When preparing your tax return, we’ll check one of the following statuses: Single, married filing jointly, married filing separately, head of household or qualifying widow(er). Filing a return as a head of household is more favorable than filing as a single taxpayer.

For example, the 2023 standard deduction for a single taxpayer is $13,850 while it’s $20,800 for a head of household taxpayer. To be eligible, you must maintain a household, which for more than half the year, is the principal home of a “qualifying child” or other relative of yours whom you can claim as a dependent.

Basic rules

Who is a qualifying child? This is a child who:

• Lives in your home for more than half the year,
• Is your child, stepchild, adopted child, foster child, sibling, stepsibling (or a descendant of any of these),
• Is under age 19 (or a student under 24), and
• Doesn’t provide over half of his or her own support for the year.

If the parents are divorced, the child will qualify if he or she meets these tests for the custodial parent — even if that parent released his or her right to a dependency exemption for the child to the noncustodial parent.

A person isn’t a “qualifying child” if he or she is married and can’t be claimed by you as a dependent because he or she filed jointly or isn’t a U.S. citizen or resident. Special “tie-breaking” rules apply if the individual can be a qualifying child of more than one taxpayer.

You’re considered to “maintain a household” if you live in the home for the tax year and pay over half the cost of running it. In measuring the cost, include house-related expenses incurred for the mutual benefit of household members, including property taxes, mortgage interest, rent, utilities, insurance on the property, repairs and upkeep, and food consumed in the home. Don’t include items such as medical care, clothing, education, life insurance or transportation.

Maintaining a home for a parent 

Under a special rule, you can qualify as head of household if you maintain a home for a parent of yours even if you don’t live with the parent. To qualify under this rule, you must be able to claim the parent as your dependent.

Marital status

You must be unmarried to claim head of household status. If you’re unmarried because you’re widowed, you can use the married filing jointly rates as a “surviving spouse” for two years after the year of your spouse’s death if your dependent child, stepchild, adopted child, or foster child lives with you and you “maintain” the household. The joint rates are more favorable than the head of household rates.

If you’re married, you must file either as married filing jointly or separately — not as head of household. However, if you’ve lived apart from your spouse for the last six months of the year and your dependent child, stepchild, adopted child, or foster child lives with you and you “maintain” the household, you’re treated as unmarried. If this is the case, you can qualify as head of household.

We can answer questions if you’d like to discuss a particular situation or would like additional information about whether someone qualifies as your dependent.

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April 18 is the deadline for filing your 2022 tax return. But a couple of other tax deadlines are coming up in April and they’re important for certain taxpayers:

1. Saturday, April 1 is the last day to begin receiving required minimum distributions (RMDs) from IRAs, 401(k)s and similar workplace plans for taxpayers who turned 72 during 2022.
2. Tuesday, April 18 is the deadline for making the first quarterly estimated tax payment for 2023, if you’re required to make one.

Here are the basic details about these two deadlines.

Taking a first RMD

RMDs are normally made by the end of the year. But anyone who reached age 72 during 2022 is covered by a special rule that allows IRA account owners and participants in workplace retirement plans to wait until as late as April 1, 2023, to take their first RMD. For an IRA, you must take your first RMD by April 1 of the year following the year in which you turn 72, regardless of whether you’re still employed.

You may have heard the age for beginning RMDs went up. Under the Setting Every Community Up for Retirement Enhancement 2.0 Act (SECURE 2.0), the age distributions must begin increased from age 72 to age 73 starting on January 1, 2023. But if you turned 72 during 2022, you must take your first RMD by April 1.

If your RMDs in any year are less than the required amount for that year, you’ll generally be subject to a penalty.

Making estimated tax payments

You may have to make estimated tax payments for 2023 if you receive interest, dividends, alimony, self-employment income, capital gains or other income. If you don’t pay enough tax during the year through withholding and estimated payments, you may be liable for a tax penalty on top of the tax that’s ultimately due.

Individuals must pay 25% of their “required annual payment” by April 15, June 15, September 15, and January 15 of the following year, to avoid an underpayment penalty. If one of those dates falls on a weekend or holiday, the payment is due the next business day. For example, this year the filing deadline is April 18 for most taxpayers because April 15 falls on a Saturday and April 17 is a holiday in the District of Columbia.

The required annual payment for most individuals is the lower of 90% of the tax shown on the current year’s return or 100% of the tax shown on the return for the previous year. However, if the adjusted gross income on your previous year’s return was more than $150,000 ($75,000 if you’re married filing separately), you must pay the lower of 90% of the tax shown on the current year’s return or 110% of the tax shown on the return for the previous year.

Generally, people who receive most of their income in the form of wages satisfy these payment requirements through the tax withheld from their paychecks by their employers. Those who make estimated tax payments generally do so in four installments. After determining the required annual payment, they divide that number by four and make four equal payments by the due dates.

But you may be able to use the annualized income method to make smaller payments. This method is useful to people whose income isn’t uniform over the year, for example because they’re involved in a seasonal business.

