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You make the callBy: NATP Research
September 16, 2021

Question: Joan and Rowland filed their Form 1040 jointly for the duration of their marriage as married filing jointly. Rowland died in early 2020 and Joan remarried in late 2020. Does Joan file her 2020 federal tax return with Roland or with her new husband?

Answer: Joan will file her Form 1040 with her new husband. They will file married filing jointly or married filing separately. When your spouse dies during the tax year, the surviving spouse is considered married for the whole year for federal tax purposes, unless the surviving spouse remarries. If the taxpayer remarries before the end of the tax year, the taxpayer will file a joint return with the new spouse.

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You make the callBy: NATP Research
September 2, 2021

Question: Gaia is a U.S. citizen who lives and works in Israel. She meets the bona fide resident test. Under §911, she elects to exclude her foreign earned income of $96,000 from U.S. taxation on Form 2555, Foreign Earned Income Exclusion. Can she also claim the foreign tax credit on Form 1116, Foreign Tax Credit, for income taxes she paid to Israel?

Answer: No. Because Gaia is using Form 2555 to exclude her foreign earned income, she cannot use Form 1116 to claim the foreign tax credit on that same income. Once Gaia elects to exclude her foreign earned income, she cannot take a foreign tax credit for taxes on income she excluded or could have excluded. If she does, one or both choices may be considered revoked [§911(d)(6)]. However, she can choose to take a foreign tax credit on any amount of foreign earned income that exceeds the amounts she excluded under the foreign earned income exclusion.

To use Form 1116, the taxpayer must have foreign tax liability that was either paid or accrued during the current tax year, the tax must be assessed on income, must be imposed on the taxpayer as an individual and must have originated legally in a foreign country.

There may be situations where it would be more beneficial to use Form 1116 to claim the credit instead of using Form 2555. For instance, people may prefer to use the credit if they live in a high-tax area, such as the United Kingdom.

To learn more, attend our upcoming Foreign Tax Days – Individual Topics and Business Topics.

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Update on cannabis tax topics in 2021 By: Larry Gray
August 31, 2021

Much has changed in the cannabis industry over the last several years. While still illegal at the federal level, in almost 20 U.S. states, cannabis is fully legal and 37 states allow for the medical use of cannabis products. Recent polling shows 60% of U.S. adults say cannabis should be legal for medical and recreational use.

A draft bill, the Cannabis Administration and Opportunity Act, exists and many speculate it is only a matter of time until cannabis is legal under federal law. Some argue, though, the federal government is in no hurry to legalize cannabis because the cannabis industry generates more revenue than many mainstream industries due to §280E, which prohibits the use of standard business deductions for companies that traffic in federally controlled substances.

Despite being illegal at the federal level, cannabis income is still required to be reported and federal income tax is still assessed. Section 61(a) does not differentiate between income derived from legal sources and income derived from illegal sources.

In states where cannabis is legal, cannabis producers and retailers face many challenges – including banking and paying taxes. Currently, possession of cannabis remains a federal offense, punishable by up to one year in jail and a minimum fine of $1,000 for a first conviction. Removing federal penalties in states where recreational use is legal would solve many problems taxpayers face.

As a practitioner, have you given any thought to your clients and cannabis? NATP government liaison Larry Gray has insight into this interesting, and perhaps controversial, topic. All answers below are from Larry Gray in a recent interview with NATP.

Q: What should practitioners know?

A: Practitioners need to know the law, industry and their client.

Regarding the law, every state is different. For example, some states limit the number of plants medical cannabis growers may possess or limit the number of patients a caregiver may serve. Each state has laws regarding licensing and taxing. For example, California has a growers tax where tax is imposed on the cannabis flower, fresh cannabis plant and cannabis leaves. California requires all cannabis retailers, cultivators (growers) and manufacturers to obtain a cannabis license. California also has a sales tax on certain cannabis transactions. If a practitioner is practicing in California, the state laws will be different than a practitioner practicing in another state. Because of the regulation at the state level, taxpayers generally are compliant as they don’t want to risk losing their business license and livelihood. It is the income from non-business taxpayers that practitioners need to be on the look-out for.

