Tag: IRS strategy

IRS Announces Higher 2020 Retirement Plan Contribution Limits For 401(k)s And More

How much can you save for retirement in 2020? The Treasury Department has announced inflation-adjusted figures for retirement account savings for 2020: 401(k) contribution limits are up; traditional IRA contribution limits stay the same; almost all the other numbers are up.

The amount you can contribute to your 401(k) or similar workplace retirement plan goes up from $19,000 in 2019 to $19,500 in 2020. The 401(k) catch-up contribution limit—if you’re 50 or older in 2020—will be $6,500 for workplace plans, up from $6,000. But the amount you can contribute to an Individual Retirement Account stays the same for 2020: $6,000, with a $1,000 catch-up limit if you’re 50 or older.

So super-savers age 50-plus can sock away $33,000 in these tax-advantaged accounts for 2020. If your employer allows aftertax contributions or you’re self-employed, you can save even more. The overall defined contribution plan limit moves up to $57,000, from $56,000.

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Sounds unreachable? During 2018, 13% of employees with retirement plans at work saved the then maximum of $18,500/$24,500, according to Vanguard’s How America Saves. In plans offering catch-up contributions, 15% of those age 50 or older took advantage of the extra savings opportunity. High earners are really saving: 6 out of 10 folks earning $150,000+ contributed the maximum allowed, including catch-ups.

Want to join in? We outline the numbers below; see IRS Notice 2019-59 for technical guidance. For more on 2020 tax numbers: Forbes contributor Kelly Phillips Erb has all the details on 2020 tax brackets, standard deduction amounts and more. We have all the details on the new higher 2020 retirement account limits too.

401(k)s. The annual contribution limit for employees who participate in 401(k), 403(b), most 457 plans and the federal government’s Thrift Savings Plan is $19,500 for 2020—a $500 boost over 2019. Note, you can make changes to your 401(k) election at any time during the year, not just during open enrollment season when most employers send you a reminder to update your elections for the next plan year.

The 401(k) Catch-Up. The catch-up contribution limit for employees age 50 or older in these plans is $6,500 for 2020. That’s the first increase since 2015 when the limit rose to $6,000. Even if you don’t turn 50 until December 31, 2020, you can make the additional $6,500 catch-up contribution for the year.

SEP IRAs and Solo 401(k)s. For the self-employed and small business owners, the amount they can save in a SEP IRA or a solo 401(k) goes up from $56,000 in 2019 to $57,000 in 2020. That’s based on the amount they can contribute as an employer, as a percentage of their salary; the compensation limit used in the savings calculation also goes up from $280,000 in 2019 to $285,000 in 2020.

Aftertax 401(k) contributions. If your employer allows aftertax contributions to your 401(k), you also get the advantage of the $57,000 limit for 2020. It’s an overall cap, including your $19,500 (pretax or Roth in any combination) salary deferrals plus any employer contributions (but not catch-up contributions).

The SIMPLE. The limit on SIMPLE retirement accounts goes up from $13,000 in 2019 to $13,500 in 2020. The SIMPLE catch-up limit is still $3,000.

Defined Benefit Plans. The limitation on the annual benefit of a defined benefit plan goes up from $225,000 in 2019 to $230,000 in 2020. These are powerful pension plans (an individual version of the kind that used to be more common in the corporate world before 401(k)s took over) for high-earning self-employed folks.

Individual Retirement Accounts. The limit on annual contributions to an Individual Retirement Account (pretax or Roth or a combination) remains at $6,000 for 2020, the same as in 2019. The catch-up contribution limit, which is not subject to inflation adjustments, remains at $1,000. (Remember that 2020 IRA contributions can be made until April 15, 2021.)

Deductible IRA Phase-Outs. You can earn a little more in 2020 and get to deduct your contributions to a traditional pretax IRA. Note: Even if you earn too much to get a deduction for contributing to an IRA, you can still contribute—it’s just nondeductible.

