Author: Jean Godin

“I filed an extension. Why do I have to pay penalties now?”

This is one of the most frequently asked questions we receive around the extended October deadline! In the spring, we just as frequently hear, “I have an extension. Why do I need to make an estimated payment?”

Unfortunately, even though an extension grants you additional time to file, it does not give you additional time to pay the tax due. That means that penalties and interest accrue on the amount of tax owed from the filing deadline until you pay the tax. We agree: this policy is confusing. We’ll discuss a few strategies on how to avoid these costs.

How can I avoid paying penalties and interest?

There are a few steps you can take to minimize the likelihood of paying penalties and interest.

First of all, if you receive a W-2, speak with your payroll administrator to adjust your withholdings to ensure that you are remitting the appropriate tax payment throughout the year. It is important to consider adjustments for life events such as changing the number of dependents you claim when one of your children begins supporting themselves.

However, withholding correctly becomes complicated for people with multiple income sources and business owners. We recommend reviewing the year-to-date financial statements for your business on an ongoing basis so that you have a good estimate of your taxable income. For our accounting and advisory services clients, we send monthly financial statements so that the data is always timely.

Do I really have to pay this?

Even with planning, surprises can come up. Larger-than-expected capital gains can result in a big tax bill since they typically do not have tax withheld. Waiting on a necessary document such as a Schedule K-1 prepared by another firm can make it impossible to know what income may be flowing from that business until the Schedule K-1 is received.

Generally, the penalties and interest assessed by the IRS must be paid. The IRS calculates the Failure to Pay Penalty based on how long your overdue taxes remain unpaid. The Failure to Pay Penalty is 0.5% of the unpaid taxes for each month or part of a month the tax remains unpaid. Importantly, the IRS applies full monthly charges even if you pay your tax in full before the month ends. They do not pro-rate the penalty. However, the penalty will not exceed 25% of your unpaid taxes.

In rare cases, you may qualify for penalty relief if you tried to comply with tax laws but were unable due to circumstances beyond your control.

Estimated Payments

If your return has been started prior to the April deadline, our tax team may reach out to you about making estimated payments. By making an estimated payment, you can avoid the Failure to Pay penalty. Your tax team will make their best estimate of the amount you owe and can even process the payments to the federal and state governments on your behalf with your authorization.

If a good estimate of the amount owed is not available due to missing information, a good place to start is ensuring that you pay as much tax for the current tax year and you did for the previous year. However, if you expect to receive a refund, no action is required.

The best way to avoid unnecessary penalties and interest around the extended deadline is to regularly communicate with your accounting firm. If you are interested in learning more about our tax planning or business advisory services, call our office at 480-294-4967 to set up a consultation.

Business Owners: Are you deducting your health insurance premiums?

With the high cost of healthcare coverage, self-employed taxpayers may find relief by taking advantage of tax deductions for health insurance premiums.

Self-employed taxpayers include sole proprietors, members of LLCs, partners, and owners of S-corporations.

Who is not eligible?

You may not take the deduction if you were eligible to participate in an employer-subsidized plan. This includes plans sponsored by your spouse’s employer. A subsidized plan is one where the employer pays a portion of the premium.

However, eligibility is determined on a month-by month basis, so even if you were covered by an employer-subsidized plan for part of the year, you may take the deduction for the remainder of the year. For example, someone who is an employee for the first six months of the year and then becomes a self-employed consultant for the final six months of the year can deduct their health insurance premiums paid from July to December.

What is included in the deduction?

The deduction includes premiums for insurance coverage for the self-employed individual, their spouse, and their dependents. While medical insurance premiums are typically the largest dollar amount, premiums for dental insurance and long-term care insurance may also be deductible. And even if you don’t itemize other deductions, you can still deduct self-employed health insurance if you meet the requirements.

Importantly, the amount of the deduction cannot exceed the earned income you collect from your business. But if you have sufficient profit, you can deduct the full amount of the premiums.

Special reporting requirements govern this deduction for S-corp shareholders who own more than 2% of the company, so we recommend talking with a tax professional. If you have questions about this deduction or want to explore other tax-saving opportunities, call our office at 480-392-6801 to schedule your tax planning meeting.

