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I find it extremely timely to discuss Earned Income Tax Credit (EITC) as the Christmas season approaches and another year on the way, which means income tax season is just around the corner.

EITC is a great gift from the government! It is one of the greatest credits within the current tax law, especially  those with minor children as you can see in the chart below. It provides subsidy to around 6 million lower to moderate income individuals by simply filing their tax return. It comes in the form of a tax refund and taxpayers have up to 3 years to file and claim the credit.

For 2018, the maximum Earned Income Tax Credit per taxpayer is:

$529 with no Qualifying Children

$3,526 with one Qualifying Child

$5,828 with two Qualifying Children

$6,557 with three or more Qualifying Children

The EITC phases out entirely (totally gone) for taxpayers with an adjusted gross income of:

$15,570 with no Qualifying Children ($21,370 if married filing jointly)

$41,094 with one Qualifying Child ($46,884 if married filing jointly)

$46,703 with two Qualifying Children ($52,493 if married filing jointly)

$50,162 with three or more Qualifying Children ($55,952 if married filing jointly)

TAXPAYERS who have filed income tax returns using Schedule C, Profit or Loss from Business, usually get surprised when they receive a notice from the Los Angeles City requiring them to apply for Business Tax Registration Certificate (BTRC).

It is a common perception that only businesses should get a tax registration. So why would then a caregiver, any domestic helper, or any independent contractor receiving 1099-MISC or cash income would be required to have a BTRC?

Any of these incomes is considered “business” or “self-employment” income and is subject to additional taxes from the city of Los Angeles, as administered by the City’s Office of Finance (OEF).

Per the LA Municipal Code (LAMC): “The City of Los Angeles, Office of Finance requires all firms that engage in any business activity within the City of Los Angeles to pay City business taxes. Each firm or individual (other than a municipal employee) is required to obtain the necessary Business Tax Registration Certification (BTRC) and pay business tax. (Los Angeles Municipal code Section 21.09 et seq.)”

Recently, the OEF has been sending demand notices to California taxpayers who have a “Los Angeles” address and have been aggressively pursuing those who received demand notices but have not registered for the BTRC.

While not to be taken for granted, these notices should not bring panic to numerous “business owners”, the self-employed, and the independent contractors in our community.

However, regardless of the nature of your self-employment, you must register and get your BTRC and advice the OEF what is the nature of your income and how much you made from it. Although OEF received your Schedule C information from the California Franchise Tax Board, the amount of your income and the nature of your business were withheld because the information on your tax return is a privileged data and OEF doesn’t have the legal and valid reason to know.

There are numerous exemptions from paying business taxes, the most common of which is LAMC Section 21.29(a)- business with less than $100,000 in gross revenue (annually). It is critical to register and apply for annual renewal prior to February 28th for the exemption to apply. Otherwise, you might become subject to penalties.

The home health professional. The gig workers of Uber,  Grubhub, Instacart, or Amazon delivery services.  These are some individuals who receive 1099-MISC in exchange of work performed. They are not employees of a business, they are their own employers.

If you are an independent contractor or a self-employed person, the company or the employer whom you provided your services will issue you Form 1099-Misc, which will show the total payment made to you in the year. Sometimes, even when you are a regular employee, for some extra payments to you (like bonus, car mileage expenses or per Diem expenses), your employer may issue you Form 1099-Misc. Normally on the 1099-Misc payments, the employer/company will not withhold any taxes from your payments. This 1099-Misc income is treated as self-employed income (even if you are a regular employee). A self employed person must file the tax return if the self employed income is $600 or more.

Nice thing about these tax forms: you get to deduct all expenses associated with your business as an independent contractor. You will be taxed only on the net profits (income minus expenses). Your net income will then determine your self-employment income. Regular deductions, such as the standard deduction or itemized deductions won’t reduce your self-employment tax. This income-expense calculation is reported under a Schedule C, Profit or Loss from Business.

Reporting on Schedule C also applies for those who are in business for themselves, or carry on a trade or business as a sole proprietor. Self-employment can include work in addition to your regular full-time business activities, such as part-time work you do at home or in addition to your regular job.

