As part of the 2020 Tax Update and Review Conference Virtual Conference series, we field questions from our students throughout the presentation. We have highlighted some of the common questions and the answers you might find valuable.
Lesson 2 deals with a variety of compensation issues including: collectibles, crowdfunding, Cryptocurrency, unemployment, non-cash prizes, workers compensation, sick pay, automotive dealer incentives, surrogacy fees, Medicaid waiver payments, renter lease buy out, W-2 after death, utility rebates, misclassified employees, tip income, social security, capital transactions, wash sales, employee stock options, qualified small business stock, uncommon home sale issues, debt relief and exclusions, personal injury, statutory employee, insurance sales and viatical settlements, interest tracing rules and qualified opportunity funds.
QUESTION: Sometimes an individual starts as a subcontractor but at a later date becomes an employee - will the employee receive both 1099NEC and W2?
ANSWER: That is true, sometimes an employer may treat a worker as an independent contractor for a period of time and switch to an employee. The worker was probably an employee all along and was misclassified by the employer. We have seen employers pay bonuses to employee and treat the bonus as 1099-NEC payment which is an absolute no-no.
However, it is the employer’s responsibility to make the classification so you should go with what you are presented by your client, be it a W-2, 1099-NEC or both.
Other states may have different rules, but in CA paid advisors (excluding attorneys and employees of the company) who "knowingly advise" employers to treat an individual as an independent contractor to avoid employee status for that individual are jointly and severally liable for any penalties imposed on the employer if the individual is found not to be an independent contractor. (Labor Code Section 2753)
Given the advisor liability provision, consultants, Enrolled Agents, CPAs, return preparers and others who might otherwise advise their clients on how to classify workers should instead refer the client to an employment attorney.
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QUESTION: Regarding the sale of the home by divorced spouses. What does "Some Time" mean? What would the period of time be for that? My client's ex-wife sold the house after 20 years and he received a 1099S for half. Does 20 years qualify as "Some Time"?
ANSWER: Some period of time is indefinite if all of the other criteria are met. The following is from the seminar text (Big Book of Taxes) page 2.08.13:
Sale after ex-spouse retains property for some period of time - Only for purposes of this exclusion is an individual treated as using property as the individual’s principal residence during any period of ownership while the individual’s spouse or former spouse is granted use of the property under a divorce or separation instrument. This means that if a husband (or wife) continues to own the home after a divorce, and his/her former wife (husband) is granted use of the property under a divorce instrument, the exclusion could be available when the husband (wife) sells the house if he (she) meets the ownership requirement and his wife (her husband) meets the use requirements. (Reg. §1.121-4(b)(2))
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QUESTION: For home sale, a duplex where owner lives in one half and rents out the other half (they assign rental basis 50% of original cost), so when they sell, how is the sale price allocated? Would the sales price be allocated by how the cost basis was? So, 50%?
ANSWER: Since the property is a duplex, one unit is a rental and the other is a principal residence. When it was originally purchased the purchase basis should have been allocated by square foot and the rental unit depreciated. Now you are separately selling a home and a rental. The sales price, and sales costs should also be allocated between two based upon square feet. Only the home gain would be subject to the Sec 121 exclusion. The rental portion will be taxable, and the rental basis adjusted for the depreciation claimed in the prior years when determining the rental gain. I may have provided more than you asked for, but just to be on the safe side.
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QUESTION: Regarding the W-2 requirement for an on-site apartment manager - Would this apply to a property manager for a condo homeowner association? I have this situation where the HOA owns the condo unit, the property manager lives on-site rent-free and also receives a contract amount. Is paid as a sub-contractor and received a 1099.
ANSWER: This is from the seminar text which provides additional details. See page 2.01.06. Landlords will often hire a resident manager to handle the day-to-day tasks of running an apartment building. In some locales and depending upon the number of units in the apartment complex, resident managers are required. For example, in California, resident managers are required where there are 16 or more units, while the requirement applies for 9 units in NY City.
