Here’s a roundup of several recent tax court cases and what they mean for you.
Thou Shalt Not Commingle Funds
(Vorreyer, TC Memo 2022-97, 9/21/22)
Don’t let sloppy record keeping prevent you from deducting legitimate business expenses. The Tax Court agreed with the IRS that business expenses must first be deducted on that business’s tax return before flowing to the owner’s tax return.
Facts: A married couple, the sole shareholders of an S corporation, operated a family farm in Illinois. In 2012 they paid the farm’s utility bills of $21,000 and property taxes of $109,000 from their personal funds, then deducted these payments on their individual Form 1040 tax return as business expenses.
Even though the utility and property tax bills were legitimate business expenses, the deduction was disallowed because the expenses should have first been deducted on the farm’s S corporation tax return, then flowed through to the shareholder’s individual tax return.
Tax Tip: To pay an expense on behalf of your business, first make a capital contribution to your business, then have your business pay the expense. Then include this expense on your business’s tax return.
Adding Tax Insult to Injury
(Dern TC Memo 2022-90, 8/30/22)
Payments received to settle a physical injury or illness lawsuit are generally considered non-taxable income. But you better be sure that the lawsuit you file is actually to compensate for a physical injury or illness, and not something else.
Facts: Thomas Dern, a sales representative for a paint products company in California, was hospitalized for acute gastrointestinal bleeding and a subsequent heart attack. When the company fired him because he could no longer do his job, he sued for wrongful termination. The parties eventually reached a settlement.
Dern argued in Tax Court that his illness led to his firing, and therefore the settlement should be classified as non-taxable income. The payment he received, however, was to settle a discrimination lawsuit and not a physical injury. The settlement therefore did not qualify to be non-taxable income.
Tax Tip: Pay attention to the tax consequences of settlement payments so you don’t get surprised with an unexpected tax bill.
You’re Stuck With the Standard Deduction
(Salter, TC Memo 2022-49, 4/5/22)
Facts: Shawn Salter, a resident of Arizona, requested and received a distribution of $37,000 from his retirement plan after being laid off from his job in 2013. Salter failed to file a tax return for 2013, so the IRS created a substitute tax return for him using the standard deduction of $6,500 for a single taxpayer. The IRS also assessed an early withdrawal penalty of 10% on the distribution.
Salter, arguing that the distribution was to pay for medical expenses which aren’t subject to the 10% early withdrawal penalty, eventually did file a 2013 tax return with $25,000 of itemized medical expenses. The Tax Court disallowed the $25,000 of itemized deductions, stating that once a substitute return is created by the IRS using the standard deduction, the taxpayer can no longer claim itemized deductions for that year. Tax Tip: Try to avoid a situation where the IRS files a substitute tax return on your behalf. Once this happens, you have no choice but to use the standard deduction for that tax year.
Long-term care costs that drain your nest egg is a financial pothole that is hard to avoid. Here are some ideas to help manage this hazard.
How much is needed
Here’s how much money you’ll need for three different types of senior living arrangements according to Genworth’s 2021 Cost of Care Survey:
In-home care – $4,957 to $5,148 monthly; $59,484 to $61,776 annually
Community and assisted living – $1,690 to $4,500 monthly; $20,280 to $54,000 annually
Nursing home facilities – $7,908 to $9,034 monthly; $94,896 to $108,408 annually
The traditional source of payment problems
Too many people unfortunately think that Social Security, Medicare and health insurance will cover the costs of long-term care. While about half of adults age 50 and over believe that Medicare will cover the cost of long-term care services, according to an AARP survey, the reality is that Medicare provides very limited coverage for long-term care.
What you can do
Here are some suggestions for how you can care for yourself and your loved ones when you need it.
Review long-term care insurance. While it’s hard to find a cost-effective policy, long-term care insurance helps pay for several types of services ranging from in-home care to nursing homes. It can be difficult to qualify for long-term care insurance, however. Policy underwriters require you to answer questions and possibly complete an exam to determine medical eligibility.
Some employers offer long-term care insurance that is purchased at group rates. If your company offers coverage, it may be a better alternative than purchasing a policy on your own.
