of the current or accumulated earnings and profits of the foreign entity is made to a PIT taxpayer, it will be subject to PIT as a dividend.

Restricted Tax Credit Bulletin 2019-01 – Claiming Donation-Based Tax Credits after the Tax Cuts and Jobs Act and Restricted Tax Credit Bulletin 2018-02 – Claiming Education tax Credits after the Tax Cuts and Jobs Act.

Pennsylvania is addressing chairity-related taxable deductions and credits. To be clear, the state has attempted to clarify the rules around the deductibility of charitable donations in exchange for PA tax credits. The federal Tax Cuts and Jobs Act limited the amount of state and local tax deduction to $10,000. As a result, some states discussed legislating a work around to allow taxpayers to get a charitable deduction in lieu of taxes. In response, the Internal Revenue Service issued a clarification limiting the amount of the charitable deduction to the amount donated in excess of the credits received. This created some confusion and uncertainty for taxpayers wanting to take advantage of the PA Educational Improvement Tax Credit, the Opportunity Scholarship Tax Credit, the Waterfront Development Tax Credit, and the Neighborhood Assistance Tax Credit.

The PA statute states that the donations to organizations in order to qualify for the credit cannot for activities that are a part of a business firm’s normal course of business. Pennsylvania has stated that if the payment is not made in the normal course of a commercial transaction, a taxpayer may claim the state credit for payments made to eligible organizations even if the taxpayer claimed a deduction for federal income tax purposes. However, for personal income tax purposes a pass-through entity must adjust its PA income by the amount claimed as a deduction on its federal income tax return. The Department still considers the contributions to be charitable in nature.

Sales and Use Tax Bulletin #1
Sales and Use Tax Bulletin 2019-01 – Maintaining a Place of Business in the Commonwealth
This bulletin is in response to the U.S. Supreme Court ruling in South Dakota v. Wayfair, Inc. This decision upheld South Dakota’s economic nexus statute that required out-of-state vendors who sold more than $100,000 worth of property or had more than 200 separate transactions into South Dakota to collect and remit sales tax. Pennsylvania joins nearly forty states by implementing the economic nexus standard for the collection of sales tax for out of state vendors. Effective July 1, 2019 out of state vendors selling more than $100,000 worth of property into Pennsylvania will be required to collect and remit Pennsylvania sales tax. PA does not have a transaction threshold. Vendors selling between $10,000 and $100,000 into Pennsylvania have the option to collect and remit or notice and report.

Philadelphia Responds to Wayfair
In response to the Wayfair decision, Philadelphia amended its regulations regarding the Philadelphia Business Income and Receipts Tax (“BIRT”). An economic nexus standard is added for tax years starting on or after January 1, 2019. If a business with no physical presence in Philadelphia has at least $100,000 in Philadelphia gross receipts during any 12-month period ending in the current year, it will be considered having nexus for the gross receipts portion of the BIRT. The “active presence standard” for nexus with Philadelphia is also amended to provide that an “active presence” will subject the taxpayer to at least the gross receipts portion of the BIRT. “Active presence” is defined as purposeful, regular and continuous efforts in Philadelphia in the pursuit of profit or gain and the performance in Philadelphia of activities essential to those pursuits.

In addition, activity rising to the level of “solicitation plus” will result in both the gross receipts and net income portions of the BIRT. “Solicitation plus” refers to cases in which the taxpayer’s business activities exceed solicitation.

For questions, please contact HBK State and Local Tax group leader and Tax Advisory Group member, Suzanne Leighton, MTA at SLeighton@hbkcpa.com.

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Decoding the 2018 Tax Form Makeover

Date December 21, 2018
Article Authors
HBK CPAs & Consultants

The passage of the Tax Cuts and Jobs Act (TCJA) resulted in a complete makeover of the forms used to prepare individual income tax returns. Apparently “filing on a post card” is possible; for some, the new Individual Income Tax Return will indeed be as simple and straightforward as filling out a two-sided post card-sized form. For many others, however, the new form will be accompanied by one or more of six new schedules.

The first page of the new form is informational. It lists the taxpayer’s filing status, name, address, social security number and dependents. It also includes a signature area for the taxpayers and the tax preparer.

The second page of the new form contains the information used to compute the tax due for the year; it has been significantly simplified from prior year forms. If additional information needs to be reported, the TCJA has provided the following schedules to be used:

  • Schedule 1 should be included in any tax return where the taxpayer receives income from capital gains (reported on Schedule D), ordinary gains (reported on Form 4797), business income (reported on Schedule C), rental and pass through income (reported on Schedule E), or any other type of income typically referred to as “Other Income.” This form will also report any adjustments to income, such as the deductible part of self-employment tax (reported on Schedule SE), the self-employed health insurance deduction, the deduction for contributions to an IRA and the student loan interest deduction.
  • Schedule 2 will be included in any tax return where the taxpayer is subject to the Alternative Minimum Tax (reported on Form 6251) or needs to make an excess advance premium tax credit repayment.
  • Schedule 3 will be used to claim nonrefundable credits such as the foreign tax credit (reported on Form 1116), any residential energy credits, general business credits or child and dependent care expenses.
  • Schedule 4 will be used to compute other taxes such as self-employment taxes (reported on Form SE), additional taxes on IRAs, net investment income taxes (reported on Form 8960), household employment taxes (reported on Schedule H) and any Section 965 taxes due.
  • Schedule 5 will be used to report any estimated tax payments as well as any payments made with an extension. This schedule will also be used to claim any refundable credits that the taxpayer is entitled to other than the earned income credit, such as the American opportunity credit or the additional child tax credit.
  • Schedule 6 should be included for any taxpayers who have a foreign address or wish to designate a third- party designee to discuss their return with the IRS.

In addition to these new schedules, taxpayers should be prepared to fill out many of the standard, familiar forms and schedules when completing 2018 returns.

Taxes can be complex, and it is important to understand how these changes might affect filings. The examples included in this article are not all-inclusive and not intended as a substitute for the value and knowledge of consulting with a tax specialist. Please contact a member of the HBK Tax Advisory Group with your questions and concerns. We’re here to help.

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