The managers may be compensated for their services, provided reduced or free rent, or a combination of both. The tax implications to the landlord and resident manager are:
Resident Manager – If the resident manager is compensated monetarily, they are treated as an employee and as such are subject to payroll withholding, and FICA. If they are provided reduced or free rent, that reduction is not included in taxable income (Reg. Sec. 1.119-1(b)) if:
- The lodging is at the landlord’s rental property,
- The lodging is furnished for the convenience of the landlord, and
- The manager is required, as a condition of employment, to live in the apartment building. (Code Sec 119 – Meals or lodging furnished for the convenience of the employer)
If the above conditions are NOT met, the rental FMV is taxable income to the manager reported on a W-2 by the landlord or other employer (Letter Ruling 9404005).
From Pub 15-B, page 17 (2020):
Example of nonqualifying lodging - A hospital gives Joan, an employee of the hospital, the choice of living at the hospital free of charge or living elsewhere and receiving a cash allowance in addition to her regular salary. If Joan chooses to live at the hospital, the hospital can't exclude the value of the lodging from her wages because she isn't required to live at the hospital to properly perform the duties of her employment.
Landlord - If the resident manager is compensated monetarily, then the manager is a W-2 employee of the landlord and subject to the normal W-2 withholding and reporting requirements. Where the landlord reduces or provides free rent, whether or not also compensating the manager monetarily, and the three conditions listed under resident manager are met, the landlord has no reporting requirements regarding the free rent and no deduction for the free rent since the lack of the rental income constitutes his adjustment for the lost rental income.
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QUESTION: Please clarify. Are Medicaid waiver payments from IHSS excluded from income as well as available for EITC credit?
ANSWER: The IRS, way back in 2014, issued Notice 2014-7 specifying that Medicaid waiver wages would be mandatorily excludable from gross income under IRC Sec 131 (qualified foster care payments) if they meet certain requirements. The notice also said this exclusion applied regardless of whether or not the caregiver and the care recipient were related. Payments can be Medicaid waiver payments only if a particular state applied for and was granted a Medicaid waiver.
The Notice went on to say that the exclusion applies to the caregivers of patients who are “placed” in their home or those receiving difficulty of care payments.
This change was a double-edged sword, as some caregivers qualified for the earned income tax credit (EITC) and additional child tax credit (ACTC) based on Medicaid waiver wages. As a result of these payments being mandatorily excluded from income, these caregivers lost their EITC and ACTC based upon that income.
The Feigh Case - Taxpayers, the Feighs, received Medicaid waiver payments as wages for caring for their disabled adult children in their own home. When the Feighs filed their tax return they excluded the income but still treated it as earned income for EITC and refundable child tax credit (much like excludable combat pay is treated). The IRS took umbrage to that position and the case ended up in Tax Court.
The Tax Court held that Notice 2014-7 could not reclassify the taxpayer’s Medicaid waiver payment to remove a statutory tax benefit. Specifically, the Court found that where income does not fall within the plain text of a statutory exclusion from gross income, IRS cannot reclassify that income through a Notice so that it no longer qualifies as "earned income" for the purpose of determining tax credits. The Court reasoned that IRS cannot remove a statutory benefit provided by Congress.
IRS Acquiescence - On March 30, 2020 the IRS issued an Action on Decision (IRB 2020-14). That AOD states the following:
“The Service will follow the Feigh opinion. Accordingly, in cases in which the Service permits taxpayers, pursuant to the Notice, to treat qualified Medicaid waiver payments as difficulty of care payments excludable under § 131, the Service will not argue that payments that otherwise fall within the definition of earned income under § 32(c)(3) are not earned income for determining eligibility for the EIC and the ACTC merely because they are excludable under the Notice”.
What this means is where applicable, returns back to 2016 can be amended to claim EITC or refundable CTC. This is especially important for 2016 as the statute of limitations for refunds expires July 15, 2020.
TAS Reporting Tip - A Taxpayer Advocate Service Tax Tip explains how to report qualified non-taxable Medicaid waiver payments (MWPs) as earned income for earned income tax credit (EITC) and additional child tax credit (ACTC) purposes on a tax return, even though MWPs are not taxable income.