If you are self-employed, you generally have to make estimated tax payments. This applies even if you also have a full-time or part-time job and your employer withholds taxes from your wages. Estimated tax is the method used to pay tax on income that is not subject to withholding. If you don’t make quarterly payments, you may be penalized for underpayment at the end of the tax year.

You can also deduct the costs of running your business. These costs are known as business expenses. These are costs you do not have to capitalize or include in the cost of goods sold but can deduct in the current year.

But as in any other income reported in Schedule C, the taxpayer needs to get a Business Tax Registration from the designated city of residence.

As of  March 2019, the IRS issued a statement saying there are $1.4 billion unclaimed refunds for 1.2 million individuals who have not filed their 2015 income tax returns. The IRS said  half of those refunds are more than $879, half are less.

Where do these unclaimed refunds come from?

It comes from low to moderate income earners who may be qualified for the Earned Income Tax Credit (EITC). These taxpayers also stand to miss out on getting back any withheld amount from their paychecks. 

For example, the standard deduction for Head of Household (HOH) in 2019 is $18,000 and $24,000 for a couple Married Filing Jointly (MFJ). Meaning the standard deduction amount would be exempt from taxes.  An HOH taxpayer who made just $18,000 or an MFJ who earned $24,000, are both entitled to receive all their payroll  withholding plus the EITC in tax refunds.  Even if they earned slightly or considerably more than the standard dedution, they could still possibly get a refund.

The EITC is a type of government subsidy for lower income earners. I have previously discussed the maximum EITC credits and income treshhold in my December 12, 2018 blog. 

Even if you think you don't need to file a tax return, you should to see if you can get a refund. If unsure, talk with a tax professional who could help. You don't want to end up being one of those missing  on a pot of gold. You have three years to file your tax return to claim these refunds. And the IRS will pay interest, too!

Too many times, taxpayers receive a surprise letter from the IRS, and even the Franchise Tax Board, on taxes owed from a cancelled debt acquired through debt settlement or debt consolidation. The general notion that once a debt has been reduced by a lender, the debtor is absolved of any other financial obligation has kept too many debtors misled and misinformed.

When the IRS comes back to collect taxes due a year to three years later, the penalties and interests would have been almost as expensive as paying the creditor the original amount of debt.

The IRS requires banks and government entities to issue a 1099-C for debt that was forgiven or reduced. The IRS logical thinking is that if you have a debt forgiven or reduced, that should be income taxed. Much to the opposition of several private sectors, the IRS has forcefully enforced on creditors to issue 1099-C’s since 2005.

The IRS has established a list of eight different situations under which a 1099-C must be issued, which includes “a discharge of indebtedness under an agreement between the creditor and the debtor to cancel the debt at less than full consideration”.

When this happens, creditor does not have an option to voluntarily waive the issuance of 1099-C on debtor; otherwise, the IRS could impose penalty on creditor. In fact, the creditor doesn’t get any leverage on doing so, if not only an administrative burden, but it has to comply with the IRS ruling.

As a rule of thumb, a taxpayer should expect to receive a 1099-C during the tax year the debt was forgiven or reduced and consider it when filing their tax return. In the event that a 1099-C was not received, the creditor should be contacted to get a copy before filing taxes.

The only exemption to this would be for victims of identity theft. Good enough, not even the IRS expects someone to pay taxes on a benefit they never received. Anyone who has been a victim needs to ensure he/she could provide all proofs and documents that his/her identify has been sacrificed.

In a tough economy like this, is there any other option that could liberate taxpayers from paying taxes on reduced or cancelled debt? After all, you are financially- strapped to be able to pay the whole amount of debt you owe. The IRS code, as complex as it can be, allows certain provisions to include insolvency or bankruptcy. The best way is to either consult with a bankruptcy lawyer or your tax professional.

You should file as Head of Household (HOH) if you are unmarried or "considered unmarried" and you could  claim one or more dependents on your tax return. That dependent could either be a minor child, a parent, or any adult who depended on more than half of his/her support on you during the tax year.

Unmarried or "considered unmarried" means you should be single, divorced, or legally separated from your spouse for at least 6 months of the year (July 1 to December 31).  You marital status at the end of the year determines your filing status. You can't be separated at the start of the year and be an HOH. Legally separated, for tax purposes, simply means you and your spouse live in two separate households. A court-ordered legal separation is not necessary.