Cost Segregation Studies for Rental Real Estate

Introduction

Last week we discussed how Section 179 depreciation generates upfront cashflow for businesses by deducting the full cost of an asset in the year it is purchased. And while the tangible property we discussed had a useful life for tax purposes of 5 to 7 years, the life for residential rental real estate is far longer: 27.5 years.

For obvious reasons, owners of residential rental real estate are eager to utilize the tax benefit from their purchase more quickly. Cost segregation is a process of identifying assets that are personal property that can be depreciated more quickly than their corresponding real property. While residential rental buildings must be depreciated over 27.5 years, assets like wiring, flooring, plumbing, appliances, fixtures, and air conditioners can be depreciated in just 5 to 7 years.  By capturing depreciation earlier in the life of the property, owners can free up cash and use it for their operating and investment needs now.

Projected Tax Savings

The tax savings generated by a cost segregation study depend upon the price of the rental property. Typically, the higher the cost the property, the greater the benefit of a cost seg will be. For a $500,000 rental property, depreciation expense under the straight-line method would be just $13,940 in the first year. However, our in-house cost segregation method that classifies assets and utilizes bonus depreciation yields a depreciation expense of $168,364—a difference of over $150,000.

If the tax loss on the rental is limited due to your income level, the loss will carry forward into future years. That means that you could earn money from your rental property for years before paying income taxes on it.

Impact of the TCJA

Changes to the tax law in the Tax Cuts and Jobs Act of 2017 fueled the efficacy of cost segregation studies. For certain assets, bonus depreciation was increased from 50% of the cost of the asset to 100%. Therefore, the cost of many building fixtures can be completely depreciated in the first year.

The 100% deduction for bonus depreciation applies to property acquired and placed in service after September 27, 2017, and before January 1, 2023. Beginning in 2023, the rate of bonus depreciation will be gradually phased out, unless Congress passes a law to extend it.

Conclusion

If you invest in real estate, we encourage you to schedule a consultation to discuss your most tax-efficient option. We can assist with the allocation of real assets and personal property, and we have contacts for cost segregation firms for very large projects. We ask that clients provide a copy of the settlement statement from the purchase of their rental property.

To schedule your appointment, call our office at 480-392-6801.

Section 179 Deductions

Tangible business assets include vehicles, equipment, and furniture. Depreciation is an accounting method used to allocate the cost of a tangible asset over its useful life. Depreciation ties the cost of using an asset with the benefit gained over its useful life. The IRS specifies the useful life of many types of assets under the Modified Accelerated Cost Recovery System (MACRS).

For example, if a realtor purchases a car to drive to showings for $30,000, the car would be depreciated over 5 years. Each year, depreciation would be deducted until the accumulated depreciation equals the purchase price.

However, taxpayers might prefer to deduct the full purchase price in the first year instead of over the useful life of the asset. Deducting the full cost of the asset would result in a lower taxable income and therefore a lower tax burden, leaving more cash on hand for investment in the business or for distributions to the owner during that year. Furthermore, the time value of money posits that a sum of money is worth more now than the same sum will be at a future date due to its earnings potential in the interim.

In some cases, the taxpayer can elect to immediately expense the asset rather than following the rates outlined in MACRS. The tax code has this provision in place to encourage business owners to grow their business with the purchase of new equipment.

Section 179 of the Internal Revenue Code outlines the requirements for an immediate deduction. For 2022, the maximum deduction is limited to $1,800,000. The property must be placed into service during the tax year in which the deduction is being claimed. In our realtor example, placing the car into service would be driving it to a business appointment. Assets must be used for business purposes more than 50% of the time to qualify for Section 179 deductions.

If you have questions about the purchase of business assets or any other tax-saving opportunities, call our office at 480-392-6801.

U.S. Energy Investments

Overview

While many potential tax saving strategies are limited to business owners, oil and gas deductions can benefit high-earning W-2 employees as well. Energy investments avoid the phased-out deductions for real estate losses that investors face between $100,000 and $150,000 in income. These investments offer large tax deductions in the first year followed by attractive returns in future years.

