Thursday, January 27, 2022

How a taxpayer’s filing status affects their tax return

A taxpayer’s filing status tells the IRS about them and their tax situation. This is just one reason taxpayers should familiarize themselves with each option and know their correct filing status. The IRS Interactive Tax Assistant can help them determine their filing status.

A taxpayer's filing status typically depends on whether they are considered unmarried or married on Dec. 31, which determines their filing status for that entire year.

More than one filing status may apply in certain situations. If this is the case, taxpayers can usually choose the filing status that allows them to owe the least amount of tax.

When preparing and filing a tax return, filing status determines:

  • If the taxpayer is required to file a federal tax return
  • If they should file a return to receive a refund
  • Their standard deduction amount
  • If they can claim certain tax credits
  • The amount of tax they owe

Here are the five filing statuses:

  • Single. Normally, this status is for taxpayers who are unmarried, divorced or legally separated under a divorce or separate maintenance decree governed by state law.  
  • Married filing jointly. If a taxpayer is married, they can file a joint tax return with their spouse. If one spouse died in 2021, the surviving spouse can use married filing jointly as their filing status for 2021 if they otherwise qualify to use that status. 
  • Married filing separately. Married couples can choose to file separate tax returns. This may benefit taxpayers who want to be responsible only for their own tax or if it results in less tax than filing a joint return. 
  • Head of household. Unmarried taxpayers may be able to file using this status, but special rules apply. For example, the taxpayer must have paid more than half the cost of keeping up a home for themselves and a qualifying person living in the home for half the year.
  • Qualifying widow or widower with dependent child. This status may apply to a taxpayer filing a 2021 tax return if their spouse died in 2019 or 2020, and they didn't remarry before the end of 2021 and have a dependent child. Other conditions also apply.

More Information
Publication 501, Dependents, Standard Deduction, and Filling Information
Publication 17, Your Federal Income Tax


Tuesday, January 11, 2022

Qualified Small Business Stock

QSBS is stock in a company where the price appreciates greatly, and when you sell it, you pay NO TAX on your profit!!!!

Also known as Section 1202 stock, QSBS can be a significant planning tool for a startup. 

Because of the potential for reaping big profits at no tax cost, companies that can qualify as a “small business” for this purpose should consider using their stock strategically for attracting investors and rewarding employees.

While the tax break for QSBS is very generous, the definition of it is very restrictive. There are many conditions; the key ones are:

The issuer must be a C corporation in the U.S. (not S corporation).

The corporation’s assets must be $50 million or less at all times before and after the issuance of the stock.

The corporation must be an active business.

The corporation must be in a business other than one involving personal services; banking, insurance, financing, leasing, or investing; farming; mining; or operating a hotel, motel, or restaurant. 

Both the corporation and the shareholder must consent to provide certain documentation for the stock.

The stock must be acquired in exchange for money or property or as pay for services provided to the corporation. 

The statute limits the per-issuer amount that can be excluded to “eligible gain,” which is the greater of:

1) $10 million reduced by any amount the taxpayer excluded from sales or exchanges of QSBS from the same issuer in prior years, or

2) 10 times the aggregate adjusted basis of the QSBS issued by the corporation disposed of by the taxpayer during the taxable year, as measured on the original issue date.

Because the limitation references the higher amount of the two measurements, the potential total gain excluded from gross income may exceed $10 million.  Because a corporation qualifying for the provision could have up to $50 million in assets upon inception,10 the maximum amount of gain eligible for exclusion could reach $500 million under the ten-times-basis limitation.

Section 1202(c)(2) contains an active business requirement, as defined in section 1202(e), for qualified small business stock. 

Section 1202(e)(1)(A) requires that during the relevant period “at least 80 percent (by value) of the assets of such corporation are used by such corporation in the active conduct of 1 or more qualified trades or businesses”. 