Could both spouses claim Head of Household? Yes, if they both meet the qualification criteria, which are: 

     1.  They have provided at least 51% of maintaining a household.

     2.  They both have one or more dependents.

     3.  They must be unmarried or "considered unmarried".

One great example is if the couple have two minor children. Even if both children live with the mother but the couple have shared custody and/or the other spouse provides financial support for the children, then both could claim a child as a dependent on his/her tax return and file as Head of Household. In several situations under divorce, claiming the children as dependent/s on a tax return is part of the marital settlement agreement. I've witnessed incidents of a couple having an only child but agree on alternately claiming that child as a dependent every other year.

 Filing as Single, if all criteria is met, is a huge mistake as you would lose a lot of tax benefits. For one, in 2019, the standard deduction for Single is $12,000 compared to the HOH standard deduction of $18,000. That is $6,000 less in taxable income- meaning either you have more refund or you pay less taxes.

Covid-19. Lockdown. Nervous businessmen. Unemployment soaring.  Wall Street tumbling down! These are the common rhetoric of these unprecedented times. It is easy to imagine investors losing hundreds of thousands of dollars, even millions. Unfortunately, the current tax law wouldn't allow you to claim all your losses at once. In fact, you could only deduct a maximum of $3,000 losses annually. 

If you have $30,000 losses, you would have to claim that within 10 years to offset any gains you might have or simply to just help decrease your taxes.

But when you sell an investment for a gain, you would have to pay capital gains taxes on it right away, at once. But it's not all bad. There is what you call a 0% tax bracket for long term capital gains or those investments which were held for at least one year. It's a consolation that you pay nothing for long term capital gains of up to $78.750 ($39.375 for single).

Long-Term Capital Gains (2019):

Rate                         Single              Married Filing Joint     Head of Household

0%                         $0-$39,375                 $0-$78,750                        $0-$52,750

15%            $39,375-$434,550     $78,750-$488,850           $52,750-$461,700

20%                        $434,550+                    $488,850+                         $461,700

Short-Term Capital Gains (2019):

Rate                               Single                Married Filing Joint      Head of Household

15%                            $0-$39,375                 $0-$78,750                          $0-$52,750

20%                                $39,375+                    $78.750+                             $52,750+

Whether you have capital gains or capital losses, you can only claim it on your tax return on the year you sold such investments (realized gain or loss). Unrealized ones can't be claimed on your tax return.

We probably see it on the news almost everyday- the staggering number of unemployed Americans has reached close to 21 million and the unemployment rate of 14.7% is the worst it has been since the Great Depression.

For almost half of the  recipients, there is an upside to being unemployed. The CARES Act awarded additional $600/week to the typical unemployment payments.  This resulted in these recipients making more to be unemployed than to work. 

But these payments come with a caveat, just like any other government benefit or payment. They come with strings attached or restrictions in your life. 

It should not come as a surprise that the regular unemployment is taxable. In fact, unemployment income has never been tax-free. But don't expect the $600/week  benefit to be tax exempt. Yes, it is taxable and if  recipients are not having income taxes withheld now, they will be hit harder than what they expected when they file their taxes in 2021.

There are 2 options to avoid getting entangled in a financial mess at the end of the year. First, they could have taxes withheld by filling out a Form W-4V and submit to the Employment Development Department (EDD). The second choice is to make quarterly estimated tax payments so that a lump sum tax bill wouldn't put too much strain on their finances.  Making these estimated tax payments will also avoid the accrual of underpayment penalty.

Here's some good news. While the unemployment checks are taxable, the stimulus check of $1,200 for adults making less than $75,000/year ($150,000 for married couple) is non-taxable. And so does the $500 payment for minor children of these beneficiaries. It is not a loan you have to pay back nor it is an advance payment for the tax refund you are about to receive when you file taxes in 2021. It is a tax credit for tax year 2020 but it wont reduce the amount of your refund.

There should be no reason to confuse the unemployment checks with the stimulus check. It could get very interesting though. Since the stimulus payment is based on 2018 or 2019 income tax return, someone who made more than the $75,000 ($150,000 for married) could possibly get more stimulus if their income decreases in 2020. These taxpayers were in a range of income with reduced stimulus.  Those who earned more than $99,000 ($198,000 for married) in 2018 or 2019 might end up qualifying if their income is reduced to below the threshold level in 2020. They would then get the stimulus as a tax refund when they file taxes in 2021.