As a result of the disparity in federal and state law, many engaged in the cannabis trade or businesses are keeping a second set of books – one for federal purposes and one for state purposes. From a federal standpoint, record keeping is easy as cost of goods is the only deductible item. For those engaged in a trade or business, a schedule attached to the state return may be needed to reconcile the additional deductions allowed at the state level. At the state level, what is allowed as a deduction? It depends. Practitioners need to be versed in their state law. Practitioners also need to educate clients who may be engaged in cannabis activity, but the activity does not rise to a trade or business. This income is still reportable.

Practitioners also need to know the industry. There are so many different ways a client can be involved in the cannabis industry. Is your client a caregiver? If yes, for themself? For others? Are they operating a dispensary? Are they a grower? Are they a retailer? There may be different state rules and regulations placed upon a retailer versus a grower, for example, and practitioners need to know exactly what activity the client is engaged in.

Finally, you need to know your client. This most likely will be tough and will require open communication and dialogue. Knowing your client requires asking the appropriate questions. Federally, the decision-making tree is easy. From the state side, not so much. On the state side, will the activity be treated the same as the federal requirements (hobby) or does it rise to the level of a trade or business? To know how to treat the activity, practitioners will first need to know about the activity and then ask appropriate questions.

Finding out about the activity is the tough, but necessary, part of working with the client. Some may be offended by you asking, some may be open to talking. There is no way to know how a client will react; however, the topic must be addressed.

For example, if your client, Joe, is a caregiver and does not have a caregiver license, Rita, the practitioner, will not care if Joe has a medical license. On the other hand, if Joe says he has a caregiver license for himself but is selling to his neighbor, Bob, for recreational use, Joe will have income to report, but the income will not be subject to self-employment tax. If Joe does not sell to his neighbor, there would be no income to report.

Q: What about practitioner due diligence?

A: As we stated earlier, there is a requirement to report income generated by cannabis sales. The big task practitioners have is how do we ask these questions of our client without risking offending them or making them uncomfortable. A personal relationship is key.

Larry said this topic is harder to address than others, such as virtual currency. With virtual currency, there is a question on the tax return; there is no such disclosure for cannabis. Also, due to the changes brought about by COVID-19, many of us are not seeing clients in person. Larry suggested one way to address this topic is to discuss it in a client newsletter.

For those with additional questions, help is available. The IRS has FAQs on the cannabis industry, our research team is available or you can purchase the NATP Cannabis Businesses self-study.

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You make the callBy: NATP Research
August 26, 2021

Question: Fred and Jan are married, live in a community property state and plan to file separate returns. Jan earns $30,000 in wages from her employer. Fred is self-employed, earning $50,000 in net profit from his Schedule C business. How much income will each spouse report on their separate tax returns? Will each be subject to self-employment tax on their share of the Schedule C business income?

Answer: Because they live in a community property state, each reports half of all income from both spouses. Jan reports $15,000 of her wages and $25,000 of Fred’s Schedule C business net profit, making her income $40,000. She will be liable for the federal income tax on the full $40,000. She will not be liable for self-employment tax for her half of Fred’s business income. Fred also reports $40,000 of income ($15,000 of Jan’s wages plus $25,000 of his business income). He will be liable for federal income taxes on his $40,000 of income and will be liable for self-employment tax on the full $50,000 of his business profits.

To learn more on this topic, register for our Community Property - U.S. and Abroad on-demand webinar.

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You make the callBy: National Association of Tax Professionals
August 19, 2021

Question: After Ally’s Social Security disability benefits finally kicked in during 2020, she repaid the $33,000 of disability she previously received in 2019 from a third-party disability insurance provider. Because Ally previously paid tax on the disability income she received in 2019, how is the 2020 repayment reported on her tax return?

Answer: The repayment is reported in 2020, the year of the repayment, not on an amended 2019 tax return. Since the repayment exceeds $3,000, Ally can deduct the full amount on Schedule A, Line 16 or apply the §1341 claim of right doctrine. The idea is to put Ally in the same position that she would have been in had the income never been received and the repayment never been made. Under the §1341 claim of right doctrine, Ally’s repayment results in a tax reduction in the form of a 2020 “payment” equivalent to the tax paid in 2019, attributable to the $33,000 of disability received. This tax difference is reported as a payment on 2020 Schedule 3 (Form 1040), Line 12d, with “IRC 1341” entered in the space next to the line.

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Additional Articles

You make the callSeptember 2, 2021
Update on cannabis tax topics in 2021 August 31, 2021
You make the callAugust 26, 2021
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