Staying on track

Contact us if you have questions about RMDs and estimated tax payments. We can help you stay on track so you aren’t liable for penalties.

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Did you make large gifts to your children, grandchildren or other heirs last year? If so, it’s important to determine whether you’re required to file a 2022 gift tax return. And in some cases, even if it’s not required to file one, you may want to do so anyway.

Filing requirements

The annual gift tax exclusion has increased in 2023 to $17,000 but was $16,000 for 2022. Generally, you must file a gift tax return for 2022 if, during the tax year, you made gifts:

• That exceeded the $16,000-per-recipient gift tax annual exclusion for 2022 (other than to your U.S. citizen spouse),
• That you wish to split with your spouse to take advantage of your combined $32,000 annual exclusion for 2022,
• That exceeded the $164,000 annual exclusion in 2022 for gifts to a noncitizen spouse,
• To a Section 529 college savings plan and wish to accelerate up to five years’ worth of annual exclusions ($80,000) into 2022,
• Of future interests — such as remainder interests in a trust — regardless of the amount, or
• Of jointly held or community property.

Keep in mind that you’ll owe gift tax only to the extent that an exclusion doesn’t apply and you’ve used up your lifetime gift and estate tax exemption ($12.06 million in 2022). As you can see, some transfers require a return even if you don’t owe tax.

You might want to file anyway

No gift tax return is required if your gifts for 2022 consisted solely of gifts that are tax-free because they qualify as:

• Annual exclusion gifts,
• Present interest gifts to a U.S. citizen spouse,
• Educational or medical expenses paid directly to a school or health care provider, or
• Political or charitable contributions.

But if you transferred hard-to-value property, such as artwork or interests in a family-owned business, you should consider filing a gift tax return even if you’re not required to. Adequate disclosure of the transfer in a return triggers the statute of limitations, generally preventing the IRS from challenging your valuation more than three years after you file.

The deadline is April 18

The gift tax return deadline is the same as the income tax filing deadline. For 2022 returns, it’s April 18, 2023 — or October 16, 2023, if you file for an extension. But keep in mind that, if you owe gift tax, the payment deadline is April 18, regardless of whether you file for an extension. If you’re not sure whether you must (or should) file a 2022 gift tax return, contact us.

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Have you bought stock in a company that later dropped in value? While you may prefer to forget such an ill-fated investment, at least you can claim a capital loss deduction on your tax return. Here are the rules that apply when a stock you own is sold at a loss or becomes completely worthless.

Stock sales produce capital losses 

Stocks are capital assets and produce capital gains or losses when they’re sold. Your capital gains and losses for the year must be netted against one another in a specific order, based on whether they’re short-term (held one year or less) or long-term (held for more than one year).

If, after netting, you have short-term or long-term losses (or both), you can use them to offset up to $3,000 of ordinary income ($1,500 for married taxpayers filing separately). Any loss in excess of this limit is carried forward to later years, until all of it is either offset against capital gains or deducted against ordinary income in those years, subject to the $3,000 limit. If you have both net short-term losses and net long-term losses, the net short-term losses are used to offset ordinary income before the net long-term losses are used.

If you’ve realized capital gains during the year from stock or other asset sales, consider selling some of your losing positions to offset the gains. A good tax strategy is to sell enough losing stock to shelter your earlier gains and generate a $3,000 loss, since this is the maximum loss that can be used to offset ordinary income each year.

Wash sale rule 

If you believe that a stock you own will recover but want to sell now in order to lock in a tax loss, be aware of the wash sale rule. Under it, if you sell stock at a loss and buy substantially identical stock back within the 30-day period before or after the sale date, you can’t claim the loss for tax purposes. In order to claim the loss, you must buy the new shares outside of the period that begins 30 days before and ends 30 days after the sale of the loss stock.

Worthless stock 

In some cases, stock you own may have become completely worthless. If so, you can claim a loss equal to your basis in the stock, which is generally what you paid for it. The stock is treated as though it had been sold on the last day of the tax year. This date is important because it determines whether your capital loss is long-term or short-term.

Stock shares become worthless when they have no liquidation value, because the corporation’s liabilities exceed its assets, and no potential value, because the business has no reasonable hope of becoming profitable. A stock can be worthless even if the corporation hasn’t declared bankruptcy. Conversely, stock may still have value even after a bankruptcy filing, if the corporation continues operating and the stock continues trading.

You may not discover that a stock has become worthless until after you’ve filed your tax return for the year of worthlessness. In that case, you can amend your return for that year to claim a credit or refund due to the loss. This can be done for seven years from the date your original return was due, or two years from the date you paid the tax, whichever is later.

Special situation

Other rules may apply. For example, if you’re a victim of a Ponzi-type investment scheme, you may be able to mitigate your financial loss by taking advantage of special tax relief available. Let us know if you have any questions.

