Let’s discuss the taxation of capital gains, in light of the president’s proposal to impose more taxes on the rich, including higher tax rates on their gains.
Long-term capital gains get favorable rates. Profits from the sale or exchange of capital assets held over a year are generally taxed at 0%, 15% or 20%. There’s also the 3.8% surtax on net investment income of single filers with modified adjusted gross incomes of more than $200,000 … $250,000 for joint filers.
The rates are based on set income thresholds, which are adjusted annually for inflation. For 2021, the 0% rate applies to individuals with taxable income up to $40,400 on single returns, $54,100 for heads of household and $80,800 for joint returns. The 20% rate starts at $445,851 for single individuals, $473,751 for head-of-household filers and $501,601 for married couples filing jointly. The 15% rate is for filers with taxable incomes between the 0% and 20% break points.
President Biden wants the wealthy to pay more tax on their capital gains.
He is calling for a 39.6% rate … 43.4% with the 3.8% NII surtax … for taxpayers reporting $1 million or more of AGI. The same AGI threshold would apply to single filers, heads of household and couples filing a joint return.
This is proposed to be retroactive, applying to gains after April 28, 2021.
Biden would also tax unrealized gains of the wealthy upon death, essentially treating death as a realization event for federal income tax purposes. Ditto for gifts by the wealthy. Biden proposes this tax hike to take effect in 2022.
Ron Wyden (D-OR), the top Senate taxwriter, also backs capital gains reform.
But the head of the Senate Finance Com. supports a different approach to having wealthy individuals pay more tax on their tradable capital gains… gains from stocks, bonds, mutual funds and other publicly traded investments.
Wyden is touting a mark-to-market policy on tradable assets. He wants certain individuals to recognize unrealized gains and losses each year on their publicly traded investments and pay income tax as if they’d sold their holdings for fair market value on the last day of each tax year. Under a discussion draft that he released in 2019, the mark-to-market requirement would affect individuals who meet either a $1 million income threshold or a $10 million asset threshold for each of the preceding three years. Special rules for figuring the asset threshold would apply to retirement accounts, such as IRAs and 401(k)s, main homes and farms.
Wyden’s plan would tax all capital gains at ordinary income tax rates.
Readers want to know what the chances are of these ideas becoming law. We don’t expect Wyden’s mark-to-market regime to gain traction on Capitol Hill. And we think the odds of a 39.6% capital gains tax on the wealthy are pretty low. There are slightly better odds for a 25% or 28% top capital gains tax for the wealthy, but even this depends on whether all Senate Democrats eventually toe the line.
Capital Gains
Note this capital gains tax break for investing in small regular corporations. Individuals who buy stock in a C corporation with assets of $50 million or less directly from the company after Sept. 27, 2010, and sell more than five years later can exclude 100% of their gain when they sell. The gain is exempt from the AMT, too. The exclusion is capped at the greater of 10 times share basis or $10 million. Stock of companies in certain lines of business is not eligible. These include banking, insurance, oil and gas, and personal services, such as law, health and consulting.
A sale of stock in a medical production corporation qualifies for gain exclusion, IRS privately rules. The corporation’s products are associated with the health industry. But its business is more akin to custom manufacturing than offering services based on individual expertise. The company is not in a trade or business involving the performance of services in the health field, or where the principal asset is the reputation or skill of one or more of its employees, according to the Service. Provided the other requirements are met, qualifying individuals who sell stock in this corporation are eligible for the capital gain exclusion described above.
Child Care
Working families have a much juicier dependent care credit this year. For 2021, the credit is worth 50% of up to $8,000 in eligible child care costs … $16,000 if you have two or more children needing care. This means the maximum credit is $4,000 for one kid and $8,000 for two or more … up from $1,050 and $2,100 for 2020. The full credit is available for taxpayers with up to $125,000 of adjusted gross income. It phases out for taxpayers with AGIs between $125,000 and $438,000. Those with AGIs over $438,000 get zero. Additionally, this credit is fully refundable for 2021.
