2024 Estimated Tax Payments (PDF)

INDIVIDUALS taxpayer can figure their required payment for each period by using either the regular installment method or the annualized income installment method. 1114.20...

INDIVIDUALS taxpayer can figure their required payment for each period by using either the regular installment method or the annualized income installment method. 1114.20 Under the regular installment method, if the estimated tax payment for any period is less than one‐fourth of taxpayer’s estimated tax, he or she may be charged a penalty for underpayment of estimated tax for that period when he or she files his or her tax return. Under the annualized income installment method, an individual’s estimated tax payments vary with his or her income, but the amount required must be paid each period. After the taxpayer makes an estimated tax payment, changes in his or her income, adjustments, deductions, credits, or exemptions may make it necessary for him or her to refigure his or her estimated tax. The taxpayer should pay the unpaid balance of his or her amended estimated tax by the next payment due date after the change or in installments by that date and the due dates for the remaining payment periods. A taxpayer does not have to pay estimated tax if his or her withholding in each payment period is at least as much as: a. One‐fourth of his or her required annual payment; or b. His or her required annualized income installment for that period. A taxpayer does not have to pay estimated tax if he or she will pay enough through withholding to keep the amount he or she owns with his or her tax return under $1,000. 1114.21 How to pay estimated tax There are five ways to pay estimated tax. a. Credit an overpayment on taxpayer’s 2023 return to the 2024 estimated tax. b. Send in a payment (check or money order) with a payment voucher from Form 1040‐ES. c. Pay electronically using the Electronic Federal Tax Payment System (EFTPS). d. Pay by electronic funds withdrawal if taxpayer is filing Form 1040 electronically. © 2024 Surgent Consolidated, LLC 63 INDIVIDUALS e. Pay by credit or debit card using a pay‐by‐phone system or the Internet. 1114.22 Credit an overpayment If a taxpayer can show an overpayment of tax after completing Form 1040 for 2023, he or she can apply part or all of it to his or her estimated tax for 2024. On Form 1040, line 36, enter the amount the taxpayer wants credited to his or her estimated tax rather than refunded. The taxpayer will then take the amount the taxpayer has credited into account when figuring his or her estimated tax payments. A taxpayer cannot have any of the amount he or she credited to his or her estimated tax refunded to him or her until he or she files his or her tax return for the following year. The taxpayer also cannot use that overpayment in any other way. 1114.23 Pay by check or money order using the estimated tax payment voucher Each payment of estimated tax by check or money order must be accompanied by a payment voucher from Form 1040‐ES. If the taxpayer made estimated tax payments last year and did not use a paid preparer to file his or her return, he or she should receive a copy of the Form 1040‐ES in the mail. It will contain payment vouchers preprinted with taxpayer’s name, address, and Social Security number. Using the preprinted vouchers will speed processing, reduce the chance of error, and help save processing costs. Use the window envelopes that came with the Form 1040‐ ES package. If a taxpayer uses his or her own envelopes, make sure he or she mails the payment vouchers to the address shown in the Form 1040‐ES instructions for the place where he or she lives. Do not use the address shown in the Form 1040 instructions. 1114.24 Pay electronically If a taxpayer wants to make estimated payments by using the Electronic Federal Tax Payment System (EFTPS), by electronic funds withdrawal, or by credit or debit card, go to www.irs.gov/e‐pay for directions. 64 © 2024 Surgent Consolidated, LLC  INDIVIDUALS 1114.25 Credit for withholding and estimated tax for 2023 When a taxpayer files his or her 2023 income tax return, take credit for all the income tax and excess Social Security or railroad retirement tax withheld from his or her salary, wages, pensions, etc. Also take credit for the estimated tax he or she paid for 2023. These credits are subtracted from the taxpayer’s total tax. Because these credits are refundable, he or she should file a return and claim these credits, even if he or she does not owe tax. 1114.26 Underpayment penalty for 2023 If a taxpayer did not pay enough tax, either through withholding or by making timely estimated tax payments, he or she may have an underpayment of estimated tax and he or she may have to pay a penalty. Generally, a taxpayer will not have to pay a penalty for 2023 if any of the following apply: a. The total of the taxpayer’s withholding and estimated tax payments was at least as much as his or her 2022 tax (or 110 percent of the 2022 tax if the taxpayer’s AGI was more than $150,000, $75,000 if his or her 2022 filing status was married filing separately) and the taxpayer paid all required estimated tax payments on time; b. The tax balance due on the 2023 return is no more than 10 percent of the taxpayer’s total 2023 tax, and the taxpayer paid all required estimated tax payments on time; c. The taxpayer’s total 2023 tax minus withholding and refundable credits is less than $1,000; d. The taxpayer did not have a tax liability for 2022 and his or her 2022 tax year was 12 months; and e. The taxpayer did not have any withholding taxes and his or her current‐year tax less any household employment taxes is less than $1,000. © 2024 Surgent Consolidated, LLC 65 INDIVIDUALS 1114.27 Installment payments of taxes owed Those who owe taxes that they are unable to pay can set up an installment plan to make payments over time to pay their liability. An installment plan with the IRS costs the taxpayer more money because the IRS charges interest and penalties on the taxes that are not paid in full before the due date. The IRS encourages taxpayers who cannot pay their tax liability to explore less costly options. In order to enter into an installment agreement with the IRS, the taxpayer must file all required tax returns and determine the largest monthly payment the taxpayer can make ($25 minimum). The IRS will apply future refunds to the taxpayer’s tax debt until it is paid in full. The taxpayer uses Form 9465 to apply for an installment agreement. 1115 Previous IRS Correspondence with Taxpayer In addition to reviewing prior year tax returns before preparing a tax return for a taxpayer, an Enrolled Agent should also review previous correspondence between the IRS and the taxpayer. This correspondence may include changes to a prior year tax return, additional tax or penalties owed, etc. It is important to review this information to determine whether the taxpayer owes tax from a previous year and whether the correspondence affects how the current year’s tax return should be filed. 1116 Special Filing Requirements 1116.01 Enrolled agents should always note when special transactions, such as gifts, foreign income, and certain disasters necessitate the preparation of special IRS forms or returns in addition to the normal Form 1040 and its associated schedules. Certain gifts that a taxpayer makes would require filing Form 709 and sometimes paying a transfer tax on the amount of the gifted property. The receipt of foreign income might require special United States as well as foreign tax reporting. 