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Tax Strategies for Windfalls

  • Written by Sidney Kess, CPA, J.D., LL.M.

mug sid kessIndividuals may have financial windfalls because of a variety of occurrences. Some windfalls result from good fortune, such as winning the lottery or selling a business, while others result from bad fortune, such as medical malpractice or an inheritance. Either way, there are tax consequences to consider. Some consequences are immediate, while others have a long-term impact.

Immediate Tax Consequences of a Windfall

The receipt of a windfall may be taxable or tax-free. The general rule is that income from whatever source derived is includible in gross income (Code Sec. 61). However, there are various exclusions that transform some recoveries into tax-free income.

Damages. Damages from lawsuits, settlements, and awards are taxable unless they are payable for a personal physical injury or sickness (Code Sec. 104(a)(2)). Thus, damages received for a non-physical personal injury, such as defamation or discrimination, are taxable. So too are punitive damages and damages for back pay and other taxable compensation. Interest paid on a judgment usually is taxable.

When an attorney agrees to represent an individual on a contingency basis and there is a recovery, the individual is taxed on the entire award (Banks II, S.Ct., 543 U.S. 426 (2005)). This is so even though the individual does not actually receive the entire award because one third (or whatever portion was agreed upon) is disbursed directly to the attorney.

Damages for a wrongful death claim typically are comprised of compensatory damages for physical and mental injury as well as punitive damages for reckless, malicious, or reprehensible conduct by the wrongdoer. The portion for compensatory damages is tax free while the portion for punitive damages is taxable. However, if a wrongful death claim is made under a state statute that treats all of the recovery as punitive damages (i.e., precludes compensatory damages), the recovery is fully excludable for federal income tax purposes (Code Sec. 104(c)).

Damages for emotional distress resulting from a nonphysical personal injury, such as job discrimination, are excludable only to the extent used for medical costs. “Soft injuries,” such as headaches, insomnia, and weight loss, usually are treated as emotional distress and allocable damages are not tax-free. For example, in one recent case a postal worker could not exclude damages for these soft injuries arising from her discrimination action; the discrimination did not cause any physical injuries (Barbato, TC Memo 2016-23).

Damages received to compensate for property losses may be tax free if the recovery does not exceed the individual’s basis in the property. The recovery is treated as a tax-free return of capital (Code Sec. 1001).

As a general rule, legal fees to recover tax-free damages are not deductible while legal fees to recover taxable damages are deductible. Deductible legal fees related to personal injury usually are treated as miscellaneous itemized deductions, which can be written off only to the extent total miscellaneous itemized deductions exceed two percent of adjusted gross income (Code Sec. 67(a)). Miscellaneous itemized deductions are not deductible for purposes of the alternative minimum tax (Code Sec. 56(b)(1)(A)(i)). However, legal fees for certain discrimination actions can be deducted as an adjustment to gross income (Code Sec. 62(a)(20)).

Gifts and Inheritances. The receipt of gifts and inheritances are tax free, regardless of amount (Code Sec. 102). However, recipients of income in respect of a decedent must include it in their gross income when received (Code Sec. 691(a)). Thus, a person who inherits a $1 million IRA is not taxed on the inheritance of the IRA. However, when distributions are taken from the IRA, they are taxed to this beneficiary.

A person reporting income in respect of a decedent can take a deduction for federal estate tax allocable to income when the income is includable (Code Sec. 691(c)).

Lotteries, Gambling, and Prizes. Good luck can translate into millions of dollars. In January 2016, three winners split a Powerball jackpot of $1.6 billion, and in May 2016, one lucky winner hit the $429.6 million Powerball jackpot. These measures of good luck are fully taxable. In the case of lottery winnings, the only question is when the winnings are taken into income.

If a lottery winner opts for the lump sum, it is fully taxable in the year of the drawing (Code Sec. 451(a)). If the winner opts for the payment in installments, the winner is taxed only when installments are received (Code Sec. 451(h)).

Business IPO and Buyouts. Entrepreneurs may make it very big, taking their companies public or selling to new owners. While not necessarily thought of as a windfall because it may be years in the making, the resulting money from the deal presents similar challenges to these individuals.

Going public does not result in any immediate tax consequences for the owner. His or her holdings merely become more valuable. The sale of a business usually results in capital gains for the owner. However, asset sales (as opposed to stock sales) may trigger some ordinary income; ordinary income results from the sale of ordinary income property (e.g., inventory).

Whistleblower Awards. The government pays for information that leads to recoveries for fraud in Medicaid, government contracting, banking, taxes, public securities, and more. For example, there are two types of whistleblower awards from the IRS (Some of these are whistleblower awards where the government pursues information provided by individuals and then shares the recovery. Others are qui tam awards for private persons who bring an action on behalf of the government. These awards can be in the millions of dollars. For example, an SEC award to an individual in June 2016 was more than $17 million. Individuals receiving whistleblower awards have argued they are capital gains, but the courts have routinely treated then as ordinary income (see e.g., Patrick, 142 TC 142 (2014), affirmed CA-7, 2015-2 USTC ¶50,454)), where the courts rejected the taxpayer’s argument that he sold information and that his recovery was a capital gain).