Upfront Tax Savings

Large deductions in the first year of investment provide immediate tax benefits. Intangible Drilling Costs (IDCs) are the expenses to develop an oil or gas well that are not a part of the final operating well. With an upfront investment of $100,000, a typical investor would receive $70,000 in IDC deductions in the first year. Furthermore, they would also receive a deduction of about $5,000 in the first year for depreciation of tangible equipment.

Future Returns

The deduction for depreciation of equipment is an estimated $5,000 per year for 7 years. Earnings on investments are estimated at 8.3%, and oil and gas fields generally have a lifespan ranging from 15 to 30 years. These investments are located on U.S. soil which increases the nation’s energy independence and protects the stability of the investment.

Next Steps

The best way to utilize the tax savings in oil and gas is to become a direct investor. We recommend investing with the U.S. Energy Development Corporation as a General Partner. For more information, contact K&R’s in-house financial advisor Rick Montgomery at [email protected].

Overview of the Inflation Reduction Act of 2022

Background

The Inflation Reduction Act that was signed into law in August is a remnant of the “Build Back Better Plan.” The original $6 trillion dollar proposal was supported by President Biden and essentially comprised his domestic agenda. While most of the original proposal died in legislation, a very limited portion of the plan was passed in the bipartisan Infrastructure Investment and Jobs Act.

Unlike the Infrastructure Investment and Jobs Act, the Inflation Reduction Act passed much more narrowly with a 220-207 vote in the house. In the Senate, Vice President Kamala Harris cast a tiebreaker in the final 51-50 vote.

The focus of the resurrected proposal was likewise narrow: investment in green initiatives and healthcare. What does this bill mean for American Taxpayers?

 

Key Provisions

Residential Energy Credits

Residential Energy Credits that were set to expire have been extended for 10 years to encourage investment in clean energy by American families. Congressional leaders hope that these incentives will reduce carbon emissions.

First, the credit for rooftop solar panels has been extended. Homeowners can also receive credits for making energy-efficient improvements to their homes. Qualifying projects include energy-efficient:

  • Water heaters
  • Heat pumps
  • HVAC systems
  • Windows
  • Doors

Starting in 2023, the credit for energy efficient residential improvements will be equal to 30% of the costs for all eligible home improvements made during the year. Furthermore, the $500 lifetime limit will be replaced by a $1,200 annual limit on the credit amount. To maximize tax savings, homeowners can time their qualifying home projects to claim the maximum credit each year.

Electric Vehicle Credits

Like the residential energy credits, electric vehicle credits are extended for 10 years. The credit applies to both new and used electric vehicles. One major change is the expansion of the credit from solely electric vehicles to any “clean vehicle” which includes hydrogen fuel cell cars.

Notably, the law limits the credit with caps on the taxpayer’s income and the retail sales price of the vehicle. The limits effectively exclude higher-priced luxury electric vehicles. On the other hand, the new law eliminates the 200,000-car cap for claiming the credit, which will allow manufacturers like Tesla, General Motors, and Toyota to qualify for the credit.

In addition, the law revived the tax credit for installing EV recharging equipment at personal residences. These residential and electric vehicle credits aim to incentivize taxpayers to reduce carbon emissions.

Healthcare

Beyond these “green”-focused credits, the Inflation Reduction Act also subsidizes healthcare initiatives. It extends premium reductions from the Affordable Care Act through 2025. Eligible individuals and families who purchase their health insurance through the federal Health Insurance Marketplace can continue to benefit from lower health care premiums, a policy that has been popular with taxpayers.

The Inflation Reduction Act also makes changes to Medicare prescription drug policies. First, it allows Medicare to negotiate the price of certain prescription drugs, bringing down the price beneficiaries will pay for their medications. In addition, Medicare recipients will have a $2,000 cap on annual out-of-pocket prescription drug costs, starting in 2025.

 

Funding the Bill

Since the environmental and healthcare programs in the bill will likely carry a high cost, taxpayers and experts alike have questioned how the act will be funded. Provisions include a 15% corporate minimum tax, an excise tax on stock repurchases, and, perhaps counterintuitively, an increase in IRS funding.

