New Law Plays With the Kiddie Tax
Computation reverts to previous rules
The new retirement planning law passed by Congress late last year—the Setting Every Community Up for Retirement Enhancement (SECURE) Act—includes a tax provision that has nothing to do with your golden years. Accordingly, the way the “kiddie tax” is calculated reverts to the method used before the Tax Cuts and Jobs Act (TCJA) of 2017 was enacted.
Although the kiddie tax provision in the SECURE Act is effective for 2020 and thereafter, you can elect to have it apply for either the 2018 or 2019 tax years—or both.
Background: Generally, income is taxed at the tax rate of the individual who receives it. Therefore, if you are in the top 37% tax bracket (reduced from 39.6% by the TCJA), any additional dollars you earn are taxed at the rate of 37%. On the other hand, if your child is the 10% bracket, the child pays tax at a maximum rate of only 10%.
However, a special rule applies to certain children who receive unearned income—like dividends and capital gains from investments— above an annual threshold. If a dependent child is under age 19 or a full-time student under age 24, the excess unearned income is subject to the kiddie tax. The annual threshold is adjusted for inflation, but recent increases have been relatively small or nonexistent. For 2019 returns, the threshold is $2,200. It remains the same in 2020.
Prior to the TCJA, the kiddie tax was based on the top tax rate of the child’s parents, regardless of the source of the income. For example, if a dependent child had $1,000 in unearned income above the annual threshold and the parents were in the 25% tax bracket, the resulting kiddie tax was $250. However, under the TCJA, the tax calculation was based on the tax rates in effect for estates and trusts. This change went into effect in 2018.
Potential problem: The TCJA change produced a bigger kiddie tax liability for certain families than the previous method did. Reason: As opposed to the tax brackets for individuals, the brackets for estates and trusts are extremely compressed. As a result, the higher tax rates may kick in sooner, causing an increased tax liability.
Now the law has been changed to go back to the way it was before the TCJA. The SECURE Act again requires the kiddie tax to be based on the top tax rate of the child’s parents.
Note that you can choose to have this change apply on your 2019 return. Furthermore, if it suits your needs, you can file an amended return for 2018 to rely on the pre-TCJA kiddie tax computation.
Going forward, keep an eye on your child’s unearned income. When possible, try to keep it below or near the annual kiddie tax threshold.
Reminder: Every situation is different. Consult with your professional tax advisor concerning the application of the kiddie tax rules.
Tax Ramifications in the Gig Economy
IRS launches new resource center
Do you pick up riders in your car, rent out a spare room in your summer home or perform various other services for customers? If so, you are likely participating in the “gig economy” that is rapidly growing in popularity around the country. For many people, this is a good way to earn extra money in their spare time or adopt a more flexible lifestyle.
But you cannot overlook the tax repercussions for working in the gig economy full-time or on a part-time basis. Generally, you will owe income tax on your earnings, as well as being responsible for meeting payroll tax obligations. To provide more information to these workers, the IRS has just launched a new Gig Economy Tax Resource Center at https://www.irs.gov/businesses/gig-economy-tax-center.
Background: For starters, whether you are a driver for Uber or Lyft or a provide another service, there is no such thing as a “free ride.” The income you earn from your gig economy job is taxable—period. Generally, you are classified as an independent contractor, rather than an employee, with certain exceptions (e.g., you are an officer of the company providing the service). Therefore, you must report your income from the activities annually on your tax return, just like other self-employed individuals.
Typically, you will receive 1099 forms from your gig economy jobs, which are then transferred over to Schedule C. The exact type of 1099 depends on the nature and volume of your activities. Conversely, company employees receive a Form W-2 from their employers.
Caution: Being self-employed may cause tax complications that regular employees do not face. Notably, instead of having taxes regularly withheld from your pay, you must be proactive about making “estimated tax” payments to the IRS. Otherwise, you could be assessed tax penalties and interest on the amounts you fail to pay, plus any regular tax that is owed.
The required amount of tax can be paid through any combination of quarterly estimated tax payments and regular income tax withholding. For example, if you are employed at another job, you could increase your withholding to compensate for the extra tax that will be due from a gig economy job.
On the plus side, if you are self-employed in the gig economy, you are able to deduct your “ordinary and necessary” business expenses, subject to the limits otherwise imposed under the tax law. These business deductions can offset taxable income.
Finally, working in the gig economy may raise state tax issues. For instance, controversial California law AB5, which went into effect on January 1, 2020, requires most workers to be treated as employees who are eligible for certain protections. Check out the applicable state tax implications for your situation.
Parting thoughts: If you are unsure about your tax obligations as a participant in the gig economy, you may refer to the new Gig Economy Tax Resource Center. When needed, you should obtain personal guidance from your professional tax advisor.
How a Noncompete Agreement Works
Protection when top employees depart
How can you stop one of the rising stars in your company from leaving for greener pastures? Of course, you cannot permanently block a move, but one technique often relied on by employers is to use a noncompete agreement. Essentially, the employee may be barred from revealing trade secrets or pilfering clients for a competitor after departing the company.
Caution: This protection is not ironclad. Notably, an employer may still have to go to court to protect its interests. The court ruling will be based on prevailing state law. And, in some states, noncompete agreements are unenforceable.