TAS says that on line 1 of the tax return (wages) include MWP received as wages that the taxpayer chooses to include in earned income for purposes of claiming the EITC or the ACTC, even if a Form W-2 was not received reporting these payments.
Then, on Schedule 1, line 8, (other income) subtract the nontaxable amount of the MWP from any other income reported on line 8 and enter the result. If the result is less than zero, enter it in parentheses.
TAS notes that for an electronically filed return, enter "Notice 2014-7" as an explanation for the MWP amount reported on Schedule 1, line 8. For a paper return, write “Notice 2014-7” on the dotted line for Schedule 1, line 8.
Another complication, at least in California, is that back when Notice 2014-7 was issued the California Department of Social Services (CDSS) allowed affected taxpayers to self-certify on Form SOC2298 that they resided in the same home as the individual for whom they were providing the care. Those who self-certified are no longer issued a W-2 for the Medicaid waiver payments. So, another form of income documentation will be needed when filing an amended return. The following is suggested copy to be used when amending a return (use at your own risk).
This return is being amended to be in accord with the Tax Court ruling in Feigh v. Commissioner, 152 T.C. No. 15 (2019) T.C. Docket No. 20163-17 and confirmed in IRS acquiescence in an AOD Dated March 30, 2020 (IRB 2020-14). Based on the court case and the AOD excluded Medicare waiver payments are treated as earned income for purposes of computing the taxpayer’s earned income tax credit (EITC) and where applicable, the additional child tax credit (ACTC). In fact, these Medicare payments are earned income regardless of whether the payments are excludable
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QUESTION: If the taxpayers buy and live at this home for only 3 years then sell the home, can they exclude the gain for $500,000?
ANSWER: Yes, the qualification is they must own and occupy the home as their personal resident for 2 out the most recent 5 years. So, if they buy the home, live in it for 2 years and then sell it, they will qualify.
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QUESTION: If debt for solar is financed separate from the mortgage is it deductible interest? If it is financed by the solar company directly?
ANSWER: Yes, since it is a substantial improvement to the home which would make it acquisition debt …PROVIDED the debt is secured by the home.
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QUESTION: Wait, why aren't we using 1099-MISC for 2020? I haven’t heard this yet.
ANSWER: The Internal Revenue Service has resurrected a form that hasn’t been used since the early 1980s, Form 1099-NEC, Nonemployee Compensation. Since 1983, the IRS has required businesses to instead file Form 1099-MISC for contract workers and freelancers. The revival of Form 1099-NEC is part of an effort mandated by Congress in the PATH Act of 2015 to require businesses to file information returns about any non-employee compensation by Jan. 31 of each year. However, there were problems with the IRS’s processing systems because there was still a March 31 due date for any Form 1099-MISC that didn’t contain non-employee compensation. You can download the “new” 1099-NEC, from the IRS Website.
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QUESTION: For reduction of SS Benefits, do S-Corp earnings count as SE income?
ANSWER: Not sure I fully understand your question, but I will give it a shot...An S-Corp is required to pay working shareholders reasonable compensation via payroll. The profit from the corporation is passed through to the shareholders on a K-1 and that income is not subject to SE tax, thus is not earned income and would not be included as earned income for the SS limit.
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QUESTION: What about legal fees paid through Social Security in order to get a lump-sum amount from SSA? Deductible?
ANSWER: Sometimes individuals will incur legal expenses to produce or collect taxable income or in connection with the determination, collection, or refund of any tax. The legal expenses cannot be used to offset the SS benefits and can only be deducted as a Tier 2 miscellaneous itemized deduction. In addition, the deduction is limited to legal expenses for collecting only the taxable part of the taxpayer's benefits. Thus, prorate to determine the amount of legal expense attributable to the taxable Social Security (Rev Rul 87-102).
Caution: The TCJA of 2017 suspended the Tier 2 miscellaneous itemized deductions for years 2018 through 2025, so even the legal fees prorated to the taxable Social Security award aren’t deductible.