Corporate Minimum Tax

Media outlets have famously pointed out very large companies that pay very little in federal taxes—Amazon, Nike, and FedEx, just to name a few. Under the new law, large businesses with more than $1 billion in annual adjusted income will pay a minimum corporate tax rate of 15%. While there are significant differences in calculating income for tax purposes and income for financial statements, the corporate alternative minimum tax is based on financial statement income. Corporations will need to compute two separate calculations and pay the greater of the two.

Excise Tax on Stock Repurchases

A stock buyback occurs when a company that issues stock pays shareholders the market value per share to reacquire a portion of its ownership. Corporations might repurchase stocks for reasons including company consolidation, equity value increase, and looking more financially attractive. After December 31, 2022, covered corporations that repurchase stock will be subject to a 1% excise tax. This policy might incentivize corporations to return capital to shareholders through dividends rather than through stock repurchases, but it is unclear how companies will react.

IRS Funding

Over the next 10 years, the Inflation Reduction Act allots $80 billion of additional funding for the IRS. Proponents argue that the budget increases will allow the IRS to close the “tax gap.” The tax gap is the difference between what taxpayers owe in taxes and what they actually pay. Some estimates place the tax gap at $600 billion. Priorities will likely include increasing staffing levels and modernizing outdated processing systems. In the bill, $5 billion in spending is allotted for technology.

A Government Accountability Office report found that historically, lower-income taxpayers have faced higher-than-average IRS audit rates. 2021 data show that IRS audit rates for people with an annual income of less than $25,000 were five times higher than audit rates for high-income taxpayers. However, the Treasury Department has indicated that low or middle-income earners and small businesses will NOT be the focus of increased IRS enforcement activity.

 

Impact on Inflation

Despite the promising name, most experts suggest that the Inflation Reduction Act is unlikely to have an impact on inflation. The Penn Wharton Budget Model, a nonpartisan, research-based organization at the University of Pennsylvania, and the Congressional Budget Office, a federal agency that provides budget and economic information to Congress, are among the organizations that have expressed a lack of confidence in the legislation’s likelihood to lower inflation. While the opportunities for extended tax credits and lower healthcare costs are attractive to many taxpayers, the strain of inflation continues to weigh on American families.

Even faced with uncertain economic conditions, proactive tax planning can help taxpayers keep more of their income. If you have a question about qualifying for extended tax credits or want to explore strategies to lower your income tax burden, call our office at 480-392-6801.

Catch-Up Retirement Contributions

Experts recommend investing for retirement early and often. When life gets in the way, however, that ideal may not be achievable. The government has provisions in place to help employees over the age of 50 either get on track or augment already solid savings. The retirement account contribution limits for employees over 50 is larger than the standard contribution limits.

The “catch-up” provision was created in 2001 by the Economic Growth and Tax Relief Reconciliation Act of 2001 (EGTRRA). The act provided relief to investors who lost significant value in their retirement portfolios in the wake of the dot-com bubble. From the bubble’s peak in March of 2000, stocks had declined in value by 75% by October of 2002. The law also revised the life expectancy tables used for determining retirement ages.

In 2006, the Pension Protection Act made provisions for catch-up contributions permanent.

As of 2022, employees over 50 may contribute:

 

Account Type Additional Contribution  
IRA $1,000 on top of the standard $6,000 contribution limit
ROTH IRA $1,000 on top of the standard $6,000 contribution limit
401(k) $6,500 on top of the standard $20,500 contribution limit
SIMPLE 401(k) $3,000 on top of the standard $14,000 contribution limit

 

Note: These contribution limits are for employees only. Small business owners may be able to contribute more as employer contributions.

Call our office at 480-392-6801 if you would like to talk about your retirement options

1031 Exchanges

Introduction

If you purchased an investment property a few years ago, you were probably thrilled to see the skyrocketing prices in the Phoenix valley and across the country recently. For those that sold properties at top dollar, however, their excitement about their profits might have been dampened by the blow of a big tax bill.

