The Inflation Reduction Act

In August 2022, congress added new tax provisions to the Inflation Reduction Act, that are designed to address health care, fight climate change, and reduce the country’s deficit. These new provisions may affect your personal finances; here is a brief explanation of some of those added provisions:

 

Negotiation of prescription drug prices for Medicare Beneficiaries

The cost for prescription drugs will decrease at the beginning of 2023 due to the tax provision allowing Medicare beneficiaries to negotiate the price of their prescription drugs. It will also include a cap of $2,000 per year in prescription drug costs for beneficiaries each year at the pharmacy and will allow free vaccinations for seniors beginning in 2023.

 

A 15% corporate minimum tax

This provision applies for all large corporations exceeding $1 billion in profits, with some exceptions to private equity firms. The provision will require a new minimum of 15% tax and will apply based on the annual income in the corporation’s financial statement rather than their taxable income. This provision was added due to large corporations paying little to no tax in the previous years.

 

Expansion of IRS agents

The IRS received $80 billion in funding and is expected to hire 87,000 new IRS agents to increase tax collections and tax compliance through more audits.   

 

Clean Energy Credit

This credit incentivizes taxpayers to install solar energy equipment to earn a non-refundable credit equal to 30% of eligible expenses. These expenses include solar panels, heat pumps, inspection and permit costs, batteries, contract labor for on-site preparation and installation, and sales tax. This credit will run until the end of 2032.

 

Electric Vehicle Tax Credit

Taxpayers who purchased a new electric vehicle before January 1, 2023, may be eligible for a tax credit of up to $7,500 and $4,500 for used electric vehicles. The amount of the credit will vary based on the manufacturing location of the vehicle when the car was purchased and placed in service, battery capacity to power, the vehicle, and other factors.

 

The Inflation Reduction Act is designed to grow the economy and reduce the deficit by billions and is projected to fall by more than $1.5 trillion during the year.

 

Disclaimer: The information provided above is not meant to be legal or tax advise. You should consult your CPA and attorney to determine the best course of action for your situation.

Mitzi E. Sullivan, CPA is a cloud based professional services provider specializing in cloud accounting.

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Economic Nexus

In 2018, the Supreme Court overruled the previous ruling that states can only require sellers to collect tax when they have a physical presence in the state. Now, states can require tax collection responsibilities on sellers who have an economic presence without a physical presence.

Many online retailers sell products all over the United States. Out of state sales without a physical presence can still trigger tax obligations in other states. Most states have economic nexus which is a threshold set by the state requiring the out of state seller to collect and remit sales tax. Economic nexus is triggered by reaching a certain amount of sales and/or number of sales transactions in another state.

If you reach any of the nexus thresholds, you must collect and remit sales tax in those states. If you do not reach the nexus threshold, you will collect and remit sales tax in the state your business is located in.

Disclaimer: The information provided above is not meant to be legal or tax advise. You should consult your CPA and attorney to determine the best course of action for your situation.

Mitzi E. Sullivan, CPA is a cloud based professional services provider specializing in cloud accounting.

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Active or Passive? That is the question…

Income falls into three buckets
  1. Active Income (wages, business where the taxpayer is materially participating, etc.)
  2. Passive Income
There are two kinds of passive activities.
1. Trade or business activities in which you don’t materially participate during the year
2. Rental activities, even if you do materially participate in them, unless you’re a real estate professional
 

3. Portfolio Income (royalties, capital gains, interest, qualified dividends, etc.)

pexels-leeloo-thefirst-8962453

How is Active Income is taxed? Ordinary tax rates plus self employment tax (SS and Medicare tax) of 15.3%.
 
For employees, SS and Medicare is automatically taken out of your paycheck and split 50/50 with employer. For someone who is self employed or active in a business, they must pay both halves of the SS and Medicare, known as self employment tax.
 
How is Passive Income taxed? Ordinary tax rates with no self employment tax. Subject to Net Investment Income Tax (NIIT) of 3.8% if your AGI is above the threshold of $250,000 for MFJ.
 
How is Portfolio Income taxed? Ordinary tax rates or preferential rates for LTCG and qualified dividends.
 
So this might seem that having passive income is better than active income. NOT NECESSARILY.
 
Losses: When you are an owner in a pass through entity (partnership, S Corp), you need to be careful with how you categorize your participation in the business because if the company is generating losses, you may not get to take them.
 