Attorneys’ fees relating to whistleblower awards are deductible from gross income (Code Sec. 62(a)(21)).

Tax Strategies for Offsetting Windfall

Income If a windfall is taxable, there are steps that can be taken to minimize taxes.

Income-Splitting. Income splitting is a strategy in which income is shared so that it is taxed among several people. For example, if there is a winning lottery ticket, reporting multiple owners of the ticket spread the resulting income accordingly. However, when trying to spread income in the family, the person holding the winning ticket must be able to show there was an agreement or arrangement in place to share the prize before the winning number was picked; otherwise it is only an attempt by the winner to shift some of the tax burden to others.

In the spirit of shifting income, an individual may give cash or property to a family member so that resulting income is taxed to the recipient. For example, an individual who is providing support to a parent may give dividend-paying stock to the parent so the parent collects the dividends and then uses them for his/her support. There are two considerations here: (1) federal gift tax rules that may influence the size of the gift and (2) the tax situation of the recipient. Income shifting, for example, will not work well for a child who is subject to the kiddie tax because such income is effectively taxed to the child at the parent’s marginal rate (i.e., no tax savings for the family).

Charitable Contributions. Someone receiving a windfall is in a position to give generously, and take a charitable contribution deduction (Code Sec. 170). With large windfalls, setting up a charitable foundation may make sense to enable the person to obtain sizable tax deductions upfront and oversee the disbursement of the funds for favored charitable purposes.

Withholding and Estimated. Taxes Some windfalls (e.g., gambling winnings, lotteries) are subject to automatic withholding. Most others are not. It is up to the individual to ensure that sufficient estimated taxes are paid on a taxable windfall to avoid estimated tax penalties.

Long-Term Impact of a Windfall

When an individual receives a windfall, likely there is a need for comprehensive financial and estate planning. Here are some tax-wise considerations:

• What investments should be made with the windfall? Some windfalls may need to be invested safely in liquid assets (e.g., a windfall needed for future medical costs). In other cases, an individual may want to invest for growth or tax-free income. For example, municipal bond holdings may be more attractive than taxable investments because the windfall recipient has been pushed into a higher tax bracket.

• Is there a concern about death taxes? For example a windfall can mean that the person’s gross estate will be larger than the federal exemption amount ($5.45 million in 2016) and subject to estate; the tax may be minimized or avoided with estate tax planning. State death tax exemptions must also be factored into estate planning.


Practitioners who have clients that receive windfalls can provide valued advice on handling the newfound wealth. Consider not only federal income tax implications, but also state and local taxes. The American Bar Association has an article about advising clients who win a lottery (http://www. americanbar.org/content/newsletter/publications/ gp_solo_magazine_home/gp_solo_ magazine_index/gerstner.html).

Executive Editor Sidney Kess is CPA-attorney, speaker and author of hundreds of tax books. The AICPA established the Sidney Kess Award for Excellence in Continuing Education in his honor, best-known for lecturing to over 700,000 practitioners on tax. Kess is Senior Consultant to Citrin Cooperman & Company and Counsel to Kostelanetz & Fink.

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Top 5 Tax Issues for Retirement

  • Written by Sidney Kess, CPA, J.D., LL.M.

kess sidneyRetirement is life changing in so many ways, and it is different for different people. For some it means downsizing and relocating. For others it means reduced work schedules, ceasing work entirely, changing careers or starting businesses. As people age, for many there is an increased need for medical care and other assistance. Each of these areas entails tax rules. Here are some of the key tax rules for retirees.

1. Social Security Benefits

Social Security benefits can begin for an eligible worker at age 62. The current full retirement age, which is the age at which benefits are not reduced, is 66. The full retirement age will rise to 67 for those born in 1960 and later. If benefits are delayed past full retirement age, additional credits can be earned to age 70. Spouses, divorced spouses, and widow(er)s may be eligible to collect on a worker’s benefits at an earlier age. Regardless of the age at which benefits commence, the same tax rules apply.

For federal income tax purposes, Social Security benefits may be tax free or includible in gross income at 50% or 85% (Code Sec. 86). High-income taxpayers can assume that they are subject to the 85% inclusion amount; others may have to do calculations to determine whether benefits are tax-free or their applicable percentage.

If “income” (defined below) is no more than a base amount, benefits are tax-free. “Income” for this purpose is income that is taxed, such as wages, interest, ordinary dividends, capital gain distributions, and pensions, tax-exempt interest, and one-half of Social Security benefits. The base amount is $25,000 if single, head of household, qualifying widow(er), or married person filing separately who lived apart from his/her spouse for the entire year; $32,000 if married filing jointly, and zero if married filing separately but lived with the spouse for any part of the year. If “income” is more than the base amount but not more than $34,000 if single, head of household, qualifying widow(er), or married person filing separately who lived apart from his/her spouse for the entire year ($44,000 for joint filers), then 50% of benefits are includible in gross income. If “income” is more than $34,000 ($44,000), then 85% of benefits are includible in gross income.

For state income tax purposes, the rules may be different. Twenty-eight states and the District of Columbia fully exempt Social Security benefits from their income taxes. A handful of other states have different income thresholds for taxing benefits than the income thresholds for federal income tax purposes.