Take advantage of tax benefits. Long-term insurance premiums may be tax deducible. Tax-qualified polices are considered a medical expense and the premiums are listed as an itemized deduction. For more information, speak with an insurance agent specializing in long-term care policies as well as your tax professional.
Research long-term care costs in your state. The cost of long-term care services varies by state, type of services required, and type of services preferred. Knowing the cost of long-term care available in your area is a good starting point in the planning process.
Leverage life insurance. Certain life insurance policies with an early withdrawal for terminal illness or care needs can be an alternative to long-term care insurance. And if structured properly, it can also have tax-free status when used.
Before taking steps for your care as you age, please talk to qualified experts. While long-term care is costly, so is making the wrong decision on how you are going to fund it.
Like a bundle of sticks, good business partners support each other and are less likely to crack under strain together than on their own. In fact, companies with multiple owners have a stronger chance of surviving their first five years than sole proprietorships, according to U.S. Small Business Administration data.
Yet sole proprietorships are more common than partnerships, making up more than 70 percent of all businesses. That’s because while good partnerships are strong, they can be a challenge to successfully get off the ground. Here are some of the ingredients that good business partnerships require:
A shared vision. Business partnerships need a shared vision. If there are differences in vision, make an honest effort to find common ground. If you want to start a restaurant, and your partner envisions a fine dining experience with French cuisine while you want an American bistro, you’re going to be disagreeing over everything from pricing and marketing to hiring and décor.
Compatible strengths. Different people bring different skills and personalities to a business. There is no stronger glue to hold a business partnership together than when partners need and rely on each other’s abilities. Suppose one person is great at accounting and inventory management, and another is a natural at sales and marketing. Each is free to focus on what they are good at and can appreciate that their partner will pick up the slack in the areas where they are weak.
Defined roles and limitations. Before going into business, outline who will have what responsibilities. Agree on which things need consensus and which do not. Having this understanding up front will help resolve future disagreements. Outlining the limits of each person’s role not only avoids conflict, it also identifies where you need to hire outside expertise to fulfill a skill gap in your partnership.
A conflict resolution strategy. Conflict is bound to arise even if the fundamentals of your partnership are strong. Set up a routine for resolving conflicts. Start with a schedule for frequent communication between partners. Allow each person to discuss issues without judgment. If compromise is still difficult after a discussion, it helps to have someone who can be a neutral arbiter, such as a trusted employee or consultant.
A goal-setting system. Create a system to set individual goals as well as business goals. Regularly meet together and set your goals, the steps needed to achieve them, who needs to take the next action step, and the expected date of completion.
An exit strategy. It’s often easier to get into business with a partner than to exit when it isn’t working out. Create a buy-sell agreement at the start of your business relationship that outlines how you’ll exit the business and create a fair valuation system to pay the exiting owner. Neither the selling partner nor the buying partner want to feel taken advantage of during an ownership transition.
One of the most common reasons businesses fail is due to lack of proper cash flow. The same is often true in many households. Here’s how this concept of cash flow applies to you along with some ideas to improve it.
Cash flow defined
Cash flow equals cash coming in (wages, interest, Social Security benefits) and cash going out in the bills you pay and money you spend. If more is coming in than going out, you have positive cash flow. If the opposite is true, you have negative cash flow. Unfortunately, calculating and forecasting cash flow can get complicated. Some bills are due weekly, others monthly. A few larger bills may need to be paid quarterly or annually.
Create your cash flow snapshot
Before improving your cash flow, you need to be able to visualize it. While there are software tools to generate a statement of cash flow, you can also take a snapshot of your cash flow by creating a simple monthly spreadsheet:
Type each month across the top of the spreadsheet with an annual total.
Note all your revenue (cash inflows), then create a list of expenses (cash outflows) in the left-hand column.
Enter your income and bills by month. Create a monthly subtotal of all your inflows. Do the same for your cash outflows. Then subtract the expenses from income. Positive numbers? You have positive cash flow. Negative numbers? You have negative cash flow.
Create a cumulative total for the year under each month to see which months will need additional funds and which months will have excess funds.
