Student loans account for a substantial portion of this country’s total indebtedness. Outstanding student loan debt is estimated at $1.5 to 1.6 trillion. The U.S. Department of Education (DOE) holds almost all of this debt, giving it substantial power over repayment, forgiveness, and discharge. Normally, discharge of debt is considered a taxable event. The IRS has established revenue procedures creating a “safe harbor” for discharges under certain DOE programs. Our Los Angeles tax advisors observed that it recently issued a new revenue procedure expanding that safe harbor.

Student Loan Discharge Programs

The DOE maintains several programs that allow partial or total discharge of student loan debt in specific situations. These programs only apply to student loans made or guaranteed by the DOE.

Closed School Discharge

The Higher Education Act (HEA) of 1965, as amended in 1986, directs the DOE to discharge the student loan debt of a borrower who is unable to complete their studies because their school closes, or because of certain fraudulent actions on the part of the school. Borrowers must apply to the DOE to obtain a discharge under this program. They must be able to demonstrate that they were either enrolled in the school or on an “approved leave of absence” at the time of closure, or that they withdrew 120 days or less before the school closed.

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The Social Security program has provided benefits for millions of people in its eighty-five years of existence. Political compromises have kept the program going as the cost of living has increased faster than wages. One of these compromises resulted in the assessment of federal income taxes on some Social Security benefits. This only applies to taxpayers with income above a threshold amount. Even if an individual’s income is above the threshold, only part of their Social Security benefits are taxable. Not all benefits payable by the Social Security Administration (SSA) are subject to federal income tax, and our Los Angeles tax advisors can explain the extent to which tax rules apply.

Types of Social Security Benefits

The SSA is an independent federal agency, meaning that while it is part of the Executive Branch of the federal government, it is not part of a federal executive department. Much of the funding for SSA programs comes from payroll taxes. The agency administers numerous benefit programs, including:
Retirement benefits, which are available to people who have made a minimum number of payments into the program through their payroll taxes, and who have reached the age of sixty-two;
Social Security Disability Insurance (SSDI), which helps eligible individuals who are unable to support themselves because of an injury or medical condition;
Survivors benefits, which provides assistance for family members of SSA beneficiaries; and
Supplemental Security Income (SSI), which pays benefits to elder individuals, blind individuals, and individuals with disabilities.

Most of these benefits are taxable if the individual meets the income threshold. Dependent or survivor benefits received by a child are usually not taxable, unless the child has sufficient income to file their own income tax return. SSI benefits are not subject to federal income tax under any circumstances.

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At the end of the year, some employers reward their employees with year-end bonuses. This can be a nice way to close out the year, but it can also bring questions about taxes. How will the IRS treat your year-end bonus when taxes come due in a few months? If your employer withholds taxes from your paychecks, they have already done most of the work for you. Depending on the size of the bonus, our Los Angeles tax advisors feel that it is often still a good idea to make sure you will not get any surprises in your tax return.

Which Bonuses Are Taxable?

Year-end bonuses can be extremely generous, or they can be a token of an employer’s appreciation (emphasis on “token.”) A bonus could take the form of a fruit basket or other gift item, or it could come in check form.

Small gift items are not necessarily considered “income” for federal tax purposes. You probably do not have to report that fruit basket, for example. Larger gifts, like a car or something similarly pricey, will count as “income.” If your employer hands you a check at the end of the year, that is definitely taxable income.
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Retirement planning is crucial to a person’s financial well-being. Contributing to a retirement account as early and often as possible can offer peace of mind, with the knowledge that many years of hard work will pay off. Certain types of retirement accounts can also offer tax benefits, either now or in the future. Starting in the early 1970s, Congress authorized favorable tax treatment for employee contributions to individual retirement accounts (IRAs). Our Los Angeles tax professionals can advise you on the benefits that each type of IRA may provide.

What Is an IRA?

An IRA is a type of financial account that offer tax advantages as a way to encourage people to save for retirement. Many employers include IRAs as a benefit for their employees. Individuals may also open IRAs on their own. The IRS refers to these accounts as “individual retirement arrangements.”

The two most well-known IRAs are:

Traditional IRA: Congress established the tax benefits of a traditional IRA in the Employee Retirement Income Security Act (ERISA) of 1974.
Roth IRA: The Taxpayer Relief Act of 1997 created this type of account, named for Senator William V. Roth, Jr. (R-DE).

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The purpose of most lawsuits is to make a plaintiff whole after an injury or other loss. Settling a lawsuit might bring the litigation to a close, but the plaintiff must still contend with the IRS. Luckily, taxation of lawsuit settlements is fairly straightforward once one understands a few principles that our Los Angeles tax advisors can explain.

Settling a Lawsuit vs. Winning a Verdict or Judgment

The IRS makes no distinction between a payment received due to a settlement and one that comes after a jury verdict or court order. In either case, a taxpayer receives compensation for one or more legal claims. We will use the term “settlement” for the sake of brevity, but the same principles apply to damage awards.

One advantage of a verdict or court order is that it is more likely to contain a breakdown of damages. Verdicts often specify the amounts awarded for different claims. This can help a plaintiff when they are preparing their taxes. For this reason, it is often advisable to include a written allocation of damages in a settlement agreement.

