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The importance of the correct amount of tax withholding By: National Association of Tax Professionals
November 22, 2022

Now is a great time to remind your clients to check their tax withholding while there’s time left in 2022 to take advantage of any necessary changes. An adjustment made now may help your client avoid a big surprise, such as a big refund or a balance due, at tax time in 2023.

Life brings constant changes to individual financial situations. Events like marriage, divorce, new tax laws, a new child or home purchase can all be reasons to adjust withholding. You can refer your clients to the IRS withholding estimator, or encourage them to set up a time to meet with you, to review their financial situation and make any necessary adjustments to their withholding.

Tax Withholding Estimator
The IRS’s tax withholding estimator, also available in Spanish, can help taxpayers determine if too much income tax is being withheld and show them the adjustments that can be made to put more cash into their own pocket. In other cases, it can help them see that they should increase their withholding or make an estimated tax payment to avoid a tax bill when they file next year.

The estimator offers workers, retirees, self-employed individuals and other taxpayers a user-friendly, step-by-step tool for effectively tailoring the amount of income tax they should have withheld from wages and pension payments based on their personal circumstances.

Pay As You Go
Taxes are generally paid throughout the year, whether from salary withholding, quarterly estimated payments or a combination of both. However, about 70% of taxpayers withhold too much every year. This typically results in a refund. The average refund in 2022 was just under $3,000.

A few other facts about refunds:

  1. Taxpayers do not have to get one. Proper withholding adjustments can help boost take-home pay rather than be over withheld and get it back as a tax refund.
  2. While most are issued in 21 days or less from the filing of an error-free and paperless tax return, many take longer for different reasons.
  3. Taxpayers are advised not to rely on their refund to pay for big purchases.
  4. Direct deposit is the easiest and most convenient way to get a refund. More than 90% of all refunds are issued this way.
  5. Paper return processing delays stemming from the pandemic are six months or more. The IRS’s COVID-19 operations page offers complete details.

Other Items That May Affect 2022 Taxes
Some unforeseen events can trigger withholding adjustments. They include:
1. Coronavirus tax relief provided help for taxpayers, businesses, tax-exempt organizations and others – including health plans – affected by the coronavirus (COVID-19).
2. Disasters such as wildfires and hurricanes may trigger tax law provisions that help taxpayers and businesses recover financially from the impact of a disaster, especially when the federal government declares their location a major disaster area.
3. Job losses can create new tax issues. IRS Publication 4128, Tax Impact of Job Loss, explains the tax implications of this unfortunate circumstance.
4. Employees subject to payroll withholding moving into the gig economy due to the pandemic. The IRS advises people earning income in the gig economy to consider estimated tax payments to avoid a balance due or penalties when they file.

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Do my clients have to have experienced a loss of revenue to get the ERC?By: Sunshine Chapman, ERC Provider
October 19, 2022

Originally when the employee retention credit (ERC) was just being implemented, it was difficult as well as overly complicated for small businesses to apply and have their qualifications accepted. However, recent changes have resulted in a significant shift in the application process. Now employee retention credits are available to businesses with under 500 employees based on the total wages paid to W-2 employees.

Navigating the world of ERCs can be a daunting task for business owners to determine if they qualify for the credit. In many cases, the language used can be confusing. As a tax preparer, you may want to partner with an ERC specialist to help your clients substantiate the pandemic’s impacts to fulfill the complicated task of qualifying for the credit. The technical jargon associated with IRS regulations can result in the false idea that the only way to prepare is if the firm has experienced a loss in revenue. This is simply not the case, as there are three ways to qualify based on the following criteria: revenue reduction, supply chain distributions, and partial or complete shutdown.

The first way to substantiate a business’s qualification is through the reduction of revenue. Out of the three qualifiers, loss of revenue is the one that most tax preparers are aware of. For 2020, a firm must have experienced a 50% reduction of gross sales in at least one quarter for quarters two, three and four of the year, as the COVID-19 pandemic began in the second quarter of 2020. When and if the revenue reduction in 2020 returned to 80% of the 2019 level, the qualification ends. Regarding the 2021 tax year, a business could qualify with a 20% reduction of gross sales for each quarter one, two and three, compared to the same quarter in 2019.