2. Health Care

Health care costs are a significant outlay in retirement. According to one report (https://www.hvsfinancial. com/PublicFiles/Data_Release.pdf), a healthy 65-year old couple retiring this year can expect to pay nearly $400,000 over the remainder of their lives for Medicare Parts B and D, a supplemental insurance policy, dental and vision care, and out-of-pocket expenses. Those with chronic health issues will pay much more.

Medicare premiums and other unreimbursed medical expenses are a deductible medical expense (Code Sec. 213). In 2016, those age 65 and older by year-end can deduct itemized medical expenses to the extent they exceed 7.5% of adjusted gross income (AGI). Starting in 2017 and later, the AGI threshold rises to 10% (the same as the threshold for younger taxpayers).

If a taxpayer is a “self-employed individual” (which for purposes of the self-employed health insurance deduction includes sole proprietors, partners, limited liability company members, and more-than-2% S corporation shareholders), Medicare premiums are deductible in full as an adjustment to gross income (Chief Council Advice Memorandum 201228037).

High-income taxpayers pay an additional Medicare premium (a surcharge), the amount of which varies with modified adjusted gross income (MAGI) two years prior to the current year. Thus, Medicare premiums for 2017 will be determined by MAGI on 2015 returns that have just been filed. For 2016, the surcharge applies for singles and married persons filing separately with MAGI over $85,000 ($170,000 for joint filers) (https:// www.medicare.gov/your-medicare-costs/part-b-costs/part-bcosts. html).

Health Savings Accounts. Once an individual reaches age 65 and can begin Medicare, contributions to a Health Savings Account (HSA) are no longer permissible (Code Sec. 223(b) (7)). However, those who have existing accounts can tap into them at any time. Withdrawals to cover qualified medical costs are tax free; withdrawals for any other purpose are taxable. Beginning at the age 65 when Medicare begins, the 20% penalty on nonqualified withdrawals no longer applies (Code Sec. 223(f) (4)(C)). Thus, funds can be used for a nonmedical purpose on a penalty-free basis.

Long-term Care. The cost of longterm care for chronic illnesses (e.g., custodial care for those who cannot manage daily living tasks on their own or who need supervision because of cognitive impairment) is not covered by Medicare. Those who lack recourses may qualify on a needs basis for Medicaid to pay for long-term care. Those who cannot qualify or cannot easily pay for this care out-ofpocket may carry long-term care insurance for this purpose.

For federal income taxes, the amount of premiums for long-term care insurance that can be treated as a deductible medical expense is capped by age. In 2016, those who are more than 60 years old but not more than 70, the dollar limit is $3,900; for those 70 and older the limit is $4,870 (Rev. Proc. 2015-53, IRB 2015- 443, 615).

For state income taxes, different rules may apply. For example, in New York, 20% of long-term care insurance premiums are a tax credit against state income taxes (https://www.tax.ny.gov/pdf/current_ forms/it/it249i.pdf).

3. Retirement Plans and IRAs

Many spend a lifetime of building up retirement savings in qualified retirement plans, such as 401(k)s and 403(b)s, and in IRAs. Those who made considerable contributions and invested wisely have a nice nest egg for retirement. Those with defined benefit (pension) plans usually begin to receive benefits at age 65 or other age specified in the plan. While there is no requirement to take lifetime withdrawals from Roth IRAs or designated Roth accounts, other tax-advantaged savings plans must adhere to distribution requirements.

Early Distributions. Funds can be withdrawn in any amount at any time. However, withdrawals before a certain age may trigger a 10% early distribution penalty (Code Sec. 72). Funds from a qualified plan can be withdrawn penalty free starting at age 55 if the taxpayer is separated from service (e.g., is terminated or retires from the job). For IRAs, as well as for qualified retirement plans for selfemployed individuals, the early distribution penalty applies for withdrawals prior to age 59-1/2 unless a special penalty exception (e.g., disability, paying education costs or first-time home buying expenses) applies. Thus, someone retiring at age 65 can withdraw funds from 401(k) accounts and IRAs penalty free; the withdrawals are fully taxable unless they relate to after-tax contributions.

Required Minimum Distributions (RMD). Generally, you must begin to draw down these retirement savings starting in the year of reaching age 70-1/2. The first RMD can be postponed to April 1 of the following year, but this means taking two RMDs in the same year: the first RMD by April 1 and the second RMD by December 31. Also, if someone is still working for a company and does not own more than 5% of the business, he or she can postpone distributions from the company’s plan until actual retirement even though after age 70-1/2.

The rules on figuring distributions and strategies for minimizing taxes on the distributions are not simple, and beyond the scope of this article. More details can be found in IRS Publication 590-B and Reg. Sec. 1.401(a)(9)-5.

Those who are age 70-1/2 or older can transfer tax free up to $100,000 annually from an IRA directly to a public charity; these are called qualified charitable distributions (QCDs) (Code Sec. 408(d)(8)). The amount transferred is applied toward RMDs for IRAs for the year. This rule does not apply to SEPIRAs, SIMPLE-IRA, or qualified retirement plans.

4. Selling a Residence

For many seniors, retirement means downsizing. This entails the sale of a principal residence. Gain on the sale of a principal residence up to $250,000 ($500,000 on a joint return) is tax free (Code Sec. 121).