Section 1202(e)(3)(A) defines a “qualified trade or business” as any trade or business other than 

(A) any trade or business involving the performance of services in the fields of health, law, engineering, architecture, accounting, actuarial science, performing arts, consulting, athletics, financial services, brokerage services, or any trade or business where the principal asset of such trade or business is the reputation or skill of 1 or more of its employees,

Important Case Laws:

Case Law: TC Memo 2012-21: Owen v. Commissioner of Internal Revenue "failed the active business requirement."

PLR 201436001 – September 5, 2014 "A biotech company met the definition of a qualified trade or business."

PLR 201717010 – April 28, 2017 "A company that provides laboratory reports to health care professionals met the definition of qualified trade or business."

PLR 201636003 – September 2, 2016 "Paper shares need not be issued for shareholders to qualify for QSBS treatment."


Wednesday, January 5, 2022

Alien Tax Status First-Year Choice

If you do not meet either the green card test or the substantial presence test for the current year (for example, 2020) or the prior year (2019), and you did not choose to be treated as a U.S. resident for part of the prior year (2019), but you meet the substantial presence test in the following year (2021), you can choose to be treated as a U.S. resident for part of the current year (2020) and be taxed as a dual-status alien for the current year (2020). To make this first-year choice, you must:

  1. Be present in the United States for at least 31 days in a row in the current year (2020), and
  2. Be present in the United States for at least 75% of the number of days following the 31-day period, beginning with the first day of the 31-day period and ending with the last day of the current year (2020). (For purposes of this 75% requirement, you can treat up to 5 days of absence from the United States as days of presence in the United States.)

When counting the days of presence in (1) and (2) above, do not include the days you were present in the U.S. as an exempt individual.

If you make the first-year choice, your residency starting date for the current year (2020) is the first day of the earliest 31-day period (described in (1) above) that you use to qualify for the choice. You are then treated as a U.S. resident for the rest of the year.

If you are present for more than one 31-day period and you satisfy condition (2) above for each of those periods, your residency starting date is the first day of the first 31-day period. If you are present for more than one 31-day period but you satisfy condition (2) above only for a later 31-day period, your residency starting date is the first day of that later 31-day period.

Residency Examples

Example 1. J is a citizen of a foreign country who came to the U.S. for the first time on November 1, 2020 and was here 31 consecutive days (from November 1 through December 1, 2020). J returned to the foreign country December 1 and came back to the United States December 17, 2020. J stayed in the United States for the rest of the year. During the following year (2021), J was a resident of the United States under the substantial presence test. J can make the first-year choice for 2020 because J was in the United States in 2020 for a period of 31 days in a row (November 1 through December 1) and for at least 75% of the days following (and including) the first day of that 31-day period (46 total days of presence in the United States divided by 61 days in the period from November 1 through December 31 equals 75.4%). If J makes the first-year choice, J’s residency starting date will be November 1, 2020.

Example 2. The facts are the same as in Example 1, except that J was also absent from the United States on December 24, 25, 29, 30, and 31. J can make the first-year choice for 2020 because up to 5 days of absence are considered days of presence for purposes of the 75% (0.75) requirement.

Filing Form 1040

You must attach a statement to Form 1040 to make the first-year choice. The statement must contain your name and address and specify the following:

  • That you are making the first-year choice for the current year (2020).
  • That you were not a U.S. resident in the prior year (2019).
  • That you qualified as a U.S. resident under the substantial presence test in the following year (2021).
  • The number of days of presence in the U.S. during the current year (2020).
  • The date or dates of your 31-day period of presence and the period of continuous presence in the U.S. during the current year (2020).
  • The date or dates of absence from the U.S. during the current year (2020), if any, that you are treating as days of presence under the first-year choice – see (2), above.

