Calsavers is a program designed to encourage California’s private sector employees to invest in retirement savings by offering a convenient, voluntary, low cost, and portable option. This article seeks to break it down so that as a private sector employer or employee you know what to expect.

Fast Facts of the Program

• Enrollment requirement depends on head count:
  • More than 100 employees? You are subject now and need to register.
  • More than 50 employees? Your deadline to register is June 30, 2021.
  • 5 or more employees? Your deadline to register is June 30, 2022.
  • If you have less than 5 employees, you are not subject to these requirements (but will become subject to the requirements if you grow to five or more)
• If you already offer an employer-sponsored retirement plan, you are not subject to these requirements.
• You do not need to wait for your tier deadline to register – registration is open now.
• It is a no cost program for employers.
• Although employers may be required to register, employee participation is 100% voluntary.
• Sole proprietors and partners of partnerships are eligible if the business otherwise qualifies as eligible employer.
• The CalSavers Website has many resources for employers regarding both registration and employee communications.

Employers

The CalSavers program requires certain California employers to facilitate this program. Other employers will be exempt. See the categorizations below.

• Employers with an existing employer-sponsored retirement plan: CalSavers does not apply. If you have an employer-sponsored plan, you have no further action required regarding CalSavers.
  • If you are exempt and received a CalSavers notice, certify exemption here.

• Employers without an employer-sponsored retirement plan: Required by state law to facilitate CalSavers if they have five or more employees. Deadlines:
  • More than 100 employees register by September 30, 2020 (Deadline Passed)
  • More than 50 employees register by June 30, 2021
  • 5 or more employees register by June 30, 2022
  • All eligible employers can register at any time prior to their registration deadline if they would like to facilitate this earlier than their required deadline

NOTE: Employers with less than 5 employees now should consider their requirement if they expect to exceed 5 employees at a later date.

Employers should consider whether they want to facilitate a CalSavers plan or implement their own employer-sponsored retirement plan. There are many options available including self-administered plans such as SIMPLE and SEP IRAs or seeking a third party administered plan such as a 401(k) or other benefit plan.

Steps for Employer Facilitation of CalSavers

• Register business for the plan
• Upload employee information
• Facilitate automatic contributions from participating employees
• Remit contributions in one transfer per pay period
• Ensure payroll is up to date for new hires

Potential Advantages for Employers

• No fees for employers
• Employers are not fiduciaries
• No employer liability
• No annual reporting tasks
• Once the employer provides the employee list to CalSavers, CalSavers will communicate directly with employees regarding any changes to their account going forward

Employees aka “Savers” under CalSavers program

CalSavers will set up an IRA account for the Employee. The Employee will contribute to their own retirement savings through an automatic payroll withholding deduction that will be directed to their IRA.

The CalSavers IRAs are defaulted as Roth IRAs. Only those Employees who are eligible to contribute to a Roth IRA should opt in. Each employee will need to review the Roth IRA Contribution Limits per Tax Year and whether they qualify to make a contribution.

CalSavers does offer an election to recharacterize your Roth IRA contributions to a Traditional IRA. A special election form is required to do so. A traditional IRA contribution may be deductible on the Employee’s tax return, however they should seek guidance from a tax advisor.

Features of CalSavers Program for Employees “Savers”

• Simple form to opt in or out
• Default contribution rate is 5%, with 1% automatic escalation to 8% (participant may change the rates at any time)
• Default is Roth IRA, but Traditional IRA is an elective option
• Investments allow for 5 options, default for the first $1,000 contributed is a Money Market with subsequent contributions defaulting into Target Date fund (Asset Allocation based on age and automatically adjusts over time)

Employees should consider the Tax and Penalty implications of Roth and Traditional IRA distributions. Seek guidance from a tax advisor. As always, Wheeler is here to help. Reach out to your advisor, or contact us at email@wheelercpa.com.

Resources:

• Employer Guide
• Resources for Employers, including communications to employees, employee info packets, etc.

Starting in January 2021, the IRS Identity Protection PIN Opt-In Program will be expanded to all taxpayers who can properly verify their identity. Previously, IP PINs were only available to identity theft victims.

What is an Identity Protection PIN?

An identity protection personal identification number (IP PIN) is a six-digit number assigned to eligible taxpayers to help prevent their Social Security number from being used to file fraudulent federal income tax returns. This number helps the IRS verify a taxpayer’s identity and accept their tax return. Taxpayers with either a Social Security Number or Individual Tax Identification Number who can verify their identity are eligible for the program and the number is valid for one year. Each January, the taxpayer must get a new one.

How to get an IP PIN

The preferred method of obtaining an IP PIN – and the only one that immediately reveals the PIN to the taxpayer – is the Get an IP PIN tool located on the IRS website. The tool is available starting mid-January 2021 and uses Secure Access authentication to verify a person’s identity. If someone is unable to pass the Secure Access authentication, there are two alternate ways to get an IP PIN.

Taxpayers with income of $72,000 or less should complete Form 15227,Application for an Identity Protection Personal Identification Number, and mail or fax it to the IRS. An IRS employee will call the taxpayer to verify their identity using a series of questions. Those who pass authentication will receive an IP PIN the following tax year.