This pandemic has, indeed, created winners and losers among us just like the introduction of the Tax Cuts and Jobs Act in 2018.

By now, the IRS has issued more than half of stimulus checks. But it is far from over. There are millions of low income individuals, who are not required to file income taxes, who may have not received their stimulus payment yet.

The stimulus was based on individuals' 2018 or 2019 income tax return. Recipients of Social Security (SSDI), railroad retirement, Social Security Income (SSI) and disability benefits and Veteran's Affairs beneficiaries also received or will receive their checks automatically. 

The IRS has created a tool within the IRS website- www.irs.gov/getmypayment so that non-filers could update their personal information to qualify for a check. This tool also assists individuals who do not have bank account information on file with the IRS- those who have not received any refund and paid their taxes by check. It also allows other taxpayers the ability to update bank account and address information.

Registration in the website is fairly easy and the IRS is calling for the widespread dissemination of this information so that more people get the check prior to the end of this year. The IRS wants to reiterate that the tool is designed for those who wouldn't normally file income tax returns due to very little or no income only. For those who have not simply filed their 2018 or 2019 income tax return, they will have to to file their tax returns or registering would create delays in the processing of their refunds.

High income doesn't really mean high net worth. While it takes tremendous effort, grit and skills to become a high-income earner, it is truly hard and expensive to maintain it. There is an acronym developed for it - HENRY (High Income but Not There Yet).

We have a lot of clients making at least $150,000/year for married couple. As I always say, it looks good on paper but in reality, a lot of these taxpayers are struggling, especially with the high cost of living in Los Angeles.

For those not earning as much, they might wonder what's the problem with the HENRY's. Here's why:

1.  The US has a progressive income tax system. which means the more you earn, the higher is the tax rate you have to pay.  Imagine the Federal tax rate ranging from 10% to 37% and California  charges its citizens between 1% to 12.3% income tax, too. For example, for a couple  who have a taxable income of $340,000, they are at 37% federal tax bracket, 9.30% for the state of California, 8.45% for Medicare and Social Security, and 1% for the State Disability Insurance. That's a total of 55.75% in taxes alone. What happens when you add the other deductions like health insurance premiums, retirement contribution, etc?  Poor taxpayer would be lucky to even take home 40% net income.

2.  Lost tax credits. The high-income earner could potentially lose all tax credits available to the lower to moderate income earner. For example, the education credit of up to $2,500 per qualified student phases out for a joint earner of $160,000 ($80,000 for single) and is totally unavailable for a couple making $180,000 ($90,000 for single) per year. Or the child tax credit of up to $2,000 per child under 17 years old disappears at a joint income of $400,000 ($200,000 for single). Dependent care credit, earned income credit, and adoption credit are others which are not available for the high-income earner.

3.  Higher Medicare taxes: Thanks to Obamacare, it is even more painful to become a HENRY. For a couple earning at least $250,000/year ($200,000 for single), the Medicare rate of 1.45% increases to 2.9% to 3.8% for every dollar earned above the threshhold.

4.  Higher capital gains taxes: When capital gains taxes was overhauled a few years back, the high-income earner ended up paying 20%, instead of 15% for the lower tax brackets, of investment gains. On top of that, any couple who make a combined income of $250,000/year ($200,000 for single), have to pay an additional 3.8% on top of the threshold, making it 23.8%

5.  Can't deduct student loan interest:  If you earn at least $180,000/year ($90,000 for single), you wont be able to deduct any of your student loan interest.

6.  Retirement Contribution Limit:  High income earners can't deduct contributions to Individual Retirement Accounts (IRA) or Educational Savings Accounts (ESA), which are available to lower earners without any restrictions.

7.  No Obamacare:  Since Obamacare is only offered to individuals earning up to 400% of the Federal Poverty Level, there is no chance at all for the high-income earner to qualify. With the program, the government subsidizes some of the individual's health insurance premiums. No subsidy for the HENRY.

