On Wednesday, March 17^th, the Treasury Department and Internal Revenue Service (IRS) announced in a news release (IR-2021-59) that they were extending the filing due date for individuals for the 2020 tax year from April 15^th, 2021 to May 17^th, 2021. Tax payers can postpone federal income tax payments until May 17^th, 2021 without penalty or interest. Penalties and interest will resume on any unpaid balance as of the new deadline.

It’s important to note, the extension does not apply to estimated tax payments due on April 15^th. Additionally, unless your state follows with their own extension, state tax deadlines remain unchanged at this time.

IRS Commissioner Chuck Rettig shared in the news release, “This continues to be a tough time for many people, and the IRS wants to continue to do everything possible to help taxpayers navigate the unusual circumstances related to the pandemic, while also working on important tax administration responsibilities. Even with the new deadline, we urge taxpayers to consider filing as soon as possible, especially those who are owed refunds. Filing electronically with direct deposit is the quickest way to get refunds, and it can help some taxpayers more quickly receive any remaining stimulus payments they may be entitled to.”

The extension does not require additional forms; however, extending until October 15^th still requires a extension request be filed.

Note: This article was published on January 11th, 2021 and based on tax law at the time. Tax laws are subject to change.

As financial planners, we often have clients wanting to sell their home. They may be doing it to purchase a larger home for their family, downsizing their home in retirement, or simply deciding to move to another area. At the time of this writing, some housing markets are very hot, and homes are being bought and sold at a rapid rate. In saying this, we often have clients asking about the tax consequence of selling their home.

Your home is considered a capital asset. It is important to understand how capital assets are taxed when they are sold. When capital assets are sold, they may receive different tax treatment than ordinary income (e.g. wages). When an asset with an appreciated price is sold, the gains on the sale (sale price minus cost basis) are treated as either short-term capital gains or long-term capital gains in the year the asset is sold. This is reported on Schedule D of the tax return. A short-term gain is when the asset was held for one year or less. These are taxed at your ordinary income tax rate, which depends on your Adjusted Gross Income (AGI). A long-term gain is when the asset was held for more than one year. Long-term capital gains receive preferential tax treatment and are taxed at either 0, 15%, or 20%, again depending on your AGI.

There is good news. The IRS tax code will allow the capital gains on the sale of your home to be excluded from taxation (not counted in your AGI) under specific limits, if certain requirements are met. This rule is found under “Section 121” of the tax code. If you file “Single” on your tax return, you may exclude up to $250k worth of capital gains from the sale of your home. Likewise, if you file “Married Filing Jointly”, up to $500k of capital gains from the sale of your home may be excluded. The transaction is not reported on Schedule D of the tax return and does not require any additional tax forms.

As previously mentioned, there are certain requirements that must be met to qualify for the Sec. 121 exclusion. One rule is that the home must be considered your principal residence. The taxpayer must have lived in the residence for two years within the five-year period preceding the sale of the home. These two years do not have to be consecutive. Either 24 full months or 730 days will satisfy the two-year ownership and use requirements. It’s also important to note that there are certain exemptions that exist if the two-year requirement is not met.

See below for some common situations regarding Sec. 121 of the tax code:

Example 1

Jeff is single and bought his home in 2012. The purchase price then was $100k. He has not made any additional improvements to the home. He sells his home for $200k in 2021. This home has been his principal residence every year for the last 9 years. Jeff meets the requirements under Sec. 121 of the tax code, meaning he can exclude up to $250k in capital gains from this transaction. The $100k in gains that resulted from the sale of his home are excluded from taxation. He will not have to report this on his Schedule D or add $100k to his AGI on his tax return. 

Example 2

Jason’s grandmother passes away. She leaves her home to Jason in her will. She bought the home 40 years ago for $50k. The home was valued at $100k on the date of her death. Jason  inherits the home via the probate process. Because of this, Sec. 121 of the tax code doesn’t come into play. Under current tax laws, he receives the home with a “stepped-up basis” according to the value of the property at her death, which was $100k. If he sells the home immediately for $100k, he pays no capital gains tax. If he were to sell it in a few months later for $110k, he would be responsible for paying short-term capital gains tax on the $10k of gains.

I hope you found this information informative. Please click here for more information on this topic directly from the IRS website.

We previously shared with you details from the U.S. House of Representatives’ Tax Cut and Jobs Act  and the U.S. Senate’s Joint Committee on Taxation’ version under the same bill name, Tax Cut and Jobs Act. After negotiations between the two governing bodies, the Tax Cut and Jobs Act of 2017 is finalized and headed to the President’s desk.

