Affordable Care Act Policies and the American Rescue Plan

There’s a lot included in the American Rescue Plan legislation that was passed in March, and many provisions have gone relatively unnoticed. Last week I wrote about the Unemployment Income Exclusion, and now I’d like to talk about another provision involving the Premium Tax Credit.

What is the Premium Tax Credit?

The Premium Tax Credit (PTC) is a refundable credit that helps individuals and families cover the premiums for their Affordable Care Act (Marketplace) health insurance policy. The monthly policy premiums are based on several factors, including what the individual expected their income to be during the year. They entered this information when they signed up for the policy, usually in November or December for coverage during the next year. Based on their income, they may receive a lower monthly premium that helps make the plan more affordable. While it’s commonly thought that this is a discount, it’s really an advance credit on their next years’ tax return. Think of it like receiving the Child Tax Credit, which can give taxpayers a $2,000 tax credit per qualifying child, split into equal payments during the year instead of on your tax return.

During tax preparation, we have to reconcile what the individual actually earned versus what they thought they would make. If their income was lower than expected then they may receive an additional tax credit on their return, the PTC. Conversely, if their income was higher, they may need to pay back a portion of the credit that they received in the form of lower insurance premiums during the previous year.

American Rescue Plan and the PTC

The American Rescue Plan includes provisions that lower the cost of Marketplace policies and expands access to the credit.

  • Individuals and families may be eligible for a temporary increase in premium tax credits. This will allow some households that earned too much to qualify for the credit to lower their monthly premiums.
  • It increases premium tax credits for coverage years beginning 2021 and 2022, lowering premiums for most policyholders.
  • Taxpayers who receive unemployment compensation during any week beginning in 2021 may be eligible to receive premium tax credits to help pay for a 2021 Marketplace policy.
  • Taxpayers who received too much in advance premium tax credits in 2020 will not have to repay the excess amount.

How do I take advantage of this?

Taxes – My role in this is to perform the required reconciliation when I prepare tax
returns. For now, I’m holding off on filing 2020 tax returns that include repayment of the PTC. As of today, the IRS hasn’t issued guidance on this topic. We don’t know whether the IRS wants us to file the returns and then amend them or if they’ll correct the returns themselves and send refunds.

Health Insurance – I live and breathe taxes, not health insurance. As unsatisfying as
this answer is, the only advice I can give you is to visit your Marketplace website or call them.

The American Rescue Plan includes many provisions designed to help individuals and families affected by the pandemic. One of which affects those with an Affordable Care Act (Marketplace) healthcare policy.

This article is a brief introduction to the topic and is not meant to provide legal or tax guidance. There may be other rules that apply to your particular situation, and I encourage you to seek additional information and talk with your tax professional and health insurance policy provider.

Megan Austin, EA
Treu Accounting
720-730-4838
megan@treuaccounting.com
www.treuaccounting.com

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Read This If You Had Unemployment Income In 2020!

American Rescue Plan: Unemployment Tax Exclusion Provision

Last week Congress passed the American Rescue Plan. The most visible benefit to come out of it is a third stimulus payment of $1,400. But for millions of Americans there is another provision that is just as important.

The New York Times reported in July 2020 that 30 million US workers were receiving unemployment benefits. While desperately needed by households it came with a downside, taxes. Unemployment benefits are taxable at the federal level, which can lead to a nasty surprise at tax time. Those receiving benefits can request that money be withheld from their payments for taxes, but few did. It is estimated that fewer than 40% of recipients requested any withholding, which is not surprising. Taxes are not the first priority for people worried about keeping a roof over their heads.

The American Rescue Plan reduces the tax impact of unemployment. It includes a provision that exempts $10,200 of unemployment benefits from federal income taxes. In order to qualify the benefits must have been received in 2020 and individuals must have modified Adjusted Gross Income (AGI) of less than $150,000. The provision is retroactive, meaning that the unemployment income reported on your 2020 tax return will be reduced by up to $10,200 if you qualify.

What Should I Do?