66 © 2024 Surgent Consolidated, LLC  INDIVIDUALS 1116.02 Casualty losses Casualty losses are generally deductible in the year the casualty occurred. However, if a taxpayer has a casualty loss from a federally declared disaster that occurred in an area warranting public or individual assistance (or both), the taxpayer can choose to treat the loss as having occurred in the year immediately preceding the tax year in which the disaster happened, and the taxpayer can deduct the loss on his/her return or amended return for that preceding tax year. 1116.03 A casualty loss in a federally declared disaster area can result from the damage, destruction, or loss of property from any sudden, unexpected, or unusual event such as a flood, hurricane, tornado, fire, earthquake, or even volcanic eruption. A casualty does not include normal wear and tear or progressive deterioration. If the property is personal‐use property or is not completely destroyed, the amount of the casualty loss is the lesser of: The adjusted basis of the property; or The decrease in fair market value of the property as a result of the casualty. 1116.04 The loss must be reduced by any salvage value and by any insurance or other reimbursement received or expected to be received. The adjusted basis of the property is usually its cost, increased or decreased by certain events such as improvements or depreciation. A taxpayer may determine the decrease in fair market value by appraisal, or if certain conditions are met, by the cost of repairing the property. 1116.05 Individuals are required to claim their casualty losses as an itemized deduction on Form 1040, Schedule A. For property held for personal use, once any salvage value and any insurance or other reimbursement is subtracted, the taxpayer must subtract $100 from each casualty or theft event that occurred during the year. Then, add up all those amounts and subtract 10 percent of the taxpayer’s adjusted gross income from that total to calculate his or her allowable casualty and theft losses for the year. © 2024 Surgent Consolidated, LLC 67 INDIVIDUALS 1116.06 Special requirements for Form 1040‐NR: Form 1040‐NR is the standard IRS form for nonresident aliens: that is, those who are not United States residents and do not primarily live in the country but do have taxable U.S. income. Everyone who is not a U.S. citizen is considered either a resident alien or nonresident alien for tax purposes. A resident alien for 2023 is anyone who either holds a green card or spent at least 31 days in the U.S. during the year and 183 days during the 3‐year period of 2023, 2022, and 2021. All other noncitizens are classified as nonresident aliens, as are those who qualify as resident aliens, but can establish they are more closely connected to another country in which they have a “tax home.” 1116.07 Nonresident aliens must file 1040‐NR if they meet any of four conditions: having engaged in a trade or business during the tax year; having other U.S. income such as dividends of interest; representing a deceased person who would have been eligible for the Form 1040‐NR; or representing an estate or trust eligible for 1040‐NR. 1117 Foreign Account and Asset Reporting (e.g., FBAR, Form 8938) 1117.01 Beginning on September 30, 2013, a taxpayer that has a financial interest in or signature authority over a foreign financial account, including a bank account, brokerage account, mutual fund, trust, or other type of foreign financial account, exceeding certain thresholds is required by the Bank Secrecy Act to report the account yearly to the Internal Revenue Service by filing electronically a Financial Crimes Enforcement Network (FinCEN) Form 114, Report of Foreign Bank and Financial Accounts (FBAR). This form is filed electronically with the Financial Crimes Enforcement Network (FinCEN). The FBAR must be received by the Department of the Treasury on or before April 15 of the year immediately following the calendar year being reported. FinCEN will grant filers failing to meet the FBAR annual due date of April 15 an automatic extension to October 15 each year. Accordingly, specific requests for this extension are not required. 68 © 2024 Surgent Consolidated, LLC  INDIVIDUALS The following individuals are required to file an FBAR:  a United States person that has a financial interest in or signature authority over at least one financial account located outside of the United States; and  the aggregate value of the foreign financial accounts exceeds $10,000 (not equal to $10,000) at any time during the calendar year. 1117.02 The FinCEN Form 114a, Record of Authorization to Electronically File FBARs, is not submitted with the filing, but instead is maintained with the FBAR records by the filer and the account owner and made available to FinCEN or the IRS on request. 1118 Kiddie Tax 1118.01 Unearned income of minor children (called the “kiddie tax”) is taxed in 2023 at the parents’ marginal tax rate. The child may file their own return, or if the child’s income is more than $1,250 but less than $13,850, it may be included on the parents’ return for 2023. The exemption from the kiddie tax for 2023 is $2,500. 1119 Affordable Care Act (ACA) Net Premium Tax Credit or Repayment 1119.01 Taxpayers who are not eligible for a health insurance plan through their employer can purchase health insurance through a federal or state marketplace. The premium tax credit (PTC) is in place to assist taxpayers who could not otherwise afford insurance. Taxpayers may qualify for the premium tax credit if their gross income is 100%–400% of the current poverty level. The American Rescue Plan Act of 2021 (ARPA) changed the affordability percentages used for premium tax credits to increase credits for individuals eligible for assistance and provide credits for taxpayers with income over 400% of the Federal Poverty Level (FPL). All individuals with premiums in excess of 8.5% of their household income are eligible for the PTC. © 2024 Surgent Consolidated, LLC 69 INDIVIDUALS 1119.02 Individuals may qualify for the advanced premium tax credit based on projected income when enrolling in a health insurance plan through the federal or state marketplace. This advanced premium tax credit is paid directly to the health insurance provider in monthly installments during the year, lowering the taxpayer’s required health insurance premium payments. 1119.03 Individuals who received the advanced premium tax credit or who may qualify for the premium tax credit must file Form 8962, Premium Tax Credit (PTC) to figure the premium tax credit and reconcile any advanced premium tax credit received during the year. Taxpayers who have a positive net premium tax credit (premium tax credit minus amount received during the year) can include the net premium tax credit as a refundable credit. Taxpayers who received a greater advanced premium tax credit than allowed must repay the excess. 70 © 2024 Surgent Consolidated, LLC  INDIVIDUALS 1200 Income and Assets 1211 Income 1211.01 Wages, salaries, and tips received by an employee for performing services for an employer must be included in the employee’s gross income. Amounts withheld for taxes, including but not limited to income tax, Social Security, and Medicare taxes are considered “received” and must be included in gross income in the year they are withheld. Generally, an employer’s contribution to a qualified pension plan for the taxpayer is not included in his or her gross income at the time it is contributed. However, amounts withheld under certain salary reduction agreements with the taxpayer’s employer may have to be included in gross income in the year they are withheld. 