The Coronavirus Aid, Relief, and Economic Security (CARES) Act was passed by Congress and signed into law on March 27, 2020. CARES temporarily affected 2018, 2019, and 2020 taxes by overriding elements of the 2017 Tax Cuts and Jobs Act (TCJA). For example, CARES provided five-year NOL carryback refund claims, whereas TCJA allowed NOL carryforwards only. CARES also waived TCJA’s excess business limitation. These changes are temporary; TCJA applies again in 2021.
The CARES Act provides tax relief and economic aid to employees, independent contractors, sole proprietors, and other small businesses. However, traders don’t fit into the usual small-business categories, so there are issues in applying for some CARES aid.
Traders eligible for trader tax status (TTS) operating in an S-Corp might be able to receive state and federal unemployment benefits. TTS S-Corps do not qualify for a forgivable loan under the Small Business Administration Paycheck Protection Program because trading is a “speculative business.” TTS traders structured as sole proprietors, partnerships, or S-Corps might be eligible for CARES five-year NOL carrybacks, relaxed retirement plan distributions, and recovery rebates.
A trader’s capital gains and Section 475 ordinary income are different from wages, earned income, and self-employment income (SEI) required for many business-related benefits under CARES. TTS sole proprietors report business expenses on Schedule C. Still, trading gains and losses go on other tax forms, including Schedule D (capital gains and losses) or Form 4797 (Section 475 ordinary gain or loss). In government agencies’ eyes, trading generates investment income derived from the sale of capital assets; it’s not a usual small business with revenue.
CARES allows NOL carrybacks
As discussed in Chapter 17, TCJA repealed two-year NOL carrybacks and only allowed NOL carryforwards limited to 80% of the subsequent year’s taxable income starting in tax-year 2018. TCJA introduced the “excess business loss” (EBL) limitation, where aggregate business losses over an EBL threshold ($500,000 for married and $250,000 for other taxpayers for 2018) are considered an NOL carryforward.
CARES suspended this limitation for 2018, 2019, and 2020 and permitted five-year NOL carrybacks for 2018, 2019, and 2020 NOLs.
Business owners should consider amending 2018 and 2019 tax returns to remove EBL limitations and consider a five-year NOL carryback refund claim. It’s too late to elect 475 ordinary loss treatment for 2018 and 2019; 2020 NOL carrybacks must wait until 2021.
Retirement plan distributions
Taxpayers negatively impacted by Covid-19 can take a withdrawal from an IRA or qualified retirement plan of up to a maximum of $100,000 in 2020 and be exempt from the 10% excise tax on “early withdrawals.” The taxpayer has the option of returning (rolling over) the funds within three years or paying income taxes on the 2020 distribution over three years. CARES also suspended required minimum distributions for 2020. (See this May 4, 2020 update on the IRS Website, https://tinyurl.com/coronavirus-tax-qa.)
Charitable deductions
CARES created an above-the-line charitable deduction for 2020 (not to exceed $300). It also modified the AGI limitations on charitable contributions for 2020 to 100% of AGI for individuals (raised from 60% in TCJA).
Unemployment benefits
CARES provided Federal Pandemic Unemployment Compensation (see U.S. Department of Labor’s news release, https://tinyurl.com/y8p9phcw). CARES also gave states the option of extending unemployment compensation to independent contractors and other workers who are ordinarily ineligible for unemployment benefits. Unemployment Insurance Relief During Covid-19 Outbreak (https://tinyurl.com/y6wvxfcw) lists contact information for state unemployment insurance offices.
TTS sole proprietor and partnership traders will likely face challenges applying for SUI and FPUC because they didn’t pay for SUI premiums. They also don’t have self-employment income as sole proprietors and partners. Most TTS traders worked from a home office and continued to trade throughout the coronavirus crisis. An employer or client has not terminated or furloughed them during the crisis. If you think you might be eligible for SUI and FPUC, apply at your state unemployment office.
SBA PPP forgivable loans
According to the AICPA, “The CARES Act established the PPP as a new 7(a) loan option overseen by the Treasury Department and backed by the SBA [Small Business Administration], which is authorized to provide a 100% guarantee to lenders on loans issued under the program. The full principal amount of the loans may qualify for loan forgiveness if the borrower maintains or rehires staff and maintains compensation levels. However, not more than 25% of the loan forgiveness amount may be attributable to non-payroll costs. Independent contractors and self-employed individuals can apply for PPP loans beginning April 10. Under the PPP, the maximum loan amount is the lesser of $10 million or calculated using a payroll-based formula specified in the CARES Act.” You can access free loan calculators here: https://tinyurl.com/ppp-resources. (See Paycheck Protection Program information here: https://tinyurl.com/sba-pp-program.)
The SBA considers a TTS trading business to be a “speculative business,” which is not eligible for an SBA loan. The list of speculative businesses includes “dealing in stocks, bonds, commodity futures, and other financial instruments.”
Recovery rebates
Under a threshold for adjusted gross income (AGI), taxpayers are eligible for an advance tax refund of a 2020 tax credit. (The payment is reduced if the taxpayer falls in a phase-out range above the threshold.) The IRS looks at the taxpayer’s 2018 or 2019 tax return filing to deposit to a taxpayer’s bank account or mail a check faster. (For social security recipients who don’t file a tax return, the IRS looks at their SSA Form 1099.)
2020 estimated taxes
Treasury also postponed Q1 and Q2 quarterly estimated tax payments for 2020 until July 15, 2020. The third and fourth quarters keep their original due dates of Sept. 15, 2020, and Jan. 15, 2021, respectively.
2020 Year-End $900 billion pandemic relief
On Dec. 21, 2020, Congress passed an emergency $900 billion pandemic relief bill, extending CARES to people in need. On Dec. 27, 2020, the President signed the legislation, part of a government funding package. The new Covid-19 legislation includes:
Direct payments: The maximum amount is $600 for individuals and $1,200 for married couples filing jointly, plus an additional $600 per qualifying child. Subject to phase out for individuals making more than $75,000 modified adjusted gross income and married couples over $150,000. It’s a 2020 advanced recovery rebate with eligibility based on 2019 tax returns. These direct payments are non-taxable income.