In 2020, the deduction for taxpayers making contributions to a traditional IRA is phased out for singles and heads of household who are covered by a workplace retirement plan and have modified adjusted gross incomes (AGI) between $65,000 and $75,000, up from $64,000 and $74,000 in 2019. For married couples filing jointly, in which the spouse who makes the IRA contribution is covered by a workplace retirement plan, the income phase-out range is $104,000 to $124,000 for 2020, up from $103,000 to $123,000.

For an IRA contributor who is not covered by a workplace retirement plan and is married to someone who is covered, the deduction is phased out if the couple’s income is between $196,000 and $206,000 in 2020, up from $193,000 and $203,000 in 2019.

Roth IRA Phase-Outs. The inflation adjustment helps Roth IRA savers too. In 2020, the AGI phase-out range for taxpayers making contributions to a Roth IRA is $196,000 to $206,000 for married couples filing jointly, up from $193,000 to $203,000 in 2019. For singles and heads of household, the income phase-out range is $124,000 to $139,000, up from $122,000 to $137,000 in 2019.

If you earn too much to open a Roth IRA, you can open a nondeductible IRA and convert it to a Roth IRA as Congress lifted any income restrictions for Roth IRA conversions. To learn more about the backdoor Roth, see Congress Blesses Roth IRAs For Everyone, Even The Well-Paid.

Saver’s Credit. The income limit for the saver’s credit for low- and moderate-income workers is $65,000 for married couples filing jointly for 2020, up from $64,000; $48,750 for heads of household, up from $48,000; and $32,500 for singles and married filing separately, up from $32,000. See Grab The Saver’s Credit for details on how it can pay off.

QLACs. The dollar limit on the amount of your IRA or 401(k) you can invest in a qualified longevity annuity contract is increased to $135,000 from $130,000. See Make Your Retirement Money Last For Life for how QLACs work.

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Ashlea Ebeling

I’m an associate editor on the Money team at Forbes based in Fairfield County, Connecticut, leading Forbes’ retirement coverage. I manage contributors who cover retirement and wealth management. Since I joined Forbes in 1997, my favorite stories have been on how people fuel their passions (historic preservation, open space, art, for example) by exploiting the tax code. I also get into the nitty-gritty of retirement account rules, estate planning and strategic charitable giving. My favorite Forbes business trip: to Plano, Ill. to report on the restoration of Ludwig Mies van der Rohe’s Farnsworth House, then owned by a British baron. Live well. Follow me on Twitter: http://www.twitter.com/ashleaebeling Send me an email: aebeling@forbes.com

Source: IRS Announces Higher 2020 Retirement Plan Contribution Limits For 401(k)s And More

The IRS announced changes to contribution and benefit limits for 2019. CSIG’s Alison Bettonville, CFA highlights the limit changes that affect various qualified retirement plans. Highlights include: -402(g) limit increased to $19,000 -415 or the Total Annual Additions limit increased to $56,000 -Catch up contributions limit remained at $6,000 -Compensation limit increased $280,000 -Highly Compensated Employee definition increased to $125,000 To the extent that any portion of the information submitted by CSIG contains material that is copyrighted, the recipient shall observe the protection of such material as provided under applicable copyright laws. Past performance does not guarantee future results. Diversification does not guarantee investment returns and does not eliminate risk of loss. We believe the information provided here is reliable, but do not warrant its accuracy or completeness. Opinions and estimates offered constitute our judgment and are subject to change without notice, as are statements of financial market trends, which are based on current market conditions. This material is not intended as an offer or solicitation for the purchase or sale of any financial instrument. The views and strategies described may not be suitable for all investors. This material has been prepared for informational purposes only, and is not intended to provide, and should not be relied on for, accounting, legal, or tax advice. References to future returns are not promises or even estimates of actual returns a client portfolio may achieve. Any forecasts contained herein are for illustrative purposes only and are not to be relied upon as advice or interpreted as a recommendation. The price of equity securities may rise or fall because of changes in the broad market or changes in a company’s financial condition, sometimes rapidly or unpredictably. International investing involves a greater degree of risk and increased volatility. There is no guarantee that companies that can issue dividends will declare, continue to pay, or increase dividends.