1211.02 An employer should provide a Form W‐2 showing the taxpayer’s total income and withholding. The taxpayer must include all wages and withholdings from all Forms W‐2 he or she receives, and if filing jointly, all of the taxpayer’s spouse’s Forms W‐2. The taxpayer should attach a copy of each W‐2 to the front of his or her tax return as indicated in the instructions. 1211.03 A taxpayer must include every increment to wealth in their gross income for federal tax purposes unless there is a specific statutory exclusion from gross income for a specific item. For example, a gift that a taxpayer receives is an increment to a taxpayer’s wealth, but the Internal Revenue Code specifically provides that gifts are not taxable. 1211.04 All increments to wealth, unless they are statutorily excluded from tax, must be included in the taxpayer’s income regardless of whether he or she receives a W‐2, K‐1, or 1099 indicating that such income will be reported to the IRS. Although income is normally received in dollars, gross income includes the fair market value of property received or the amount of debt a taxpayer is relieved of. © 2024 Surgent Consolidated, LLC 71 INDIVIDUALS 1211.05 Most individuals use the cash basis method of accounting. Under the cash basis method of accounting, a taxpayer includes items on income in the years in which they are received. The term “received” includes actual receipt and constructive receipt. Constructive receipt occurs when a taxpayer is legally entitled to receive income. This concept applies to various types of income such as interest, compensation, and dividends. 1211.06 A taxpayer has constructive receipt on the first date he or she has a right to claim income. Thus, a taxpayer does not have to physically possess the income; it is considered received if it is credited to the taxpayer’s account or made available to the taxpayer. There is no constructive receipt if there are substantial limitations or restrictions on the taxpayer’s control of its receipt. Example: The taxpayer received a paycheck on December 31, 20X1, but did not cash the check until sometime in January 20X2. The taxpayer must include the paycheck as income on their 20X1 tax return as the money was available to them in 20X1. 1211.07 Earned income includes all the taxable income and wages a taxpayer gets from working. There are two ways to get earned income: the taxpayer works for someone who pays them; or they work in a business they own or run. Taxable earned income includes: a. Wages, salaries, tips, and other taxable employee pay; b. Union strike benefits; c. Long‐term disability benefits received prior to minimum retirement age; d. Net earnings from self‐employment if: (i) The taxpayer owns or operates a business, or (ii) The taxpayer is a minister or member of a religious order. e. Gross income received as a statutory employee. 72 © 2024 Surgent Consolidated, LLC  INDIVIDUALS 1211.08 Examples of income that is not earned income include the following: a. Pay received for work while an inmate in a penal institution; b. Interest and dividends; c. Retirement income; d. Social Security; e. Unemployment benefits; f. Alimony; and g. Child support. 1211.09 If a taxpayer works as an employee in the United States, he or she must pay Social Security and Medicare taxes in most cases. The taxpayer’s payments of these taxes contribute to his or her coverage under the U.S. Social Security system. An employer deducts these taxes from each wage payment. In general, U.S. Social Security and Medicare taxes apply to payments of wages for services performed as an employee in the United States, regardless of the citizenship or residence of either the employee or the employer. 1211.10 The United States has entered into totalization agreements with certain foreign countries to coordinate the taxation of United States citizens employed for part or all of their working careers in certain foreign countries and the taxation of foreign citizens from certain countries working in the United States. These agreements are commonly referred to as “totalization agreements.” Under these agreements, dual coverage and dual contributions (taxes) for the same work are eliminated. The agreements generally make sure that Social Security taxes (including self‐employment tax) are paid only to one country. These agreements must be taken into account when determining whether any alien is subject to the U.S. Social Security/Medicare tax, or whether any U.S. citizen or resident alien is subject to the Social Security taxes of a foreign country. © 2024 Surgent Consolidated, LLC 73 INDIVIDUALS 1211.11 The United States has an “extraterritorial” income tax, in that an American citizen or a resident of the United States must report all income regardless of where it is earned. Thus, a United States citizen living and working in Canada must report and pay tax on all his or her income to the United States. 1211.12 Generally, a taxpayer is in constructive receipt of income when interest is posted to his or her savings or checking account regardless of whether the taxpayer withdraws or spends the interest. A taxpayer who owns a certificate of deposit (CD) or some other deferred interest account will be paid interest one or more times per year, or in one lump sum at maturity. The taxpayer must report the interest as income when he or she actually receives it or when he or she can withdraw money from the CD without paying a substantial penalty. If a taxpayer withdraws funds from a deferred interest account before it matures and he or she pays an early withdrawal penalty, the taxpayer must report the total amount of interest paid during the year without subtracting the penalty. 1211.13 Interest Income Generally, all interest received is taxable. Interest on state and municipal obligations is, however, excluded from gross income. Interest on U.S. Savings Bonds may be reported in the year accrued or postponed until the year of surrender by a cash‐basis taxpayer. Original issue discount (OID) Original issue discount (OID), a form of interest, is the excess of an obligation’s stated redemption price at maturity over its issue price (acquisition price for a stripped bond or coupon). A discount of less than 1/4 of 1 percent of the stated redemption price at maturity, multiplied by the number of full years from the date of issue to maturity, is considered to be zero. Original issue discount can apply to securities, such as bonds, debentures, notes, or certificates and is the difference between the maturity, or face value, of the security and the original cost to purchase the security. The original issue discount is important because the IRS uses special rules for determining them. Taxpayers receive the amount of their original issue discount on Form 1099‐OID. 74 © 2024 Surgent Consolidated, LLC  INDIVIDUALS The issuer will prepare a Form 1099‐OID for each person who is a holder of record of the obligation if the OID includible in the holder’s gross income is $10 or more and the debt instrument term is at least one year. A taxpayer may be able to exclude from income all or part of the interest they receive on the redemption of qualified U.S. savings bonds during the year if the taxpayer pays qualified higher educational expenses during the same year. This exclusion is known as the Education Savings Bond Program. 