Passive Activity Losses (PALs): When a taxpayer has a loss from a passive activity, it can only offset passive income, NOT active income.
 
Example of passive investor and passive activity loss limitations:
Pete is an individual taxpayer who owns a 25% interest in an LLC. He is categorized as a limited partner and his 25% ownership interest is just an investment as he does not participate in the day-to-day managerial decisions of the business. This means that Pete is a passive partner. The LLC generated a $100,000 loss, $25,000 allocated to Pete on his Schedule K-1. Pete has a full time job where he makes a salary of $100,000.
 
It would appear that Pete can offset his $100,000 income from his W-2 with his $25,000 loss from his Schedule K-1, however, because the loss is passive and the income is active, Pete cannot deduct the $25,000 loss until he has passive income. Therefore, the loss rolls forward until the LLC generates income in a future year, or Pete has passive income from another income stream.
 
How do you qualify as material participation?
    1. You participated in the activity for more than 500 hours.
    2. Your participation was substantially all the participation in the activity of all individuals for the tax year, including the participation of individuals who didn’t own any interest in the activity.
    3. You participated in the activity for more than 100 hours during the tax year, and you participated at least as much as any other individual (including individuals who didn’t own any interest in the activity) for the year.
    4. The activity is a significant participation activity, and you participated in all significant participation activities for more than 500 hours. A significant participation activity is any trade or business activity in which you participated for more than 100 hours during the year and in which you didn’t materially participate under any of the material participation tests, other than this test. See Significant Participation Passive Activities under Recharacterization of Passive Income, later.
    5. You materially participated in the activity for any 5 (whether or not consecutive) of the 10 immediately preceding tax years.
    6. The activity is a personal service activity in which you materially participated for any 3 (whether or not consecutive) preceding tax years. An activity is a personal service activity if it involves the performance of personal services in the fields of health, law, engineering, architecture, accounting, actuarial science, performing arts, consulting, or any other trade or business in which capital isn’t a material income-producing factor.
    7. Based on all the facts and circumstances, you participated in the activity on a regular, continuous, and substantial basis during the year.
Rental Activities
Rental activities are always passive unless you are a “Real Estate Professional.” There is a special $25,000 allowance for a taxpayer who actively participates in a passive rental real estate activity. So you can deduct up to $25,000 of passive loss against active income if you are deemed to have “actively participated” in the rental real estate activity.
 
Rental-Property-2
 
Active participation- not the same as material participation. Active participation is a less stringent standard than material participation. Examples of active participation (management decisions, approving new tenants, deciding on rental terms, approving expenses, etc.).
 
**So basically any taxpayer can easily qualify as active participation as long as they are making high level decisions for the rental.
 
Real Estate Professional Status
 
You qualified as a real estate professional for the year if you met both of the following requirements.
 
  • More than half of the personal services you performed in all trades or businesses during the tax year were performed in real property trades or businesses in which you materially participated.
  • You performed more than 750 hours of services during the tax year in real property trades or businesses in which you materially participated.

Disclaimer: The information provided above is not meant to be legal or tax advise. You should consult your CPA and attorney to determine the best course of action for your situation.

Mitzi E. Sullivan, CPA is a cloud based professional services provider specializing in cloud accounting.

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Accrual vs. Cash Basis

The two primary accounting methods are accrual and cash basis

The main difference between the two methods is the timing of when expenses and revenues are recognized. There are advantages and disadvantages to both methods, so depending on your company’s operations and goals, you can decide which method best aligns with your company’s needs and preferences.

Consult with a Certified Public Accountant or tax professional to ensure the appropriate accounting method is used.

Accrual Accounting

Under this method, revenue is recognized when a sale transaction occurs and expenses are recognized when the purchase of goods or services occur, regardless of whether any cash was received or dispersed.  

The Accrual method is more complex but provides a more accurate picture of a company’s financial position due to its recognition of payables and receivables. However, because some transactions are recorded before cash is actually received, a company’s revenue books will not be aligned with the current amount of cash in their bank account.

The Accrual method is most commonly used by publicly traded companies that are required to receive a financial audit and is accepted under the Generally Accepted Accounting Principles (GAAP).

One example of revenue recognition under the Accrual method: You work for a landscaping company, you mulched a lawn for a client and you invoice the client $200 on December 31. You will recognize revenue on December 31 because the service was performed that day, regardless of whether you received a form of payment from the client.