To qualify for this exclusion, you must have owned and used your home as your principal residence for a period aggregating at least two years out of the five years prior to its date of sale. The ownership and use tests can be met during different two-year periods. However, you must meet both tests during the fiveyear period ending on the date of the sale. Generally, you cannot use the exclusion if you excluded the gain from the sale of another home during the two-year period prior to the sale of your home.

Expensive Homes. If gain is more than the applicable exclusion amount, any additional gain is subject to the capital gains tax (15% for most taxpayers; 20% for those in the top income tax bracket). What’s more, there may be different state or local tax rules. For example, in New York, there’s a so-called “mansion tax” of 1% on sales of homes of $1 million or more (https://www.tax.ny.gov/pdf/publications/ real_estate/pub577.pdf).

Also, for a high-income taxpayer (income over $200,000 for singles, $250,000 for joint filers, and $125,000 for married persons filing separately), the additional capital gain is subject to the net investment income (NII) tax (Code Sec. 1411). This can mean an additional 3.8% tax on the gain that is not excluded (the amount of the NII tax depends on net investment income and modified adjusted gross income over the income thresholds listed above).

5. Relocating

At retirement, some people move for a variety of reasons: to be in a warmer climate, to be closer to children and grandchildren, to obtain a lower cost of living. Whatever the reason, when relocating across state lines, consider the impact of state and local taxes. These include state income taxes, sales taxes, death taxes, and if owning a home, property taxes. It should be noted that federal law prohibits states from taxing pensions, including IRAs and 401(k)s), payable to former residents (P.L. 104-95).

Moving expenses. While the cost of moving for a job or self-employment is tax deductible (Code Sec. 217), the cost of relocating in retirement is not deductible.


Retirement is a complex subject, which is further complicated by the tax implications of various decisions and actions. Taking a comprehensive tax approach to retirement can help to save taxes in the long run.

Executive Editor Sidney Kess is CPA-attorney, speaker and author of hundreds of tax books. The AICPA established the Sidney Kess Award for Excellence in Continuing Education in his honor, best-known for lecturing to over 700,000 practitioners on tax. Kess is senior consultant for Citrin Cooperman and is consulting editor to CCH.

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New Tax Rules for Business Tax Returns

  • Written by Sidney Kess, CPA, J.D., LL.M.

mug sid kessThe Protecting Americans from Tax Hikes (PATH) Act (P.L. 114-113), which was signed into law on December 18, 2015, contains over 100 tax provisions. The law makes permanent more than 20 provisions that had expired at the end of 2014. It also extends other provisions through 2019, or for two years (2015 and 2016). According to the Joint Committee on Taxation, the extenders are projected to cost the government $628 billion over 10 years. The extenders and other provisions in the PATH Act impact individuals and businesses. Here is a roundup of the key provisions for businesses and how they affect 2015 returns as well as tax planning for 2016.  


A number of business deductions have been made permanent or extended, as indicated below:

Write-offs for equipment purchases
Two important deduction options apply to purchases of equipment and machinery:

• Sec. 179 deduction – The $500,000 deduction limit and the $2 million cap on equipment purchases before the deduction limit is phased out, have been made permanent. They had been set to revert to $25,000, and $200,000, respectively, in 2015. Starting in 2016, the dollar amounts can be adjusted for inflation. Also made permanent is the treatment of off-the-shelf software as qualifying for a Sec. 179 deduction as well as the option to make or revoke a Sec. 179 election without IRS consent.

• Bonus depreciation – This deduction, which applies to new (not pre-owned) property, has been extended through 2019. However, the 50% write-off for the cost of qualified property applies only for 2015, 2016, and 2017. In 2018, the deduction decreases to 40%; in 2019 it is 30%.

Write-offs for leasehold, restaurant, and retail improvements
Several tax breaks relate to write-offs for these improvements:

• Sec. 179 deduction – Such improvements qualify for the Sec. 179 deduction. However, for 2015, there is a $250,000 cap. Starting in 2016, the cap is removed.

• Bonus depreciation – Qualified leasehold improvements qualify for the allowable percentage of bonus depreciation in 2015 (Code Sec. 168(k)). For 2016 through 2019, bonus depreciation applies to qualified improvements, which can include restaurant or retail improvements as well as leasehold improvements; there is no longer a requirement that the improvement be placed in service more than three years after the building was first placed in service. The 50% percentage applies for 2015, 2016, and 2017. The percentage decreases to 40% in 2018 and 2019.

• 15-year recovery period – Any amounts for improvements not deducted using the Sec. 179 deduction or bonus depreciation can be recovered using straight line depreciation over a 15-year recovery period (Code Sec. 168). This recovery period has been made permanent.

Other write-off rules:
• Film and television production costs – These costs in 2015 and 2016 can be expensed up to $15 million, a tax break that benefits small producers (Code Sec. 181). For 2016, this deduction rule applies to theater productions as well.

• Sports complexes – A seven-year recovery period applies to motorsports entertainment complexes (Code Sec. 168).

• Race horses – A three-year recovery period for race horses applies through 2016 (Code Sec. 168).

Charitable contributions
Corporations can deduct their contributions up to 10% of taxable income. Contributions by pass-through entities are claimed by owners on their personal returns, subject to their adjusted gross income limits.