1211.14 Dividends of cash or property: a. Dividends are distributions of cash or property from a corporation to its shareholders. Generally, dividends are taxable when received. Federal law requires a corporation to inform the shareholder as to taxable and nontaxable amounts. b. Dividends paid on deposits with the following: mutual savings banks, cooperative banks, credit unions, U.S. building and loan associations, and other similar institutions are not considered dividends. These are interest and should be reported as such. c. There are two types of dividends. 1) Ordinary dividends are paid out of the earnings and profits of a corporation. They are the most common type of dividends and taxed at the taxpayer’s ordinary tax rate, along with most other income. 2) Qualified dividends are subject to a lower tax rate than ordinary dividends. The qualified dividend tax rates are 0% for amounts that would be taxed at 10% or 15%, 15% for amounts that would be taxed at 15%–37%, and 20% for amounts that would be taxed at a higher rate than 37%. Use the worksheet included with Schedule D instructions to figure the qualified dividends tax rate. To be a qualified dividend, the dividend must have been paid by a U.S. corporation or qualified foreign corporation, the taxpayer must meet the holding period © 2024 Surgent Consolidated, LLC 75 INDIVIDUALS (generally greater than 60 days during the 121‐day period beginning 60 days before the first date following the declaration of a dividend on which the buyer cannot receive the next dividend payment, or the ex‐dividend date), and the dividend cannot be one of the following: i. Capital gain distributions ii. “Dividends” that are actually interest (discussed in (b) above) iii. Dividends on employer securities paid by a corporation and held by an employee stock ownership plan (ESOP) iv. Dividends on stock for which the taxpayer is required to purchase substantially similar or related property v. Payments in lieu of dividends (if the taxpayer knows or has reason to know that the payments are not qualified dividends) vi. Dividends reported as qualified dividends from a foreign corporation to the extent the taxpayer knows or has reason to know that these are not qualified dividends 3) Capital gain distributions are paid by regulated investment companies (RICs) and real estate investment trusts (REITs). These are always reported as long‐term capital gains and must be reported even if undistributed. d. Individuals with modified adjusted gross income over certain threshold amounts must pay the Net Investment Income Tax (NIIT) if they have net investment income. This is a 3.8% tax on the lesser of net investment income or the modified adjusted gross income (MAGI). The threshold amount for 2023 is $250,000 for joint returns, $125,000 for married filing separate returns, and $200,000 for other filing statuses. The Net Investment Income Tax is a contribution to Medicare and is calculated/reported on 76 © 2024 Surgent Consolidated, LLC  INDIVIDUALS Form 8960, Net Investment Income Tax – Individuals, Estates, and Trusts. e. If the taxpayer has a choice of stock or cash: 1) Any cash received is income. 2) Any stock received is income to the extent of the fair market value of the stock on the date received. i. The basis of the new stock is also the fair market value of the stock. ii. The holding period for the new stock begins on the date the dividend is received. f. Stock dividends that do not result in a disproportionate distribution are not considered income. Likewise, stock splits do not produce income for the shareholders. 1) The basis of original shares must be allocated between the new and the original shares. 2) The holding period of the acquired stock is the same as that of the old stock. g. Any distribution of stock or stock rights made to preferred shareholders is taxable as a dividend. 1) The fair market value of the property received constitutes income and establishes the basis of that property. 2) The holding period for this property begins at the date of receipt. h. Property received as a dividend is income. 1) The fair market value of the property on the date of distribution constitutes income. 2) The basis of the property is also equal to the fair market value. 3) The holding period of the property acquired begins on the date the property is received. © 2024 Surgent Consolidated, LLC 77 INDIVIDUALS i. Amounts received in a partial or complete liquidation are treated as follows: 1) A return of capital until the taxpayer’s investment is recovered. 2) A capital gain on amounts received after the taxpayer’s investment is recovered. 1211.15 Rents and royalties: a. Royalties are included in gross income when received. b. Rental income is any payment received for the use or occupation of property. A taxpayer must include in gross income all amounts that are received as rent. 1) Rent is taxable when received if the taxpayer uses the cash basis; or when accrued, if the taxpayer uses the accrual basis. Any amount received from a tenant to cancel a lease is treated as rent and included in income. 2) If a tenant pays any of the taxpayer’s expenses, the payments are rental income and included in income. 3) Prepaid rental income (i.e., advance rent) is recognized in the year received whether the taxpayer is on the accrual or cash basis. c. Security deposits are not included in rental income if the amount is to be returned to the tenant at the end of the lease. If the taxpayer keeps part or all of the security deposit during any year because the tenant does not live up to the terms of the lease, the amount retained becomes income for that year. d. If an amount called a security deposit is to be used as a final payment of rent, it is advance rent, and as such, it is included as rental income in the year that it is received. 78 © 2024 Surgent Consolidated, LLC  INDIVIDUALS e. Rental of personal residence: 1) When a personal residence is rented out for less than 15 days, no rental income is recognized and expenses are not required to be prorated between personal use and rental use. 2) When a personal residence is rented out for more than 14 days, the rental income is recognized and the expenses must be allocated between personal use and rental use. A portion of mortgage interest and real estate taxes must be allocated to reduce the rental income. Taxpayers cannot deduct a loss from renting a personal residence. 1211.16 Gambling winnings and losses: a. All gambling winnings are included in gross income. b. Losses are deductible as an itemized deduction, but only to the extent of winnings. Under the Tax Cuts and Jobs Act of 2017 (TCJA), the law is clarified: for example, an individual’s expenses traveling to and from a casino are only deductible to the extent of gambling winnings. That is, there is no separate deduction for expenses incurred in winning the gambling income. 1211.17 Tax treatment for forgiveness of debt In general, if a taxpayer is liable for a debt that is canceled, forgiven, or discharged, he or she will receive a Form 1099‐C, Cancellation of Debt, and must include the amount of the canceled debt in gross income unless he or she qualifies for an exception under §108. For example, §108 provides that if the debtor is insolvent or in bankruptcy, he or she need not include the cancelled debt in income. If the taxpayer receives a Form 1099‐C, but the creditor continues to attempt to collect the debt, then the creditor has not cancelled the debt and the taxpayer does not have taxable cancellation of debt income at that time. One exception to this rule is debt forgiveness associated with PPP (Paycheck Protection Program) loans. The Tax Relief Act of 2020 clarified that PPP loan forgiveness will not generate income from cancellation of debt. Additionally, the taxpayer will not have to © 2024 Surgent Consolidated, LLC 79 INDIVIDUALS decrease any tax attributes as a result of nonrecognition of income. 