Sec. 1031 Exchanges are a technique for deferring paying taxes on investment gains. To qualify, the investor must reinvest the proceeds into a similar (like kind) property as part of a qualifying like-kind exchange.

In its simplest form, an exchange involves two persons trading one property for another. In practice, however, finding one person that wants the exact property that someone else would like to trade can be nearly impossible. Most 1031 Exchanges, therefore, go through a third-party broker. These brokers navigate investors through the difficult regulatory requirements governing like-kind exchanges. If investors do not follow these regulations completely, they may be held liable for taxes, penalties, and interest on their transactions.

Before we share more details on the ins and outs of 1031 Exchanges, we’ll address the most important DON’Ts:

  • Taxpayers do NOT qualify for a deferral simply by selling and buying a similar investment.
  • Taxpayers may NOT receive the proceeds of the sale. The funds must be held in escrow by a third party intermediary until they are used directly to purchase the new property.
  • Investors are NOT limited to individuals. Any taxpaying entity can participate in a 1031 Exchange including partnerships, S-corps, C-corps, LLCs, and trusts.

 

Defining “Like-Kind”

To qualify for a 1031 Exchange, the property given up and received must be “like-kind.” But what exactly counts as like-kind has a fairly broad definition. First, the property must be used for trade or business. Personal property such as a primary residence or a vacation home do not qualify. Generally, the properties involved are both real estate, but they don’t have to be properties that lay people would consider similar. For example, a lot with a rental house could be exchanged for vacant land. One exception is that property within the United States is not considered like-kind to property outside of the United States.

Before the passage of the Tax Cuts and Jobs Act (TCJA) in 2017, some exchanges included other property such as franchise licenses, aircraft, and equipment. However, under current tax law, ONLY real property as defined in Section 1031 qualifies.

The law also specifically excludes the following from being eligible for 1031 Exchanges:

  • Inventory or stock in trade
  • Stocks, bonds, or notes
  • Other securities or debt
  • Partnership interests
  • Certificates of trust

 

Time Constraints

Aside from the requirements of like-kind properties, the other major constraint on using a 1031 Exchange is timeliness. From the date you sell the relinquished property, you have 45 days to identify potential replacement properties to purchase. Importantly, the identification must be in writing, signed by you, and delivered to a person involved in the exchange. Qualified persons can include the seller of the replacement property or the qualified intermediary. On the other hand, notice to your attorney, real estate agent, or accountant is NOT sufficient. The IRS allows investors to designate up to three replacement properties as potential investments at the 45-day mark.

The investor must complete the purchase of the replacement property either by 180 days after the sale of the exchanged property or the due date of the income tax return for the tax year in which the relinquished property was sold, whichever is earlier. The due date for the tax return includes extensions. The replacement property received must be substantially the same as property identified within the 45-day limit described above.

 

Investment Strategies

While there are strict rules governing 1031 Exchanges, there is no limit on how frequently investors can utilize them. Savvy investors can integrate like-kind exchanges into their strategy for significant savings from tax deferment.

 

Deferring Depreciation Recapture

When an investment property that has been previously depreciated, like a rental property, is sold, the depreciation is recaptured which increases the taxable gain on the sale.  Generally, a 1031 Exchange delays depreciation recapture by rolling over the cost basis from the relinquished property to the new one that replaces it. Essentially, the depreciation calculation continues as if you still owned the old property.

Importantly, the investor (or their accountant!) must carefully track their basis in the new property. Furthermore, it is important to remember that even though the gain is deferred, it is not forgiven. Tax will be paid on the gain when it is recognized upon the sale of the new property.

 

Reverse Exchange

In most 1031 Exchanges, one property is sold prior to the new property being purchased. However, investors also have the option to acquire the new property before the old property is sold. This is called a “reverse exchange.” This technique allows the investor to hold the old property longer when they predict that the market value will increase.