• Conservation easements – The enhanced deduction limit on conservation easements is permanent (Code Sec. 170(b)). Effectively, the deduction is up to 50% of adjusted gross income (instead of the usual 30% cap on donations of appreciated property). Farmers and ranchers have a 100% limit. Also the carryover period for deductions that cannot be fully used in the current year because of the AGI cap is 15 years (instead of the usual five-year carryover). Starting in 2016, the special rules apply to conservation easements by corporations under the Alaska Native Claims Settlement Act.

• Donations of food inventory – Businesses can take an enhanced charitable deduction for donations of their food inventory (Code Sec. 170). This rule has been made permanent.


Tax credits usually are used to reduce income tax liability on a dollar-for-dollar basis. Some credits have been extended temporarily; others have become permanent.

Research credit
The 20% credit for increasing research expenditures, which was first introduced into the law in 1981, has been made permanent (Code Secs. 38 and 41). This credit had been subject to numerous expirations and extensions. With permanency, businesses can plan ahead for their research activities.

Starting in 2016, small businesses can use up to $250,000 of the research credit as an offset to the employer’s Social Security taxes, rather than as an offset to income tax liability. Small businesses for this purpose are defined as those with gross receipts for the taxable year of less than $5 million and no gross receipts for any year before the five taxable year period ending with the current taxable year. This break helps small technology businesses with little or no revenue benefit taxwise from their research activities.

Employment-related credits
There are several employment-related credits that have been extended:

• Work opportunity credit has been extended through 2019 (Code Secs. 51 and 52). Starting in 2016, the credit applies for hiring the long-term unemployed (those unemployed for at least 27 weeks).

• Empowerment zone employment credit has been extended for 2015 and 2016 (Code Sec. 1396).

• Indian employment credit has been extended for 2015 and 2016 (Code Sec. 45A).

• Credit for wage differential payments to reservists called to active duty has been made permanent (Code Sec. 45P).

S corporations

Two key tax rules affecting S corporations and their shareholders have been made permanent:

Basis adjustment for charitable donations
When S corporations donate appreciated property, shareholders must reduce their basis in S corporation stock only by their share of the corporation’s adjusted basis in the property (Code Sec 1367). This is so even though their share of the charitable contribution deduction is based on the fair market value of the property. Because a shareholder’s deduction for losses that pass through are limited to his/her share of basis in stock and debt, this favorable basis adjustment rule allows for a greater loss deduction by a shareholder when the corporation has a bad year.

Built-in gains period
When a C corporation elects S corporation status, any gain in appreciated property is taxed to the S corporation if the property is disposed of within a set period. Originally, the built-in gains period had been 10 years. It has been reduced to five years (Code Sec 1374).

Energy-related provisions

Various energy-related provisions have been extended temporarily only for 2015 and 2016:

Energy-efficient buildings
The deduction for commercial buildings that achieve certain energy standards is $1.80 per square foot (Code Sec. 179D).

Electric motorcycles
There is a 10% credit for the cost of buying an electric motorcycle (Code Sec. 30D). The credit is capped at $2,500. However, the previous credit for a three-wheeled vehicle which expired at the end of 2014 has not been extended.

Energy-efficient homes
This credit equals $1,000 in the case of a new home that meets a 30% standard for efficiency; it is $2,000 in the case of a new home that meets a 50% standard (Code Sec. 45L). Only manufactured homes are eligible for the $1,000 credit.

Alternative fuel refueling property
There is a credit for qualified property up to 30% of cost, up to set dollar limits (Code Sec. 30C). The basis of the property is reduced by the amount of the credit. No credit can be claimed if the cost is expensed under Code Sec. 179.

Other tax changes

Various other tax rules have changed. Some changes are temporary; others are permanent.

Parity for transportation fringe benefits
The amount of the exclusion is the same for employer-paid free parking, monthly transit passes, and van pooling (Code Sec. 132(f)). For 2015, the exclusion amount for these transportation fringe benefits is $250 per month (it had been only $130 for transit passes and van pooling). For 2016, the monthly cap is $255 (Rev. Proc. 2015-53, IRB 2015-44, 615).

Because of the reinstatement of parity, the IRS has provided guidance to employers on how to handle overwithholding (Notice 2016-2, IRB 2016-2, 265). For 2015, employers must reduce the taxable wages of affected employees, as reported on Forms 941 and W-2 and any equivalent forms, by the amount of any excess transit benefits. An employer has a duty to assure that its employee’s rights to recover overcollected taxes are protected by repaying or reimbursing overcollected amounts. Alternatively, an employer may obtain the employee’s consent to the filing of the refund claim. No refund to the employer is allowed for the overpayment of withheld income tax which the employer deducted or withheld from an employee. An employer can correct overpayments by filing Form 941-X, Adjusted Employer’s QUARTERLY Federal Tax Return or Claim for Refund.

Exclusion for small business stock
Section 1202 stock, which can be issued by a qualified small business, enjoys special tax treatment. A qualified small business for this purpose is a C corporation that is in retail, wholesale, manufacturing, or technology, and that meets certain other conditions. Under the new law, if the stock is held more than five years, all of the gain on the sale of the stock is excludable from gross income. The 100% exclusion had been set to revert to the old 50% exclusion, but the 100% exclusion has been made permanent.