Supply chain disruptions that resulted from government-ordered shutdowns are another way a business can qualify. Businesses that rely on third-party sources, such as vendors and suppliers, for their companies to function can take this route to qualify. The qualification must have resulted from a government suspension order that impacted a business’s suppliers, resulting in the third party not being able to deliver crucial goods or components. An example of this would be a hotel that could not obtain certain products such as sheets, shampoo, towels or laundry soap during the pandemic. Another qualifying instance would be construction firms that could not receive windows or lumber due to the closures and delays at ports. These impacts qualify a company, regardless of revenue gain or loss.

The third option to qualify involves when a business has experienced a partial or full shutdown. This qualification is based on a “suspension test” to demonstrate that operations were partially or fully suspended due to a COVID-19 governmental order. For this option, it’s essential to know that a government restriction may have directly impacted operations, even if that shutdown order wasn’t given to the business directly. Trade shows were canceled due to government orders, making it impossible for all types of businesses to meet and obtain new customers. Another example would be a cleaning service that used to earn most of its revenue by disinfecting restaurants and office buildings, which was no longer possible during the mandated shutdowns. The cumulative effect of the full or partial suspensions needs to have had a more than nominal, meaning more than a 10% impact on the business’s bottom line when considering the gross receipts of that portion of your business in 2019. Calendar appointments and other business records can also be used to show the more than nominal impact. Revenue does not have to have decreased to use this qualification.

The employee retention credit has changed several times since its inception, and it now offers a significant refundable tax credit to many more business owners. As a tax preparer, it can be hard to stay on top of the ever-changing ERC regulations. Referring your clients to an ERC expert can allow them to take advantage of this lucrative program without adding hours of labor to your practice.

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Partial COVID failure-to-file penalty relief may still be available after deadlineBy: National Association of Tax Professionals
October 18, 2022

Taxpayers who missed the Sept. 30 filing deadline for COVID-19 penalty relief may still be eligible for limited penalty relief if they file in the next few months, according to the IRS. That is because, tucked into the IRS’s Sept. 22 press release reminding taxpayers of the Sept. 30 deadline, was a provision stating that for 2019 and 2020 individual and business returns filed after the deadline, failure-to-file penalties would be calculated from Oct. 1, 2022.

The sixth paragraph of the press release (IR-2022-164) states that those who file during the “first few months” after the Sept. 30 cutoff will still qualify for partial penalty relief. The IRS explained that the partial penalty relief will be the result of how it will calculate failure-to-file penalties. It said that for eligible taxpayers who did not file their 2019 and 2020 returns by the cutoff date the IRS will treat their failure-to-file penalties as accruing from Oct. 1, 2022, not the dates the returns were initially due. Relief from failure-to-file penalties is automatic and taxpayers do not need to attach a statement or other documents to their returns to receive it.

The IRS usually assesses the failure-to-file penalty at a rate of 5% per month, or portion of a month, up to 25% of the unpaid tax when returns are filed late. Therefore, taxpayers filing returns in the first few months after Oct. 1 will pay smaller failure-to-file penalties than if they waited until later. If the taxpayer has not filed by the end of February 2023, the failure-to-file penalty maxes out at 25%.

Finally, the IRS noted that taxpayers who late-file their 2019 and 2020 returns will only receive partial relief from their failure-to-file penalties. That means the failure-to-pay penalty and interest will still apply to any unpaid tax and will begin to accrue on the original due date for the return. The failure-to-pay penalty is normally 0.5% per month and the interest rate increased from 5% to 6% Oct. 1.

The IRS said partial relief from failure-to-file penalties will be available to the same types of income tax returns that are listed in Notice 2022-36, which says the following income tax returns are eligible for relief:

  • Form 1040, U.S. Individual Income Tax Return; Form 1040-C, U.S. Departing Alien Income Tax Return; Form 1040-NR, U.S. Nonresident Alien Income Tax Return; Form 1040-NR-EZ, U.S. Income Tax Return for Certain Nonresident Aliens With No Dependents; Form 1040 (PR), Federal Self-Employment Contribution Statement for Residents of Puerto Rico; Form 1040-SR, U.S. Tax Return for Seniors and Form 1040-SS, U.S. Self-Employment Tax Return (Including the Additional Child Tax Credit for Bona Fide Residents of Puerto Rico)

  • Form 1041, U.S. Income Tax Return for Estates and Trusts; Form 1041-N, U.S. Income Tax Return for Electing Alaska Native Settlement Trusts and Form 1041-QFT, U.S. Income Tax Return for Qualified Funeral Trusts