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Education

IRS Announces New Per Diem Rates For Taxpayers Who Travel For Business

Are you wondering about those updated per diem rates? The new per-diem numbers are now out, effective October 1, 2019. These numbers are to be used for per-diem allowances paid to any employee on or after October 1, 2019, for travel away from home. The new rates include those for the transportation industry; the rate for the incidental expenses; and the rates and list of high-cost localities for purposes of the high-low substantiation method.

I know, that sounds complicated. But it’s intended to keep things simple. The Internal Revenue Service (IRS) allows the use of per diem (that’s Latin meaning “for each day” – remember, lawyers love Latin) rates to make reimbursements easier for employers and employees. Per diem rates are a fixed amount paid to employees to compensate for lodging, meals, and incidental expenses incurred when traveling on business rather than using actual expenses.

Here’s how it typically works: A per diem rate can be used by an employer to reimburse employees for combined lodging and meal costs, or meal costs alone. Per diem payments are not considered part of the employee’s wages for tax purposes so long as the payments are equal to, or less than the federal per diem rate, and the employee provides an expense report. If the employee doesn’t provide a complete expense report, the payments will be taxable to the employee. Similarly, any payments which are more than the per diem rate will also be taxable.

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The reimbursement piece is essential. Remember that for the 2019 tax year, unreimbursed job expenses are not deductible. The Tax Cuts and Jobs Act (TCJA) eliminated unreimbursed job expenses and miscellaneous itemized deductions subject to the 2% floor for the tax years 2018 through 2025. Those expenses include unreimbursed travel and mileage.

That also means that the business standard mileage rate (you’ll find the 2019 rate here) cannot be used to deduct unreimbursed employee travel expenses for the 2018 through 2025 tax years. The IRS has clarified, however, that members of a reserve component of the Armed Forces of the United States, state or local government officials paid on a fee basis, and certain performing artists may still deduct unreimbursed employee travel expenses as an adjustment to income on the front page of the 1040; in other words, those folks can continue to use the business standard mileage rate. For details, you can check out Notice 2018-42 (downloads as a PDF).

What about self-employed taxpayers? The good news is that they can still deduct business-related expenses. However, the per diem rates aren’t as useful for self-employed taxpayers because they can only use the per diem rates for meal costs. Realistically, that means that self-employed taxpayers must continue to keep excellent records and use exact numbers.

As of October 1, 2019, the special meals and incidental expenses (M&IE) per diem rates for taxpayers in the transportation industry are $66 for any locality of travel in the continental United States and $71 for any locality of travel outside the continental United States; those rates are slightly more than they were last year. The per diem rate for meals & incidental expenses (M&IE) includes all meals, room service, laundry, dry cleaning, and pressing of clothing, and fees and tips for persons who provide services, such as food servers and luggage handlers.

The rate for incidental expenses only is $5 per day, no matter the location. Incidental expenses include fees and tips paid at lodging, including porters and hotel staff. It’s worth noting that transportation between where you sleep or work and where you eat, as well as the mailing cost of filing travel vouchers and paying employer-sponsored charge card billings, are no longer included in incidental expenses. If you want to snag a break for those, and you use the per diem rates, you may request that your employer reimburse you.

That’s good advice across the board: If you previously deducted those unreimbursed job expenses and can no longer do so under the TCJA, ask your employer about potential reimbursements. Companies might not have considered the need for specific reimbursement policies before the new tax law, but would likely not want to lose a good employee over a few dollars – especially when those dollars are important to the employee.

Of course, since the cost of travel can vary depending on where – and when – you’re going, there are special rates for certain destinations. For purposes of the high-low substantiation method, the per diem rates are $297 for travel to any high-cost locality and $200 for travel to any other locality within the continental United States. The meals & incidental expenses only per diem for travel to those destinations is $71 for travel to a high-cost locality and $60 for travel to any other locality within the continental United States.