If you can, wait. Here’s why:

  1. The legislation passed made the benefits non-taxable; it didn’t give instructions on how to implement it. The IRS is working quickly to find solutions to the many issues involved. Once they provide guidance the tax preparation companies will incorporate the fix into their programs. There are several issues, and solutions may not all be implemented at the same time.
    Yesterday the IRS put out an Unemployment Compensation Exclusion Worksheet to assist in computing the amount of unemployment that is not taxable. That is lightening quick for an organization that still uses faxes for many routine tasks. While this will not address all of the issues, it’s a step that shows how dedicated the IRS is to quickly administer the provision.
  2. Right now we don’t know whether previously filed returns with unemployment will be adjusted with an e-filed amendment or if they’ll need to be mailed in. Waiting to include the exclusion on your return, even if it delays filing by a few weeks, may get you your refund much faster than fixing a return that has already been filed.
    To give you an idea as to why this is, last year many taxpayers updated their info on the IRS website to get their stimulus payments as quickly as possible and by direct deposit instead of a check. What they didn’t know is that this counted as an Informational Tax Return, and when they filed their real 2019 return it rejected because only one original return can be e-filed for each SSN. To correct this a return had to be mailed in. In normal times paper-filed returns are usually processed within 16 weeks.
  3. At this time no one knows what will need to be done to correct returns already filed or how long it will take. Most taxpayers pay to file their returns, either through DIY software or to a tax preparer. These are businesses that provide a service, tax preparation and filing, in exchange for monetary compensation. And many of these businesses either charge for amendments or do not offer amendment services.
    Will they charge in this instance? I have no way of knowing, but you should be aware of the possibility. This isn’t a situation where the business did something wrong. They couldn’t have foreseen this, and there was nothing incorrect or missing from the return when they filed it.

I’ve Already Filed My Return, What Do I Do?

As discussed above, we don’t know what needs to be done to allow taxpayers to take advantage of this provision. Guidance will probably be released within the next few weeks, anything said or published before then is just conjecture.

However, March is not a good month to make big changes that affect current year tax returns. This time of year is always hectic for anything tax-related. Everyone would like for this to be implemented quickly, but even more importantly, correctly.

Here’s what I suggest:

  1. If you had your return prepared by a tax professional, they may not have the ability to quickly sort through returns to find those that include unemployment. I don’t speak for anyone but myself, but I would welcome a short email or phone message letting me know that you had unemployment income on your return, and that it has already been filed. I could then add you to a list so that I can quickly address your return when possible. This year stimulus payments, mortgage refinances, and other time sensitive items have created a tidal wave of returns. Even when the unemployment issue is resolved, turn-around time will most likely not be instant, so please be kind and patient.
  2. If you prepared your return yourself using online software, log into your account periodically and keep an eye on your email, including your spam, promotions, or social media folders. They should let you know what steps you need to take. If you haven’t seen anything in a week or two, call their customer service number and ask how they’re addressing this and how you’ll be notified.

The Unemployment Tax Exclusion Provision included in the American Rescue Plan is an unprecedented effort to help taxpayers recover from the economic effects of Coronavirus. Its implementation will not be overnight, but the IRS and tax preparation companies are working quickly to solve the issues that its passage creates.

This article is a brief introduction to the exclusion and is not meant to provide legal or tax guidance. There may be other rules that apply to your particular situation, and I encourage you to seek additional information and talk with your tax professional.

Megan Austin, EA
Treu Accounting
720-730-4838
megan@treuaccounting.com
www.treuaccounting.com

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Wildfire Mitigation Tax Deductions in Colorado

Colorado has suffered devastating wildfires over the last few years that have taken lives and destroyed property. Pre-wildfire mitigation (actions designed to minimize the destructive effects of wildfire) has never been more crucial.

Mitigation can help by increasing accessibility for emergency personnel, giving homeowners a longer window to evacuation, decreasing the amount of fuel that feeds the fire, and reducing the destruction of property. As more people choose to live in areas with a high wildfire risk, mitigation can mean the difference between life and death.

However, while the benefits are well known, it can be prohibitively expensive. To encourage property owners to perform mitigation on their properties, Colorado allows a tax deduction for qualifying expenses.

Who Can Take the Deduction?

To take the deduction, the taxpayer must be an individual, estate, or trust. Corporations, partnerships, and other legal entities don’t qualify. You also must be an owner of record on the land, and it must be private land.