Cash Accounting

This method is known for its simplicity of keeping track of cash flow because revenue and expenses are accounted for only when cash is received or dispersed.

The Cash method gives you an accurate picture of the cash in your bank account today but does not account for payables or receivables; therefore, the risk of overstating the health of a company is present and does not provide an accurate representation of a company’s financial position. Typically, this method is most used for small businesses and sole proprietorships.

The Cash method is not acceptable under the Generally Accepted Accounting Principles (GAAP).

One example of a revenue recognition under the Cash method: Let’s use the same example from above. You work for a landscaping company, you mulched a lawn for a client, and you invoice the client $200 on December 31. You do not recognize revenue on December 31, because you have not received any form of payment. You will record revenue on the day you receive cash, a check, or a credit card payment from the client for your mulching services.

Why is it important to choose the correct accounting method?
  • It is useful to track your cash flow and understand the future of your company’s financial position
  • It is important for tax purposes in order to determine the accurate amount of annual taxes you will need to pay to the Internal Revenue Service (IRS)
  • It is important to ensure compliance of state and federal regulations. Some states have a preferred accounting method to be used by businesses
Can a company change its method of accounting?

Yes, but a tax return must be filed and approved by the Internal Revenue Service (IRS) before changing its accounting method. To make this legal change, Form 3115, Application for Change in Accounting Method, must be filed by the taxpayer.

Disclaimer: The information provided above is not meant to be legal or tax advise. You should consult your CPA and attorney to determine the best course of action for your situation.

Mitzi E. Sullivan, CPA is a cloud based professional services provider specializing in cloud accounting.

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Filing 1099s in 2023 – Updates and New IRS Filing Portal

What is a 1099?

  • The IRS Forms 1099 are a series of forms used to report certain types of income that do not come from a direct employer in the form of wages, salaries, tips, etc. The most common is Form 1099-NEC (nonemployee compensation), frequently used by small business owners.
  • The primary purpose of these forms is to give nonemployees (contractors or subcontractors) a record of total annual payments they received and need to report during tax time. When paying a nonemployee, businesses do not withhold or pay any employer taxes on those payments. When tax time comes, each individual or business who has received a 1099 is required to report this income and pay any related taxes.

Businesses and Individuals Required to file Forms 1099

  • If a business pays $600 or more in compensation through the year to a contractor or other nonemployee, the business is required to send copies of Form 1099-NEC to the IRS and payees. This form is typically issued to individuals, sole proprietors, partnerships, interest payees, rent payees, and single member LLCs (businesses are not required to send a 1099-NEC to S and C corporations). However, all attorneys receive a 1099, even if they are an S or C corporation.
  • Refer to the IRS guidance here.

Due Date for Forms 1099

  • The due date for filing a copy of a 1099 with the IRS and providing a copy to your contractors and vendors is January 31 for most businesses. If the business is not filing Forms 1099-NEC, the due date to submit any other type of 1099 is February 28. If either of these dates is on a weekend, the deadline falls on the following Monday.

Information required to file a 1099

  • Have all contractors complete a Form W-9. This will request their full name, social security number, and address (if it is an individual) or their business name, EIN, and address (if it is a business).
  • A total of all payments made to the nonemployee (contractor) throughout the year.

Electronic Filing Update – New IRS Portal

  • The IRS is scheduled to launch a new internet filing portal in early January 2023. Under Section 2102 of the Taxpayer First Act, the IRS is developing an internet portal that will allow taxpayers to electronically file Forms 1099 after December 31, 2022. Reference part F of the IRS Instructions for additional information.

Disclaimer: The information provided above is not meant to be legal or tax advise. You should consult your CPA and attorney to determine the best course of action for your situation.

Mitzi E. Sullivan, CPA is a cloud based professional services provider specializing in cloud accounting.

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  1. Active Income (wages, business where the taxpayer is materially participating, etc.)
  2. Passive Income
There are two kinds of passive activities.
1. Trade or business activities in which you don’t materially participate during the year
2. Rental activities, even if you do materially participate in them, unless you’re a real estate professional
 

3. Portfolio Income (royalties, capital gains, interest, qualified dividends, etc.)

pexels-leeloo-thefirst-8962453

How is Active Income is taxed? Ordinary tax rates plus self employment tax (SS and Medicare tax) of 15.3%.
 