  • Form 1120, U.S. Corporation Income Tax Return; Form 1120-C, U.S. Income Tax Return for Cooperative Associations; Form 1120-F, U.S. Income Tax Return of a Foreign Corporation; Form 1120-FSC, U.S. Income Tax Return of a Foreign Sales Corporation; Form 1120-H, U.S. Income Tax Return for Homeowners Associations; Form 1120-L, U.S. Life Insurance Company Income Tax Return; Form 1120-ND, Return for Nuclear Decommissioning Funds and Certain Related Persons; Form 1120-PC, U.S. Property and Casualty Insurance Company Income Tax Return; Form 1120-POL, U.S. Income Tax Return for Certain Political Organizations; Form 1120-REIT, U.S. Income Tax Return for Real Estate Investment Trusts; Form 1120-RIC, U.S. Income Tax Return for Regulated Investment Companies and Form 1120-SF, U.S. Income Tax Return for Settlement Funds (Under Section 468B)

  • Form 1066, U.S. Real Estate Mortgage Investment Conduit (REMIC) Income Tax Return

  • Form 990-PF, Return of Private Foundation or Section 4947(a)(1) Trust Treated as Private Foundation and Form 990-T, Exempt Organization Business Income Tax Return (and Proxy Tax Under Section 6033(e)).

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You make the callBy: NATP Research
September 8, 2022

Question: Asha and Malik have been married several years with three school-age children. Due to COVID-19 complications, Asha died in mid-June 2021. Malik does not wish to file married filing joint (MFJ) as the surviving spouse for Asha’s 2021 final tax return. If Asha’s 2021 final tax return uses the filing status of married filing separate (MFS), can the 2021 final return claim their children as qualifying dependents based on the period when Asha was alive?

Answer: No. Asha’s final Form 1040, U.S. Individual Income Tax Return, may not claim the children as qualifying dependents because they do not meet all of the dependency tests.

In general, the requirements of filing a return where the taxpayer has not been in existence for the entire taxable year are the same as filing a return for a taxable year of 12 months ending on the last day of the short period [Reg §1.443-1(a)(2)].

To claim children on the decedent’s MFS return, the children need to meet the requirements of the support and residency tests for more than half the calendar year, not the partial year Asha was alive during the tax year (§152). The full calendar year is the test period, not the partial year that the decedent was alive. Even if the decedent had income after death used to support the children for the balance of the calendar year, that income could not be used to meet the test because the estate and decedent are considered different taxpayers by IRS so it would be the estate furnishing support, not the decedent.

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Bankruptcy court awards damages for automated IRS notices By: National Association of Tax Professionals
June 22, 2022

A West Virginia bankruptcy court has ordered the IRS to pay damages after the agency sent automated notices to taxpayers who’d had their tax debt discharged through bankruptcy. The court rejected the IRS’s claim that it had not willfully violated the discharge order because the collection attempts were made through automated delivery systems that were affected by the COVID-19 pandemic

The In re. Williams-McAuliffe (Bankr. N.D.W. Va. 2022) decision by the U.S. Bankruptcy Court for the Northern District of West Virginia found the IRS must pay damages when an employee willfully violates a discharge order by sending a collection notice. It is a violation of federal law to attempt to collect a debt after it has been discharged in bankruptcy.

While the court only awarded the taxpayers $498 in damages (and refunded the $235 fee for reopening the bankruptcy case), the decision is notable for finding the IRS liable for damages taxpayers suffered because of erroneously issued collection notices. In February the IRS suspended most of its automated collection notices after coming under pressure from the Taxpayer Relief Coalition — which includes NATP — and other advocacy organizations because many of the notices were being issued erroneously due to the IRS’s substantial backlog of unprocessed returns.

Couple files for Chapter 13 bankruptcy

The McAuliffes are a married couple who filed for Chapter 13 bankruptcy in 2016, the bankruptcy court said. The IRS filed a bankruptcy court claim seeking $13,625 in unpaid taxes for 2010 and 2011, $7,230 of which was secured. While the couple entered into an installment agreement to repay the IRS, they terminated their agreement and paid their outstanding debt through the Chapter 13 repayment plan. The McAuliffes received a bankruptcy discharge in September 2019 and the IRS received 22% of the unsecured portion of its claim, which was roughly $1,400.