Despite the limitations, the popularity of noncompete agreements continues to rise. According to recent research, about 30 million Americans are currently subject to certain restrictions and this number is only expected to grow.
Basic premise: Briefly stated, an employer may require a noncompete to be signed as a condition of employment or upon "separation from service" (e.g., quitting, being fired or retiring). For instance, signing the agreement may entitle a departing employee to receive a severance package. The noncompete will generally limit employment activities in the same field for a designated period of time.
However, the agreement cannot be overly restrictive and must be carefully worded. In other words, you cannot bar an ex-employee from pursuing his or her livelihood.
Typically, an individual may be allowed to join a competing firm, but will be prohibited from contacting former clients or customers. An experienced attorney should approve the language in the agreement.
The enforceability of a noncompete, or a clause in a more substantive employment contract, generally depends on whether the restrictions are “reasonable” or not. When assessing the reasonableness of a noncompete agreement, the courts will weigh the following factors:
- The length of time the agreement remains in force
- The scope of the geographic area restricting the employee
- The reason for the employee's departure
- If the agreement restricts activities not in competition with the company
- If the agreement prevents the employee from working in his or her chosen field
A court's decision on violation of a noncompete usually hinges on the extent of the employee's knowledge and his or her actions. For example, an employee may claim that he or she has no knowledge of trade secrets or other confidential information, but only "general knowledge" of the business. In that case, the burden of proof is on the company to establish that the knowledge includes trade secrets or is otherwise confidential.
If a court finds that the employee has only general knowledge, or the agreement is simply designed to hinder the competition, there is no legitimate business interest being protected. As a result, the noncompete is not likely to be enforceable.
In summary: As you can see, it is important to handle noncompete agreements with care and diligence. Obtain expert professional advice with respect to your company's situation.
Six Late Moves for 2019 Returns
Cash in on tax-saving opportunities
Before you know it, the April 15th deadline for filing tax returns will be here, but there are still several ways you might reduce taxes, even though the tax year is over. Following are six possibilities for shaving your 2019 tax bill.
1. Filing status: In the past, filing jointly was often a no-brainer for married couples.
However, under the recently-enacted Tax Cuts and Jobs Act (TCJA), you may fare better by filing separately as marrieds on your 2019 return. For instance, the TCJA authorizes a new deduction for qualified business income (QBI) of pass-through entities and sole proprietorships. Due to the way the QBI deduction is figured, you may choose to file separately.
2. Carryover losses: You may benefit on your 2019 return from a loss carried over from a prior tax year. For example, you could have an excess capital loss that can be carried over from your 2018 return to offset capital gains realized in 2019, plus up to $3,000 of ordinary income. Similarly, you may benefit from a 2018 charitable contribution that exceeded the annual tax law limits and is carried over.
3. Retirement plans: If you meet the April 15th deadline for contributing to an IRA or a retirement plan for small business owners, like a Simplified Employee Pension (SEP), you may be able to deduct those amounts on your 2019 return. Contributions to a traditional IRA are deductible, subject to a phase-out if your adjusted gross income (AGI) exceeds an annual threshold and you (or your spouse, if married) actively participate in a plan. Generally, you can deduct the full amount of your SEP contributions.
4. Catch-up contributions: Maybe you’ve already contributed to a traditional IRA for the 2019 tax year, but you will still owe tax on your return. If you are age 50 or older, the tax law allows you to add an extra $1,000 contribution to further reduce your tax liability and potentially provide a refund. Note, however, that catch-up contributions are not allowed for a SEP.
5. Medical expenses: Normally, you may not qualify for a medical deduction on your return, even if you itemize. However, the “extenders” legislation enacted late last year restores a lower floor for deducting medical expenses, based on your adjusted gross income (AGI). The 7.5%-of-AGI floor, which was scheduled to increase to 10% of AGI, remains at 7.5% through 2020. This may result in a deduction on your 2019 return.
6. Health Savings Accounts: If you had a high deductible health insurance plan in 2019, you have until April 15 to contribute to a health savings account (HSA), as long you are under age 65. These contribution amounts, which are based on your plan coverage, are deductible unless your employer made them on your behalf.
These are just six ways you could reduce your 2019 tax liability. There are others, but you have to move fast. Contact your professional tax advisor as soon as possible.
Just Saying Thank-You
In this high-tech world, an “old-fashioned” idea may go a long way toward cementing business relationships.
A personal thank-you note is usually appreciated. You might send one to express thanks for a job interview, to show your appreciation for a referral or recommendation or to simply say thanks for the business you have received.
The little time you take to say thank-you now can pay big dividends in the future. Do not dismiss its importance.
Facts and Figures
Timely points of particular interest
Direct Deposit.—Soon after tax return season kicked off, the IRS reminded taxpayers about the advantages of having tax refunds deposited directly into their checking or savings account. Besides being the fastest way to get your money, the IRS is touting the safety and security of the system. Currently, eight out of ten taxpayers receive their refunds through the direct deposit method.
Give And Take—Developing good negotiation skills is critical for getting ahead in the business world. If you are able to negotiate deals, you can build better relationships, develop long-term solutions to problems and help avoid future conflicts. Aim to create a constructive environment that is a win-win for both sides. Remember that you will likely be sitting down at the bargaining table again.