You cannot file Form 1040 or the statement for the current year (2020) until you meet the substantial presence test in the following year (2021). If you have not met the test for the following year (2021) as of April 15 of 2021 (the filing due date of the current year), you can request an extension of time for filing your Form 1040 for the current year (2020) until a reasonable period after you have met that test for the following year (2021). To request an extension to file, use Form 4868, Application for Automatic Extension of Time to File U.S. Individual Income Tax Return.

Once you make the first-year choice, you may not revoke it without the approval of the Internal Revenue Service.

Note: If you do not follow the procedures discussed here for making the first-year choice, you will be treated as a nonresident alien for the entire tax year. However, this does not apply if you can show by clear and convincing evidence that you took reasonable actions to become aware of the filing procedures and significant steps to comply with the procedures.

Choosing Resident Alien Status

If you are a dual-status alien, you can choose to be treated as a U.S. resident for the entire year if all of the following apply.

You were a nonresident alien at the beginning of the year.

You are a resident alien or U.S. citizen at the end of the year.

You are married to a U.S. citizen or resident alien at the end of the year.

Your spouse joins you in making the choice.

This includes situations in which both you and your spouse were nonresident aliens at the beginning of the tax year and both of you are resident aliens at the end of the tax year.

Note. If you are single at the end of the year, you cannot make this choice.

If you make this choice, the following rules apply.

You and your spouse are treated as U.S. residents for the entire year for income tax purposes.

You and your spouse are taxed on worldwide income.

You and your spouse must file a joint return for the year of the choice.

Neither you nor your spouse can make this choice for any later tax year, even if you are separated, divorced, or remarried.

The special instructions and restrictions for dual-status taxpayers in chapter 6 do not apply to you.

Note. A similar choice is available if, at the end of the tax year, one spouse is a nonresident alien and the other spouse is a U.S. citizen or resident. See Nonresident Spouse Treated as a Resident, later. If you previously made that choice and it is still in effect, you do not need to make the choice explained here.

Making the choice. You should attach a statement signed by both spouses to your joint return for the year of the choice. The statement must contain the following information.

A declaration that you both qualify to make the choice and that you choose to be treated as U.S. residents for the entire tax year.

The name, address, and taxpayer identification number (SSN or ITIN) of each spouse. (If one spouse died, include the name and address of the person who makes the choice for the deceased spouse.)

You generally make this choice when you file your joint return. However, you can also make the choice by filing Form 1040-X, Amended U.S. Individual Income Tax Return. Attach Form 1040 or 1040-SR and print "Amended" across the top of the corrected return. If you make the choice with an amended return, you and your spouse must also amend any returns that you may have filed after the year for which you made the choice.

You must generally file the amended joint return within 3 years from the date you filed your original U.S. income tax return or 2 years from the date you paid your income tax for that year, whichever is later.

References/Related Topics



Why should I keep records?

Good records will help you monitor the progress of your business, prepare your financial statements, identify sources of income, keep track of deductible expenses, keep track of your basis in property, prepare your tax returns, and support items reported on your tax returns.

What kinds of records should I keep?
You may choose any recordkeeping system suited to your business that clearly shows your income and expenses. Except in a few cases, the law does not require any special kind of records. However, the business you are in affects the type of records you need to keep for federal tax purposes.

How long should I keep records?
The length of time you should keep a document depends on the action, expense, or event the document records. You must keep your records as long as needed to prove the income or deductions on a tax return.

How should I record my business transactions?
Purchases, sales, payroll, and other transactions you have in your business generate supporting documents. These documents contain information you need to record in your books.

What is the burden of proof?
The responsibility to substantiate entries, deductions, and statements made on your tax returns is known as the burden of proof. You must be able to prove certain elements of expenses to deduct them.

How long should I keep employment tax records?
Keep all records of employment taxes for at least four years.


Sole Proprietorships

A sole proprietor is someone who owns an unincorporated business by himself or herself. However, if you are the sole member of a domestic limited liability company (LLC), you are not a sole proprietor if you elect to treat the LLC as a corporation.

If you are a sole proprietor, use the information in the chart below to help you determine some of the forms that you may be required to file.