Extension of federal pandemic unemployment compensation: Restores FPUC supplement to all state and federal unemployment benefits at $300 per week, starting after Dec. 26, 2020, and ending March 14, 2021. These unemployment benefits are taxable income.
Small business PPP forgivable loans: The new legislation clarifies tax treatment under the CARES Act. Borrowers may deduct PPP business expenses financed with PPP loans, and loan forgiveness is not taxable income. New funding allows “PPP second-draw” loans for smaller and harder-hit businesses, with a maximum of $2 million.
Business meals tax deduction raised to 100% through 2022, increased from 50%. Traders don’t have many business meals.
TTS traders might qualify for direct payments but not unemployment benefits since they don’t have earned income from trading. The SBA labels trading a speculative business precluding it from SBA loans, including PPP loans.
Full details have yet to be released, so stay tuned to our blog to see how this impacts TTS traders. Also, see https://tinyurl.com/cares-act-provisions.
The 2017 Tax Cuts and Jobs Act (TCJA) impacts investors, traders, and individuals positively and negatively, beginning in the tax year 2018. In this chapter, I explore TCJA’s impact on these groups.
INVESTORS
TCJA suspends “certain miscellaneous itemized deductions that are subject to the 2% floor under present law.” These include investment fees and certain investment expenses, unreimbursed employee business expenses (job expenses), and tax compliance fees for non-business taxpayers.
Investment interest expenses retained. TCJA did not suspend or modify investment interest expense on Schedule A. Investment interest expense remains deductible up to the extent of investment income. The excess is carried over to the subsequent tax year.
Business interest expense modified. Business interest expense is limited to 30% of adjusted taxable income, business interest income, and floor plan financing interest. The excess amount carries over indefinitely to subsequent tax years. (Traders are not affected unless they make over 26 million in trading gains, as explained in our guide.)
Carried interest modified. TCJA modified the carried interest tax break for investment managers in investment partnerships, lengthening their holding period on profit allocation of long-term capital gains (LTCG) to three years from one year. If the manager also invests capital in the investment partnership, she has LTCG on that interest after one year.
C-CORPS
When taking into account TCJA, traders shouldn’t focus solely on the federal 21% flat tax rate on the C-Corp level. There are plenty of other taxes, including capital gains taxes on qualified dividends, corporate taxes in 44 states, and accumulated earnings tax assessed on excess retained earnings.
When a C-Corp pays qualified dividends to the owner, double taxation occurs with capital gains taxes on the individual level. If an owner avoids paying sufficient qualified dividends, the IRS is entitled to assess a 20% accumulated earnings tax (AET). It’s a fallacy that owners can’t retain all earnings inside the C-Corp. Traders face difficulties in creating a war chest plan for justifying accumulated earnings and profits to the IRS. (See How To Decide If A C-Corp Is Right For Your Trading Business.)
INDIVIDUALS
The individual tax cuts are temporary through 2025, which applies to most provisions, including the suspension of certain investment expenses.
TCJA brings forth a mix of changes for individuals. The highlights for 2018 limits include:
Lower tax rates in all seven brackets to 10%, 12%, 22%, 24%, 32%, 35%, and 37%; four tax brackets for estates and trusts: 10%, 24%, 35%, and 37%;
Standard deduction raised to $24,000 married, $18,000 head-of-household, and $12,000 for all other taxpayers, adjusted for inflation;
An expanded AMT exemption to $109,400 married and $70,300 single;
Many itemized deductions and AGI deductions suspended or trimmed (more on this later);
Mortgage debt lowered on new loans;
Personal exemptions suspended;
Child tax credit increased;
New 20% deduction for pass-through income with many limitations;
Pease itemized deduction limitation suspended;
ACA shared responsibility payment lowered to zero for non-compliance with the individual mandate starting in 2019;
Children’s income is no longer taxed at the parent’s rate; kids must file tax returns to report earned income, and unearned income is subject to tax using the tax brackets for trusts and estates.
SALT capped at $10,000 per year. The most contentious deduction modification is to state and local taxes (SALT). After intense deliberations, conferees capped the SALT itemized deduction at $10,000 per year ($5,000 for married filing separately). TCJA allows any combination of state and local income, sales, real estate taxes, or domestic property tax. SALT may not include foreign real property taxes.
Medical expenses modified. TCJA retained the medical-expense itemized deduction, which is allowed if it’s more than the AGI threshold. In 2017, the AGI threshold was 10% for taxpayers under age 65, and 7.5% for age 65 or older. TCJA uses a 7.5% AGI threshold for all taxpayers for taxable years ending after 2018 and beginning before 2021.
Mortgage debt lowered on new loans. As of Dec. 15, 2017, new acquisition indebtedness is limited to $750,000 ($375,000 in the case of married taxpayers filing separately), down from $1 million, on a primary residence and second home. Mortgage debt incurred before Dec. 15, 2017, is subject to the grandfathered $1 million limit ($500,000 in the case of married taxpayers filing separately). If a taxpayer has a binding written contract to purchase a home before Dec. 15, 2017, and to close by Jan. 1, 2018, she is grandfathered under the previous limit. Refinancing debt from before Dec. 15, 2017, keeps the grandfathered limit providing the mortgage is not increased.
SUSPENDED DEDUCTIONS
Unreimbursed employee business expenses. TCJA suspends unreimbursed employee business expenses (job expenses) that were normally deducted on Form 2106 — there is no Form 2106 for 2018 through 2025. Speak with your employer about implementing an accountable reimbursement plan and “use it or lose it” before year-end.
Tax prep and planning fees. TCJA suspended tax compliance (planning and preparation) fees as itemized deductions. Ask your accountant to break down their invoices into individual vs. business costs because the business portion is allowed as a business expense.
Miscellaneous itemized deductions. TCJA suspended “certain miscellaneous itemized deductions subject to the two-percent floor” in the Joint Explanatory Statement (p. 95-98).