You can find the list of high-cost localities for all or part of the calendar year – including the applicable rates – in the most recent IRS notice. As you can imagine, high cost of living areas like San Francisco, Boston, New York City, and the District of Columbia continue to make the list. There are, however, a few noteworthy changes, including:

  • The following localities have been added to the list of high-cost localities: Mill Valley/San Rafael/Novato, California; Crested Butte/Gunnison, Colorado; Petoskey, Michigan; Big Sky/West Yellowstone/Gardiner, Montana; Carlsbad, New Mexico; Nashville, Tennessee; and Midland/Odessa, Texas.
  • The following localities have been removed from the list of high-cost localities: Los Angeles, California; San Diego, California; Duluth, Minnesota; Moab, Utah; and Virginia Beach, Virginia.
  • The following localities have changed the portion of the year in which they are high-cost localities (meaning that seasonal rates apply): Napa, California; Santa Barbara, California; Denver, Colorado; Vail, Colorado; Washington D.C., District of Columbia; Key West, Florida; Jekyll Island/Brunswick, Georgia; New York City, New York; Portland, Oregon; Philadelphia, Pennsylvania; Pecos, Texas; Vancouver, Washington; and Jackson/Pinedale, Wyoming.

You can find the entire high-cost localities list, together with other per diem information, in Notice 2019-55 (downloads as a PDF). To find the federal government per diem rates by locality name or zip code, head over to the General Services Administration (GSA) website.

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Kelly Phillips Erb

Years ago, I found myself sitting in law school in Moot Court wearing an oversized itchy blue suit. It was a horrible experience. In a desperate attempt to avoid anything like that in the future, I enrolled in a tax course. I loved it. I signed up for another. Before I knew it, in addition to my JD, I earned an LL.M Taxation. While at law school, I interned at the estates attorney division of the IRS. At IRS, I participated in the review and audit of federal estate tax returns. At one such audit, opposing counsel read my report, looked at his file and said, “Gentlemen, she’s exactly right.” I nearly fainted. It was a short jump from there to practicing, teaching, writing and breathing tax. Just like that, Taxgirl® was born.

Source: IRS Announces New Per Diem Rates For Taxpayers Who Travel For Business

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Per Diem is one of the largest tax deductions available to owner-operator truck drivers. Effective October 1, 2018, the daily rate was increased. In this video, we discuss Per Diem and how it will affect owner-operators.

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Autos & Vehicles

IRS Introduces New Tax Withholding Estimator To Help Taxpayers Avoid Surprises In 2020

Remember all of the times that the Internal Revenue Service (IRS) reminded you to do a payroll checkup (like this one)? And remember that you didn’t? The IRS is hoping you’ll reconsider this year. The agency has launched a new Tax Withholding Estimator that they hope will make it easier for everyone to figure the right amount of tax withheld during the year.

Why the need for a checkup? Under the Tax Cuts and Jobs Act (TCJA), many individual taxpayers experienced significant changes. Those changes included new tax rates, limits on the deductions for state and local taxes (SALT taxes), a cap on the amount that you can borrow for purposes of the home mortgage interest (you can find additional information about re-fis here), and exclusions for certain kinds of job-related expenses (like the home office deduction – more here).

With the first official tax season following the TCJA now in the books, the IRS has been exploring ways to help taxpayers have a better tax year in 2020. That includes replacing the old Withholding Calculator with the new Tax Withholding Estimator.

“The new estimator takes a new approach and makes it easier for taxpayers to review their withholding,” said IRS Commissioner Chuck Rettig. “This is part of an ongoing effort by the IRS to improve quality services as we continue to pursue modernization and enhancements of our taxpayer relationships.”

One of the criticisms of the old Withholding Calculator was that it didn’t work well for all taxpayers; it tended to benefit single-wage earners who were also W-2 employees. Now, the IRS says that the new Tax Withholding Estimator offers workers, as well as retirees and self-employed individuals, a more user-friendly tool to figure the amount of income tax they must have withheld from wages and pension payments.