8.  Alternative Minimum Tax (AMT): In 2019, the AMT exemption is $111,700 for married couple ($71,700 for single). Dubbed as the wealth tax, it is designed to prevent taxpayers from paying their fair share of liability through tax breaks. 

YOU’RE probably one of those employees wanting to tap your 401(k), 403(b), or other retirement accounts to get you through dire financial need. With the economic disaster brought by Covid-19 lockdowns, your choices must have been exhausted so you’re left with no choice.

You assume withdrawing your retirement savings should come in uncomplicated and effortless; after all, it’s yours. But doing so should be dealt with great caution and prudence as it comes with costs.

A hardship withdrawal and loan are two distinct methods. Withdrawal poses more challenges and costs than taking out a loan. Once withdrawn, you lose the option to put it back to the savings account and become a taxable event; meaning, you’d have to pay your taxes relevant to your tax bracket.

The IRS considers it this way: the money that went to the account was tax-free so once it’s taken out of the account, it becomes a “source of income” that’s added to your annual gross income. (Remember, the only things tax free in America are life insurance and Roth IRA).

Realizing that workers would not want to put substantial amount of savings through many years without any access to it, legislation has devised terms and conditions for workers to be able to take hardship withdrawal. They include: 

• To buy a primary residence. 
• To prevent foreclosure or eviction from your home. 
• To pay college tuition for yourself or a dependent, provided the tuition is due within the next 12 months.
• To pay unreimbursed medical expenses for you or your dependents.

But the IRS still discourages these withdrawals by imposing a 10% penalty if you’re less than 59 1⁄2 years of age. However, you could qualify for a waiver of early withdrawal penalty if you meet one of the following:

• You become totally disabled.
• Direct rollover to an Individual Retirement Account (IRA).
• You are in debt for medical expenses that exceed 7.5% of your adjusted gross income.
• You are required by court order to give the money to your divorced spouse, a child, or a dependent.
• You are separated from service (through permanent layoff, termination, quitting or taking early retirement) in the year you turn 55, or later.
• You are separated from service and you have set up a payment schedule to withdraw money in substantially equal amounts over the course of your life expectancy. (Once you begin taking this kind of distribution you are required to continue for five years or until you reach age 591⁄2, whichever is longer)..

As opposed to withdrawal, you should check if you could take a loan instead. Loans are not subject to the same strict rules as withdrawal and they are tax and penalty-free, as long as you are employed by the same employer.

Generally, you could loan up to 50% of the total value of the investment though terms and conditions can differ by the plan carrier. The loan is usually paid back through salary deductions within 5 years while you continue making additional contributions.

But as soon as you leave your employer, the loan can’t be repaid and is treated as a distribution subject to the same taxes and penalties as a withdrawal.

In conclusion, taking money out of your retirement should be thought out carefully. You don’t tap it to finance vacations and buy discretionary items. You only use it as a last resort to cover financial emergencies. And even if you decide taking a withdrawal is the only choice, talk to a financial advisor first. Your tax preparer or financial planner is a great source. At least you get an overview of its tax ramifications and perhaps, staggering withdrawals will turn useful in the long run.

HOW much of their home office expenses can be deducted is one of the most misjudged tax questions faced by home workers. The reality of home office expense deductibility is much more complex than the common perception.

The costs associated with maintaining a home office can be deducted only if strict IRS guidelines are met — generally that the office is used exclusively for business purposes.  The Taxpayer Relief Act of 1997 has eased the requirements for determining if the costs associated with a home office can be deducted. The new law states that a home office qualifies as a “principal place of business” if (1) the taxpayer uses the office to conduct administrative or management activities of a trade or business and (2) there is no other fixed location of the trade or business where the taxpayer conducts substantial administrative or management activities of the trade or business.

Deductions will continue to be allowed for a home office meeting the above two-part test only if the taxpayer uses the office exclusively on a regular basis as a place of business and, in the case of an employee, only if such exclusive use is for the employer’s convenience.

The home office deduction is limited to the gross income from the activity, reduced by expenses that would otherwise be deductible (such as mortgage interest and taxes) and all other expenses related to the activities that are not house-related. A deduction isn’t allowed to the extent that it creates or increases a net loss from the activity. Any disallowed deduction may be carried over to future years.