Qualifying Mitigation

Actions that qualify are those that meet or exceed any applicable standards established by the Colorado State Forest Service or the Division of Fire Prevention and Control and:

  • Create a defensible space around structures
  • Establish fuel breaks
  • Thin woody vegetation for the primary purpose of reducing risk to structures from wildfire
  • Treat fuels by “lopping, scattering, piling, chipping, or removing from the site”
  • Prescribed burning

Qualifying Expenses

Qualifying expenses that are explicitly stated in Colorado Department of Revenue FYI Income 65 are:

  • Payment to a contractor to perform wildfire mitigation measures
  • The cost of a chainsaw if purchased primarily for wildfire mitigation
  • The cost to rent an all-terrain vehicle, truck, tractor, or trailer if rented primarily to perform wildfire mitigation measures

There are varying degrees of aggressiveness at play when preparing taxes. Some taxpayers will readily forego deductions and credits that they clearly qualify for, while others stretch the limits. Taking deductions that qualify, but aren’t explicitly stated, is a judgment call by both the taxpayer and tax professional. Expenses you may decide are appropriate, but not explicitly stated include:

  • Expenses for running or maintaining a chainsaw used primarily for mitigation (oil, gas, sharpening, tune-up, and repair)
  • Costs incurred to get rid of debris (slash disposal, chipper rental)
  • Cost of protective gear (chaps, helmet, eye and ear protection)

Non-Qualifying Expenses

Not every expense incurred in mitigation qualifies, including:

  • Inspection or certification fees paid in association with performing mitigation
  • In-kind donations or contributions of time, labor, materials, or equipment to perform mitigation
  • Value of the property owner’s time or labor
  • Cost-sharing, incentives, or grants that facilitate the performance of mitigation
  • Expenses incurred for activities not primarily for mitigation purposes. One example would be if you take down trees on your property that qualify as mitigation but are used as fuel for a woodstove or to sell.

Calculation and Limitations of the Deduction

The deduction allowed each year is the lower of $2,500 or 50% of the qualifying costs for performing wildfire mitigation measures. This limit applies whether filing a Single or Joint return. If filing Married Filing Separately, the deduction may only be taken on one of the property owners’ return.

Documentation

The deduction is taken on the Subtractions from Income Schedule (DR 0104AD) submitted with your Colorado Individual Income Tax Return (DR 0104). You must also submit copies of receipts documenting the claimed expenses. If not clearly identified on the receipt, I highly suggest making a note on it stating what the expense was for. For electronically filed returns, you can either submit scanned receipts attached to your e-filed return (if the software allows) or by using the E-Filer Attachment at www.colorado.gov/revenueonline/

How You Can Help

When a wildfire breaks out that threatens lives and structures, many people are motivated to help those affected. This is wonderful, and much appreciated! But the truth is, the best way to help is to prevent forest fires and mitigate beforehand. If you don’t live in an affected area, you can still help by:

  • Obeying all local laws regarding fires
  • Practicing Fire Safety – Only You Can Prevent Forest Fires!
  • Donating to an organization that helps with mitigation
  • Volunteering with a mitigation organization near you (it’s a fabulous workout!).

Summary

Wildfire is a disaster that increasingly affects Coloradans. Pre-fire mitigation helps reduce the risk and severity but can be costly. For property owners, costs can be partly offset by taking advantage of a deduction on their Colorado tax return for qualifying expenses.

This article is a brief introduction to the deduction and is not meant to provide legal or tax guidance. There may be other rules that apply to your particular situation, and I encourage you to seek additional information and talk with your tax professional.

Megan Austin, EA
Treu Accounting
720-730-4838
megan@treuaccounting.com
www.treuaccounting.com

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Pay Less Tax When Selling Your Home

Almost everyone who has sold a home has heard that the sale is non-taxable. While this is true for many homeowners, there are rules and reporting requirements. Knowing these can reduce the amount of tax you pay and ward off a letter from the IRS.

Sale of Home Exclusion

The IRS allows for an exclusion of capital gains (profit) on the sale of your primary residence of up to $250,000 for those filing Single on their tax returns, and up to $500,000 for those filling Married Filing Jointly (MFJ). This can save taxpayers a large amount of taxes.

Basic Gain Formula

There are three parts to the formula: proceeds, basis, and gain. The amount you originally paid for the home is the basis. The amount you sold the home for is the proceeds. Gain is the difference between the two, or how much profit you made.

Proceeds – Basis = Gain

Example: Gain Formula

Mary bought a house for $300,000, and sold it 10 years later for 700,000. Using the
formula, her gain (before exclusion) is $400,000.