You can find the Tax Withholding Estimator on the IRS website here. To get started, you’ll need to be able to estimate your 2019 income, the number of children you will claim for the Child Tax Credit (CTC) and Earned Income Tax Credit (EITC), and other items that will affect your 2019 taxes like itemized deduction amounts. You’ll also want to have your most recent pay stubs and a copy of your last year’s form 1040 handy.

The Tax Withholding Estimator is more user-friendly than its predecessor. Here’s what the opening screen looks like:

You’ll begin by entering information about you, including your dependents:

You’ll next input information about your income. Unlike the last calculator, the new Tax Withholding Estimator gives you more options related to the kinds of income you might receive, like these:

Along the way, the tool uses plain language, asking taxpayers questions like:

Deductions reduce the amount of your income subject to income tax. Most taxpayers take the standard deduction. Would you like to take the standard deduction or itemize your deductions?

If you itemize, you can estimate the value of those deductions:

The Tax Withholding Estimator also allows you to go back and fix your errors without starting over – and skip questions that don’t apply (that’s a big change from before).

Remember that the results are only as good as the information you provide. And if your circumstances change during the year (say, for example, that you get a new job, buy a new house or have a baby), you’ll want to revisit the Tax Withholding Estimator to make sure that your withholding is still correct.

If you are an employee, the Tax Withholding Estimator can help you determine whether you need to give your employer a new form W-4, Employee’s Withholding Allowance Certificate (downloads as a PDF). You can use your results to help fill out the form and adjust your income tax withholding. For more information about form W-4, click here. If you receive pension income, you can use the results to complete a form W-4P (downloads as a PDF).

One more thing: if you’re worried about privacy, the Tax Withholding Estimator will not ask you to provide sensitive personally-identifiable information like your name, Social Security number, address or bank account numbers. Additionally, the IRS says that it does not save or record the information you enter on the Tax Withholding Estimator.

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Kelly Phillips Erb

Years ago, I found myself sitting in law school in Moot Court wearing an oversized itchy blue suit. It was a horrible experience. In a desperate attempt to avoid anything like that in the future, I enrolled in a tax course. I loved it. I signed up for another. Before I knew it, in addition to my JD, I earned an LL.M Taxation. While at law school, I interned at the estates attorney division of the IRS. At IRS, I participated in the review and audit of federal estate tax returns. At one such audit, opposing counsel read my report, looked at his file and said, “Gentlemen, she’s exactly right.” I nearly fainted. It was a short jump from there to practicing, teaching, writing and breathing tax. Just like that, Taxgirl® was born.

Source: IRS Introduces New Tax Withholding Estimator To Help Taxpayers Avoid Surprises In 2020

 

Bitcoin: IRS Takes On The Crooks—And The Good Guys

Image result for bitcoin and IRS

Are cryptocurrencies reportable for FBAR? For Fatca? No and maybe.

Turns out there’s no FBAR mandate on your offshore bitcoin account. Is the government making a tactical retreat in its war on money launderers and tax cheats?

In response to a request for guidance from an accountants’ group, the Treasury Financial Crimes Enforcement Network has recently decreed that cryptocurrency accounts held by exchanges located outside the country don’t have to be disclosed.

That means you don’t have to confess your Binance assets on the Foreign Bank and Financial Accounts Report, alias FBAR. The report, which is filed on a form called Fincen 114, is required when a taxpayer’s financial assets (cash and securities) held in foreign institutions top $10,000.

Why the leniency? Mostly because the antiquated laws aimed at financial mischief simply can’t cope with crypto.

A rational observer would say that bitcoin, which is both a store of value and a medium of exchange, is money. But the IRS, enforcing legislation written in a pre-internet age, has concluded that cryptocurrencies are “property”—more like Picassos than pesos.

At some point the tax police will get up to speed. They’ll rewrite rules or get legislation including digital assets in the offshore reporting scheme. But they’ll still have a hard time ferreting out hidden wealth. Cryptocurrencies, already somewhat anonymous, are getting more so. There are tumblers that erase bitcoin trails and there are newer currencies designed to offer enhanced privacy.