If your client is a CA taxpayer, even though CA still allows tier II deductions, because SS is not taxable to CA the legal fees would not be deductible for purposes.
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QUESTION: When electing SS withholding percentages, I can never figure out how the SSA came up with the ACTUAL amount to withhold. Math never works.
ANSWER: I have never double checked their math. Of course, they are supposed to withhold 7%, 10%, 12%, or 22% of the total benefit payment. I did look on the SSA and IRS websites as well as the internet itself and could not find anything related any adjustments the percentages.
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QUESTION: Taxpayer owns home jointly with father. Father provided down payment and is only one on loan. Taxpayer paid all costs of the home, taxes, mortgage payments, repairs, utilities, etc. Taxpayer has reported 100% on her return for every year. Taxpayer meets both use and ownership. For the sale of the home can the entire sale be reported by the taxpayer or does some portion need to be reported on the parent's return?
ANSWER: This question comes up all the time in one form or another. The parent is probably on the loan because the child would not otherwise qualify for the loan. However here are some of the issues.
- Was the down payment under the threshold for a gift tax return requirement? If not, was a gift tax return filed?
- Is the parent on title?
- Did escrow issue a 1099-S to both the father and the taxpayer? If escrow has not closed will they issue the 1099-S to your taxpayer only? Of course, in certain home sales they are not required to issue a 1099-S at all.
- Depending on how the 1099-S is handled, including all the gain on taxpayer’s return, it may not be an issue. Otherwise still report on your taxpayer’s return and the father can explain why he is not reporting any portion of the gain on an 8275-disclosure form.
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QUESTION: What happens to NOL when debt is cancelled but not taxable due to insolvency? I have this coming up this year and need to know what to do on the tax return. I guess this follows the tax attribute rule reduction - right?
ANSWER: When COD income is excluded (insolvency exclusion) the form 982 must be completed and the taxpayer’s tax attributes reduced to the extent the COD income is excluded. The reduction of attributes is made in a specific sequence. NOLs are third in that sequence, line 6 on the 982.
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QUESTION: If a spouse dies and the taxpayer stayed in the home until he got married again and then sold the home to move into the new spouse’s house - does the taxpayer get the $500K exclusion because he is now married again?
ANSWER – The first issue is that when the spouse passed away the taxpayer (TP) got an adjustment to basis. Depending upon state law and how title was held, the adjustment would be to 50% of the basis or 100% of the basis. This is commonly referred to as step-up in basis but is actually FMV at the date of death. So, the TP may not need more than $250K anyway.
Next, a surviving single spouse qualifies for the up-to-$500,000 exclusion if the sale occurs not later than 2 years after their spouse's death and the requirements for the $500,000 exclusion were met immediately before the spouse's death. (Code Sec. 121(b)(4)).
Next, if the home is sold after remarrying, and the new spouse meets the 2 out of 5 occupancy (use) requirements for the living in the home the TPs exclusion would be $500K. Note, the new spouse need only meet the occupancy requirement not the ownership test.
Finally, if the new spouse does not meet the occupancy (use) requirement for the TP home, the exclusion would be limited to $250K.
As you can see there are several outcomes depending on the circumstances.
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QUESTION: If a trustee (who is also a beneficiary) pays themselves for settling the estate, does this income go on the 1099-MISC as other income or on the 1099-NEC (subject to self-employment tax). This is not their normal job (fiduciary work).
ANSWER - A person who administers the estate of a deceased person (i.e., the fiduciary) is subject to SE tax if:
(a) the person is a professional fiduciary.
(b) the person is a nonprofessional fiduciary who manages an estate that includes an active trade or business. Nonprofessional fiduciaries are generally not treated as receiving income from a trade or business unless all of the following are met:
- There is a trade or business among the assets of the estate.
- The fiduciary actively participates in the operation of this trade or business.
- The fees of the fiduciary are related to the operation of the trade or business.
There are numerous examples in the Big Book of Taxes, page 8.03.05. So, the 1099-NEC would apply if subject to SE Tax.
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