 

Estate Planning

The major downside of 1031 Exchanges is that when the tax deferral ends, the investor will likely owe a significant amount of taxes on the gain. However, careful estate planning can avoid this situation. If the investor continues to hold a property purchased through a 1031 Exchange until they pass away, their heirs will inherit the property not at the cost basis of the original property but at the stepped-up market rate of the new property. The heirs can sell the inherited property without paying taxes on the previously deferred gain.  It is important to note that this estate planning is based on current tax rules governing step-up in cost basis and like all tax laws, could change in the future.

 

Converting Vacation Homes

As we discussed earlier, 1031 Exchanges apply to property used for business, not personal property. However, one possible strategy for using a like-kind exchange to defer gains on a vacation home is to convert the vacation home to a rental property before selling it. To establish the home as a rental property, most resources recommend renting it out for between six months to a year. Furthermore, the property is expected to generate rental income, and the venture should be conducted in a businesslike way. Business practices include maintaining accounting records, advertising the property on common rental platforms, and renting it to unrelated parties.

 

Conclusion

Investment strategies using 1031 Exchanges offer huge potential for savings through tax deferment. To utilize them effectively, investors should hire a third-party broker, meet the requirements for like-kind properties and timeliness, carefully track their tax basis and have a tax professional well versed in 1031 Exchanges.  If a 1031 Exchange is something that you may want to pursue, please contact our office today at 480-392-6801.

Charges Filed in First Insider Trading Case Involving Crypto

In July of 2022, the Department of Justice charged three individuals in the first-ever insider trading case concerning cryptocurrency. This move reflects the US government’s increasingly aggressive commitment to regulating crypto.

What We Know

  • 3 individuals charged with wire fraud conspiracy and wire fraud
  • 1 of the individuals is a former employee at Coinbase
  • Estimated $1.5 million in illegal gains

As a product manager at Coinbase, Ishan Wahi had sensitive knowledge of about the timing and content of upcoming listing announcements on the exchange platform. These announcements usually resulted in a dramatic increase in the value of the asset. Coinbase warned its employees against trading on confidential information or providing it to others. Between June of 2021 and April of 2022, Wahi fed insider information to his brother, Nikhil Wahi, and his friend, Sameer Ramani.

Based on the confidential information, these associates used Ethereum blockchain wallets to purchase at least 25 different crypto assets. After the assets were listed, the group generated gains of an estimated $1.5 million total.

The Role of Online Communities

The group’s illegal activities came to a halt in April of 2022. When a Twitter user active in the crypto online community tweeted about a massive purchase that occurred just prior to an asset listing, Coinbase was quick to reply that an investigation was already underway.

 

 

However, many users online were skeptical of the ability of regulators to keep up with fraud perpetrated in the cryptocurrency space.

This case points to fundamental questions about the cryptocurrency market. What was Coinbase’s responsibility for monitoring its employees’ use of confidential information? Does the Department of Justice have the same responsibility to monitor fraud involving crypto as they do financial securities? Do purchasers of crypto give up their rights to protection by trading in an unregulated asset?

Governments Struggle to Keep Up

The defining feature of cryptocurrencies is that they are not issued by a central authority. Theoretically, that renders them immune from government interference or manipulation. Nonetheless, governments are concerned about the opportunity for crimes like fraud and tax evasion made possible by crypto platforms.

In response, governments across the globe have responded with a patchwork of regulations. For example, the People’s Bank of China (PBOC) bans crypto exchanges from operating in the country. Furthermore, China placed a ban on bitcoin mining in May of 2021.

In the United States, regulators can’t even agree on a definition of the nebulous asset. The Securities and Exchange Commission (SEC) views cryptocurrency as a security, while the Commodity Futures Trading Commission (CFTC) treats it as a commodity, and the Department of Treasury calls it a currency. Crypto exchanges in the United States fall under the regulatory scope of the Bank Secrecy Act (BSA) and must register with the Financial Crimes Enforcement Network (FinCEN).

The charges brought against this insider trading ring demonstrates that governmental regulation is an inevitable part of the present and future of cryptocurrency.

Other Troubling Trends

The insider trading case is not the only recent blow dealt to the crypto market.