Personal casualty and theft losses suspended. TCJA suspended the personal casualty and theft loss itemized deduction, except for losses incurred in a federally declared disaster. If a taxpayer has a personal casualty gain, she may apply the loss against the gain. If deducting home office expenses, enter “excess casualty losses” on Form 8829, line 29.
Gambling loss limitation modified. TCJA added professional gambling expenses to gambling losses in applying the limit against winnings. Professional gamblers may no longer deduct expenses more than net winnings.
Alimony deduction. TCJA suspended alimony deductions for divorce or separation agreements executed in 2019 and subsequent years, and the recipient does not have taxable income.
Moving expenses. Starting in 2018, TCJA suspended the AGI deduction for moving expenses, and employees may no longer exclude moving expense reimbursements, either. One exception: Active duty military members “who move pursuant to a military order and incident to a permanent change of station.”
MORE TCJA CHANGES
20% QBI deduction. TCJA introduced a new tax deduction for pass-through businesses, including sole proprietors, partnerships, and S-Corps. Subject to haircuts and limitations, a pass-through business could be eligible for a 20% deduction on qualified business income (QBI).
Traders eligible for TTS are a “specified service activity,” which means if their taxable income is above an income cap, they won’t receive a QBI deduction. The taxable income (TI) cap is $426,600/$213,300 (married/other taxpayers) for 2020, and $429,800/$214,900 (married/other taxpayers) for 2021. The phase-out range below the cap is $100,000/$50,000 (married/other taxpayers), in which the QBI deduction phases out for specified service activities. The W-2 wage and property basis limitations also apply within the phase-out range. Investment managers are specified service activities, too.
QBI for traders includes Section 475 ordinary income and loss and trading business expenses. QBI excludes capital gains and losses, Section 988 forex ordinary income or loss, dividends, and interest income.
TCJA favors non-service businesses, which are not subject to an income cap. The W-2 wage and property basis limitations apply above the TI threshold of $326,600/$163,300 (married/other taxpayers) for 2020 and $329,800/$164,900 (married/other taxpayers) for 2021. The IRS adjusts the annual TI threshold for inflation each year.
Sole proprietor TTS traders cannot pay themselves wages, so they likely cannot use the phase-out range.
Ordinary tax rates reduced. TCJA lowered tax rates on ordinary income for individuals for almost all tax brackets and filing status. It decreased the top rate to 37%, starting in 2018, from 39.6% in 2017. Short-term capital gains are taxed at ordinary rates, so investors receive this benefit.
Filing status equalization. TCJA fixed several inequities in filing status, including the tax brackets by making single, married filing jointly (MFJ), and married filing separately (MFS) brackets equivalent, except for divergence at the top rate of 37% for single filers, retaining some of the marriage penalty. See the 2020 tax brackets: MFS brackets are exactly half the MFJ brackets throughout all the rates, so MFS filers are not penalized on rates. Filing separately could unlock a QBI deduction.
Repeal of recharacterization for Roth IRA conversions. If a 2017 converted Roth account dropped significantly in value in 2018, a taxpayer could have reversed the Roth conversion with a “recharacterization” by the tax return’s due date, including extensions (Oct. 15, 2018). That option is no more; TCJA repealed it starting with 2018 Roth IRA conversions.
Charitable contribution deduction limitation increased. TCJA raised the 50% limitation of AGI for cash contributions to public charities and certain private foundations to 60%. Excess contributions can be carried forward for five years.
Per TCJA, retirees who must take required minimum distributions by age 70½ (raised to 72 under the SECURE Act) should consider “qualified charitable distributions” (QCD). This move satisfies the RMD rule with the equivalent of an offsetting charitable deduction, allowing you to take the standard deduction rather than itemize.
Expanded use of 529 account funds. TCJA significantly expanded the permitted use of Section 529 education savings account funds. “Qualified higher education expenses” include tuition at an elementary or secondary public, private, or religious school. (Check with your state.)
If you paid the Affordable Care Act (ACA) Medicare surtaxes on unearned or earned income in 2016 through 2019, you might be eligible for a potential tax refund if the Supreme Court of the United States (SCOTUS) rules against ACA. SCOTUS agreed to take the ACA case, and experts expect a decision in early 2021. Traders have unearned income, and they pay the ACA 3.8% Medicare surtax on net investment income over the AGI threshold (see below).
Act fast for 2016 Some taxpayers need to act fast before SCOTUS renders their decision about ACA. If you paid ACA taxes on your 2016 income tax return and filed that return by its original due date of April 18, 2017, then consider submitting a “protective claim for refund” due by July 15, 2020. That’s the date the 2016 tax year closes, three years from April 18, 2017, the original tax return deadline, plus the three-month postponement under the CARES Act. A protective claim for refund extends the deadline for purposes of this ACA refund, giving you ample time to react to the SCOTUS decision. If you miss the July 15, 2020 deadline, at least you can still submit the protective claim for 2017, 2018 and 2019,
If you filed an extension for 2016 taxes, extending the deadline six-months until October 15, 2017, you have three years from the actual filing date up to October 15, 2020. For example, if you filed your 2016 income tax return on August 30, 2017, the tax year closes three years later on August 30, 2020.
There’s no rush to submit a protective claim for refund of ACA taxes for 2017, 2018, and 2019 tax returns. The 2017 tax year would close April 15, 2021, unless you filed a 2017 tax extension until October 15, 2018, in which case the year closes three years after filing date.
ACA taxes and potential refunds
If SCOTUS rules against ACA, it could trigger this refund opportunity for ACA taxes paid in 2016 through 2019.
These ACA taxes include the 0.9% Medicare Surtax on earned income (Form 8959) and 3.8% Net Investment Income Taxes on unearned income (Form 8960) for 2016 through 2019. The ACA net investment tax applies to individuals with net investment income (NII) and modified adjusted gross income (AGI) exceeding $200,000 single, $250,000 married filing jointly, or $125,000 married filing separately. ACA law does not index the threshold for inflation.
Filing a protective claim ensures that if SCOTUS invalidates ACA taxes, taxpayers who paid them could formalize a refund request, even after the amended tax return filing deadline closes. Congress could enact a statute that would allow (or require) the IRS to issue refunds for closed tax years even without filing a protective claim.