Ideas to improve your cash flow
Identify your challenges. See if you have months where more cash is going out than is coming in to your bank account. This often happens when large bills are due. If possible, try to balance these known high-expense months throughout the course of the year. Common causes are:
Holidays
Property tax payments
Car and homeowners insurance
Income tax payments
Vacations
Build a reserve. If you know there are challenging months, project how much additional cash you will need and begin to save for this in positive cash months.
Cut back on annuities. See what monthly expense drivers are in your life. Can any of them be reduced? Can you live with fewer cell phone add-ons? How about cutting costs in your cable bill? Is it time for an insurance review?
Shop your current services. Some of your larger bills may create an opportunity for savings. This is especially true with home and car insurance.
Create savings habits to add to cash flow. Consider paying a bill to yourself in your cash outflows. This saved money is a simple technique to create positive cash flow each month to build an emergency reserve.
Your 2023 Social Security Benefits Find out how your benefits have changed
Average Retirement Benefits Starting January 2023
All workers in 2022: $1,681/mo
All workers in 2023: $1,827/mo (+$146)
The 2023 maximum Social Security retirement benefits for a worker retiring at full retirement age: $3,627/mo
An 8.7% cost of living increase for Social Security retirement benefits and SSI payments begins with December 2022 benefits (payable in January 2023).
Increase your Social Security retirement benefits by 5 to 8% per year when you delay applying until you’re age 70.
Social Security Revenues & Expenditures
Revenue Sources = $1.09 trillion
3.5% – Taxation of benefits
6.4% – Interest
90.1% – Payroll taxes
Expenditures = $1.14 trillion
0.6% – Administrative expenses
0.4% – Railroad Retirement financial interchange
99.0% – Benefit payments
SOURCE: 2022 Annual Report of the Board of Trustees of the Federal Old-Age and Survivors Insurance and Disability Insurance Trust Funds, Table Il.B1.
2023 Social Security & Medicare Tax Rates
If you work for someone else…
Your employer pays 7.65%
You pay 7.65%
If you’re self-employed…
You pay 15.3%
NOTE: The above tax rates are a combination of 6.2% for Social Security and 1.45% for Medicare. There is also a 0.9% Medicare wages surtax for those with wages above $200,000 single ($250,000 joint filers) that is not reflected in these figures.
Item
2023
2022
Change
Maximum amount you may pay in Social Security taxes
$9,932.40
$9,114.00
+ $818.40
Maximum earnings amount Social Security will tax at 6.2%
$160,200.00
$147,000.00
+ $13,200.00
165+ million people work and pay Social Security taxes
Social Security has provided financial protection for Americans since 1935
Social Security Payments Explained
Social Security (SS) retirement benefits are for people who have paid into the Social Security system through taxable income.
Social Security Disability (SSD or SSDI) benefits are for people who have disabilities but have paid into the Social Security the system through taxable income.
Supplemental Security Income (SSI) benefits are for adults and children who have disabilities, plus limited income and resources.
Maximum SSI Payments
Filing Status
2023
2022
Change
Individual
$914/mo
$841/mo
+ $73
Couple
$1,371/mo
$1,261/mo
+ $110
How does Social Security work?
When you work, you pay taxes into Social Security.
The Social Security Administration uses your tax money to pay benefits to people right now.
Any unused money goes into Social Security trust funds and is borrowed by the government to pay for other programs.
Later on when you retire, you receive benefits.
Here’s how you qualify for retirement benefits
When you work and pay Social Security taxes, you earn credits toward benefits. The number of credits you need to earn retirement benefits depends on when you were born.
If you were born in 1929 or later, you need 40 credits (10 years of work) to receive retirement benefits
You receive one credit for each $1,640 of earnings in 2023
4 credits maximum per year
Did you know you can check your benefits status before you retire?
You can check online by creating a my Social Security account on the SSA website. If you don’t have an account, you’ll be mailed a paper Social Security statement 3 months before your 61st birthday.
It shows your year-by-year earnings, and estimates of retirement, survivors and disability benefits you and your family may be able to receive now and in the future.
If it doesn’t show earnings from a state or local government employer, contact them. The work may not be covered within Social Security.