Here’s a quick tutorial on the rules for taking the dependent care credit: Expenses for the care of children under age 13 and qualifying relatives must be incurred so you can work or look for a job, and you must report the provider’s tax ID number on Form 2441. If taking the credit to help care for a relative who isn’t a qualifying child, such as an aging parent or grandparent, that person needs to have lived with you for more than six months during the year and be unable to care for him- or herself.
Remember that summer day camp costs qualify for the dependent care credit. The same goes for camps to help improve your child’s reading or study skills. But expenses for summer school, tutoring programs and overnight camps don’t qualify.
In Congress
Democrats want to make permanent recent expansions to four tax credits: The child tax credit, the earned income tax credit for workers without kids, the premium tax credit for uninsured individuals who opt to buy health coverage through the marketplace, and the child and dependent care credit for working parents. The premium credit expansions apply for 2021 and 2022 … the rest only for 2021. Congressional Democrats are urging that the expansions be made permanent. Biden wants the higher child credit to go through 2025 and the rest made permanent.
Here’s something that lawmakers on both sides of the aisle can agree on:
A tax credit to incentivize production of semiconductors in the U.S. A bipartisan Senate bill would give a 25% investment tax credit to firms for the cost of equipment and construction of facilities used in semiconductor manufacturing. Businesses could elect to receive this credit in advance through direct payments.
Another item getting the attention of both Democratic and GOP lawmakers:
Abusive syndicated conservation easement donations by pass-through firms. A 2016 IRS notice requires disclosure and reporting of syndicated easement deals that offer investors charitable deductions equal to at least 250% of their investments. A bipartisan congressional bill would deny the charitable write-off in these instances.
Penalties
Many taxpayers try to assert a reasonable-cause defense to avoid a penalty. In doing so, they have to prove their position was based on reasonable cause and they acted in good faith. They must show that they exercised the same care that a reasonably prudent person would have under similar circumstances.
Here are key factors IRS looks at in weighing a reasonable-cause defense: The taxpayer’s effort to report the proper tax liability. The taxpayer’s experience, education, knowledge and sophistication with respect to federal tax laws. Plus reliance on the advice of a tax advisor who was provided all relevant information.
A man escapes a penalty because he relied on his lawyer in good faith. After IRS assessed a substantial understatement penalty against the man, he claimed the penalty was erroneous because he reasonably relied in good faith on the advice of an experienced tax attorney. He gave his lawyer all the facts and documents. He had no tax or financial background, and he took extensive steps to try to ensure that he was receiving adequate tax advice (Hussey, 156 TC No. 12).
Tax Disputes
There are times when IRS can go back more than three years to seek taxes. If over 25% of gross income is omitted from a return, then IRS has six years to assess the tax, unless the filer disclosed the omission on the return. Here, a couple reported $1.5 million of capital gain on their return instead of the proper $4.9 million. IRS sent out the deficiency notice after the usual three-year limitation period but before the end of the six-year period. The couple argued that the six-year period does not apply because they didn’t fully omit the gain, but only understated it. Not so, says the Tax Court, giving IRS the victory here (Pragias, TC Memo. 2021-82).
Trying to get IRS to abate interest on your tax debt? It’s an uphill climb. You need to show the interest was because of an unreasonable IRS delay or error. In doing this, you must prove a correlation between the act and the specific period for which you are requesting abatement of interest. You must also demonstrate that you would have paid the tax debt earlier if there had been no error or delay. And your actions must not have contributed in any way to the error or delay.
Business Taxes
Butane does not qualify for the alternative-fuel-mixture excise tax credit, a federal appeals court says in affirming a 2020 district court decision. A company that mixes butane and gasoline and sells the mixture to customers claimed the 50¢-per-gallon credit for the butane that it blends with the gasoline. Butane is a taxable fuel, not an alternative fuel, under a federal tax statute and IRS regulations, so no credit is allowed (U.S. Venture v. U.S., 7th Cir.).
