Reminder—Food and Beverage Industry Businesses May Be Eligible for an Income Tax Credit for FICA Taxes Paid on Tips

By William R. Stromsem, J.D., CPA, Assistant Professor, Department of Accountancy, George Washington University School of Business

Now that customers are back in restaurants and bars, a reminder might be in order of a tax break for these businesses. Many employers that sell food and beverages (in a bar or restaurant or delivered) may be unaware that they may have a substantial income tax credit for the employer’s share of Social Security and Medicare taxes paid on reported tips above the minimum wage.

Tipped workers report their tip income to employers, and employers pay FICA taxes on tip income even though technically the compensation was paid by the tipper, not the restaurant or bar. This credit is intended to provide relief for payment of FICA taxes on income over the minimum wage, the amount that the employer would have had to pay FICA taxes on if there were no tips. On the cynical side, some might say that this credit is intended to discourage businesses from underreporting tips to avoid paying the FICA taxes.

This credit is claimed on IRS Form 8846 and the instructions give calculation details. https://www.irs.gov/pub/irs-access/f8846_accessible.pdf

Remember that PTIN Holders Need a Data Security Plan

Practitioners, you can now obtain or renew your IRS preparer tax identification number (PTIN) for the upcoming filing season. Since TXCPA is receiving inquiries, it is a good time to highlight that the PTIN application includes a checkbox for practitioners to attest to having a Written Information Security Plan (WISP) on file – a document that details a firm’s security controls, processes and policies to protect client data. The WISP requirement is in accordance with the Federal Trade Commission’s Safeguards Rule.

Fortunately, the IRS has released a template for tax preparers to use, Creating a Written Information Security Plan for your Tax & Accounting Practice. If you have additional questions or application issues, call the IRS’ PTIN Account Information Line at 877-613-7846, available 8 a.m. – 5 p.m. (CT).

Current PTINs expire Dec. 31.

More information:

Security Summit releases new data security plan to help tax professionals; new WISP simplifies complex area

Here’s what tax professionals should know about creating a data security plan

Contact the Return Preparer Program

Publication 4557, Safeguarding Taxpayer Data

Publication 5293, Data Security Resource Guide for Tax Professionals

Identity Theft Information for Tax Professionals

Schedules K-2 and K-3 Filing Requirements Update

By Tom Ochsenschlager, J.D., CPA

The Tax Cuts and Jobs Act enacted in 2007 required taxpayers to provide more information relevant to international tax matters. The IRS believed there was significant inconsistency reporting the items of international tax relevance on the Form K-1 and therefore is now increasing the detail required for the reporting.

To comply with this legislative requirement and to clarify items of international tax relevance, in June 2021, the IRS released Schedules K-2 and K-3 that are, in effect, a replacement (enhancement) of line 16a-r and line 20 of the K-1. The K-2 and K-3 must now be included in the filing of Forms 1065 and 1120-S. Generally, the Schedule K-2 will be filed with the partnership or S corporation return while the K-3 will be included with the individual partner’s or shareholder’s K-1s. Although these schedules relate to international tax matters, in January 2022, the IRS announced it would require the forms to be filed even in circumstances where the entity does not have foreign partners, foreign source income, foreign assets that generate income or foreign taxes paid or accrued. The rationale for this seemingly unnecessary requirement is that, in some circumstances, a partner or shareholder is claiming a foreign tax credit that would require specific information from the partnership or S corp.

The IRS has clarified that partnerships and S corps did not need to file the Forms K-2 and K-3 for the 2021 tax year if none of the partners were foreign partnerships, corporations, individuals, or estates or trusts, and the S corporation or partnerships had no foreign activity, foreign taxes or ownership of assets that did or could be expected to generate foreign source income.  

On Oct. 25, 2022, the IRS released drafts of the partnership and partners’ instructions for Schedules K-2 and K-3 and requested comments regarding the drafts be submitted by Nov. 8.

The IRS has submitted responses on its website to 27 of the questions it has been receiving:  Schedules K-2 and K-3 Frequently Asked Questions (Forms 1065, 1120S, and 8865).

The draft forms are available at 2022 Partnership Instructions for Schedules K-2 and K-3 (Form 1065).

IRS Publishes Draft of 2022 Form 1065 K-2 and K-3 Instructions With Revised Exemptions from Filing — Current Federal Tax Developments

Beware of Employee Retention Credit Scams

By David Donnelly, CPA-Houston, and Anna Johnson, CPA-Houston

Judging by the calls that tax professionals have been receiving, many employers are receiving numerous solicitations from vendors to help the employer claim the Employee Retention Credit (ERC) as provided for in the Coronavirus Aid, Relief, and Economic Security (CARES) Act and the Taxpayer Certainty and Disaster Tax Relief Act (the “Relief” Act).  