Below is a brief rundown of some of the most notable changes for individuals and families. Most of the new tax laws are in effect for tax year 2018 and beyond unless otherwise noted.

Individual Income Tax Brackets

While House Republicans had proposed a four bracket system for income taxes, the TCJA retains the seven bracket system. However, rates and income thresholds have been adjusted. This means that almost all U.S. taxpayers will see a reduction in income taxes for tax year 2018. The current system’s income tax brackets are 10%, 15%, 25%, 28%, 33%, 35%, and 39.6%. The new system sets the brackets at 10%, 12%, 22%, 24%, 32%, 35%, and 37%.  The income threshold amounts will continue to adjust for inflation.

The decreased tax rates are not permanent, however, as there is a sunset provision. After 2025, without future legislation, the tax rates would increase. The Senate and House will be faced with deciding the fate of the sunsetting provision in future years.

Changes to Exemptions and Standard Deduction

One of the most notable pieces of the TCJA is the elimination of personal exemptions. The new legislation instead combines personal exemptions and the standard deduction into one single increased standard deduction amount. The new standard deduction amount is $12,000 for individuals, $24,000 for joint filers, and $18,000 for head of household. The additional standard deduction of $1,250 for blind individuals or someone over age 65 remains.

For larger families, this will mean an overall decrease in the combined amount when compared to the current combination of exemptions and standard deduction. However, the TCJA increases and expands the Child Tax Credit, from $1,000 to $2,000 per child, which should more than offset the loss of exemptions in most families. High income earners, $200,000 for individuals and $400,000 for couples, begin to phase out of the Child Tax Credit.

Changes to exemptions, standard deductions, and the child tax credit are subject to the 2025 sunset provision.

Changes to Itemizations

The Pease limitation on itemized deductions has been repealed. The Pease limitation is a reduction in certain itemized deductions that takes affect depending upon your filing status and income level. Once your income crossed the threshold amount ($261,500 for individuals and $313,800 for married filing jointly in 2017), itemized deductions would begin phasing out. The rule acts as a surtax on high income earning households. The repeal will result in a 1% to 1.3% reduction in taxes for high income earners. The sunset provision applies to this repeal, meaning the Pease limitation could return in 2026.

Additional changes to itemizations include:

• Elimination of miscellaneous itemized deduction, including tax preparer fees, investment management fees, and unreimbursed employee business expenses.
• $10,000 cap on combined state/local income tax and local property taxes.
• Deductible mortgage interest only on the first $750,000 of new principal debt. Mortgages taken prior to December 15^th, 2017 retain deductibility on the first $1,000,000 of principal debt.
• Elimination of home equity indebtedness interest deductibility.
  • If a home equity loan is used to substantially improve the home, it is treated as “acquisition debt” and is still deductible.
• Medical deductions were not repealed. Instead, the deduction was temporarily reduced to 7.5% of AGI for tax year 2017 and 2018. It reverts back to 10% of AGI in 2019.

Charitable Donations

Current rules limits donations to public charities to 50% of your AGI. The new rules increase the limitation to 60% of AGI making it easier to claim larger contribution or use carryforward charitable deductions.

The charitable mileage rate, which was expected to be increased, remains unchanged at 14 cents.

Capital Gains and Dividend Rates

There had long been concern that the 0% long-term capital gains and qualified dividends tax rate would be eliminated, but the TCJA retains the three-bracket system of 0%, 15%, and 20%. Under the old system, taxpayers in the 10% and 15% income tax bracket had a 0% capital gains tax rate. With the new tax bracket system, the capital gains rate is tied to an income threshold amount rather than the brackets. Thus, individuals with $38,600 and couple with $77,200 or less in income will have a 0% capital gains tax rate.

Instead of having the 20% capital gains tax rate take effect at the highest tax bracket, it now takes affect at the threshold amounts of $452,400 for individuals and $479,000 for couples. This means some tax payers in the new 35% income tax bracket will find themselves in the highest capital gains tax rate.

Unfortunately, the 3.8% Medicare surtax on capital gains and qualified dividends still applies. Individuals with income over $200,000 and couples over $250,000 will face the additional surtax. This effectively retains a four tax brackets of 0%, 15%, 18.8%, and 23.8% for capital gains and qualified dividends.

No Repeal of the Alternative Minimum Tax

The original bills by both the Senate and the House proposed a complete repeal of the Alternative Minimum Tax (AMT) system for individuals. Unfortunately, in negotiations, the AMT survived although the exemption amount has increased.

This difficult-to-understand supplemental income tax system dates back to 1969 and was originally designed to ensure wealthy taxpayers paid their fair share of taxes. Yet, over the years, the AMT began affecting more and more middle-income taxpayers. With the exemption amount increased to $70,300 for individuals and $109,400 for joint filers, fewer middle class taxpayers will be affected.

