Articles Posted in Tax Laws

If you are employed, your boss probably pays many of your taxes for you. Your pay stubs will show withholding for federal income tax, Medicare, and FICA. At the end of the year, you will receive a W-2 showing your total earnings from your job and the total amount of taxes withheld. Self-employed people must also pay these taxes, and they have to handle all of the details themselves. To understand whether you have to pay the self-employment tax, you need to determine whether you are “self-employed” for federal tax purposes, and whether you make enough from self-employment to need to pay the tax. Our Los Angeles tax advisors can help you assess these factors.

What Is the Self-Employment Tax?

It might be easiest to define the self-employment tax by comparing it to the taxes paid by employed persons. A typical employee has two types of tax withheld from their paychecks. The first is their individual federal income tax withholding. The amount that their employer withholds from each paycheck is based on the information they provided on Form W-4.

The other type of tax, commonly known as “payroll tax,” goes towards Social Security and Medicare. The Social Security portion is often known as the FICA tax, after the Federal Insurance Contributions Act. The employer withholds the following percentages of the employee’s gross wages:
– 6.2% for Social Security; and
– 1.45% for Medicare
The employer must match these amounts. While the employee pays 7.65 percent of their paycheck, the total amount received by the government equals 15.3 percent.

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The world has had to learn a new vocabulary in recent weeks. In an effort to slow the spread of the coronavirus and the disease it causes, COVID-19, public health officials across the globe have urged people to practice “social distancing.” Non-essential businesses are closed, and thousands if not millions of people have quickly learned how to work remotely. In the midst of all of this, the federal government has offered some relief by delaying Tax Day for three months. Instead of income tax returns and payments being due on April 15, they will now be due on July 15.

Why April 15?

April 15 has been the due date for federal income taxes for a little less than seventy years. Income taxes themselves have only been an inevitable part of life nationwide for a bit more than a century.

The Sixteenth Amendment to the U.S. Constitution first authorized the federal government to levy an income tax in 1913. Eight years earlier, the Supreme Court had ruled that an income tax contained in a tariff bill was unconstitutional. Amending the Constitution overruled the court.
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Our tax advocates know that investing in an individual retirement account (IRA) can be an excellent way to set money aside for retirement and save on federal income taxes. An important caveat for traditional IRAs is the required minimum distribution (RMD). As the name implies, you must withdraw a minimum amount by a certain date, based on your age. A bill signed into law last year, the Setting Every Community Up for Retirement Enhancement (SECURE) Act, raises the age for the RMD, and removes an obligation for banks to notify their IRA customers of an upcoming RMD date.. The new law took effect almost immediately, which might catch some banks by surprise. The IRS has therefore issued a notice giving latitude to banks that issue incorrect notices in 2020, provided they also issue a correction to those customers.

What Is a Required Minimum Distribution?

With a “traditional” IRA, you can contribute money before taxes up to a certain amount each year, but you must withdraw a minimum amount by a specified date. Prior to the SECURE Act, the Internal Revenue Code (IRC) required an RMD by April 1 of the calendar year following whichever occurs later:  the account owner reaches the age of 70½; or the account owner retires. This can be confusing for many people:

– If a person turned 70 years old on February 1, 2017, they would turn 70½ on August 1, 2017, and their RMD date would be April 1, 2018.
– If, however, they turned 70 on August 1, 2017, then they would turn 70½ on February 1, 2018, and their RMD date would be April 1, 2019.

This might be why the law required banks to notify customers with traditional IRAs of an upcoming RMD. Banks use IRS Form 5498 to show IRA contributions during the year. Box 11 shows whether an IRA owner must make an RMD. Boxes 12a and 12b show the RMD date and amount, respectively. Banks must send these forms out by January 31 of each year.

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In December 2019, Congress passed the Setting Every Community Up for Retirement Enhancement (SECURE) Act, with the intention of facilitating the creation and use of retirement accounts, including individual retirement accounts (IRAs) and 401(k) plans. Whether intentional or not, the bill has eliminated a popular tool used in estate planning known as the “stretch IRA,” which allowed people to convey an IRA to their heirs while minimizing tax liability. Some options may still be available, though, and our Los Angeles tax advisors can explain them.

What Was a Stretch IRA?

A stretch IRA was a way of passing both the value of a retirement account and its tax deferrals from generation to generation. The term does not describe a type of account, but rather a strategy used to maximize the returns on a retirement account passed down through a will with a minimal tax bill. It was most commonly used with traditional IRAs, which defer income taxes on contributions until the money is distributed to the owner or other beneficiary.

Under new rules found in the SECURE Act, owners of traditional IRAs must begin taking required minimum distributions (RMDs) by a certain date. The amount of the RMD is based on the account owner’s life expectancy, using IRS tables. The remaining balance of the account is divided by the number of years left in the owner’s life expectancy.

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Paying taxes involves disclosing a vast amount of personal information about oneself, one’s family, and one’s business to the IRS. If you seek the assistance of an accountant or other tax preparer, your personal information makes an additional stopover on its way to the government. Unfortunately, the wealth of information included in tax returns is incalculably valuable to identity thieves and other scammers. As a result, federal law closely protects the privacy of taxpayer information. This protection relies on extensive security measures by both the government and the businesses that handle taxpayers’ returns. Our Los Angeles tax advisors want to take this opportunity to explain the scope of your protections.

Privacy of Taxpayer Information

Section 6103 of the Internal Revenue Code (IRC) establishes that the information in taxpayers’ returns is confidential. The IRS may not disclose taxpayer information to anyone without the taxpayer’s written consent, unless disclosure to other tax officials or law enforcement is specifically required by law.

Federal law holds the IRS to a high standard of accountability in this matter. An IRS employee or other person who accesses confidential taxpayer information in violation of § 6103 commits a criminal offense punishable by up to one year in prison and a fine of up to $1,000. The taxpayer whose information is accessed without authorization may bring a civil suit against the U.S. government for the greater of either $1,000 per violation, or the actual damages they suffered plus, in the event of a willful or grossly negligent violation, punitive damages.

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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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