$700,000 – $300,000 = $400,000

Sale of Home Exclusion Rules

For the most part, the exclusion rules are relatively straight forward. There are exceptions, notably if the home has been used as a rental, so be sure to talk to your tax preparer. But in general, to qualify homeowners must:

  • Own and live in their home as their primary residence for two of the last five years before the sale.
  • The ownership and residence requirements do not have to be met concurrently.
  • Not have sold another primary residence and excluded the gain within the last two years before the current sale.

Example: Married Filing Jointly

Jack and Jill bought their home in 2015 for $300,000, and have lived in it as their primary residence up until they sold it for $700,000 during 2020, and file their taxes using the MFJ status. Their gain is $400,000, but because it is under the $500,000
MFJ exclusion cap, they owe no taxes on the sale.

Example: Not living in the home at the same time it is owned

Bill and Barbara, who file MFJ, rented a home to live in during 2016, and purchased it from the owners in 2018 for $300,000. However, after they bought the home they moved out, and allowed their son to live there (rent free) from 2018-2020 while attending college. When he graduated in 2020, they sold it for $800,000.

In this example, the couple did not live in the house during the time they owned it. Their son living there does not make it their primary residence during that time. However, they lived in the home two of the past five years, and owned it for two of the last five years. Despite the fact that they did not live in the home while they owned it, they qualify for the full $500,000, making none of the gain taxable.

Gain Above Exclusion

But what if you made more than the exclusion? Is there anything you can do?

If the gain is more than your exclusion, or you don’t qualify for the exclusion, there are additional steps you can take to raise your basis or lower the proceeds, making less, or all, of the gain non-taxable.

Raising Basis

Many homeowners make improvements to their home while they live there. The IRS allows you to add amounts to your basis that were paid for substantial physical improvements that: materially adds to the value of your home, significantly prolongs its useful life, or adapts it to new uses.

Qualifying improvements include:

  • New windows, doors, or roof
  • New wall-to-wall carpeting or other permanent flooring
  • Installing new insulation, pipes, duct-work
  • Building an addition such as a bedroom, bathroom, office, or garage
  • Replacing driveways or walkways
  • Installing a new or upgraded heating or air conditioning system
  • Installing new built-in appliances
  • Installing new fences, retaining walls, porches, patios, or decks
  • Installing extensive new landscaping, such as a new lawn
  • Items that do not qualify include:
  • Repairs – roof, cracks in driveway, appliances
  • Maintenance – painting walls, cleaning carpets

Example: Raising basis

Jacqueline bought a house for $500,000 in 2010 and sold it in 2020 for $1,000,000, resulting in a gain of $500,000. She qualifies for the $250,000 exclusion for taxpayers who file single, leaving $250,000 taxable gain. However, while she owned the property, she completely remodeled the kitchen for $40,000, added a home office to the house for $50,000, and installed new energy efficient windows for $20,000 (she did not take a tax credit for the windows). All of these items qualify to be added to her basis. After adding these items, her adjusted basis is $610,000, and taxable gain is $140,000

Original basis $ 500,000
Kitchen + $ 40,000
Home Office + $ 50,000
Windows + $ 20,000
Adjusted basis =$610,000

Proceeds $1,000,000
Adjusted basis – $ 610,000
Exclusion- $ 250,000
Taxable Gain =$ 140,000

By increasing the basis, Jacqueline will pay taxes on $140,000 instead of $250,000, a $110,000 difference. Much better, but there is more that can be done.

Reducing Proceeds

The IRS also allows you to reduce the proceeds by expenses typically incurred by the seller. Qualifying expenses cannot physically affect the property, and may include:

  • Advertising
  • Appraisal fees
  • Attorney fees
  • Closing costs
  • Document preparation fees
  • Escrow fees
  • Notary fees
  • Real estate broker’s commission
  • Settlement fees
  • Title search fees

Example: Reducing Proceeds

Let’s go back to Jacqueline. She sold the house for $1,000,000, but incurred substantial expenses while selling. She paid commissions of $60,000 (6%) to the real estate brokers, and another $30,000 in attorney fees, closing costs, escrow, and other qualifying fees.

When subtracted from the original proceeds, the adjusted proceeds are now $910,000 and, using the adjusted basis of $610,000 from the Raising Basis section above, and her Sale of Home Exclusion, her taxable gain is $50,000 (illustrated below).

Proceeds $1,000,000
Commission – $ 60,000
Other costs – $ 30,000
Adjusted proceeds =$ 910,000

Adjusted proceeds $ 910,000
Adjusted basis – $ 610,000
Exclusion – $ 250,000
Taxable Gain =$ 50,000

While not zero, taxes on $50,000 will be much lower than on the original $250,000 gain that would have been taxable if we’d just used the original proceeds ($500,000) and basis ($250,000).