1211.18 A debt includes any indebtedness whether the taxpayer is personally liable or liable only to the extent that he or she owns the property securing the debt. Cancellation of all or part of a debt that is secured by property may occur because of a foreclosure, a repossession, a voluntary return of the property to the lender, abandonment of the property, or a loan modification. The taxpayer must report any taxable amount of a cancelled debt for which he or she is personally liable, as ordinary income from the cancellation of debt. The taxpayer must report as taxable amount of a discharged or forgiven debt whether or not he or she receives a Form 1099‐C (exception to this rule is PPP loan forgiveness, see above). 1211.19 If a taxpayer’s debt is secured by property and that property is taken by the lender in full or partial satisfaction of the debt, the taxpayer will be treated as having sold that property and may have a reportable gain or loss. The gain or loss on such a deemed sale of property is a separate issue from whether any canceled debt also associated with that same property is includable in gross income. 1211.20 Canceled debts that meet the requirements for any of the following exceptions or exclusions are not taxable: a. Amounts specifically excluded from income by law such as gifts or bequests; b. Cancellation of certain qualified student loans; c. Canceled debt that if paid by a cash basis taxpayer is otherwise deductible; and d. A qualified purchase price reduction given by a seller. 80 © 2024 Surgent Consolidated, LLC  INDIVIDUALS 1211.21 Canceled debts that qualify for exclusion from gross income are as follows: a. Cancellation of qualified principal residence indebtedness; b. Debt canceled in a Title 11 bankruptcy case; c. Debt canceled during insolvency; d. Cancellation of qualified farm indebtedness; e. Cancellation of qualified real property business indebtedness; and f. Cancellation of debt associated with PPP (Paycheck Protection Program) loans. 1211.22 The exclusion for “qualified principal residence indebtedness” provides canceled debt tax relief for many American homeowners involved in the mortgage foreclosure crisis that affected much of the country. The exclusion allows taxpayers to exclude up to $750,000 ($375,000 if married filing separately) of “qualified principal residence indebtedness.” The debt must be used to buy, build, or substantially improve the main or second home. The excluded amount reduces the taxpayer’s basis in the residence. 1211.23 Generally, if a taxpayer excludes canceled debt from income under one of the exclusions listed above, he or she must also reduce his or her tax attributes (certain credits, losses, and basis of assets) by the amount excluded. The taxpayer must file Form 982, Reduction of Tax Attributes Due to Discharge of Indebtedness (and Section 1082 Basis Adjustment), to report the exclusion and the corresponding reduction of certain tax attributes. 1211.24 Tax treatment of a U.S. citizen/resident with foreign earned income: If a taxpayer meets certain requirements, he or she may qualify for the foreign earned income, foreign housing exclusions, and the foreign housing deduction. A U.S. citizen or a resident alien of the United States who lives abroad is taxed on his or her worldwide income. However, the taxpayer may qualify to exclude from income up to $120,000 in 2023. In addition, a taxpayer can exclude or deduct certain foreign housing amounts. © 2024 Surgent Consolidated, LLC 81 INDIVIDUALS 1211.25 To claim the foreign earned income exclusion, the foreign housing exclusion, or the foreign housing deduction, a taxpayer must meet all three of the following requirements. a. The taxpayer’s tax home must be in a foreign country; b. The taxpayer must have foreign earned income; and c. The taxpayer must be one of the following: (i) A U.S. citizen who is a bona fide resident of a foreign country or countries for an uninterrupted period that includes an entire tax year, (ii) A U.S. resident alien who is a citizen or national of a country with which the United States has an income tax treaty in effect and who is a bona fide resident of a foreign country or countries for an uninterrupted period that includes an entire tax year, or (iii) A U.S. citizen or a U.S. resident alien who is physically present in a foreign country or countries for at least 330 full days during any period of 12 consecutive months. 1211.26 Tax home in a foreign country To qualify for the foreign earned income exclusion, the foreign housing exclusion, or the foreign housing deduction, the taxpayer’s tax home must be in a foreign country throughout his or her period of bona fide residence or physical presence abroad. 1211.27 Tax home If a taxpayer does not have a regular or main place of business because of the nature of his or her work, the taxpayer’s tax home may be the place where he or she regularly lives. If the taxpayer has neither a regular or main place of business nor a place where he or she regularly lives, the taxpayer is considered an itinerant and his or her tax home is wherever he or she works. 82 © 2024 Surgent Consolidated, LLC  INDIVIDUALS 1211.28 Temporary or indefinite assignment The location of a taxpayer’s tax home often depends on whether his or her assignment is temporary or indefinite. If he or she is temporarily absent from his or her tax home in the United States on business, he or she may be able to deduct his or her away‐ from‐home expenses (for travel, meals, and lodging), but he or she would not qualify for the foreign earned income exclusion. If his or her new work assignment is for an indefinite period, his or her new place of employment becomes his or her tax home and he or she would not be able to deduct any of the related expenses that he or she has in the general area of this new work assignment. If his or her new tax home is in a foreign country and he or she meets the other requirements, his or her earnings may qualify for the foreign earned income exclusion. If he or she expects his or her employment away from home in a single location to last, and it does last, for one year or less, it is temporary unless facts and circumstances indicate otherwise. If he or she expects it to last for more than one year, it is indefinite. If the taxpayer expects it to last for one year or less, but at some later date he or she expects it to last longer than one year, it is temporary (in the absence of facts and circumstances indicating otherwise) until his or her expectation changes. Once his or her expectation changes, it is indefinite. 1211.29 Foreign country To meet the bona fide residence test or the physical presence test, a taxpayer must live in or be present in a foreign country. A foreign country includes any territory under the sovereignty of a government other than that of the United States. © 2024 Surgent Consolidated, LLC 83 INDIVIDUALS 1211.30 Bona fide residence test A taxpayer meets the bona fide residence test if they are a bona fide resident of a foreign country or countries for an uninterrupted period that includes an entire tax year. The taxpayer can use the bona fide residence test to qualify for the exclusions and the deduction only if they are either: a. A U.S. citizen; or b. A U.S. resident alien who is a citizen or national of a country with which the United States has an income tax treaty in effect. 