IF you are liable for:THEN use Form:
Income Tax

1040, U.S. Individual Income Tax Return 

or  1040-SR, U.S. Tax Return for Seniors

and Schedule C (Form 1040 or 1040-SR), Profit or Loss from Business

Self-employment taxSchedule SE (Form 1040 or 1040-SR), Self-Employment Tax
Estimated tax1040-ES, Estimated Tax for Individuals
Social Security and Medicare taxes and income tax withholding

941, Employer's Quarterly Federal Tax Return

943, Employer's Annual Federal Tax Return for Agricultural Employees

944, Employer's Annual Federal Tax Return

Providing information on Social Security and Medicare taxes and income tax withholding

W-2, Wage and Tax Statement (to employee)

and W-3, Transmittal of Wage and Tax Statements (to the Social Security Administration)

Federal unemployment (FUTA) tax940, Employer's Annual Federal Unemployment (FUTA) Tax Return
Filing information returns for payments to nonemployees and transactions with other personsSee Information Returns
Excise TaxesRefer to the Excise Tax webpage

Small Business Tax Responsibilities

What are the types of payments that are taxable income for a business?

Any payment you receive connected to your business is considered taxable business income?

There are traditional forms such as cash, checks, and credit cards for products sold or services rendered.

In addition, if you receive a payment that would not have been made if you didn't have the business, that payment is business income.

Business income can include bartering, real-estate rents, interest and dividends, cancelled debt, damages, or even kickbacks.

Also, if you direct payment through a third party, it is still your income and must be reported on your return. But there are business deductions, too.

You can deduct business expenses -- the cost of carrying on a trade or business.

There are several types of deductible business expenses.

To be deductible, a business expense must be both ordinary, which is common and accepted in the line of work, and necessary, that is, helpful and appropriate.

It's important to separate business expenses from other expenses, such as cost of goods sold if your business makes or resells products, the purchase of assets, or personal expenses. It's very important to keep good records about your business income and expenses.

You don't want to overreport your income and pay too much tax, and you don't want to underreport and pay too little.

There are benefits to having a formal set of books and records, accounting or financial software, and separate bank accounts for business and personal income and expenses.

Small Business Tax Responsibilities Publication 4591 IRS Publications

Pub 15 (Circular E), Employer’s Tax Guide

Pub 334 Tax Guide for Small Business

Pub 463 Travel, Entertainment, Gift, and Car Expenses

Pub 505 Tax Withholding and Estimated Tax

Pub 535 Business Expenses

Pub 583 Starting a Business and Keeping Records

Pub 587 Business Use of Your Home

Pub 946 How to Depreciate Property

Pub 966 Electronic Choices to Pay all your Federal Taxes

Pub 1779 Independent Contractor or Employee

Pub 3148 Tips on Tips: A Guide to Tip Income Reporting

Pub 3402 Taxation of Limited Liability Companies

Pub 3995 Recognizing Illegal Tax Avoidance Schemes


Who is eligible to take the qualified business income deduction QBID?

Qualified Business Income Deduction under 199A.

This is also known as the passthrough deduction or sometimes the Section 199A deduction. 

Who is eligible to take the qualified business income deduction QBID? 

Taxpayers; other than C corporations, that includes individuals in certain trust and estate who have qualified business income from tax years ending after December 31, 2017 and that income comes from a qualified trade or business or a qualified publicly-traded partnership PTP; Section 199A real estate investment trust dividends [REIT dividends or R-E-I-T dividend.] 

Partnerships and S corporations don't determine the deduction at the entity level, but they will passthrough the information necessary for their partners and shareholders can claim the deduction on their tax return. 

Individuals and certain trust and estate may be entitled to a qualified business income deduction

The deduction is limited to the lesser of these amounts or taxable income less net capital gain. 

What is qualified business income QBI. 