There are many reputable vendors offering these services; however, there appear to be some disreputable vendors offering questionable services. Their scam follows the traditional format—sell the client a service that is flawed and disappear before the client finds out.

The basic scam is as follows:

• The vendor convinces the employer that they qualify for the ERC even if gross receipts did not decline.
• The vendor prepares the forms to apply for the tax credits for a fee that is a percentage of the claimed credit, usually 20% to 35%.
• The payment to the vendor for the services is required when the forms are completed and filed.
• The vendor will offer a guarantee that the credit will be received.

There are at least two flaws in this pitch—first, the employer may not qualify for the ERC and second, the guarantee only works if the vendor is still in business and can be found.

The basic requirement for qualification for the ERC is that there was a significant decline in gross receipts. For 2020, this decrease has to be 50% compared to the same quarter in the previous year; for 2021, this decrease has to be 20% compared to the same quarter in the previous year.   

There are many other factors that determine qualification, a discussion of which is beyond the scope of this article.

There is a provision in the guidance that allows the credit if “the operation of the trade or business…is fully or partially suspended due to orders from an appropriate government authority limiting commerce, travel or group meetings…due to COVID-19… .” (see Notice 2021-20).

The dubious vendors will advise the employers that they qualify under this “government authority” clause regardless of the effect the pandemic had on their business. An argument that they make is that “if your employees had to work remotely, you qualify.” This is not the case. There has to be specific governmental orders restricting commerce. An example of a specific order is when a state or local government requires bars or restaurants to be closed. 

The IRS is examining many of the claims for refund. Presumably, those filed under the “appropriate government authority” will attract extra scrutiny.

In order to protect themselves from this scam, employers should be alert for the following:

• A newly formed or newly organized vendor,
• A vendor with no professional qualifications, or
• A vendor claiming that the employer qualifies under the “appropriate government authority” clause.

The IRS has addressed these scams in the Oct. 19, 2022 news release IR-2022-183.

CPAs can help their clients avoid these scams by properly advising them about their qualification for the ERC and, if necessary, researching the vendors that the client may be considering.

Resources:

Report ERC credit mills

• Form 3949-A (Rev. 10-2020) (irs.gov) 
• Hotline | U.S. Treasury Inspector General for Tax Administration OIG (tigta.gov)

Employee retention credit: Your questions answered | Resources | AICPA (members only)

 

 

 

IRS Tax Year 2023 Inflation Adjustments

By Chris Keegan, CPA-Austin

The IRS recently released annual inflation and cost of living adjustments for the upcoming 2023 tax year. 

Inflation adjustments were released in Revenue Procedure 2022-38 and they impact over 60 tax provisions. Many of these adjustments are significantly larger than usual this year given the current high rate of inflation.

These changes impact many common income tax items, including:

• An increase in the standard deduction to:
  • $27,700 for married couples filing jointly
  • $13,850 for single taxpayers and married individuals filing separately
  • $20,800 for heads of household
• Adjustments to the marginal tax brackets with the highest bracket of 37% now beginning at $578,125 for single filers and $693,750 for joint filers
• An increase in the lifetime estate exclusion to $12,920,000
• An increase in the annual gift exclusion to $17,000

For a full listing of all changes visit:

• IRS Provides Tax Inflation Adjustments for Tax Year 2023
• Rev Proc 2022-38

In addition to the inflation adjustments noted in Rev. Proc. 2022-38, the IRS has issued guidance for pension related cost of living adjustments. These adjustments include:

• An increase of the limit on deferrals into 401(k) and 403(b) plans to $22,500
• An increase of the 401(k)/403(b) catchup contribution amount to $7,500
• An increase in the IRA deferral limit to $6,500

Details on the pension related cost of living adjustment can be found here:

• 401k and IRA Limits Increase
• Notice 2022-55

Good News – The IRS Delayed New Guidance in Inherited IRAs

Under the Setting Every Community Up for Retirement Enhancement Act of 2019 (SECURE Act), non-spousal beneficiaries of IRAs inherited after 2019 had to receive the entire balance in the account within 10 years. In regulations proposed by the IRS on Feb. 24, 2022, the IRS said that a non-spousal beneficiary who inherited an IRA from someone who died before reaching the age of required minimum distributions (RMDs) would have to start taking distributions annually, presumably calculated like RMDs, to deplete the account ratably over 10 years. Before these proposed regs, many practitioners and taxpayers had read the fairly clear language of the SECURE Act to say the payments just had to be completed by the end of 10 years and had decided to defer payment until the end of the period. The proposed regs would have resulted in many taxpayers retroactively not being in compliance with a provision for 2020 and 2021 distributions, before the February 2022 regulations were proposed.

The IRS received plenty of comments, including those from TXCPA’s Federal Tax Policy Committee, asking the IRS to defer the effective date so that taxpayers would not be penalized by a retroactive requirement contrary to a reasonable interpretation of earlier guidance.