Reporting Requirements

Even if none of the gain ends up being taxable, you may be required to report it to the IRS. This will be done on both IRS Forms 8949 and Schedule D (Sch D) on your tax return.

You must report the sale when:

  • The sales price is over $500,000. The title company is required to issue you a form 1099-S, Proceeds from Real Estate Transactions, at the beginning of the next year. They must also file this form with the IRS. Not reporting these transactions on your return will cause the IRS computers to automatically send you a letter stating that you owe tax on all of the original proceeds from the sale.
  • There is any taxable gain after the exclusion is taken. This is determined by the using the original proceeds and basis, not the adjusted. If this calculation shows a gain, you must report the transaction, even if there is no taxable gain after all adjustments are made.
  • You choose not to take the exclusion – there are a number of reasons to not take the exclusion. Talk with your tax professional about whether this action is right for you.

What to Watch Out For

Tax preparation software, both those used by DIYers and tax professionals, have steps used to calculate whether the gain is taxable. The problem is that if the sale is over $500,000 but is not taxable according to the software’s calculations, it may generate a worksheet showing the calculations, but not automatically carry the information to the 8949 or Sch D. In most cases, the IRS does not receive the worksheet when the return is filed. There are steps within the software that will correct this, but may not be intuitive.

You Received a Letter from the IRS

In the event that you do receive a letter due to incorrect reporting, it’s not the end of the world, but it can be a hassle. A response will need to be prepared showing the correct basis, proceeds, and gain. It’s then mailed to the IRS, and you wait for it to be processed. Unlike the automatic letter you received, the response is processed by a human, and takes time. Factor in delays due to due to unforeseen circumstances (Covid, new laws, government shutdowns), and it can take months before you receive a response. During 2020, turnaround was taking roughly 10 months.

Save yourself the hassle; make sure the sale is reported on the correct forms before the return is e-filed.

Conclusion

The Sale of Home Exclusion is a useful, legal way to reduce the amount of taxes paid on the profits earned on the sale of your personal residence. The rules are relatively straightforward, and reporting is not onerous, although it’s important to make sure that the transaction is reported correctly.

Megan Austin, EA
Treu Accounting
720-730-4838
megan@treuaccounting.com
www.treuaccounting.com

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Covid-19 and Individual Income Taxes

Covid-19 has affected virtually every aspect of our lives this year. Next year it will probably impact your taxes. Everyone’s tax situation is different, and what may be true for one person does not necessarily hold true for another. However, at this time we do know of several provisions in the Coronavirus Aid Relief & Economic Security (CARES) Act that will affect a majority of taxpayers.

Stimulus Payments – Did you receive one? How much? This information will likely need to be entered on your 2020 tax return. The payment is not taxable, it’s an advance on a credit that will appear on your return. If you received a payment but don’t qualify for it on your 2020 return, don’t worry, you won’t have to pay it back. But if you didn’t receive a payment, or less than the full payment, and you qualify based on your 2020 tax return information, you will receive the credit on your return.

Unemployment benefits – A record number of people filed for unemployment this year. While it’s much needed income, it can create a nasty surprise at tax time. Unemployment benefits, Pandemic Unemployment Assistance (PUA) payments, and the $600 additional weekly amount are all taxable income. Whether or not this increases your tax liability will depend upon your overall tax situation. If you are receiving benefits and are concerned about an increased tax bill next year, you can request that the state withhold federal and/or state taxes from your payment.

Charitable Contributions – In prior years you had to choose to itemize your deductions in order to deduct charitable contributions. Those who were better served by taking the standard deduction were not able to take the deduct charitable donations. For 2020, the CARES Act allows you to deduct charitable donations of up to $300 even if you use the standard deduction. Donations still must be made to a qualified nonprofit organization to qualify.

Retirement Account Withdrawals – Previously, there was a penalty of 10% on withdrawals from retirement accounts made before you turned 59 ½. This was in addition to the income tax owed on the withdrawal itself. The CARES Act has removed the 10% penalty and allows you to spread out the tax liability on withdrawals over three years. For simplicity, let’s say you withdrew $3,000. Under this provision you could choose to pay taxes on $1,000 of the withdrawal on 2020’s tax return, taxes on another $1,000 on 2021’s return, and tax on the remaining $1,000 on your 2022 return.