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You generally must pay federal tax on all income you receive but there are some exceptions when you can exclude it. For example, compensatory awards and judgments for “personal physical injuries or physical sickness” are free from federal income tax under the tax code. This includes amounts received in a lawsuit or a settlement and in a lump sum or in installments.

But as taxpayers in two U.S. Tax Court cases learned, not all awards are tax-free. For example, punitive damages and awards for unlawful discrimination or harassment are taxable. And the tax code states that “emotional distress shall not be treated as a physical injury or physical sickness.”

Here are the facts of the two cases.

Case #1: Payment was for personal injuries, not physical injuries

A taxpayer received a settlement of more than $327,000 from his former employer in connection with a lawsuit. He and his spouse didn’t report any part of the settlement on their joint tax return for the year in question. The IRS determined the couple owed taxes and penalties of more than $119,000 as a result of not including the settlement payment in their gross income.

Although the settlement agreement provided the payment was “for alleged personal injuries,” the Tax Court stated there was no evidence that it was paid on account of physical injuries or sickness. The court noted that the taxpayer’s complaint against the employer “alleged only violations of (state) labor and antidiscrimination laws, wrongful termination, breach of contract, and intentional infliction of emotional distress.”

The taxpayer argued that he had a physical illness that caused his employer to terminate him. But he didn’t provide a “direct causal link” between the illness and the settlement payment. Therefore, the court ruled, the amount couldn’t be excluded from his gross income. (TC Memo 2022-90)

Case #2: Legal malpractice payment doesn’t qualify for exclusion

This case began when the taxpayer was injured while at a hospital receiving medical treatment. She sued for negligence but lost her case. She then sued her attorneys for legal malpractice.

She received $125,000 in a settlement of her lawsuit against the attorneys. The amount was not reported on her tax return for the year in question. The IRS audited the taxpayer’s return and determined that the $125,000 payment should have been included in gross income. The tax agency issued her a bill for more than $32,000 in taxes and penalties.

The taxpayer argued that the payment was received “on account of personal physical injuries or physical sickness” because if it wasn’t for her former attorneys’ allegedly negligent representation, she “would have received damages from the hospital.” The IRS argued the amount was taxable because it was for legal malpractice and not for physical injuries. The U.S. Tax Court and the 9th Circuit Court of Appeals agreed with the IRS. (Blum, 3/23/22)

Strict requirements

As you can see, the requirements for tax-free income from a settlement are strict. If you receive a court award or out-of-court settlement, consult with us about the tax implications.

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If you’re getting ready to file your 2022 tax return, and your tax bill is higher than you’d like, there may still be an opportunity to lower it. If you’re eligible, you can make a deductible contribution to a traditional IRA right up until this year’s April 18 filing deadline and benefit from the tax savings on your 2022 return.

Rules for eligibility

You can make a deductible contribution to a traditional IRA if:

• You (and your spouse) aren’t an active participant in an employer-sponsored retirement plan, or
• You (or your spouse) are an active participant in an employer plan, but your modified adjusted gross income (MAGI) doesn’t exceed certain levels that vary from year-to-year by filing status.

For 2022, if you’re a married joint tax return filer and you are covered by an employer plan, your deductible IRA contribution phases out over $109,000 to $129,000 of MAGI. If you’re single or a head of household, the phaseout range is $68,000 to $78,000 for 2022. For married filing separately, the phaseout range is $0 to $10,000. For 2022, if you’re not an active participant in an employer-sponsored retirement plan, but your spouse is, your deductible IRA contribution phases out with MAGI of between $204,000 and $214,000.

Deductible IRA contributions reduce your current tax bill, and earnings within the IRA are tax deferred. However, every dollar you take out is taxed in full (and subject to a 10% penalty before age 59½, unless one of several exceptions apply).

IRAs often are referred to as “traditional IRAs” to differentiate them from Roth IRAs. You also have until April 18 to make a Roth IRA contribution. But while contributions to a traditional IRA are deductible, contributions to a Roth IRA aren’t. However, withdrawals from a Roth IRA are tax-free as long as the account has been open at least five years and you’re age 59½ or older. (There are also income limits to contribute to a Roth IRA.)

Here’s another IRA strategy that may help married couples save tax. You can make a deductible IRA contribution, even if you don’t work. In general, you can’t make a deductible traditional IRA contribution unless you have wages or other earned income. However, an exception applies if your spouse has earned income and you’re a homemaker or not employed. In this case, you may be able to take advantage of a spousal IRA.

The contribution limit

For 2022 if you’re eligible, you can make a deductible traditional IRA contribution of up to $6,000 ($7,000 if you’re age 50 or older). For 2023, these amounts are increasing to $6,500 ($7,500 if you’re 50 or older).

In addition, small business owners can set up and contribute to Simplified Employee Pension (SEP) plans up until the due date for their returns, including extensions. For 2022, the maximum contribution you can make to a SEP is $61,000 (increasing to $66,000 for 2023).

Contact us if you want more information about IRAs or SEPs, or ask about them when we’re preparing your return. We can help you save the maximum tax-advantaged amount for retirement.

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