We cannot assess the likelihood that these ACA taxes will be deemed unconstitutional retroactively to these years, but we wanted to bring the possibility to your attention.
Here’s a template of the informal protective claim for refund if you decide that you would like to submit it to the IRS for tax year 2016. It should be mailed (preferably by certified mail, return receipt, if available at your local post office) to the IRS service center within the PDF file based on your current mailing address.
We are available for questions on this matter after July 15, 2020, the postponed tax deadline.
In this 50-minute recording, trader tax specialist Robert Green explains investment expense treatment, how trader tax status (TTS) business expense treatment is much better and how to qualify for TTS. Mr. Green explains how active traders use entities to maximize deductions for retirement plan contributions and health insurance premiums. Published Sep. 17, 2015
The Patient Protection and Affordable Care Act (also known as Obamacare) enacted in 2012 has taken several years to implement and phase in. But now that the Obamacare 2014 individual health insurance mandate is in effect, many taxpayers will face confusion over tax penalties, exemptions, premium tax credits, claw backs of subsidies (advanced credits) and extra tax-preparation fees on 2014 tax filings. In this Webinar, we will clarify the details of the mandate to avoid confusion. 2014 is the second year for the Net Investment Income Tax (NIT) and we’ll show you some strategies to reduce or avoid it. Here are a few things you’ll learn:
Three scenarios for dealing with the Obamacare mandate on 2014 tax returns.
How to handle the five new Obamacare tax forms to your advantage.
When to enroll on an exchange for 2015 coverage and have an opportunity for a premium tax credit.
Tips for upper-income traders to reduce or avoid NIT.
The Patient Protection and Affordable Care Act (also known as Obamacare) enacted in 2012 has taken several years to implement and phase in. But now that the Obamacare 2014 individual health insurance mandate is in effect, many taxpayers will face confusion over tax penalties, exemptions, premium tax credits, claw backs of subsidies (advanced credits) and extra tax-preparation fees to comply with Obamacare on 2014 tax filings. In this post, I help clarify the details of the mandate.
There are three scenarios for dealing with the mandate on 2014 tax returns:
1. Off-exchange coverage: If you had ACA-compliant health insurance coverage for all of 2014 — either an individual plan purchased directly from an insurance company (off exchange), an employer plan or government-sponsored programs like Medicare or Medicaid — there’s little to do. You may receive a new IRS Form 1095-B reporting your health insurance coverage from an insurance company and, if applicable, a Form 1095-C from your employer. Both of these tax forms are not mandatory for 2014. Give the 1095s to your accountant and you’re finished. There won’t be any penalties, premium tax credits or return of exchange subsidies.
2. On-exchange coverage: If you purchased your 2014 health insurance on an exchange (marketplace), you will receive a mandatory Form 1095-A from the marketplace and you must file new tax Form 8962 (Premium Tax Credit). When you applied for your 2014 health insurance coverage, you submitted estimates of your 2014 income which the exchange relied on for pricing your plan, perhaps offering a subsidized plan with “advanced credits.” The purpose of Form 8962 is to determine your rightful premium tax credit based on income reported on your 2014 tax return and to reconcile advanced credits (if any) with the premium tax credit calculated on Form 8962. Estimates probably won’t match actual income, especially for traders who have fluctuations in trading gains and losses.Therefore, one of three things will happen on Form 8962:
i. You will have a tax liability caused by advanced credits being greater than the premium tax credit.
ii. You will have a tax credit caused by advanced credits being less than the premium tax credit.
iii. No tax liability or credit because you used an exchange but did not receive an advanced credit and there is no premium tax credit.
The Obamacare Website says individuals can use an exchange even without getting a subsidized plan, but we heard from taxpayers that they were not permitted to use some state exchanges unless they qualified for subsidies. Some individuals say they received a better quote off exchange compared to on exchange without subsidies. Expect to receive new tax information document IRS Form 1095-A from the exchange reporting your coverage and any advanced credits paid for a subsidized plan. Give the 1095s to your accountant and he or she will prepare Form 8962. Tax software should have an input area to enter Form 1095 information and calculate Form 8962 and the premium tax credit.
3. No health insurance coverage: If you did not have ACA-compliant health insurance coverage for 2014 — and that includes large gaps in coverage — and you don’t qualify for an exemption from Obamacare, then you will owe a shared-responsibility payment (tax penalty). Apply to an exchange to receive a Form 8965 exemption for certain types of exemptions, and for others types of exemption claim them on a self-prepared Form 8965. As of Oct. 29, the IRS had not yet released a draft tax form for calculating the shared responsibility payment.
The shared responsibility payment is whichever amount is larger of the following: For 2014, the payment is either $95 per adult and $47.50 per child (up to $285 for a family) or 1% of household income. For 2015, it’s either $325 per adult and $162.50 per child (up to $975 for a family) or 2% of household income. For 2016, it’s either $695 per adult and $347.50 per child (up to $2,085 for a family) or 2.5% of household income. Per the IRS Website, “the individual shared responsibility payment is capped at the cost of the national average premium for the bronze level health plan available through the Marketplace in 2014.” As has been widely publicized, the shared responsibility payment is not enforceable by the IRS. That means the IRS will offset the payment against tax refunds due, but it can’t file liens, levy assets or start collection proceedings for this payment. The IRS may fully enforce claw-backs of advanced credits (subsidies) reported on Form 8962.
The 2014 Form 1040 has three lines dealing with the Obamacare health insurance mandate:
Payment (line 69): Net premium tax credit. Attach Form 8962.
Other Taxes (line 61): Health care: individual responsibility (see instructions). Full-year coverage (box to check).
Open enrollment through exchanges for 2015 coverage Traders should consider special strategies for purchasing 2015 health insurance coverage through exchanges. The open enrollment period runs from Nov. 15, 2014 to Feb. 15, 2015. Most individuals will purchase 2015 insurance before they deal with Obamacare tax compliance on 2014 tax returns.