This month, a federal jury convicted a man of fraud for marketing and selling fraudulent virtual currency. Between 2014 and 2017, the founder of My Big Coin defrauded investors by making misrepresentations about the assets. Randall Carter of New York claimed that Coins was a cryptocurrency backed by $300 million in gold, oil, and other valuable assets. He also falsely told investors that My Big Coin had a partnership with MasterCard. Carter defrauded investors an estimated $6 million which he spent on collectibles including artwork and jewelry.

In a move surprising to many, Tesla sold 75% of its Bitcoin holdings in July of 2022. The coins were valued at almost a billion dollars. Elon Musk cited concerns about COVID-19 lockdowns in China as the reason that Tesla moved to maximize its cash position. Still, the massive sale added uncertainty to the already volatile crypto market.

Conclusion

Regarding the charges brought against Ramani and the Wahi brothers, U.S. Attorney Damian Williams declared: “Fraud is fraud is fraud, whether it occurs on the blockchain or on Wall Street.”

As an accounting firm, we can’t provide investment advice or protect our clients from predatory investments. We do, however, take seriously our ability to share relevant information. Every year, we see more questions from clients about their obligations to report crypto income and their ability to deduct losses. As governmental agencies in the US and around the world strengthen the regulations around cryptocurrency, change is a certainty.

Additional Resources

DOJ Press Release: https://www.justice.gov/usao-sdny/pr/three-charged-first-ever-cryptocurrency-insider-trading-tipping-scheme

SEC Press Release: https://www.sec.gov/news/press-release/2022-127

IRS Heightens Scrutiny on P2P Payments

Person-to-Person Payments

Zelle… Venmo… Square… PayPal… Cash App…

Options for person-to-person payment services (P2Ps) have exploded over the last decade.

Venmo is known for its social aspect—an estimated 30% of transaction descriptions include emojis. However, don’t be surprised if you hairdresser requests payment through the app. On the other hand, Zelle is popular for being directly integrated with online banking and therefore offering faster processing than its competitors. Big-name banking institutions that partner with the service include giants such as Citigroup, Bank of America Corp, Chase, Morgan Stanley, and Wells Fargo. In 2017, its first year in operation, Zelle processed $75 million in transactions. In 2020, the company processed $307 billion.

As more and more of our economy moves through electronic channels, the IRS is turning its attention to capturing income that might otherwise go unreported. While transfers to repay friends, for example, do not have taxable implications, transfers used to pay for goods or services were always required to be reported as income by the seller. But now the onus for reporting income is shifting from almost entirely on the seller to the platforms that facilitate these transactions.

 

 

New IRS Requirements

Previously, the IRS required P2Ps to report transactions for goods and services sold that met or exceeded $20,000 and at least 200 transactions in a calendar year. Starting in 2022, that threshold is slashed to just $600. Anyone who receives at least $600 in payments for goods and services through a P2P can expect to receive a Form 1099-K by January 31, 2023.

Form 1099-K—given the straightforward name “Payment Card and Third-Party Network Transactions”—is a tax form used to report payments for goods and services transactions. Intermediaries like credit card processors and payment services are required to file them with the IRS and send copies to the payment recipient. In preparation for meeting these filing requirements, P2Ps are pushing their users to provide necessary information, like social security numbers or other tax identification numbers. For example, Venmo has placed a hold on users being able to transfer money out of their account until they provide their tax information. Users have spoken out about the hold, but the platform is less concerned with disgruntled users than the penalties that back up IRS requirements.

Importantly, start-ups that do not reach the $600 threshold to receive a 1099-K may still have income required to be reported. Unofficial statements should be provided on your online account, and they should always be provided to your tax preparer.

Heightened reporting requirements are the new normal for taxpayers and financial services firms alike, especially as our economy shifts away from cash payments. And electronic payments are only growing more complex. For example, Cash App allows users to make payments using Bitcoin which poses the additional complication of cryptocurrency exchange rates when calculating tax implications.

For entrepreneurs who may be receiving 1099-Ks for the first time, proactive tax planning is more essential than ever. The right accounting firm will not only meet the IRS’s compliance standards but also take advantage of credits, deductions, and taxation decisions to ensure the most beneficial outcome for their client.