Kiddie Tax Rules

The Kiddie Tax is a tax on unearned income for children under the age of 19 or full-time students under 24. In 2017, tax law allowed for the first $1,050 of unearned income to be tax-free, the following $1,050 taxed at the child’s rate, and any income above that amount taxed at the parent’s rate. TCJA changes this so that the any amount above $2,100 is taxed at trust tax rates, not the parent’s tax rate. This is significant because the highest trust rate is 37% at ordinary income of only $12,500. It would take total income over $600,000 at the parents’ joint rate in order for the 37% tax bracket to apply.

Estate and Gift Taxes

The estate and gift tax exemption has effectively doubled allowing an individual to pass $11.2M and couples to pass $22.4M estate tax free. Portability of the exemption survived; if the first spouse to die doesn’t use the exemption, the surviving spouse can port the unused amount to themselves. The top rate remains at 40%. Some early discussion indicated that the estate tax could be repealed at a future date, but the repeal did not make it into the legislation. These changes are subject to the 2025 sunset provision.

Trust and Estate Tax Brackets

Tax brackets for trusts and estate were compressed, much like the individual income tax rates, leaving just four tax brackets – 10%, 24%, 35%, and 37%. However, the income thresholds tied to those tax rates did not change very much. Thus, it only takes $12,500 in trust or estate income before hitting the top bracket.

Education Planning

While a number of changes were expected to affect education planning, such as repeal of the Coverdell ESA plan and education tax credits, most did not make it into the final bill. However, one change is significant. You can now use up to $10,000 per year from 529 plans for private school expenses for elementary and secondary education. Previously, only the Coverdell ESA could be used tax-free for private educational institutions.

Alimony Credit

The bill eliminates the tax deduction for alimony paid and no longer taxes the alimony received for divorces finalized after December 31^st, 2018.

Miscellaneous

• Deductibility of student loan interest and out-of-pocket classroom expenses for teachers remains unchanged.

• The mandate requiring that individuals retain health insurance has been repealed for 2019 and beyond.

• No changes to 401(k) plans, IRAs, and Roth IRAs. However, the ability to recharacterize a previous Roth conversion has been repealed.

• There are new rules for deferred compensation plans and equity granting plans, like stock option plans, that could result in funds being taxed earlier than under current plan designs. As a result, there may be changes to current plans.

An AL.com contributor called the Alabama Accountability Tax Act of 2013 the “most radical education reform in decades”.  Similar legislation had only been passed in 16 other states at the time the Alabama Accountability Act passed in February 2013.¹ It was developed with the intent to allow flexibility in meeting children’s educational needs, improve overall education performance, encourage innovation in meeting the needs of school systems and provide financial assistance through income tax credits.² Since it was passed, there has been a great deal of controversy over the Act, which lead to a lawsuit over the constitutionality of the document. On March 2^nd, the Alabama Supreme Court upheld the Act, so it is important to know how you may benefit from it.

The Act opens the door for Alabama residents to make donations to a Scholarship Granting Organization (SGO). Scholarship Granting Organizations are 501(c)3 (charitable) organizations that are created with the purpose of granting scholarships to eligible students at failing public schools so they may transfer to a private school.  The scholarships are provided to students who qualify based on family income requirements. All taxpayers who make a donation to a SGO qualify for a state tax credit of 50% of their state income taxes, up to $7500. C corporations also qualify for a 50% credit, but there is not a maximum limit on the amount of the credit. In addition, taxpayers can claim the donation as a charitable deduction on their federal return. For some, this is just a zero-sum game. The taxpayer receives a credit from the state, which lowers the state tax deduction by the same amount of the federal charitable deduction taken. However, for those who pay Alternative Minimum Tax (AMT), it actually results in additional savings because state taxes are disallowed for the AMT calculation, while charitable contributions are not.  

The Alabama Accountability Act outlines a process for making SGO donations and claiming the tax credit. The state has earmarked $25M for these credits on a first come, first serve basis. Please let us know if you are interested in learning more about this opportunity or about how to make a donation and claim a credit. This is not something you want to plan on waiting until the end of the year for if you are interested.

*In full disclosure, Jessica Smith serves on the board of a local Scholarship Granting Organization.

¹ McClendon, Robert. (March 1, 2013) “Alabama Accountability Act FAQ, a guide to the most radical education reform in decades.” Retrieved April 24, 2015 from AL.com: http://blog.al.com/wire/2013/03/alabama_accountability_act_faq.html. 

²Alabama Accountability Act of 2013 (HB 84, 2013)