If you want to receive a premium tax credit on Form 8962, you need to enroll through an exchange, not directly with an insurance provider or employer. You can’t receive premium tax credit if you are eligible for other “minimum essential coverage,” such as employer-sponsored coverage that’s considered adequate and affordable. Traders should use a reasonable basis for providing the exchange with an estimate of household income perhaps qualifying for a subsidized plan with advanced credits. Some exchanges ask for monthly household income for either 2014 or 2015. Remember, you will have to square up with the IRS on a 2015 Form 8962 but at least you’re in the game for filing a Form 8962 and receiving a premium tax credit. Many traders may have low income in 2015 and they should keep this opportunity open. High-income sole proprietors have confidence they won’t get a premium tax credit and they can skip the exchange all together if working directly with an insurance provider is more convenient.
The exchange system is inconvenient for traders who have fluctuating income Most individuals consider ACA-compliant non-subsidized health insurance plans expensive. If your household income is above 400% of the Federal Poverty Line, you or your family won’t qualify for a subsidized plan on the exchange. You may even face obstacles in using an exchange. No worries, you can purchase an individual or employer ACA-compliant health insurance plan directly through an insurance company. Just keep in mind that rules out the possibility of getting a premium tax credit if you wind up with household income under 400% of the Federal Poverty Line since the insurance must be purchased through an exchange to qualify for the credit.
Many traders have wide fluctuations in trading gains and losses from year-to-year. They could easily fall under 400% of the Federal Poverty Line in 2014 and qualify for an exchange-subsidized plan for the year of 2015. But these traders may wind up with large trading gains in 2015, thereby triggering an “excess advance premium tax credit repayment” (claw back of subsidies) on their 2015 Form 8962. The big problem is the exchange requires an estimate of income before the coverage year starts, and traders don’t know their income until the year ends. Tip: Traders can use an exchange but decline the subsidies up front and file for a premium tax credit if their income is under 400% of the federal poverty line.
There are five new Obamacare tax forms for 2014
1. Form 1095-A: Health Insurance Marketplace Statement. The exchange issues this form to individuals who purchased insurance through an exchange for 2014. (Similar to a bank or broker that issues a tax information Form 1099.) Its instructions state: “You received this Form 1095-A because you or a family member enrolled in health insurance coverage through the Health Insurance Marketplace. This Form 1095-A provides information you need to complete Form 8962, Premium Tax Credit (PTC). You must complete Form 8962 and file it with your tax return if you want to claim the premium tax credit or if you received premium assistance through advance credit payments (whether or not you otherwise are required to file a tax return). The Marketplace has also reported this information to the IRS. If you or your family members enrolled at the Marketplace in more than one qualified health plan policy, you will receive a Form 1095-A for each policy.” If the Form 1095-A does not list any advanced credits and you are confident your income will be well above 400% of the Federal Poverty Line, you don’t have to prepare Form 8962. Some taxpayers may easily generate the form with their tax software and choose to attach it with their return just in case IRS computers look for it.
2. Form 1095-B: Health Coverage. The insurance provider issues this form to individuals, although it’s not mandatory for 2014. Its instructions state: “This Form 1095-B provides information needed to report on your income tax return that you, your spouse and individuals you claim as dependents had qualifying health coverage (referred to as “minimum essential coverage”) for some or all months during the year. Individuals who do not have minimum essential coverage and do not qualify for an exemption may be liable for the individual shared responsibility payment. Minimum essential coverage includes government-sponsored programs, eligible employer-sponsored plans, individual market plans and miscellaneous coverage designated by the Department of Health and Human Services. For more information on minimum essential coverage, see Pub. 974, Premium Tax Credit (PTC).”
3. Form 1095-C: Employer-Provided Health Insurance Offer and Coverage. The employer issues this form to individuals, although it’s not mandatory for 2014. Its instructions state: “This Form 1095-C includes information about the health coverage offered to you by your employer. Form 1095-C, Part II, includes information about the coverage, if any, your employer offered to you and your spouse and dependent(s). If you purchased health insurance coverage through the Health Insurance Marketplace and wish to claim the premium tax credit, this information will assist you in determining whether you are eligible. For more information about the premium tax credit, see Pub. 974, Premium Tax Credit (PTC).” Some people used an exchange to receive subsidies even though their employer offered them a good health insurance plan as reported on Form 1095-C, so these individuals should be prepared for a claw back of subsidies on Form 8962.
4. Form 8962: Premium Tax Credit. This tax form is prepared by taxpayers and/or their tax preparers. Its instructions state: “Complete Form 8962 only for health insurance coverage in a qualified health plan (described later) purchased through a Health Insurance Marketplace (also known as an exchange). This includes a qualified health plan purchased on www.healthcare.gov.” Caution: An “excess advance premium tax credit repayment” increases estimated income taxes due, whereas a “net premium tax credit” (payment) does not reduce estimated taxes due since payments are listed below tax liability. (That’s inconsistent and unfair in our view.)
The Federal Poverty Line and household income Exchange subsidies and the Form 8962 premium tax credit are granted to individuals and families with household incomes between 100% and 400% of the “Federal Poverty Line.” Household income is also used for calculating the Obamacare shared responsibility payment for not having minimum essential coverage or an exemption from coverage (Form 8965). Household income is basically taxpayer’s adjusted gross income reported on the tax return plus: Social Security payments excluded from AGI, tax-exempt income (i.e. municipal bond interest), and Form 2555 exclusions for U.S. residents abroad (foreign earned income and housing allowance). Household income also includes the income of any dependents covered on the family insurance plan.
Tax planning tip: Try to defer income and accelerate losses and expenses for household income so you don’t go just a few dollars over 400% of the federal poverty line, as that would require a 100% claw-back of exchange subsidies on Form 8962.
An Obamacare website https://www.healthcare.gov/income-and-household-information/income/ confirms household income includes “Social Security payments, including disability payments — but not Supplemental Security Income (SSI).” According to Form 8962 instructions, social security benefits otherwise not subject to income tax are “added back” since you start with modified AGI rather than just AGI. Eighty-five percent of Social Security payments are included in AGI if the taxpayer exceeds the Social Security AGI threshold of $44,000 for married filing joint ($34,000 for all other taxpayers). Taxpayers under those thresholds exclude 100% of Social Security payments from AGI. Including all social security payments in household income pushes many seniors above the Federal Poverty Line and prevents them from getting a premium tax credit, but most seniors don’t use the exchange because they are covered under Medicare.