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One aspect of estate planning involves devising strategies to minimize the amount paid in federal taxes out of one’s estate. At the end of 2017, the total exemption for the federal estate, gift, and generation-skipping transfer (GST) taxes doubled. This increase is currently set to expire after eight years, after which it will revert to pre-2018 levels. This provides taxpayers with a limited window of time to take advantage of the significantly higher exemption amounts. Our Los Angeles tax advisors can help you make use of this opportunity.

What Are the Estate, Gift, and GST Taxes?

The Internal Revenue Code (IRC) defines the estate tax in a rather circular fashion as a tax on “the transfer of the taxable estate of” a decedent. The gift tax is defined in a similar fashion as a tax “on the transfer of property by gift.” A highly-oversimplified definition of GST is a transfer to an individual, known as a “skip person,” who is at least two generations younger than the transferor, such as a grandchild and grandparent. The term “skip person” may also refer to a trust in which all beneficiaries are skip persons.

Tax Exemptions for 2020 and Beyond

The IRC allows for a “unified credit” against the estate tax, which also covers the gift and GST taxes. The tax reform law passed in 2017 amended the IRC to double the unified credit from $5 million to $10 million, with adjustments for inflation. The adjusted unified credit for 2020 is $11,580,000, or $23,160,000 for married couples. Those numbers will likely increase in 2021, and every year after that through 2025. The unified credit amount reverts to $5 million, adjusted for inflation, on January 1, 2026, unless Congress amends the IRC again.

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As of November 2019, Senator Elizabeth Warren of Massachusetts is one of the front runners in the Democratic primary contest to determine the party’s 2020 presidential nominee. She has released detailed proposals for programs she would support as president. One initiative that has caught the attention of our California tax advisors involves proposed changes to the Internal Revenue Code (IRC) that would provide additional revenue to the federal government. Rather than expand the longstanding trend of taxing individual and business income, Senator Warren’s proposals would tax wealth and eliminate a major loophole with regard to the taxable value of inherited property.

What Is a Wealth Tax?

The Sixteenth Amendment to the U.S. Constitution, ratified in 1913, authorized Congress to impose an income tax at the federal level. This has been the primary source of tax revenue for the federal government ever since. The idea, for many, is that people with greater income would pay larger amounts of tax in order to benefit society as a whole. The IRS collects taxes on income, and on capital gains from the sale of assets.

Unlike income tax, which looks at how much a person earns in a particular year, a wealth tax would look at how much wealth a person has accumulated. A high net worth does not necessarily mean that a person has a high income, and vice versa. The New York Times notes that one of the richest people in the United States (and the world) has a net worth of about $84 billion, but an annual salary of only $100,000, plus capital gains on assets he actually sells. Under current tax law, he only pays tax on that income.

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The IRS has many options for collecting unpaid taxes, but a limited budget means that the agency must prioritize its enforcement and collection efforts. For most taxpayers who are in arrears, penalties and interest accrue as the IRS sends notices by mail. Eventually, the IRS might place liens on a taxpayer’s property, and then execute a levy. This can be costly and time-consuming, and the agency would rather obtain unpaid taxes by other means. It recently announced that IRS revenue officers will be conducting in-person visits with delinquent taxpayers in several states. While this will not affect California taxpayers right away, that could change in the future. If you are behind in filing and/or paying taxes, you may want to speak with a California tax advisor about your situation.

IRS Debt Collection

Federal law gives the agency two main options for pursuing tax debt that has remained on the books for some time. These may apply to both individual taxpayers and businesses. The Taxpayer’s Bill of Rights (TBOR) applies in all cases.

Revenue Officers

The IRS describes revenue officers (ROs) as “civil enforcement employees” assigned to cases involving unpaid taxes or missing tax returns. A RO’s involvement in a case typically begins with another written notice sent by mail. The RO’s job, according to the IRS, is to help bring taxpayers into compliance, “not to make threats or demand some unusual form of payment for a nonexistent liability.”

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Virtual currency, which the IRS defines as “a digital representation of value” that does not represent the U.S. dollar or any other national currency, has gained in popularity in recent years. For some, it offers an alternative to “real currencies” like the dollar for financial transactions. For others, virtual currencies offer investment opportunities. The IRS has held since 2014 that virtual currency is “property” for the purposes of federal income tax. A recent ruling, Rev. Rul. 2019-24, offers further guidance for investors and California tax advisors alike. The ruling addresses two specific events, known as “hard forks” and “airdrops.”

What Is Cryptocurrency?

Several key features define cryptocurrency and distinguish it from other virtual currencies:
Cryptography: Encryption protects cryptocurrency from forgery and other forms of manipulation. Many cryptocurrencies use blockchain technology, which creates a new and unique record every time a unit of currency is transferred.
Decentralization: Cryptocurrencies are not issued by any centralized financial authority. Instead, they are created through computing processes known as “mining.” Cryptocurrency transactions are logged on databases known as “distributed ledgers,” which are maintained across multiple computer systems, or “nodes.” This also protects against forgery or falsification of records.

Taxable Gross Income

Section 61 of the Internal Revenue Code (IRC) identifies various forms of “gross income” that is subject to federal income tax. This includes “gains derived from dealings in property.” The IRS ruled in 2014 that cryptocurrency is “property” for the purpose of calculating gross incomes.

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