There is also an incentive to put the money back into your retirement accounts when the need has passed. It’s not required, but if you choose to pay back some or all of the money you withdrew, and do so within the next three years, you can file an amended 2020 tax return and treat the returned portion of the distribution as if it never happened, potentially receiving a refund.

Required Minimum Distributions – Prior to the Tax Cuts and Jobs Act (TCJA) passed in 2017, taxpayers with qualified retirement plans and traditional IRA’s were required to take required minimum distributions (RMD) in the year that they turned 70 ½. TCJA raised the age to 72 for taxpayers who had not yet been required to take distributions. Under the CARES Act, RMD’s for 2020 are no longer required for anyone. It is unclear at this time whether a taxpayer will be allowed to reverse a RMD already received this year.

Possible Future Deduction for Unreimbursed Employee Expenses – Congress may change or pass new laws at any time, and often does so to address current economic conditions. This year there has been an explosion in the number of employees working from home. Many of these employees incurred expenses that were not reimbursed by their employer such as laptops, monitors, and headsets. Before TCJA these expenses could be deducted when itemizing, but the deduction was hard to take and the deduction was eliminated. While there is currently no indication that any of the impending legislation includes provisions to address this issue, it is always a good idea to keep your receipts to ensure you have adequate documentation to justify any possible credits and deductions.

Individual situations will vary, and this article is for general informational purposes only. If you have questions about how any of these provisions will affect you personally, please contact your tax professional.

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You Have a Quick Question (Why I Don’t Have a Quick Answer)

Anyone who prepares taxes has answered many calls that begin with the dreaded “I have a quick question”. Dreaded because 90% of the time there isn’t a quick answer, or at least one that is accurate according to your personal situation.

Taxes are complex, with many rules that only apply in certain situations, or that interact with other rules in ways that aren’t initially obvious. Most questions require a thorough knowledge of your personal situation, evaluation of your recent tax returns, and a discussion about your goals and future plans. To give an accurate answer, most accountants need more information and time to evaluate the situation. Giving you a quick answer may not be accurate or helpful in the long run.

Take this example:

Quick Question: What is the tax rate on stocks?

Quick answer: either your normal income tax rate or between 0-20%.

Better answer: It depends. While the rates are readily available on the internet, the tax rate on stocks isn’t usually the question being asked. You want to know what the tax rate will be on your stocks based on your circumstances.

To answer that, your accountant may need more information such as:

  • How long have you owned the stocks?
  • How much did the stocks cost?
  • How much do you believe you will be selling them for?
  • Did you inherit the stocks?
  • Were these stocks part of an ESPP/RSU/ISO?
  • What other income sources do you have?
  • How much do you project your income to be including wages, interest, dividends, business income, passive income, retirement, etc?
  • Do you expect to itemize? If so, how much do you expect the deduction to be (medical expenses, state taxes, personal property taxes, property taxes, mortgage interest, charitable giving)?
  • Any other big changes in your life this year?

After asking these questions, and perhaps others, I can tell you the tax rate on your stocks will be x%.

But knowing the tax rate doesn’t give you a full picture of how the sale of the stocks will affect your overall tax situation.

Depending upon your overall income, you may also have the pleasure of paying the Net Investment Income Tax; an additional 3.8% on your investment income. I call it the “Congratulations! You earned money on your investments and now you get to pay more tax” tax.

  • Income or losses on stocks may also affect:
  • the income tax bracket you’re in for your regular income
  • how much of your Social Security income is taxable
  • the amount you can contribute to an IRA
  • education credits
  • credits related to dependents
  • how much you pay for an ACA healthcare policy

Summary: Asking your tax professional for a quick answer is in many ways like calling your doctor, telling him your stomach hurts, and expecting him to diagnose and treat it immediately over the phone. Most of the time you’re not going to get the results you want. The doctor will likely need to ask additional questions, examine you, and maybe run some tests in order to treat you.

The same is true for taxes. In order to get the results you want, your tax professional will often need information and time to fully address your question.

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Sharing the Wealth Without Paying Gift Taxes

As the holidays grow close, the challenges of 2020 may have led you to consider giving gifts of money or assets to loved ones. Maybe you want to give cash to help with bills or a down payment on a house, or you’d like to transfer ownership of a house to someone.
If so, there may be no better time than now. The temporary increases in the Lifetime Estate and Gift Tax Exemption provided by the Tax Cuts and Jobs Act (TCJA) can help you potentially lower the taxes owed by your estate.