To investors, crypto is an asset class that might warrant an allocation in a portfolio. Although cryptocurrencies are volatile, they have the virtue of being not very correlated to stocks and bonds that fall, directly or indirectly, under the spell of central banks.

To enforcers, crypto is nothing but trouble. Bitcoin was the common currency of Silk Road, that bazaar of contraband whose manager got a life sentence. Russian hackers used bitcoin in their election meddling. A press release in May from Immigration & Customs Enforcement, crowing about the indictment of an alleged fentanyl vendor, gives bitcoin a prominent mention.

Donald Trump doesn’t like crypto. His Treasury secretary, Steven Mnuchin, complained recently that cryptocurrencies are being used illicitly. He vowed to produce regulations to keep them from turning into a new form of numbered Swiss bank account.

But aren’t bitcoins by their nature numbered accounts? The blockchain—a record of all transactions to date—is a string of integers, with no holders’ names attached. Still, holders can get nailed for doing something wrong.

Chain analysis software traces the history of a bitcoin as it moves from account to account. If at any point that coin passed through an exchange subject to U.S. know-your-customer rules (like Coinbase), the cops can get the name and taxpayer ID of someone who used the coin. That may give them a wedge, via subpoena or a threat of prosecution, to identify other participants in the chain of ownership.

And then there are users who make mistakes. Evidently the fellow accused of selling fentanyl wanted to convert bitcoins to dollars, and in the process of doing that transferred the coins to addresses that were controlled by federal agents. This is reminiscent of the bank robber who hops into what he thinks is a getaway car but turns out to be a police vehicle.

Cryptocurrency users who want their activities to be more cryptic have options. They can use one of the tumbler services that take in possibly dirty coins and replace them with randomly selected coins. They can use Monero or Zcash, currencies explicitly designed to be more private than bitcoin. And how is Secretary Mnuchin going to police Binance, the fast-growing coin repository that hops from jurisdiction to jurisdiction? It is now in Malta, where regulators are proud of their light touch.

Yet another way to keep coins hidden is to keep them in your own wallet instead of in the custody of an exchange. Just don’t lose the key.

Sean Golding, an Irvine, California attorney whose clientele includes global investors, says that you are under no obligation to report coins held in a wallet on your desktop, any more than you are obliged to report gold stored under your bed. You must, though, report and pay tax on profitable sales of either.

What about your account at an offshore exchange? Even with the recent dispensation from the IRS, Golding says, it might be a good idea to file the FBAR anyway. You might, after all, do some trading that temporarily turns bitcoins into dollars or euros. If your total of cash and securities held offshore exceeds $10,000, even for a day, the FBAR is mandatory.

The government takes the Fincen 114 form seriously. It’s trying to collect a $4.7 million fine from someone who forgot to fill it out.

Your account at a U.S. exchange needs no FBAR. The IRS can already see the account. Thus, Coinbase customers who neglect to declare gains from crypto sales can expect to hear from the feds.

What about Fatca? The Foreign Account Tax Compliance Act is another disclosure regime, overlapping Fincen but with its own set of rules and different thresholds ($50,000 for a single taxpayer, $100,000 for a joint return filer). Play it safe, advises Golding. The recent guidance on FBAR doesn’t apply here. If you’re at or above the cutoff, file the Fatca report.

The FBAR must be filed electronically with Fincen, a Treasury unit separate from the IRS. Start here.

For Fatca, file Form 8938 with the 1040 you send to the IRS. It can be on paper. The form is here and the instructions are here.

A useful comparison between the FBAR and Fatca requirements is here.

This Journal of Accountancy report describes the recent guidance from Fincen.

The FBAR regs are here.

William Baldwin

I aim to help you save on taxes and money management costs. I graduated from Harvard in 1973, have been a journalist for 44 years, and was editor of Forbes magazine from 1999 to 2010. Tax law is a frequent subject in my articles. I have been an Enrolled Agent since 1979. Email me at williambaldwinfinance — at — gmail — dot — com.