For employees, SS and Medicare is automatically taken out of your paycheck and split 50/50 with employer. For someone who is self employed or active in a business, they must pay both halves of the SS and Medicare, known as self employment tax.
 
How is Passive Income taxed? Ordinary tax rates with no self employment tax. Subject to Net Investment Income Tax (NIIT) of 3.8% if your AGI is above the threshold of $250,000 for MFJ.
 
How is Portfolio Income taxed? Ordinary tax rates or preferential rates for LTCG and qualified dividends.
 
So this might seem that having passive income is better than active income. NOT NECESSARILY.
 
Losses: When you are an owner in a pass through entity (partnership, S Corp), you need to be careful with how you categorize your participation in the business because if the company is generating losses, you may not get to take them.
 
Passive Activity Losses (PALs): When a taxpayer has a loss from a passive activity, it can only offset passive income, NOT active income.
 
Example of passive investor and passive activity loss limitations:
Pete is an individual taxpayer who owns a 25% interest in an LLC. He is categorized as a limited partner and his 25% ownership interest is just an investment as he does not participate in the day-to-day managerial decisions of the business. This means that Pete is a passive partner. The LLC generated a $100,000 loss, $25,000 allocated to Pete on his Schedule K-1. Pete has a full time job where he makes a salary of $100,000.
 
It would appear that Pete can offset his $100,000 income from his W-2 with his $25,000 loss from his Schedule K-1, however, because the loss is passive and the income is active, Pete cannot deduct the $25,000 loss until he has passive income. Therefore, the loss rolls forward until the LLC generates income in a future year, or Pete has passive income from another income stream.
 
How do you qualify as material participation?
    1. You participated in the activity for more than 500 hours.
    2. Your participation was substantially all the participation in the activity of all individuals for the tax year, including the participation of individuals who didn’t own any interest in the activity.
    3. You participated in the activity for more than 100 hours during the tax year, and you participated at least as much as any other individual (including individuals who didn’t own any interest in the activity) for the year.
    4. The activity is a significant participation activity, and you participated in all significant participation activities for more than 500 hours. A significant participation activity is any trade or business activity in which you participated for more than 100 hours during the year and in which you didn’t materially participate under any of the material participation tests, other than this test. See Significant Participation Passive Activities under Recharacterization of Passive Income, later.
    5. You materially participated in the activity for any 5 (whether or not consecutive) of the 10 immediately preceding tax years.
    6. The activity is a personal service activity in which you materially participated for any 3 (whether or not consecutive) preceding tax years. An activity is a personal service activity if it involves the performance of personal services in the fields of health, law, engineering, architecture, accounting, actuarial science, performing arts, consulting, or any other trade or business in which capital isn’t a material income-producing factor.
    7. Based on all the facts and circumstances, you participated in the activity on a regular, continuous, and substantial basis during the year.
Rental Activities
Rental activities are always passive unless you are a “Real Estate Professional.” There is a special $25,000 allowance for a taxpayer who actively participates in a passive rental real estate activity. So you can deduct up to $25,000 of passive loss against active income if you are deemed to have “actively participated” in the rental real estate activity.
 
Rental-Property-2
 
Active participation- not the same as material participation. Active participation is a less stringent standard than material participation. Examples of active participation (management decisions, approving new tenants, deciding on rental terms, approving expenses, etc.).
 
**So basically any taxpayer can easily qualify as active participation as long as they are making high level decisions for the rental.
 
Real Estate Professional Status
 
You qualified as a real estate professional for the year if you met both of the following requirements.
 
  • More than half of the personal services you performed in all trades or businesses during the tax year were performed in real property trades or businesses in which you materially participated.
  • You performed more than 750 hours of services during the tax year in real property trades or businesses in which you materially participated.

Disclaimer: The information provided above is not meant to be legal or tax advise. You should consult your CPA and attorney to determine the best course of action for your situation.

Mitzi E. Sullivan, CPA is a cloud based professional services provider specializing in cloud accounting.

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LinkedIn

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Avoiding and Navigating IRS Audits

Whether you are trying to avoid an IRS audit, or have received a notice from the IRS, this guide contains helpful information: irsaudits2019

See also: New Tax Law. What’s Hot. What’s Not.

~Mitzi E. Sullivan, CPA

Mitzi E. Sullivan, CPA is a cloud based professional services provider specializing in cloud accounting.

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