In recent Notice 2022-53, the IRS gave a status of the proposed rules, announcing that it is changing the proposal to allow payments to be made on a schedule determined by the taxpayer so long as the IRA is depleted within 10 years. The notice provides transition relief from the RMD proposed rules for qualified designated beneficiaries of decedents dying after 2019. There is no penalty for 2021 and 2022 RMD failures. The IRS announced that RMDs are not required to commence until at least 2023. 

The IRS indicated: "To the extent a taxpayer did not take a specified RMD (as defined in Section IV.C of this notice), the IRS will not assert that an excise tax is due under Section 4974. If a taxpayer has already paid an excise tax for a missed RMD in 2021 that constitutes a specified RMD, that taxpayer may request a refund of that excise tax." This provides necessary relief for taxpayers with RMDs previously due under the proposed regulations for 2021 and 2022.

The IRS is still working on finalizing the proposed regulations.    

TXCPA Comments Letter on Proposed Regs on RMDs for Inherited IRAs 7-15-22

Importance of Substantiating Charitable Income Tax Deductions

By Jenny Wang, CPA

A recent U.S. Tax Court case, Albrecht v. Commissioner of Internal Revenue, No. 13314-20, T.C. Memo 2022-53, highlights the importance of substantiating charitable income tax deductions, including having a valid "contemporaneous written acknowledgement" (CWA) to support any charitable contribution of $250 or more.

In this case, the tax court stated that the requirements to obtain a CWA is a “strict one” and ruled that the taxpayer had not met the substantiation requirements because the CWA did not specify whether the donee provided any goods or services in return for the donation or state that it represented the entire agreement between the donee and the taxpayer. 

Decision reinforces substantiating charitable tax deductions: PwC

Circumstances Where R&D Credit Denied

By Tom Ochsenschlager, J.D., CPA

The IRS recently released a Field Attorney Advice (FAA) memo that denied a taxpayer’s claim for a research tax credit involving five instances where the taxpayer’s customers funded the research. The FAA indicated its conclusion as based on its review of the terms of the contracts the taxpayer had with its customers regarding termination clauses, ownership of the deliverable, payment terms, acceptances/inspections and warranties. 

The IRS examination concluded that the payments from the customers were not contingent on the success of the research and the terms of the payments for the research did not permit the taxpayer to use the results of the research. The IRS found that, under these conditions, the contracts were “funded research” and that the taxpayer could not claim the research credit under Section 41.

AICPA again critiques new IRS requirements for R&D credits - Journal of Accountancy

https://us.aicpa.org/content/dam/aicpa/advocacy/tax/downloadabledocuments/56175896-aicpa-comment-letter-section-41-research-credit-refund-claims-technical-comments.pdf 

Withholding on Distributions from Pensions, Annuities and IRAs

By Tom Ochsenschlager, J.D., CPA

The IRS will now permit electronic and telephonic submissions of Forms W-4P (for distributions from pensions and annuities) and W-4R (for distributions from retirement plans and IRAs) where a taxpayer requests withholding from the distributions that differs from the “default” withholding. Specific guidance to apply for electronic filing of these two forms is available at IRS Publication 15-A (2022), Employer's Supplemental Tax Guide and Publication 15-T (2022), Federal Income Tax Withholding Methods.

The “default” withholding rate is 10% for periodic distributions and 20% for “rollover” distributions. In both instances, a higher percentage can be elected. 

Telephonic submissions of W-4P are permitted. The IRS will issue further guidance on how this will be applied but, pending the submission of the guidance, taxpayers should use a “script” that incorporates the first page of the paper Form W-4P but should skip the paper’s “step 2” and “step 3.”

Additional Guidance for Substitute and Telephonic Submissions of Forms W-4P and W-4R | Internal Revenue Service (irs.gov)

TIGTA Reviewed IRS Exams of Joint Returns Where Couple Divorced or Separated

By Tom Ochsenschlager, J.D., CPA

The Treasury Inspector General for Tax Administration (TIGTA) released Report Number 2022-30-058 regarding its review of case files from the Office of Appeals and Taxpayer Advocate Service (TAS) where the IRS had determined a balance due on a jointly filed return but at the time of the IRS determination, the taxpayer and spouse were separated or divorced. TIGTA was concerned that although the husband and wife who filed the return were both liable for the underpayment, the IRS Appeals and TAS failed to disclose joint collection liability to the separated or divorced spouse during the examination or its determination, resulting in the former spouse having a liability but no way to participate in the examination process.

The TIGTA report recommended that the IRS provide guidance on what collection activity must be disclosed to both taxpayers filing the joint returns and additional training for Appeals personnel to implement the guidance. The IRS agreed to both recommendations.