1211.31 A taxpayer does not automatically acquire bona fide resident status merely by living in a foreign country or countries for one year. If a taxpayer goes to a foreign country to work on a particular job for a specified period of time, they ordinarily will not be regarded as a bona fide resident of that country even though they work there for one tax year or longer. The length of their stay and the nature of their job are only two of the factors to be considered in determining whether they meet the bona fide residence test. 1211.32 To meet the bona fide residence test, a taxpayer must have established a bona fide residence in a foreign country. A taxpayer’s bona fide residence is not necessarily the same as their domicile. A taxpayer’s domicile is their permanent home, the place to which they always return or intend to return. Example: A taxpayer could have their domicile in Cleveland, Ohio, and a bona fide residence in Edinburgh, Scotland, if they intend to return eventually to Cleveland. The fact that a taxpayer goes to Scotland does not automatically make Scotland their bona fide residence. If they go there as a tourist, or on a short business trip, and return to the United States, they have not established bona fide residence in Scotland. But if they go to Scotland to work for an indefinite or extended period and they set up permanent quarters there for themselves and their family, they probably have established a bona fide residence in a foreign country, even though they intend to return eventually to the United States. 84 © 2024 Surgent Consolidated, LLC  INDIVIDUALS 1211.33 The taxpayer is clearly not a resident of Scotland in the first instance. However, in the second instance, they are a resident because their stay in Scotland appears to be permanent. If their residency is not as clearly defined as either of these illustrations, it may be more difficult to decide whether they have established a bona fide residence. 1211.34 Physical presence test A taxpayer meets the physical presence test if he or she is physically present in a foreign country or countries 330 full days during a period of 12 consecutive months. The 330 days do not have to be consecutive. Any U.S. citizen or resident alien can use the physical presence test to qualify for the exclusions and the deduction. The physical presence test is based only on how long a taxpayer stays in a foreign country or countries. This test does not depend on the kind of residence he or she establishes, his or her intentions about returning, or the nature and purpose of his or her stay abroad. Generally, to meet the physical presence test, a taxpayer must be physically present in a foreign country or countries for at least 330 full days during a 12‐month period. The taxpayer can count days he or she spent abroad for any reason. 1211.35 Foreign earned income To claim the foreign earned income exclusion, the foreign housing exclusion, or the foreign housing deduction, a taxpayer must have foreign earned income. Foreign earned income generally is income a taxpayer receives for services he or she performs during a period in which he or she meets both of the following requirements: a. His or her tax home is in a foreign country; and b. He or she meets either the bona fide residence test or the physical presence test. © 2024 Surgent Consolidated, LLC 85 INDIVIDUALS 1211.36 Earned income This is pay for personal services performed, such as wages, salaries, or professional fees. The list that follows classifies many types of income into three categories. The column headed Variable Income lists income that may fall into either the earned income category, the unearned income category, or partly into both. Earned Income Unearned Income Variable Income Salaries and wages Dividends interest Business profits Commissions Capital gains Royalties Bonuses Gambling winnings Rents Professional fees Alimony Scholarships and fellowships Tips Social Security benefits Pensions Annuities 1212 Other Income 1212.01 Scholarships and fellowships a. A degree candidate may exclude scholarships and fellowships to the extent the amount received is used for tuition, course fees, books, and supplies. Amounts used for room and board are taxable. b. Amounts received are taxable if specific services, such as teaching, are required to receive the scholarship or fellowship. c. Any amount paid to a nondegree candidate is taxable. 1212.02 Bartering income a. Bartering occurs when a taxpayer exchanges goods or services without exchanging money. An example of bartering is a plumber doing repair work for a dentist in exchange for dental services. A taxpayer must include in gross income in the year of receipt the fair market value of goods and services received in exchange for goods or services the taxpayer provided. b. Generally, a taxpayer reports this income on Form 1040, Schedule C, Profit or Loss from Business. If a taxpayer 86 © 2024 Surgent Consolidated, LLC  INDIVIDUALS failed to report this income, he or she should correct his or her return by filing a Form 1040X. c. A barter exchange or barter club is any organization with members or clients or persons who contract with each other (or with the barter exchange) to jointly trade or barter property or services. The term does not include arrangements that provide solely for the informal exchange of similar services on a noncommercial basis. d. The Internet has provided a medium for new growth in the bartering exchange industry. This growth prompts the following reminder: barter exchanges are required to file Form 1099‐B for all transactions unless they meet certain exceptions. Persons who do not contract a barter exchange, but who trade services, are not required to file Form 1099‐B. However, they may be required to file Form 1099‐MISC. If a taxpayer is in a business or trade, he or she may be able to deduct certain costs incurred to perform the work that was bartered. If a taxpayer exchanged property or services through a barter exchange, he or she should receive a Form 1099‐B, Proceeds from Broker and Barter Exchange Transactions. The IRS also will receive the same information. 1212.03 Hobby income a. The TCJA of 2017 eliminates the itemized deduction for hobby expenses. Some expenses, however, are deductible regardless of hobby income. These would include all expenses to which the taxpayer is normally entitled as a personal deduction, such as interest, taxes, and casualty losses. b. A hobby may be treated as a business if it meets the following profitability tests: 1) A profit is generated in three out of five consecutive years. 2) A profit is generated in two out of seven consecutive years for breeding, training, showing, or racing horses. © 2024 Surgent Consolidated, LLC 87 INDIVIDUALS c. If facts and circumstances can prove an intent to make a profit, the activity may still be considered a business after failing the above test. However, the burden of proof is on the taxpayer. 