Gift Tax

The Gift Tax is a federal tax that the Internal Revenue Service (IRS) imposes on transfers of money or property while getting nothing (or less than full value) in return. The rates range from 18-40% and are usually paid by the giver. The point of the gift tax is to prevent people from avoiding the federal estate tax by giving all of their assets away before they die.

Annual Gift Tax Exclusion

The Annual Gift Tax Exclusion allows you to give anyone up to a specified amount of money each year without affecting your taxes. For 2020 the limit is $15,000 per recipient. The recipient could be your son, great aunt, dog walker, Lyft driver, anyone. If you’re married, your spouse can give $15,000 to anyone as well. Gifts between spouses are excluded from gift and estate taxes.
The purpose of the Exclusion is to prevent taxpayers from having to report every gift given during the year, such as giving their grandchild a gift worth $100 for their birthday, or giving their daughter $2,000 to put towards her honeymoon. For once common sense ruled the day and the Exclusion was created to avoid time-consuming paperwork that benefitted no one. As long as you give each person $15,000 or less, there is nothing else you need to do.

Lifetime Estate and Gift Tax Exemption

The Lifetime Estate and Gift Tax Exemption, on the other hand, allows you to give a large amount during your lifetime and through your estate without paying gift taxes on it. Before TCJA was passed in 2017 that exemption was $5 million. TCJA temporarily changed that amount to $10 million plus adjustments for inflation. For 2020 the exemption is $11.58 million. If you are married, your spouse can use the full exemption as well.
As an example, let’s say that you have decided to pay for your grandchild’s college education, and the first year will cost $100,000.

Gift $100,000
Annual Exclusion – 15,000
Gift after Exclusion $ 85,000

If the Lifetime Exemption didn’t exist, you’d have to pay gift tax on $85,000. Let’s take it further and include the Exemption:

Lifetime Exemption $11,580,000
Gift after Exclusion – 85,000
Remaining Exemption $11,495,000

By taking the remaining $85,000 out of the Lifetime Exemption, no tax will need to be paid on the gift.

How Does this Help with Taxes?

If you have substantial assets, gifting the assets now allows you to transfer it at its current value, keeping any appreciation between now and your death out of the estate. For instance, if you transfer ownership of your vacation home to your son now, and it’s currently valued at $500,000, the amount deducted from your Lifetime Exemption would be $485,000 after the Exclusion. But if you kept it, and it was worth $1 million when you died, the entire amount would be deducted from your Exclusion as it passed through your estate.

But what if you don’t have over $11 million in assets that you’re looking to give away? How does this benefit you? Let’s say you want to give someone $150,000 to help with a down payment on a house. Without the exemption you would have to give them $15,000 for 10 years ($30,000 for 5 years if you’re married) to avoid paying gift taxes. With the exemption, you can give it to them all at once.

Why is Now a Good Time?

The exemption increases provided for in the TCJA are not permanent, it is set to expire in 2025 and will decrease to around $6 million beginning January 1, 2026. That timeframe is not guaranteed, Congress can change tax laws at any time, and there are no assurances that there won’t be changes before 2025.
On the bright side, if you were to give $11.58 million now and then the limit is reduced, the IRS has decided that there will be no clawback of gifts; they won’t retroactively charge tax on the excess. If the lifetime limit is decreased after you give the gift, the additional amount you gave will not be subject to estate taxes in the future.

How Do I Take Advantage of This?

The simplest method of using the exemption is to give an outright gift, provided you are willing to give up all control of the asset. Once it is given, you have no legal say in what the recipient does with it.
Another option is to put the asset in a trust, which can offer the giver more control over how the asset is used. A trust may be beneficial to those who are reluctant to give sizeable gifts due to the potential need for assets in the future. There are several types of trusts, and many ways to structure management and distribution of the assets in the trust. If you are considering establishing a trust, consult with an estate attorney and a CPA or Enrolled Agent with experience in trusts and estates.

The Bottom Line

The current tax laws offer a rare opportunity to gift a substantial amount while avoiding paying gift/estate taxes. Because it is a limited time offer, it may make sense to gift the assets now rather than wait for them to pass to your estate.

The issues surrounding gifts are complex. Every tax situation is unique, and what works for one person may not for another. Before you make any irrevocable decisions, consult with a tax and estate professional to determine what is the best course of action for you.

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