Despite the IRS debt having been discharged, the bankruptcy court said the agency sent the McAuliffes demand letters in February and March 2020 seeking to collect the monthly payment due under the terminated installment agreement. The husband, a bankruptcy attorney, sent a letter to the IRS in March 2020 explaining the error, but sent it to the wrong office. The couple received another collection letter in August 2020.

Despite the third demand letter, the IRS failed to acknowledge the McAuliffes’ March 2020 letter until Sept. 29, 2020, at which point the IRS said it would need 60 days to review their liability. However, contrary to the statement that it would review the couple’s liability, the IRS had already abated their 2010 and 2011 taxes the day before the letter was sent. The IRS attributed the seven-month delay in responding and miscommunication to a combination of the COVID-19 pandemic and the McAuliffes’ mailing their letter to the wrong office.

While the couple’s bankruptcy case was before the bankruptcy court, they incurred additional tax liabilities for the 2018 tax year, which they did not contest. The McAuliffe’s said they intended to enter into an installment agreement for those debts but were prevented from doing so by the IRS’s claims they had unpaid 2010 and 2011 tax debts. The court said they tried to contact the agency in an attempt to enter into an installment agreement regarding their debts for 2018 as early as January 2020.

The bankruptcy court reopened the McAuliffes’ bankruptcy case in December 2020 and the couple filed for an adversary proceeding shortly thereafter. The IRS was granted no relief through administrative remedies, but in August 2021 it sent the couple a letter stating its intent to end their installment agreement and that $1,150 must be paid immediately to avoid default. It also sent a notice of intent to levy. About this time the couple was notified by the IRS that it was accepting their installment agreement to pay their 2018 debts, which was almost 20 months after their initial request.

Taxpayers seek damages based on bankruptcy law

The McAuliffes sought damages under §7433(e) of the U.S. Bankruptcy Code, which allows debtors to seek damages for violations of a bankruptcy discharge.

The IRS claimed the automatic collection notices were “non-threatening” and should not be viewed as a collection action. The court disagreed, noting the letters state that a monthly payment is due immediately and threatens the taxpayer with default if no payment is made. Additionally, the court observed the notice contained no disclaimers stating that it was not trying to collect a debt. “This surely gives the appearance of an attempt to collect, whether sent to a layperson or a well-experienced bankruptcy attorney and his spouse,” it concluded.

Next, the IRS argued that to find a willful violation, the court needed to find that a specific employee violated the discharge order; it also cited cases where courts found that clerical errors were inadvertent. The bankruptcy court found the IRS failed to enter the discharge into its system for almost 12 months and the McAuliffes made multiple attempts to resolve the issue only for the agency to continue trying to collect the debt. It said that those did not qualify as clerical errors.

The IRS also contended the automatic nature of the collection notices removed them from the control of IRS employees, which should shield the agency from penalties intended to punish employee misconduct. The bankruptcy court rejected the argument, finding that if the IRS employees and automated systems are disconnected from the actions of other offices, it is the agency that should be held responsible and not the taxpayer.

Finally, the bankruptcy court did not agree with the IRS’s claim that the COVID-19 pandemic should be taken into account when assessing the agency’s actions. “While COVID-19 is having a significant impact on all levels of the federal government, it does not excuse repeated attempts to collect on a Plaintiff doing everything possible to correct any miscommunications,” the court explained.

Damages based on interest and penalties accrued

The McAuliffes asked the court for damages related to the IRS’s unlawful collection attempts, court costs and legal fees. Among other things, the couple claimed they accepted an offer for their house that was $15,000 below its market value because they were concerned about the notices they were receiving from IRS about the discharged tax debt. However, the court found the sale took place nearly a year after they received an abatement for their 2010 and 2011 taxes from the IRS; therefore, the claim was speculative and not concretely proven.

The bankruptcy court did award the McAuliffes damages based on the interest and penalties assessed by the IRS on their 2018 tax liability. It found that the interest and missed payment penalties the couple accrued between the time they received their first collection letter until the IRS’s decision to accept their settlement offer were actual damages resulting from the agency’s violation of its discharge order. It concluded that the interest and failure to pay penalties had increased by $498 during the time between the IRS issuing the March 2020 notice and the time the IRS accepted an installment agreement.

For more information on bankruptcy, installment agreements and other collection alternatives, check out the NATP’s on-demand online workshop on resolving back tax debts.

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