 

 

Source: Bitcoin: IRS Takes On The Crooks—And The Good Guys

How IRS Taxes Fire Victims

Image result for IRS Taxes

Do wildfire victims worry about their taxes? You bet. How fire victims are taxed depends on what they collect, what they claim on their taxes, if they are rebuilding their property, their insurance and more. Another big variable is whether they sue PG&E. It can build out a complex tax picture, especially now that there is a new tax on litigation settlements, as many legal fees can no longer be deducted.

The IRS (and California’s notoriously tough Franchise Tax Board) require annual tax filings, so several years may be peppered with fire items. Say you lose a $1M home, but collect $1M from your insurance company or PG&E. There’s no tax, right? Not so fast. You need to know about the tax basis of the property, usually purchase price, plus improvements. Your property might be worth $1M when it was destroyed, but if the original purchase price plus improvements was only $100K, there is a $900K gain.

Does that mean a fire victim must pay tax on $900K? Not necessarily. If you qualify and replace your home, you can apply your old $100K tax basis to a replacement. That means you should not need to pay tax on that $900K gain until you eventually sell the replacement home. The replacement must generally be purchased within two years after the close of the first year in which any part of the casualty gain is realized. For Federal Declared Disasters, you get four years. However, if your insurance company has paid you enough to create even $1 of gain on your destroyed property, the clock for acquiring replacement property may already have started.

Another big issue is claiming a casualty loss. Up until 2018, many taxpayers could claim casualty losses on their tax returns. For 2018 through 2025, casualty losses are allowed only if your loss was the result of a Federal Declared Disaster. Most major California wildfires are a Federal Declared Disaster, but determining whether claiming a loss is a good move can be complex.

How to handle expenses for temporary housing and similar expenses can also be tricky. If your primary residence is damaged or destroyed, insurance proceeds intended to compensate you for living expenses like housing and food may be partially tax-free. However, if the insurance proceeds pay you for living expenses you would have normally incurred if your home had not been damaged, say your mortgage payment or your typical food expenses, that portion may be taxable income to you. If the insurance proceeds exceed the actual amount you spend on temporary housing, food, and other living expenses, that surplus can be taxable.

For victims who eventually get a legal settlement, how will it be taxed? Health problems from smoke inhalation or from the exacerbation of pre-existing medical problems can be enough for tax-free damages. Section 104 of the tax code excludes damages for personal physical injuries or physical sickness. But the damages must be physical, not merely emotional, and that can be a chicken or egg issue.

Most money in fire cases is fully taxable, and if you do not reinvest in time, you may have a big capital gain. However, up to $500K from a primary residence may be tax free for a married couple filing jointly. It isn’t only the IRS that collects tax. States do too, notably California, where all income is taxed at up to 13.3%, even capital gain.

Many fire victim plaintiffs use contingent fee lawyers. Up until 2018, it was clear that legal fees were virtually always tax deductible. Now, however, many legal fees are no longer deductible. Thus, some plaintiffs may have to pay taxes on their gross recoveries, even though 40% or more is paid to their lawyer, who also must pay tax on the same fees. The tax treatment of the legal fees has become a major tax problem associated with many types of litigation. Fortunately, if the money can be treated as capital gain, the legal fees can often be treated as additional basis or as a selling expense. In effect, it can mean paying tax only on the net recovery.

Understandably, most fire victims hope not to face any tax hit at all. That is possible in some cases, but it can involve scrupulous attention to timing and details. When it comes to taxes or fire, be careful out there.

This is not legal advice. For tax alerts or tax advice, email me at Wood@WoodLLP.com.

Check out my website.

Robert W. Wood

I handle tax matters across the U.S. and abroad (www.WoodLLP.com), addressing tax problems, tax disputes, writing tax opinions, tax advice on legal settlements

 

Source: How IRS Taxes Fire Victims

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