For a full description of household income, see Form 8962 instructions.
Federal Poverty Line Chart (based on Form 8962 instructions; these numbers are slightly different for Hawaii and Alaska residents)
Family
100% of
Federal Poverty
400% of Federal
Size
Line
Poverty Line
1
11,490
45,960
2
15,510
62,040
3
19,530
78,120
4
23,550
94,200
5
27,570
110,280
6
31,590
126,360
7
35,610
142,440
8
39,630
158,520
5. Form 8965: Health Coverage Exemptions and instructions. A state or federal exchange needs to issue Form 8965 for certain types of exemptions (like religious), and for other types of exemptions (such as a short coverage gap) the taxpayer may self-prepare the Form 8965. (Be diligent to apply to the appropriate exchange on time — exchanges won’t contact you first.) Taxpayers without a Form 8965 exemption or minimum essential coverage are subject to a shared responsibility payment (see above). For one-page summaries of the exemptions available, see http://www.irs.gov/uac/ACA-Individual-Shared-Responsibility-Provision-Exemptions or IRS Publication 5172 – Facts about Health Coverage Exemptions.
According to Obamacare Mandate: Exemption and Tax Penalty, “The mandate’s exemptions cover a variety of people, including: members of certain religious groups and Native American tribes; undocumented immigrants (who are not eligible for health insurance subsidies under the law); incarcerated individuals; people whose incomes are so low they don’t have to file taxes (currently $9,500 for individuals and $19,000 for married couples); and people for whom health insurance is considered unaffordable (where insurance premiums after employer contributions and federal subsidies exceed 8% of family/household income); and those going without insurance for less than three months in a row … Hardship Exemption Update: If you had your plan canceled in 2014 due to the Affordable Care Act you now qualify for a hardship exemption in 2014. That means you won’t have to pay the shared responsibility payment if you decide to go without insurance and will qualify for low premium, high out-of-pocket catastrophic plans on your state’s health insurance marketplace.” U.S. residents abroad who qualify for Section 911 (foreign earned income exclusion) are deemed to have minimum essential coverage whether they do or not. That means they don’t apply for a Form 8965.
Obamacare is progressive taxation Obamacare is the epitome of progressive taxation and transfer payments using fiscal policy. Upper-income taxpayers pay more to subsidize lower-income folks, and middle-class taxpayers pay their fair share of more expensive coverage that can’t rider out pre-existing conditions. Like many new major social programs enacted before it, some Obamacare tax hikes started on upper-income taxpayers before the new benefits were even provided, including Obamacare Net Investment Income Tax, which started in 2013 even though Obamacare benefits didn’t start until 2014. (Read more about Net Investment Income Tax reported on Form 8960.)
Open question: Are federal exchange subsidies legal?
One court ruled that federal exchange subsidies are illegal and another court overruled it. The Supreme Court agreed to hear the case (WSJ Nov. 7). Obamacare law authorizes subsidies “through an exchange established by the state,” it does not mention a federal exchange. Obamacare law contemplated that all states would have a state exchange but many states balked and chose to participate in HealthCare.gov, the federal exchange just as some also balked at Obamacare’s Medicaid expansion. Did Obamacare purposely provide an incentive to states to create their own exchange, or was leaving out subsidies for the federal exchange an inadvertent oversight? (Read more: http://www.cnbc.com/id/102137279 and http://www.cnbc.com/id/102147639.)
Two Helpful IRS Fact Sheets on ACA
Per Thompson Reuters on Nov. 10 “Affordable Care Act Provisions Impacting Individuals and Employers: Two new IRS fact sheets provide details on key provisions of the ACA. The IRS notes the most important ACA tax provision for individuals and families is the premium tax credit and individuals without coverage and those who don’t maintain coverage throughout the year must have an exemption or make an individual shared responsibility payment. These provisions will affect 2014 income tax returns filed in 2015. For employers, the workforce size is significant because that’s what determines the applicable ACA provisions. Generally different rules apply to employers with fewer than 50 employees. IRS Fact Sheets FS-2014-09 and FS-2014-10 are available at http://www.irs.gov/uac/Newsroom/Fact-Sheets-2014.”
The employer mandate was delayed
Individuals have felt the brunt of Obamacare compliance over the individual mandate. President Obama issued an executive order to delay the employer mandate. But that delay is ending soon. See CNBC Nov. 11 Obamacare Cadillac plans? You’re gonna pay for that….
More changes Prior to Obamacare, S-Corps could reimburse employees for health insurance on a tax-free basis by not including health insurance reimbursements in employee taxable wages. But starting in 2014, S-Corps must include the health insurance reimbursements in taxable wages for income, FICA and Medicare taxes. Don’t skip over making this change as the Obamacare law includes a fine of $100 per employee, per day. An employer group health insurance plan still delivers tax-free benefits to employees. (Postscript 2/18/15: The IRS issued relief for the above draconian penalty. Read more.)
Bottom line Consult with your tax adviser to discuss how Obamacare taxes will affect your 2014 tax return and how it may be best for you to obtain coverage for 2015. There’s still plenty of confusion and new surprises will arise, so stay tuned for updates on our blog.
Postscript Nov. 24, 2014: The IRS published new guidance on ACA’s individual mandate, hardship exemption, and premium tax credit. Notice 2014-76, Rev Proc 2014-62 and final regs for Section 5000A on the individual mandate. Notice 2014-76 “Individual Shared Responsibility Payment Hardship Exemptions that May Be Claimed on a Federal Income Tax Return Without Obtaining a Hardship Exemption Certification from the Marketplace.” Rev Proc 2014-62 “This table is used to calculate an individual’s premium tax credit.” The Rev Proc “announces the indexed applicable percentage table in Code Sec. 36B(b)(3)(A), which is used to calculate an individual’s premium tax credit for tax years beginning after calendar year 2015.”