Employer leave-donation programs for COVID-19 charities get IRS’s approval through 2021. Some employers let their employees forfeit paid vacation or sick days in exchange for cash payments that the employer donates to charitable organizations that help victims of the COVID-19 pandemic. IRS had blessed these programs for 2020 and is now extending relief through 2021. Workers will escape payroll or income taxes on the value of the donated leave, but they cannot claim charitable deductions. Employers can write off the payments as charitable contributions or business expenses.
Marijuana
One often-litigated issue that the Supreme Court has chosen not to review:
The inability of legal marijuana dispensaries to take business deductions on federal returns. The Service takes the view that even in states where it is legal to sell and use marijuana, a federal tax statute prohibits business deductions (other than cost of goods sold) for sellers of controlled substances that are illegal under U.S. law. A medical marijuana firm in Colo. asked the Supreme Court for relief after IRS, during its audit of the firm in connection with improper business write-offs, issued a third-party summons to a state agency. The Court declined to hear the case.
Home Sales
A reminder on calculating gain or loss from the sale of your primary home. You start with the amount of gross proceeds reported in box 2 of Form 1099-S and subtract selling expenses such as commissions to arrive at amount realized. You then reduce that figure by your tax basis in the home to come up with gain or loss. Taxpayers who have owned and used the property as their principal residence for at least two out of five years before the sale can exclude up to $250,000 of the gain … $500,000 for joint filers. Any gain in excess of the $250,000 or $500,000 exclusion is taxed at capital gains rates. Losses from sales of primary homes aren’t deductible. IRS Publication 523 has details, including whether you need to report the sale at all.
If you sell a main home that you previously used as a vacation home …
Some or all of the gain is ineligible for the home-sale exclusion if the house was converted to personal use after 2008. The portion of the gain that is taxed is based on the ratio of the period of time after 2008 that the home was used as a second residence or rented out to the total time that the seller owned the house. The remaining gain is eligible for the $250,000 or $500,000 home-sale exclusion.
Tax Debts
Making an offer to settle your federal tax debt at less than what you owe?
There are two payment options: Lump sum cash, which requires 20% of the total offer amount to be paid up front, with the remaining balance to be paid in five or fewer installments within five months of the date your offer is accepted.
Periodic payment requires that your first payment be made with the offer, with the remainder remitted in monthly installments over a period of 6 to 24 months.
Check out IRS’s Form 656-B booklet for forms and eligibility requirements.
Beware of promises to settle your IRS tax debts for pennies on the dollar. IRS calls firms that hawk these types of tax-debt relief plans “offer-in-compromise mills.” Many of them charge big upfront fees, warn that time is running out to settle the debt, and churn out applications for relief that most of their clients can’t even qualify for.
Filing Season
Still waiting for your tax refund on your timely filed 2019 or 2020 return?
Millions of others are in the same boat, if that makes you feel any better. As of June 25, IRS had a backlog of 16.7 million 2019 and 2020 individual returns that require manual processing by agency employees. Some of these are paper returns. Others were suspended during electronic processing and need further review. Unfortunately, there is not much that taxpayers or preparers can do about the delays.
But there are reasons for some hope. IRS expects to complete the processing of 2019 Forms 1040 that were filed on paper sometime this summer. And new returns are now trickling into IRS at a slower rate than during the midst of filing season.
Wonder why it’s been so hard to reach a live person at IRS by phone?
One reason is the historic number of callers. During the 2021 filing season, IRS received 85.1 million calls on its toll-free 1040 phone line. Compare this figure with 7.3 million and 12.1 million calls for the 2019 and 2020 filing seasons. So far in 2021, only 3% of callers reached a live customer service representative. According to IRS’s National Taxpayer Advocate, the huge increase in calls this year is caused by numerous factors. For example, taxpayers whose refunds on 2019 or 2020 returns were delayed called IRS often and repeatedly. The Service likely also got lots of calls from people who didn’t get their expected stimulus checks.