Excise tax on medical devices
The 2.3% excise tax imposed by the Affordable Care Act on manufacturers or importers of medical devices has been suspended for 2016 and 2017 (Code Sec. 4191). It is set to reapply in 2018 unless Congress again changes this rule.

Transmittals for W-2s and 1099s
Starting with reporting for wages and nonemployee compensation in 2016 (i.e., W-2s and 1099-MISCs filed in 2017), the transmittals to the Social Security Administration (for W-2s) and to the IRS (for 1099s) are due by the same date as furnishing them to workers (Code Secs. 6071 and 6402). Thus, in 2017, the deadline is January 31, 2017.

De minimis safe harbor for errors on information returns
Employers do not have to file corrected information returns if the error is de minimis (Code Secs. 6721 and 6722). An error for any single amount not exceeding $100 (or $25 in the case of withholding or backup withholding) need not be corrected.


The changes made by the PATH Act allow businesses to do multi-year tax planning. However, Speaker Paul Ryan of the U.S. House of Representatives is seeking comprehensive tax reform before the November election. This could dramatically change the “permanent” rules just enacted. Toward this end, on February 4, 2016, he appointed Rep. Brady, chairman of the House Ways and Means Committee, to head up a six-member group “tasked with developing a pro-growth agenda” with the ultimate goal of developing a new tax code. The rules that have been made permanent may not be so permanent.

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Required Minimum Distributions: Year End Issues

  • Written by Sidney Kess, CPA, J.D., LL.M.

kess sidneyThe end of the year is the deadline for most individuals with qualified retirement plans and IRAs to take their required minimum distributions (RMDs) if they have attained age 70½ or inherited their benefits (Code Sec. 408(a)(9)). RMDs for 2016 are based on the account’s value at the end of 2015. The failure to take RMDs can result in a 50% penalty (Code Sec. 4974). As part of its Tax Preparedness Series, the IRS reminded affected individuals to remember to take their RMDs by December 31 (IR- 2015-122, 10/29/15). Here are some key issues that can impact RMDs.

Those who Turned 70½ in 2015

Clients who were born July 1, 1945, to June 30, 1946, attained age 70½ in 2016. This means that they have attained their required beginning date for purposes of RMDs and must take their first one by December 31, 2016. However, they can opt to postpone the first RMD until April 1, 2017. Doing so means taking two RMDs in 2017 (one by April 1 and one by December 31).


For those who meet the age requirement but are still working, the first RMD with respect to qualified retirement plan benefits can be postponed until they leave employment (assuming the plan permits this action). However, this rule does not apply to anyone owning more than 5% of the company. The rule does not apply with respect to IRAs, regardless of company ownership.

Roth IRAs

The RMD rules do not apply for account owners during their lifetime.

Other Matters

An RMD does not have to be taken in a single withdrawal. All that is required is that the total amount withdrawn for the year at least equals the RMD amount. Withdrawals are not limited to the RMD amount; more or even all of the account can be withdrawn even though the owner has reached his or her required beginning date.

Figuring RMDs

Usually, for IRAs, the trustee or custodian shows the RMD amount in Box 12b of Form 5498, IRA Contribution Information. Thus, the 2016 RMD amount should have been shown on a 2015 Form 5498, which would have been issued to the IRA owner in January 2016. For qualified retirement plans, the administrator must compute the RMD and provide this information to the participant.

In figuring RMDs, all traditional IRA accounts can be aggregated with the annual sum withdrawn from one or more of the accounts. In figuring RMDs from qualified retirement plans , no aggregation is permitted; RMDs must be figured for and taken from each plan.

Qualified Direct IRA Transfers

Under a special rule, those age 70½ or older by the end of the year can directly transfer up to $100,000 from their IRAs to a public charity, and such transfer is taxfree (Code Sec. 408(d)(8)). The transfer, called a qualified charitable donation (QCD), can include RMDs. Those who inherited an IRA can use this rule as long as they are at least age 70½ by year-end. Married persons filing jointly can exclude $100,000 each (a total of $200,000 on a joint return). No charitable contribution deduction is allowed for the transfer. This direct transfer rule does not apply to SEPIRAs, SIMPLE-IRAs, or Roth IRAs.

Tax Benefits of Qualified Direct IRA Transfer

By keeping the IRA distribution out of gross income, adjusted gross income (AGI) is minimized. This has the favorable effect of increasing eligibility to various other tax breaks based on AGI or modified AGI. For those who do not itemize, it is a way to benefit their favorite charities on a tax-advantaged basis. For all higher-income individuals, minimizing AGI in 2015 can translate into avoiding or minimizing the additional Parts B and D premiums for Medicare in 2017.

Inherited Accounts

Those who recently inherited IRAs and qualified retirement benefits have decisions to make. There are actions to take that impact the taxation of inherited benefits. If the decedent died after age 70½, his or her RMD for the year must still be taken; it is taxable on the decedent’s final income tax return.

Surviving Spouses

They can treat the account as their own, allowing them to postpone distributions until they are age 70½ and name their own beneficiaries. If they do not treat the account as their own, then they must take RMDs under the same rules applicable to nonspouse beneficiaries.