Darren Neuschwander, CPA and Star Johnson, CPA contributed to this article.
Hosted by GreenTraderTax and presented by Robert A. Green, CPA
Learn how to navigate the minefield, avoid taxes and maximize benefits.
We’ll discuss several topics, including:
• The OC 3.8% Medicare surtax on unearned income — including trading gains — for AGIs over $250k married/$200k single started in 2013. IRS proposed regulations disenfranchise many traders from losing trades, only counting their winning trades. That’s ridiculous and hopefully our petition helps fix the proposals.
• The OC health insurance mandate/tax phase-in begins on March 31, 2014. The penalty is the greater of: $95 per uninsured person or 1% of household income over the filing threshold in 2014; $325 per uninsured person or 2% of household income over the filing threshold in 2015; and $695 per uninsured person or 2.5% of household income over the filing threshold in 2016 and beyond. There are some exemptions; learn more about the individual mandate here. Many traders rely on purchasing health insurance in the individual marketplace, while others benefit from employer-provided insurance. President Obama granted a one year delay to the employer mandates and related taxes.
• To avoid the OC individual mandate/tax, traders must purchase “minimum essential coverage” by March 31, 2014. Traders making less than 400% of the federal poverty level on their 2012 tax return filing qualify for tax credit subsidies on the federal and state exchanges. Because traders’ income and loss fluctuates significantly, they face the prospect of claw-backs since actual 2014 household income may be materially higher than their 2012 tax filing. What happens in the reverse case where 2012 income is materially higher than 2014? Can you get subsidies after the fact? Learn how to calculate household income and try out this subsidies calculator tool based on 2014 estimated income. Traders should not overlook qualifying for (free) Medicaid, set at 138% of the federal poverty level.
• The OC individual mandate/tax is not enforceable like other tax liabilities. While the IRS may not levy your bank account to collect it, it will offset a subsequent tax refund with this tax liability. Eventually, it will be very hard to avoid paying the IRS what you owe.
• Make sure to get a 100% AGI deduction for your self-employed health insurance premiums. Traders often need a trading entity to financially engineer “earned income” — administration fees or salaries — otherwise AGI deductions generally can’t be taken against individual trading gains. The same goes for retirement plan deductions.
The 2012 Patient Protection and Affordable Care Act (ACA) introduced the 3.8% Net Investment Income Tax (NIT) on upper-income individuals and trusts.
Net Investment Income Tax
New taxes were ushered in to finance the law. The Net Investment Income Tax (NIT) (originally referred to as the (ACA 3.8% Medicare surtax on unearned income) affected upper-income taxpayers as of Jan. 1, 2013. It only applies to individuals with net investment income (NII) and modified adjusted gross income (AGI) exceeding $200,000 single, $250,000 married filing jointly, or $125,000 married filing separately. These thresholds are not indexed for inflation. (Modified AGI means U.S. residents abroad must add back any foreign earned income exclusion reported on Form 2555.) The tax also applies to irrevocable trusts (and estates) on the undistributed NII more than the dollar amount at which the highest tax bracket for trusts begins. TCJA did not suspend or modify ACA’s NIT.
Net Investment Income
Notice the terms “investment income” and “unearned income.” People who receive earned income from a job pay Social Security tax (on the social security base amount) and Medicare on their wages or self-employment income. In general, unearned income includes interest, dividends, rents, royalties, capital gains, income and loss from companies in which you are passive, and income and loss from pass-through investment and trading companies. NIT subjects this type of income to Medicare taxes, too — albeit at upper-income brackets only.
NII requires the segregation of different types of unearned income into three different buckets. (Take a look at Form 8960 and the final IRS regulations.)
NII buckets include the following:
Portfolio income (includes interest, dividends, and annuity distributions), royalties (net of oil and gas depletion expenses), and rents (net of depreciation);
Passive activity income and loss from pass-through entities and investment and trading companies;
Capital gains net of capital losses.
NII excludes:
Wages and self-employment income;
Tax-free municipal bond interest income;
IRA and qualified plan distributions;
Income from the disposition of, or pass-through from, active (earned-income related) LLCs, partnerships, and S-corps;
Capital gain received from the sale of your company (and you have been active in it);
Income from rental real estate; and
The “exclusion” portion of a capital gain on the sale of a primary residence. The taxable portion above the exclusion amount is included in NII.
NIT calculations
NIT is assessed on whatever is lower: NII or the AGI amount over the threshold. Here’s an example: A single taxpayer has $300,000 AGI, which is $100,000 over the $200,000 modified AGI threshold. NII is $125,000 after deducting available trading business expenses and certain investment expenses, including stock borrow fees and investment-interest expense. (Trading business expenses on Schedule C or E offset self-employment income first, and any excess may be deducted against NII.) Since NII is higher than the AGI amount over the threshold, NIT is calculated on the lower amount or $100,000 in this example: 3.8% x $100,000 = $3,800 of NIT on Form 8960. If the taxpayer had $75,000 NII, then NIT would be calculated on that lower amount instead (3.8% x $75,000 = $2,850).
NII deductions
Starting in 2018, TCJA suspended “certain miscellaneous itemized deductions subject to the 2% floor,” including investment fees and expenses. The IRS removed those line items from Schedule A.
Section 1411 regulations for NIT require that a permissible deduction for NII must first be allowed elsewhere on an income tax return and investment fees and expenses are no longer deductible on Schedule A or otherwise. Therefore, it may be best not to deduct investment fees and expenses on Form 8960 in determining NII.
Form 8960 Part II, “Investment Expenses Allocable to Investment Income and Modifications,” allows line-item deductions for investment-interest expenses; state, local, and foreign income taxes; and miscellaneous investment expenses.
The Patient Protection and Affordable Care Act (also known as “ObamaCare”) has many new and different types of taxes to finance the law, starting on different dates.
One of these new tax regimes — the “ObamaCare 3.8% Medicare surtax on unearned income” — affects upper-income traders and investment managers as of Jan. 1, 2013. It only applies to individuals with modified adjusted gross income (AGI) exceeding $200,000 (single), $250,000 (married filing jointly) or $125,000 (married filing separately). (Modified AGI means U.S. residents abroad must add back any foreign earned income exclusion reported on Form 2555.)
