Clarifying Tax Law Confusion

Last month, President Trump issued an executive order to provide employees relief from withholding taxes. The result is additional take-home pay for the employee. This article focuses on the mechanics and results of this order. I will also opine on the impact of such order to the solvency of the Social Security Benefit Program which, as stated in my previous article, remains marginally funded through 2035.

We all wish to create greater amounts of cash flow for our living expenses but at what price does this wish come true? For example, if you are currently employed, you are contributing to your future through a withholding program titled “Federal Insurance Contributions Act” abbreviated as FICA. Two components make up the FICA portion of your paycheck withholding. The first component is the Social Security Tax, also called the Old-Age, Survivors and Disability Insurance (OASDI) Tax, at a rate of 6.2% of your gross wages to a maximum wage limit of $137,700.

The second component of the FICA is the Medicare Tax at the rate of 1.45%. This tax is applied to all wages paid to an employee. Unlike the Social Security Tax, the Medicare Tax has no annual wage limit. These withheld funds are committed, by the U.S Government, to your future for purposes of assisting with lifestyle expense. 

The president’s order requires employers to discontinue withholding the 6.2% FICA from employees’ paychecks. However, the employer continues to be responsible for the matching funds at a rate of 6.2%. To further complicate the application of the order, employees with bi-weekly income of greater than $4,000 do not qualify for the deferral of the 6.2% Social Security Tax. Based on a weekly payroll of $2,000, employees earning less than $104,000 in annual wages will be eligible for the deferral and will take home more net pay.

As with any tax benefit, the applicable period for the deferral of Social Security Tax for eligible employees is September 1 through December 31, 2020. The desire of the Executive Branch of our government is to develop a law that will allow the deferred balance of Social Security Tax to be eliminated instead of repaid by the employee.

To remedy the confusion on which party, employer or employee, pays the deferred Social Security Tax, the IRS issued on August 28, 2020, Notice 2020-65. The notice directs employers to remit the deferred Social Security Taxes ratably over the period January 1, 2021 through April 30, 2021. Failure to remit the taxes deferred from 2020 will subject the employer to interest and penalties.

One could argue the additional cash flow required to pay both employee and employer shares of the Social Security Tax places a burden on the employer. What will be the tax deduction allowed the employer if both shares of the tax are paid by the employer? Tax policy would dictate the fairness of allowing the employer the deduction since the economic impact is actually borne by the employer. However, tax policy in the United States is not based on equality but rather revenue generation. Who knows what will happen until we receive additional guidance from the Treasury Department?

Until then, keep smiling, enjoy your extra cash and I’ll see you on the golf course! 

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Social Security Funding Challenges

Social Security benefits are considered sacred territory by elected officials due to the large number of voting beneficiaries. This important “third rail” of untouchable programs started with a mission and purpose that was admirable. However, the projection of beneficiaries compared to those taxpayers funding the program has been dealt a significant blow lately.

To provide working families a larger paycheck, the president has recently ordered that all employer withholding for FICA and Medicare contributions from employees be deferred until January 1, 2021. Can you imagine the furor this caused? Although the intent is beneficial for those working, it is not an elimination of the tax from the pay but merely a deferral. This means that you, the employee, will be required to pay the deferral back to the system at some point. 

The IRS has not issued guidance on this process for repayment but the deferral will begin September 1, 2020 and continue through December 31, 2020. Let’s look at an example of the additional funds an employee will retain through this deferral period. Assume the weekly salary is $500. An employee’s share of SSA benefits withheld, notwithstanding the Medicare portion of 1.45%, is 6.2% of the gross salary or $31.00 ($500 x 6.2%). As of the date this article was authored, seventeen weeks remain in 2020. This provides the employee with an additional $527 of cash flow for her living needs.

How will this seventeen-week deferral impact the reserves for Social Security benefit payments? The SSA Board of Trustees analyzes the economic projections of the program when issuing their report to the public. Below is a graph reflecting the solvency of the program through 2035 under current funding projections.

Old-Age & Survivors Insurance & Disability Insurance Combined Trust Funds Reserves

By reducing the contributions of working individuals to the program for the short period, officials estimate the solvency would be impaired much sooner. Change creates confusion and chaos soon ensues. This is the current state of the changes to the Social Security Program funding for the remainder of 2020.

What does it mean “the program will be insolvent” in 2035? The SSA Board of Trustees has projected the program can continue to fund existing beneficiaries from current income received by the fund. However, the level of funding will only allow beneficiaries to receive approximately 79% of scheduled benefits. What will this mean for future beneficiaries? An obvious answer I inform younger clients is that the program will be available for them but we are not certain of the benefit structure.

One caveat I would offer is that current beneficiaries will not be impacted by this short-term change. However, future changes of a more sustainable nature should be addressed to continue the functions of the current program. The funding source (employed citizens below the retirement age for program benefits) is shrinking in comparison to the beneficiaries receiving benefits.

It is critical that one does not solely rely on SSA benefits for your retirement income. By becoming self-sufficient for your needs, you will be confident and enjoy your retirement years much more. If you are concerned how the changes to the Social Security Program will impact your retirement decisions, seek out a Certified Financial Planner® professional that specializes in retirement planning. It never hurts to get a complimentary second opinion. See you on the golf course!

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Tax Law Changes Due to COVID-19

Many U.S. citizens have been subjected to financial and other difficulties due to the pandemic. In March, 2020, the U.S. Treasury Department issued an extension of time for filing, and paying, income taxes for individuals. The good news is that you have until July 15, 2020, to file your 2019 individual income tax returns and pay your taxes. Even better news is that you will not be penalized for filing the returns and paying your taxes after April 15, 2020, which is the original legal due date. This exception for the filing date is only applicable to this year due to the disruption in the economy and the “safer at home” implementation protocol for reducing the spread of COVID-19.