Taxpayers who cannot verify their identities remotely or who are ineligible to file Form 15277 should make an appointment for in-person identity verification at an IRS Taxpayer Assistance Center and bring two forms of picture identification. After the taxpayer passes authentication, an IP PIN will be mailed to them within three weeks.

What else taxpayers need to know before applying:

• The IP PIN must be entered correctly on electronic and paper tax returns to avoid rejections and delays.
• Any primary or secondary taxpayer or dependent can get an IP PIN if they can prove their identity.
• Taxpayers who want to voluntarily opt into the IP PIN program don’t need to file a Form 14039, Identity Theft Affidavit.
• The IRS plans to offer an opt-out feature to the IP PIN program in 2022.

Confirmed victims of tax-related identity theft

For confirmed victims of tax-related identity theft, there is no change in the IP PIN Program. These taxpayers should still file a Form 14039,Identity Theft Affidavit if their e-filed tax return is rejected because of a duplicate SSN filing. The IRS will investigate their case and once the fraudulent tax return is removed from their account, they will automatically receive an IP PIN by mail at the start of the next calendar year.

IP PINs will be mailed annually to confirmed victims and participants enrolled before 2019. For security reasons, confirmed identity theft victims can’t opt-out of the IP PIN program. Confirmed victims also can use the IRS Get an IP PIN tool to retrieve lost IP PINs assigned to them.

As a reminder, taxpayers should never share their IP PIN with anyone but their tax provider. The IRS will never call to request the taxpayer’s IP PIN, and taxpayers must be alert to potential IP PIN scams. If you have any questions about the IP PIN, don’t hesitate to call.

San Jose: (408) 252-1800

Watsonville: (831) 726-8500

The Consolidated Appropriations Act, 2021, H.R. 133 included funding for the government, extensions for expiring tax extenders, tax relief under the COVID-related Tax Relief Act of 2020, and many more items. Passed by both the House and Senate, it was signed into law by President Trump on December 27, 2020.

Let’s take a look at a few of the highlights related to pandemic taxpayer relief under the COVID-Related Tax Relief Act of 2020:

Individuals

Economic impact payments. $600 per taxpayer ($1,200 for married taxpayers filing jointly) and an additional $600 per qualifying child (under age 17). The recovery rebate payment begins to phase out starting at $75,000 of modified adjusted gross income for single filers, $112,500 for heads of household, and $150,000 for married taxpayers filing jointly. These payments are similar to the ones many taxpayers received earlier this year under the CARES Act.

Unemployment benefits. Additional unemployment insurance in the amount of $300 has been extended for an 11-week period beginning from December 26, 2020.

Educator expenses. Clarification that Personal Protective Equipment (PPE) used for the prevention and spread of COVID-19 will be treated as a deductible expense, retroactive to March 12, 2020.

Charitable contributions – Nonitemizers. The $300 above-the-line deduction for cash contributions given to a qualified charitable organization is extended through 2021 and increases to $600 for married taxpayers filing joint returns. In 2020, the maximum amount was $300.

Charitable contributions – Itemizers. The increased contribution limit to qualified charities that was specified in the CARES Act is extended through 2021 and applies to individuals and corporations. Amounts of up to 100 percent of adjusted gross income (AGI) are allowed as deductions (same as 2020). In 2019, the limit for the deduction for cash contributions was 60% of AGI.

Earned Income. For the 2020 tax year, taxpayers may use earned income amounts from the immediately preceding tax year when figuring the Earned Income Tax Credit and the Additional Child Tax Credit.

Flexible spending arrangements. Taxpayers can rollover unused amounts from 2020 to 2021 and from 2021 to 2022 and employers may allow employees to make a contribution change mid-year in 2021.

Money purchase pension plans. The COVID-related Tax Relief Act of 2020 also allows money purchase pension plans to be included as a qualified retirement plan, retroactive to the CARES Act. The CARES Act allowed taxpayers to make penalty-free withdrawals of up to $100,000 from certain retirement plans for coronavirus-related expenses, with the option to pay tax on that income over a three-year period or recontribute withdrawn funds.

Businesses

Paycheck Protection Program (PPP) Loans. Retroactive to the effective date of the CARES Act, PPP loans that are forgiven will be treated as tax-exempt income. Gross income does not include loan forgiveness for Economic Injury Recovery Loans (EIDLs) and certain other loans or loan repayment assistance. Under the CARES Act, taxpayers receiving an EIDL were required to reduce any PPP loan forgiveness by the amount of the EIDL.

In addition, businesses with 300 or fewer employees with a gross revenue loss of 25 percent in any quarter of 2020 compared to the same quarter in 2019 are eligible for a second round of PPP loans.

Deductible expenses. Deductions are also allowed for deductible expenses (that would otherwise be deductible) paid for with the proceeds of a forgiven PPP loan. This reverses earlier IRS guidance that stated no deduction would be allowed. This tax provision applies to the second round of PPP loans as well.

Payroll tax credits. Refundable payroll tax credits for paid sick and family (Families First Coronavirus Response Act) leave are extended through March 2021. Employers are not required to provide paid leave after December 31, 2020; however, employers may still claim the credit if the employee would have qualified for paid leave if the mandate had been extended beyond December 31, 2020, and the employer provides paid leave.