Basically, QBI is the net amount of qualified items of income, gain deduction and loss for many qualified trade or business. 

Only those items that are included in taxable income are counted. So, for example, if you have a current year business loss, or losses, that are limited by the passive activity loss limitations, only the losses from the businesses that are allowed to be claimed on the current years' Form 1040 would be included in the QBI computation. In addition, the items must be effectively connected with the United States trade or business.

Now, the businesses that may generate QBI would include those conducted through sole proprietorships, sub-chapter S corporations, partnerships, trusts and estates. 

But remember, that income earned through a C corporation is not eligible for the deduction.


Tax implications of employing family members at your small business

The tax rules for family employees may differ from other employees depending on the family relationship and the business entity type.

Let´s start with a child working for a parent.

Payments for the child´s services are subject to income tax withholding, regardless of age.

However, if the child is under 18 and working for a parent in a trade or business, payments are generally not subject to Social Security and Medicare taxes.

And if the child is under 21, those payments are not subject to FUTA.

That´s unemployment tax.

However, if the business is structured as a corporation, an estate, or a partnership where only one of the parents is a partner, then you must withhold all of these taxes from the child´s wages.

Now, what if a parent is working for their child?

If the child employees the parent in a trade or business, then the child withholds income tax, Social Security, and Medicare taxes.

Wages paid to the parent are not subject to FUTA tax, regardless of the type of services, but if your parent works for you in some other capacity not related to your business, Social Security and Medicare taxes do not apply to the wages paid to them.

But they do apply to some domestic services where certain conditions exist.

Our final situation would be a spouse employed by the other spouse in a trade or business.

These wages are subject to income tax withholding and Social Security and Medicare taxes but not FUTA tax.

There are exceptions.

If the spouse works for a corporation, even if it´s controlled by the individual´s spouse, or a partnership, even if the individual´s spouse is a partner, in those cases, FUTA tax would apply, too.

The IRS has many resources to help you understand all these nuances in the tax law when it comes to employing family members.

You can go to and enter "Employing Family" or "Business with Employees" in the search box.

And you can also download Publication 15, Circular E, Employer´s Tax Guide, for more comprehensive information.


Home Office Deduction - What's Allowable?

More and more small-business owners are running businesses out of their homes.

But just what is and is not tax-deductible?

Generally, you may not deduct expenses related to the rent, purchase, maintenance, and repair of a personal residence.

However, if you use a portion of your home for business, you may be able to take a home-office deduction if you meet certain requirements.

Deductible expenses might include the business portion of real estate taxes, mortgage interest, rent, utility, insurance, depreciation, painting, and repairs.

Those who work out of their homes are entitled to deduct ordinary and necessary expenses related to the business.

This includes costs related to regular and exclusive business use that can be clearly distinguished from personal use or reasonably allocated between the two.

Exclusive use means a specific area of your home is used only for trade or business.

Regular use means it's used regularly, not just occasionally or incidentally.

And that's important because both conditions must apply.

Also, if you work as someone's employee, you can claim this deduction only if the regular and exclusive business use of the home is for your employer's convenience, not yours, and your employer does not rent the business portion of your home.

Here are just a few criteria that you would need to meet when considering a business deduction for using part of your home.

You use part of your home exclusively and regularly as your principal place of business...

you meet or deal with patients, clients, or customers there...

you have a separate, free-standing structure not attached to the home, such as a studio, garage, or barn that you use exclusively and regularly for your trade or business 

you have a separate, identifiable part of your home that you use regularly for storage, such as inventory or product samples, as rental property, or as a home daycare facility.

Personal, family, and living expenses are not deductible under any circumstances.

A common error is to deduct expenses for a portion of the home that is not regularly used or exclusively used for business.

It's important to understand the rules, compute the deductions correctly, and keep accurate records to substantiate those deductions.

For worksheets and additional information on computing the allowable home-office deduction, check out Publication 587, Business Use of Your Home.

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