1212.04 Alimony and separate maintenance payments Note: The TCJA of 2017 changes the treatment of alimony and separate maintenance payments negotiated after December 31, 2018. (see f. below) a. Excluding the portion that is designated for child support, qualified payments are included in the gross income of the recipient and deductible from gross income by the payor if the payments are made after: 1) Decree or divorce or separate maintenance, 2) Written separation agreement, or 3) Decree for support (this applies to periods pending finality of divorce or legal separation). b. Qualified payments are required to meet the following guidelines: 1) Payments must be in cash. 2) Payments must terminate at the death of the recipient. 3) Payments cannot be made to a payee who lives in the same household as the payor. 4) Payments cannot be specified as something other than alimony. c. Special rules apply if alimony payments in the second‐ or third‐year decrease by more than $15,000 from the payments made in the previous year. 1) If the change in payments exceeds statutory limits, recapture of excessive alimony payments will result. 2) All of the recapture will take place in the third year. 88 © 2024 Surgent Consolidated, LLC  INDIVIDUALS i. The payor must include the excess amounts in gross income. ii. The payee is allowed to deduct the excess payments from gross income to arrive at adjusted gross income. d. Any amount that can be identified as child support cannot be treated as alimony. 1) Child support payments are neither deductible by the payor nor income to the recipient 2) If both child support and alimony are provided for in the agreement, any amounts paid are first considered to be child support until that obligation is met. e. The transfer of property between divorcing spouses in exchange for release from marital obligations is nontaxable. The basis of the transferred property to the transferee will be the same as it was to the transferor. f. For any divorce or separation agreement executed after December 31, 2018, or executed before that date but modified after it (if the modification expressly provides that the new amendment applies), alimony and separate maintenance payments are not deductible by the payor spouse nor includible in income of the payee spouse. 1212.05 Military combat pay a. U.S. Armed Forces members, including enlisted persons or warrant officers, may exclude military pay received for military services for the entire month of any month while serving in a combat zone. Commissioned officers are capped at the highest enlisted pay, plus any hostile fire or imminent danger pay received. b. Military pay received by enlisted personnel who are hospitalized as a result of injuries sustained while serving in a combat zone is excluded from gross income for the period of hospitalization. c. Reenlistment bonuses received are excluded from gross income if the member reenlists early while in a combat © 2024 Surgent Consolidated, LLC 89 INDIVIDUALS zone even if the bonus is not received until several months later while stationed outside the combat zone. d. Deadlines, including filing and paying income tax due, are automatically extended for service persons in a combat zone. 1212.06 Canceled debt: a. Generally, a canceled debt is income to the debtor when the cancellation is not intended to be a gift. b. The presence or absence of consideration is a vital factor in determining whether or not a gift was intended. c. When a seller cancels a buyer’s purchase indebtedness, the buyer can generally avoid income recognition by electing to reduce the basis of the property by the amount of the debt discharged. d. Discharge of indebtedness due to debtor insolvency or federal bankruptcy law is generally not included in gross income but is used instead to reduce the basis of assets or other items carrying favorable tax attributes, such as loss or credit carryovers. e. A shareholder’s cancellation of a corporation’s indebtedness is treated as a contribution of capital. f. Some states make loans to students under an agreement that the loan will be canceled if the student works in a certain profession, in a location within the state after graduation. 1) The canceled debt is excluded from gross income. 2) This exclusion also applies to loans from tax‐ exempt charitable organizations. However, the debt cancellation cannot relate to services performed for the lender organization. 3) The TCJA of 2017 excludes any income resulting from the discharge of student debt due to death or disability for discharges of student loans after 2017 and before 2026. 90 © 2024 Surgent Consolidated, LLC  INDIVIDUALS 1213 Constructive Receipt of Income 1213.01 An accounting method is a set of rules used to determine when and how income and expenses are reported. A taxpayer’s accounting method includes not only the overall method of accounting he or she uses, but also the accounting treatment he or she uses for any material item. 1213.02 A taxpayer chooses an accounting method for his or her business when he or she files his or her first income tax return that includes a Schedule C for the business. After that, if a taxpayer wants to change his or her accounting method, he or she must generally get IRS approval. Generally, a taxpayer can use any of the following accounting methods: a. Cash method; b. An accrual method; c. Special methods of accounting for certain items of income and expenses; or d. Combination method using elements of two or more of the above. A taxpayer must use the same accounting method to figure his or her taxable income and to keep his or her books and must use an accounting method that clearly shows his or her income. 1213.03 A taxpayer can account for business and personal items under different accounting methods. For example, a taxpayer can figure business income under an accrual method, even if he or she uses the cash method to figure personal items. If a taxpayer has two or more separate and distinct businesses, he or she can use a different accounting method for each if the method clearly reflects the income of each business. They are separate and distinct only if he or she maintains complete and separate books and records for each business. © 2024 Surgent Consolidated, LLC 91 INDIVIDUALS 1213.04 Cash method Most individuals and many sole proprietors with no inventory use the cash method because they find it easier to keep cash method records. However, if an inventory is necessary to account for income, the taxpayer must generally use an accrual method of accounting for sales and purchases. Under the cash method, the taxpayer should include in gross income all items of income he or she actually or constructively received during his or her tax year. If a taxpayer receives property or services, he or she must include their fair market value in income. Example: On December 30, 20X1, Mrs. Sycamore sent taxpayer a check for interior decorating services the taxpayer provided to her. The taxpayer received the check on January 2, 20X2. The taxpayer must include the amount of the check in income for 20X2. A taxpayer has constructive receipt of income when an amount is credited to his or her account or made available to him or her without restriction. The taxpayer does not need to have possession of it. If the taxpayer authorizes someone to be his or her agent and receives income for the taxpayer, he or she is treated as having received it when his or her agent received it. Example: Interest is credited to a taxpayer’s bank account in December 20X1. The taxpayer does not withdraw it or enter it into his or her passbook until 20X2. The taxpayer must include it in his or her gross income for 20X1. 