Nonspouse Beneficiaries

They cannot roll over inherited accounts to their name as can surviving spouses. The account must be retitled property to reflect the decedent’s name, date of death, and the beneficiary’s name with the beneficiary designation. However, nonspouse beneficiaries can roll over inherited accounts (e.g., change brokerage firms for an IRA) as long as the accounts are registered properly.

No RMDs usually are required in the year of the decedent’s death. Beneficiaries must begin their RMDs by December 31 of the year following the year of death (e.g., December 31, 2016, for a decedent dying in 2015). Here are the payout options:

• Begin RMDs based on the beneficiary’s life expectancy. Life expectancy is found in IRS Publication 590-B, Appendix B, Table I (Single Life Expectancy). However, if the decedent died on or after attaining age 70 ½, RMDs are based on the longer of the beneficiary’s life expectancy (from the Single Life Expectancy table) or the decedent’s life expectancy (usually Table III (Uniform Lifetime). This rule is helpful in minimizing distributions to a beneficiary who is older than the decedent.

• Delay distributions but withdraw the entire account by the end of the fifth year following the year of the owner’s death.

Beneficiaries under age 59½ taking distributions from IRAs and qualified retirement plans are not subject to the 10% early distribution penalty (Code Sec. 72(t)(2)(A)(ii)).

Roth IRAs

While distributions from Roth IRAs are not taxable, inherited accounts are subject to the same distribution rules as those applied to IRAs and qualified retirement plans.


RMDs, other than for Roth IRAs and other accounts in which there is basis (the owner made after-tax contributions), taxable income results. Federal income tax is automatically withheld from distributions. A 10% withholding rate applies to nonperiodic distributions (e.g., RMDs) unless the taxpayer wants no withholding. If the 10% withholding is not sufficient to meet projected tax liability, the client can ask that an additional amount be withheld. Form W-4P, Withholding Certificate for Pension and Annuity Payments, is used to opt out of withholding or request additional withholding. Alternatively, the client can pay estimated taxes for projected tax liability on RMDs.


Those who must take RMDs for 2016 should determine their necessary withdrawals. Clients should also decide now how to receive their distributions (e.g., by check, transfers to taxable accounts), and advise plan administrators, custodians, and trustees accordingly.

Executive Editor Sidney Kess is CPA-attorney, speaker and author of hundreds of tax books. The AICPA established the Sidney Kess Award for Excellence in Continuing Education in his honor, best-known for lecturing to over 700,000 practitioners on tax. Kess is counsel at Kostelanetz & Fink, senior consultant to Citrin Cooperman & Company in New York City and is consulting editor to CCH.

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Tax Ramifications of Recent Supreme Court Decisions

  • Written by Sidney Kess, CPA, J.D., LL.M.

kess sidneyJust before the U.S. Supreme Court closed its 2014 term, two notable decisions were announced. Both have important tax consequences for individuals and businesses, nationwide and on a state level.

Premiums Tax Credit

Under the Affordable Care Act (ACA), an individual who purchases health coverage from a marketplace (also called an exchange), has household income below a set level, and meets certain other requirements can receive government assistance to pay the premiums. The assistance is in the form of the premium tax credit (Code Sec. 36B). The credit can be obtained on an advanced basis to pay the premiums or claimed as a tax credit when an eligible individual files his or her federal income tax return.

Eligibility for the credit was challenged because of the wording of the statute, which limits the credit to those enrolled in coverage through “an Exchange established by the State.” It was argued that the word “state” meant the credit applied only to those enrolled through a state-established exchange. At present, 27 states rely entirely on the federal marketplace, seven maintain partnership exchanges (HHS views them as federal exchanges), and three have federally supported state-based exchanges that rely on the federal IT platform; only 13 states have state-created exchanges. Individuals in states that did not set up their own exchanges could obtain coverage through the federal exchange (www.healthcare.gov), but as the argument went, they would be ineligible for the credit. Effectively, these individuals would be unable to afford the coverage.

One appellate court said the statute “unambiguously restricts” the tax credit to state-created exchanges (Halbig v. Burwell, CA-DC, 758 F. 3d 390, 394 (2014)). Another held that the credit applied to coverage obtained through any government exchange (King v. Burwell, CA-4, 759 F. 3d 358 (2014)). (The cases were originally brought against then Secretary of Health and Human Services Sebelius.)

Now the U.S. Supreme Court has settled the matter in favor of the Administration, which had argued for a broad interpretation (King v. Burwell, S.Ct., USTC ¶50,356). In a six to three decision, the majority concluded that the language of the statute referring to “State” should be read to include federal exchanges. Chief Justice Roberts, in the majority opinion, said “[t]he context and structure of the Act [ACA] compel us to depart from what would otherwise be the most natural reading [of this word].” The effect of the opinion from a tax perspective is to enable otherwise eligible individuals to claim the credit as long as they are enrolled for health coverage through a government exchange. The estimated 6.2 million individuals that would have lost their subsidy had the Court ruled to the contrary can continue to enjoy eligibility for the credit.