Confusion arises when you are one of the taxpayers required to make estimated tax payments to resolve your tax liability. For example, the typical estimated tax payment schedule would be April 15, 2020, June 15, 2020, September 15, 2020 and January 15, 2021. The confusion arises when the original due date for your 2019 return has been extended beyond the payment date for your second quarterly estimated tax payment. To reconcile this quandary, the IRS changed the order of the required estimated tax payments to be as follows: 1st quarter – July 15, 2020; 2nd quarter – July 15, 2020; 3rd quarter – September 15, 2020; and 4th quarter – January 15, 2021. 

Additional time to file returns and pay taxes is an anomaly for U.S. tax filers. Typically, an extension of time would be requested by filing a Form 4868 with the IRS on or before April 15. Consequently, if additional time is needed to complete and file your 2019 returns beyond the extended due date of July 15, you must file a Form 4868 to request additional time to file until October 15, 2020. Remember, the tax you owe for 2019 must be paid by July 15, 2020, or additional penalties and interest may be incurred. To alleviate these onerous penalties and interest, remit your estimated amount owed with your filing of Form 4868.

For those of us that are charitably minded but lack the required level of expenses that qualify for itemizing deductions on our individual return, the IRS is allowing an “above-the-line” deduction of $300 for qualified charitable contributions. My philosophy is to support my favorite qualified exempt organizations despite the ability to deduct the contribution. The pandemic has dealt a cruel blow to the finances of many exempt organizations during a time the need is much greater than anticipated. Take advantage of this opportunity to provide support for our citizens in need of these services and deduct up to $300 without itemizing your deductions for your 2020 income tax returns.

Individuals who wish to be generous in their contributions to exempt organizations can donate even more than the previously law allowed in 2020. Under prior law, the limit for cash donations was increased from 50% to 60% of the taxpayer’s adjusted gross income. The CARES Act suspends the limit of 60% and allows you to contribute 100% of your adjusted gross income to qualified exempt organizations. This provision of law was intended to help the funding shortfalls of the exempt organizations during the pandemic. The suspension applies to cash contributions only (of course, a check or other forms of cash will suffice) and not to contributions of property. Let’s support these organizations that provide a substantial service to our communities!

Lastly, join me in taking the necessary actions to eliminate or thwart the spread of the virus. Each of us has a responsibility in our community to do our part. Adhere to the three “W’s”: Wear a mask, Wait for six feet in distance between you and others in small gatherings to avoid close contact and Wash your hands. All people, including our friends in other countries, should care for one another and work together to rid our world of this deadly virus.

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How Long to Keep Tax Records?

If you are like most individuals, you have a drawer in your home or a box in the garage that contains all of your tax returns and supporting information from 1987. It is the sacred box of “all things to defend myself from the IRS”. Today, I am providing you some guidance that will help you clean out that drawer or box as well as relieve your mind from future inquires of taxing agencies.

There is no other word that strikes fear in the hearts of citizens worse than “Internal Revenue Service”. You go to mailbox and open it with a smile hoping that Ed McMahon has sent you the winning ticket to a sweepstakes only to find an ominous envelope from the IRS. Before opening the envelope, your mind races through a myriad of circumstances and outcomes. Survival instincts fire in your brain that you should seek a lawyer or CPA, transfer assets to other relatives or some other ridiculous plan to counter the attack by this federal agency.

Would you believe that most correspondence from the IRS is clerical in nature? The complicated system of revenue collection in the United States does not process without mistakes. A few years ago, one of our new clients came to the office, looking white as a sheet, and holding a rather large, white envelope. Her introduction omitted pleasantries and she immediately initiated her case of fearing the IRS and now “I will lose my house!” After speaking with her for a few minutes, providing a nice cold drink of water, and opening the envelope to read its contents, we disclosed some good news to her. She didn’t owe the government any money, she was actually receiving a refund. She looked at me with her eyes as big as silver dollars and exclaimed, “What?” Her previous tax returns, prepared by someone else, had omitted one of her estimated tax payments and she was receiving a refund of almost $21,000. 

The moral of this story is that many citizens do not understand the role, authority and power of the IRS. This agency is one of the most powerful of our government. However, in my 33-year career of interacting with the IRS, I have experienced very few instances where I was treated unfairly or unprofessionally.

Maintaining proper and complete records of your financial transactions reported on your tax returns is critical to good outcomes. The statute of limitations for most individual income tax returns is three years from the date you filed your return or two years from the date you paid the tax owed. This means that any of your individual income tax return forms can be destroyed or scanned to electronic storage. You should keep all records to document income, expenses, gains and losses from the three years’ of returns so that you may properly defend your tax returns should you be selected for audit. Wow! That sounds like a sinister word – audit.

Certain documents should be retained indefinitely such as property deeds, birth certificates, gift tax transactions, stock certificates, bonds, and marriage licenses. Most of these documents can be reclaimed but the process is rather time consuming.

The key to a pleasant and happy life is to understand the role government plays in our lives. Too often myths and speculation rule our minds when the actual facts are much less menacing. If you receive a notice from any taxing agency, contact your CPA or tax preparer to determine the appropriate response. As citizens, you have appeals rights, amendment capabilities and other actions you can take to mitigate or eliminate your tax matter.

If you have a question about filing your individual income tax returns, click this link for information that may be helpful. Until next week, stay safe and well.

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