Final IRS regulations and tax form 8960 instructions were late
The IRS released its final regulations for “net investment income” (NII) and “net investment tax” (NIT) in December 2013, and draft instructions for Form 8960 (Net Investment Income Tax) in January 2014. The IRS was late because the proposed IRS regulations were highly problematic for many CPAs and industry groups who submitted comments asking the IRS for many changes. The proposed regulations disenfranchised taxpayers from deducting their losses against NII which was unfair and against the spirit of the tax code.
Thankfully, the final regulations are better. We are pleased with the results for business traders, who went from being the most disenfranchised to the most enfranchised. Unlike most taxpayers with NII, business traders may deduct trading business net losses and expenses against NII.
What’s included and excluded from NII?
Notice the term “investment income” is used in lieu of “unearned income.” People who receive “earned income” from a job pay FICA (on the social security base amount) and Medicare on their wages or self-employment income. In general, unearned income includes interest, dividends, rents, royalties, capital gains and distributions from companies in which you are passive. Now, this type of income is subject to Medicare taxes, too — albeit at upper-income brackets only.
NII’s proposed regulations interpreted the tax code to require segregation of different types of unearned income into three different buckets, for the main purpose of disenfranchising taxpayers from using losses from any given bucket. The final regs make some serious amends here and the Section 475 MTM trader fares very well…
The NII buckets include the following:
Bucket 1: Portfolio income (includes interest, dividends and annuity distributions), royalties (net of oil and gas depletion expenses) and rents (net of depreciation);
Bucket 2: Passive activity income and loss from pass-through entities;
Bucket 3: Capital gains and losses from the sale of property not used in an active business. In the final regs, the IRS moved trading businesses into bucket 3, so trading business capital gains and losses are counted with investment capital gains and losses. Smart move!…..
There may be even better news, too
The regulations state: “To minimize the inconsistencies between chapter 1 and section 1411 for traders, the final regulations assign all trading gains and trading losses to section 1411(c)(1)(A)(iii). The final regulations also permit a taxpayer to deduct excess losses from the trading business of a section 475 trader from other categories of income. Part 5.C of this preamble describes the treatment of those excess losses.”
Good news for business traders and investment managers: Our petition and request for fixes to the Net Investment Tax worked! The IRS just issued final regulations (TD 9644) for the Affordable Care Act’s “Net Investment Tax” (NIT), the 3.8% Medicare surtax on unearned income above the AGI thresholds of $250,000 married and $200,000 single.
We are pretty satisfied with the final regulations as they affect business traders and investment managers. What could have been a huge mess complying with the proposed regulations — with unintended consequences like overcharging taxes — worked out to be a simple aggregation with tax fairness on true net trading income in the final regulations.
The NIT regulations affect all types of unearned income activities and they are very complex and beyond the scope of this blog. But in this blog, we’re focused on business traders and investment managers.
The problem in the proposed regulations
There are three separate buckets for different types of unearned income: portfolio income goes in bucket #1, passive activity entities and trading businesses go in bucket #2, and capital gains and losses are housed in bucket #3. The biggest problem with the proposed regulations for the NIT is they counted trading gains in bucket #2, but they (probably unintentionally) counted trading losses in bucket #3. You can’t count an individual bucket with a net loss when aggregating net investment income (NII). Wouldn’t it make more sense to put trading businesses in bucket #3, as they are not passive activities anyway?
Our petition showed how a trading business with a net loss could have NII of several hundred thousand dollars because only gains would be counted and not losses.
Problem solved in the final regulations
Kudos to the IRS, not only did they listen to us — and the AICPA, plenty of other accountants and trading industry groups — but they crafted a clever and simple solution for this fix. In a nutshell, a trading business with an entity structure or without (sole proprietorship), with a Section 475 MTM election or default cash method, are all counted in bucket #3 capital gains and losses. This immediately fixes the glaring problem of a trading entity having gains counted in bucket#2 and losses counted separately in bucket #3.
Using bucket #3 for all trading business gains and losses makes good sense. Doesn’t a trading business have more to do with capital gains and losses in bucket #3 than a passive-activity entity in bucket #2? While many trading businesses are conducted in pass-through entities, it is not considered a passive activity under the “trading rule” in Section 469. Bucket #2 is important for passive activities with unearned income because active businesses generally have earned income subject to Medicare tax on earned income.
There may be even better news, too
The regulations state: “To minimize the inconsistencies between chapter 1 and section 1411 for traders, the final regulations assign all trading gains and trading losses to section 1411(c)(1)(A)(iii). The final regulations also permit a taxpayer to deduct excess losses from the trading business of a section 475 trader from other categories of income. Part 5.C of this preamble describes the treatment of those excess losses.”
Consider the example of a Section 475 MTM trader who arbitrages securities trades against interest income. He has interest income in bucket #1 and securities trading gains and losses in bucket #3. With the final regs, it may be possible for him to offset bucket #1 interest income with net Section 475 MTM ordinary losses in bucket #3. Stay tuned for more news on these regs.
Click here for an excerpt of TD 9644 showing these changes. We added yellow highlights.
According to respected blogger Farm CPA Today, “The final regulations now allow at least three new ways of using losses:
If you have a net capital loss for the year, the regular tax laws limit this loss to $3,000. The final regulations allow this up to $3,000 loss to offset other investment income.
If you have a passive loss such as Section 1231 losses, as long as that loss is allowed for regular income tax purposes, you will be allowed to offset that against other investment income.
Finally, if you have a net operating loss carry forward that contains some amount of net investment losses, you will be allowed to use that portion of the NOL to offset other investment income.”
Bottom line
In our petition, we wanted the IRS to scrap all three buckets entirely, or allow a bucket with a net loss to be counted in NII, as that is how we read the law enacted by Congress. While the IRS hasn’t gone that far, and these regs are still an abomination of complexity and nuance, we are happy the IRS made the law fairer for traders and investors.
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