The decision reflects Chief Justice Robert’s view that, “Congress passed the Affordable Care Act to improve health insurance markets, not to destroy them.” Strong dissenting opinions considered the majority opinion to be judicially out of line in trying to fix a poorly written statute. While it may have been the intention of Congress to grant the credit to enrollees in all government exchanges, the clear language of the law would appear to limit them to state exchanges.

While the decision puts to rest any other challenges to the premium tax credit, it does not end all legal challenges to ACA. There are more than 100 current cases challenging various aspects of ACA; these challenges include:

• House v. Burwell (DC DC, filed 11/21/14) in which the House of Representatives is challenging the costsharing reduction payments to insurers. The House argues that there needs to be explicit appropriations for these payments to be made. The House is also challenging the Administration’s delay of the employer mandate.

• Sissel v. HHS (CA-DC, appeal for a rehearing en banc filed 10/6/14) is challenging the constitutionality of ACA on the grounds that its enactment violated the Origination Clause of the U.S. Constitution, which requires bills that raise revenue to originate in the House of Representatives. Note: Another case making a similar argument was dismissed for lack of standing (Holtz v. Burwell, CA-5, 4/24/15).

• Post-Burwell v. Hobby Lobby Stores, Inc. (S. Ct., 2014-2 USTC ¶50,341), which allowed a privately held company to object to paying for some forms of contraception for their employees, did not end the matter. There are more than 100 active cases challenging the requirement that insurers and employers provide contraceptive coverage for enrollees without any accommodations on religious grounds.

• Kawa Orthodontics LLP v. Lew (CA-11, 12/2/14) is challenging the delay of the employer mandate. The Eleventh Circuit dismissed for lack of standing, but Kawa is appealing to the U.S. Supreme Court (writ of certiorari filed 5/19/15).

In addition, Congressional action may limit or change parts of ACA. On June 18, 2015 the House voted 280 to 140 in favor of the Protect Medical Innovation Act (H.R. 160), which would repeal the 2.3% excise tax on medical devices. This tax, which took effect in 2013, is imposed on manufacturers and importers of medical devices. Opponents of the tax who support repeal argue that it stifles innovation. The measure now heads to the Senate, where there appears to be some bi-partisan support. Of course, any passage must have sufficient support to withstand a presidential veto.

Also before Congress is a bill called the Middle Class Health Benefits Tax Repeal Act (H.R. 2050), which would repeal the so-called Cadillac tax. This is a 40% excise tax on insurance plans that cost more than $10,200 per year for individual coverage or $27,500 for family coverage and is poised to go into effect in 2018. The measure is supported by unions that offer members these general health benefits and by many other interest groups. It is projected by one professional services company (http://www.towerswatson.com/en-US/Press/2014/09/nearly-half-us-employers-to-hit-health-care-cadillac-tax-in-2018-with-82-percent-by-2023) that 48% of large employers would be affected in 2018 and, because of the way the law is written, as many as 82% of large employers would be affected by 2023.

Same-sex marriage

The day after settling questions about the premium tax credit, the U.S. Supreme Court held that all states must issue marriage licenses to same-sex couples and recognize valid same-sex marriages entered into in other jurisdictions (Obergefell v. Hodges, S.C., 2015-1 USTC S.Ct., USTC ¶50,357). In a five to four decision, the Court held that the 14th Amendment guarantees the right of personal choice in marriage. From a tax perspective, the decision has far-reaching consequences.

State income taxes. The Court’s decision striking down Section 3 of the federal Defense of Marriage Act (DOMA) and requiring the federal government to recognize same-sex marriages (Windsor, S.Ct., 2013-2 USTC ¶50,400), prompted the IRS to issue guidance (Rev. Rul. 2013-17). That ruling allowed same-sex couples to file joint tax returns, starting in all open tax years; it did not require them to file amended returns claiming joint filing status before September 16, 2013. Now, states that had not recognized same-sex couples until the new decision could follow the IRS’s lead. This would allow those who chose to do so to file amended state income tax returns using married filing jointly status but likely same-sex couples would not be required to amend returns for open years if they did not want to do so. Note: If couples amend state income tax returns, it affects the itemized deduction for state income taxes claimed on federal returns. Thus, amended federal income tax returns would be necessary.

Certain tax rules should also be reviewed on a state income tax level. For example, health benefits provided to a same-sex spouse may have been taxed to the employee; this is no longer so. Similarly, other tax-free spousal benefits provided by employers may have been taxed to an employee with a same-sex spouse but is not tax free.

State death taxes. Executors of decedents who died in states with estate or inheritance taxes that have not previously recognized same-sex marriages may need to file refund claims. This would be necessary where property passing to a same-sex spouse had not previously received the same treatment as property passing to an opposite-sex spouse. What states are going to do about allowing claims against estates by same-sex spouses that had not been able to make them before the Court’s decision is uncertain.


While the high Court has settled certain important questions, there continues to be ambiguity and open tax questions. Settlement of these matters remains for another day.

Executive Editor Sidney Kess is CPA-attorney, speaker and author of hundreds of tax books. The AICPA established the Sidney Kess Award for Excellence in Continuing Education in his honor, best-known for lecturing to over 700,000 practitioners on tax. Kess is counsel at Kostelanetz & Fink and is consulting editor to CCH.

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