1213.05 Delaying receipt of income: A taxpayer cannot hold checks or postpone taking possession of similar property from one tax year to another to avoid paying tax on the income. The taxpayer must report the income in the year the property is received or made available to him or her without restriction. Example: Frances Jones, a service contractor, was entitled to receive a $10,000 payment on a contract in December 20X1. She was told in December that her payment was available. At her request, she was not paid until January 20X2. She must include this payment in her 20X1 income because it was constructively received in 20X1. 92 © 2024 Surgent Consolidated, LLC  INDIVIDUALS 1213.06 Checks: Receipt of a valid check by the end of the tax year is constructive receipt of income in that year, even if the taxpayer cannot cash or deposit the check until the following year. Example: Dr. Redd received a check for $500 on December 31, 20X1. She could not deposit the check in her business account until January 3, 20X2. She must include this fee in her income for 20X1. 1214 Passive Income 1214.01 In order to understand the rules dealing with rental income and expenses, it is necessary to understand how the passive activity loss rules work. The passive activity loss rules (§469 of the Internal Revenue Code) limits the taxpayer’s ability to deduct losses from businesses in which he or she does not materially participate and from rental activities. The passive activity loss rules are applied at the individual level and extend to virtually every business or rental activity whether reported on Schedule C, Schedule F, or Schedule E of the Form 1040, as well as to flow‐through income and losses from partnerships, S corporations, and trusts. The passive loss limitations also apply to personal service corporations and to closely held C corporations, but with limited applications. 1214.02 In general, losses generated by passive activities can only be used to offset income generated by passive activities. A passive activity is an activity for the tax year if the activity is a trade or business activity in which the taxpayer does not materially participate for such taxable year or is a rental activity, without regard to whether or to what extent the taxpayer participates in the activity. 1214.03 Section 469 generally divides a taxpayer’s income and losses into three types, which relate to the three types of activities provided for under §469: 1. Passive; 2. Active; and 3. Portfolio. © 2024 Surgent Consolidated, LLC 93 INDIVIDUALS 1214.04 Section 469 provides that passive losses may only be used to offset passive income and expenses related to passive activities can be deducted only to the extent of income from all of the taxpayer’s passive activities. Passive losses that cannot be used to offset other income are suspended and carried forward to offset passive income in a subsequent year. Suspended passive losses may also offset portfolio or active income when the taxpayer disposes of his or her entire interest in the activity that generated the suspended passive losses. 1214.05 When the taxpayer makes a full and compete disposition of a passive activity with suspended losses, the losses are used to offset income in the following order: 1. Gain on the disposition of the passive activity. 2. Net income from any of the taxpayer’s passive activities. 3. All other income ‐‐ active and portfolio income. 1214.06 Activities that are generally passive: Income and losses from the following activities are generally passive: 1. Rental real estate (except rentals in which a real estate professional materially participates) and equipment leasing. 2. Sole proprietorship or a farm in which the taxpayer does not materially participate. 3. Limited partnership interest, with some exceptions. 4. Partnership, S corporation, and limited liability company business in which the taxpayer does not materially participate. 1214.07 Activities that are generally non‐passive: Income and losses from the following are generally non‐passive: 1. Salaries, wages, and Form 1099‐MISC commissions. 2. Guaranteed payments from partnerships. 3. Portfolio income (interest, dividends, royalties, gains on stocks and bonds). 4. Sale of undeveloped land or other investment property. 94 © 2024 Surgent Consolidated, LLC  INDIVIDUALS 5. Royalties. 6. Sole proprietorship or farm in which the taxpayer materially participates. 7. Partnership, S corporation, or LLC business in which the taxpayer materially participates. 1214.08 Portfolio income: Passive activity gross income does not include portfolio income, which includes all gross income other than income derived in the ordinary course of a trade or business that is attributable to the following: Interest Dividends The disposition of property that produces interest Gross income derived in the ordinary course of a trade or business The disposition of property held for investment Royalties 1214.09 Definition of passive activity loss: Generally, a taxpayer’s passive activity loss for the tax year is the excess of his or her passive activity deductions over his or her passive activity gross income. Closely held corporations can offset net active income with passive activity losses but cannot use passive losses to offset their portfolio income. Portfolio income is interest, dividends, annuities, and royalties not derived in the ordinary course of a trade or business. For a closely held corporation, the passive activity loss is the excess of passive activity deductions over the sum of passive activity gross income and net active income. A trade or business activity is not a passive activity if the taxpayer materially participated in the activity. © 2024 Surgent Consolidated, LLC 95 INDIVIDUALS 1214.10 Material participation tests: A taxpayer materially participated in a trade or business activity for a tax year if he or she satisfies any one of the following tests: 1. He or she participated in the activity for more than 500 hours. 2. His or her participation was substantially all the participation in the activity of all individuals for the tax year, including the participation of individuals who did not own any interest in the activity. 3. He or she participated in the activity for more than 100 hours during the tax year, and he or she participated at least as much as any other individual (including individuals who did not own any interest in the activity) for the year. 4. The activity is a significant participation activity, and the taxpayer participated in all significant participation activities for more than 500 hours. A significant participation activity is any trade or business activity in which the taxpayer participated for more than 100 hours during the year and in which he or she did not materially participate under any of the material participation tests, other than this test. 5. The taxpayer materially participated in the activity for any five (whether or not consecutive) of the ten immediately preceding tax years. 6. The activity is a personal service activity in which the taxpayer materially participated for any three (whether or not consecutive) preceding tax years. An activity is a personal service activity if it involves the performance of personal services in the fields of health (including veterinary services), law, engineering, architecture, accounting, actuarial science, performing arts, consulting, or any other trade or business in which capital is not a material income‐producing factor. 7. Based on all the facts and circumstances, the taxpayer participated in the activity on a regular, continuous, and substantial basis during the year. 96 © 2024