Employee retention tax credits. Implemented as a refundable credit under the CARES Act, the employee retention tax credit (ERTC) is extended through June 30, 2021. The following also applies for calendar quarters beginning after December 31, 2020:

• The credit rate is increased from 50 to 70 percent of qualified wages.
• The limit on per-employee creditable wages is increased from $10,000 for the year to $10,000 for each quarter.
• The required reduction in a year-over-year decline in gross receipts on a quarterly basis is reduced from 50 to 20 percent.
• When determining the relevant wage base, the definition of a “large employer” that can only claim the credit for employees that are not working because of the COVID pandemic increases from more than 100 to more than 500 employees.
• Certain government employers are now allowed to claim the ERTC.
• Safe harbor allowing employers to use prior-quarter gross receipts to figure eligibility.
• New employers in 2020 (i.e., those not in existence in 2019) can claim the credit.

Furthermore and retroactive to the date of the CARES Act, the ERTC is expanded to allow employers who receive PPP loans to qualify for the credit with respect to wages that are not paid with forgiven PPP proceeds. It also clarifies that group health plan expenses can be considered qualified wages even if no other wages are paid to an employee.

Employee portion of payroll tax deferral. The repayment period for deferral of payroll tax is extended through December 31, 2021.

Contact your preparer if you have any questions about how the COVID-19 Relief Act of 2020 impacts you. Specific questions about PPP or the Employee Retention Credits should be directed to our PPP team at ppp@wheelercpa.com.

San Jose: (408) 252-1800

Watsonville: (831) 726-8500

Every year, it’s a sure bet that there will be changes to current tax law and this year is no different. From standard deductions to health savings accounts and tax rate schedules, here’s a checklist of tax changes to help you plan the year ahead.

Individuals

In 2021, a number of tax provisions are affected by inflation adjustments, including Health Savings Accounts, retirement contribution limits, and the foreign earned income exclusion. The tax rate structure, which ranges from 10 to 37 percent, remains similar to 2020; however, the tax-bracket thresholds increase for each filing status. Standard deductions also rise, and as a reminder, personal exemptions have been eliminated through tax year 2025.

Standard Deduction
In 2021, the standard deduction increases to $12,550 for individuals (up from $12,400 in 2020) and to $25,100 for married couples (up from $24,800 in 2020).

Alternative Minimum Tax (AMT)
In 2021, AMT exemption amounts increase to $73,600 for individuals (up from $72,900 in 2020) and $114,600 for married couples filing jointly (up from $113,400 in 2020). Also, the phaseout threshold increases to $523,600 ($1,047,200 for married filing jointly). Both the exemption and threshold amounts are indexed annually for inflation.

“Kiddie Tax”
For taxable years beginning in 2021, the amount that can be used to reduce the net unearned income reported on the child’s return that is subject to the “kiddie tax,” is $1,100. The same $1,100 amount is used to determine whether a parent may elect to include a child’s gross income in the parent’s gross income and to calculate the “kiddie tax.” For example, one of the requirements for the parental election is that a child’s gross income for 2021 must be more than $1,100 but less than $11,000.

Health Savings Accounts (HSAs)
Contributions to a Health Savings Account (HSA) are used to pay current or future medical expenses of the account owner, his or her spouse, and any qualified dependent. Medical expenses must not be reimbursable by insurance or other sources and do not qualify for the medical expense deduction on a federal income tax return.

A qualified individual must be covered by a High Deductible Health Plan (HDHP) and not be covered by other health insurance with the exception of insurance for accidents, disability, dental care, vision care, or long-term care.

For calendar year 2021, a qualifying HDHP must have a deductible of at least $1,400 for self-only coverage or $2,800 for family coverage and must limit annual out-of-pocket expenses of the beneficiary to $7,000 for self-only coverage and $14,000 for family coverage.

Medical Savings Accounts (MSAs)
There are two types of Medical Savings Accounts (MSAs): The Archer MSA created to help self-employed individuals and employees of certain small employers, and the Medicare Advantage MSA, which is also an Archer MSA, and is designated by Medicare to be used solely to pay the qualified medical expenses of the account holder. To be eligible for a Medicare Advantage MSA, you must be enrolled in Medicare. Both MSAs require that you are enrolled in a high-deductible health plan (HDHP).

Self-only coverage. For taxable years beginning in 2021, the term “high deductible health plan” means, for self-only coverage, a health plan that has an annual deductible that is not less than $2,400 ($2,350 in 2020) and not more than $3,600 (up $50 from 2020), and under which the annual out-of-pocket expenses required to be paid (other than for premiums) for covered benefits do not exceed $4,800 (up $50 from 2020).

Family coverage. For taxable years beginning in 2021, the term “high deductible health plan” means, for family coverage, a health plan that has an annual deductible that is not less than $4,800 and not more than $7,150, and under which the annual out-of-pocket expenses required to be paid (other than for premiums) for covered benefits do not exceed $8,750.

AGI Limit for Deductible Medical Expenses
In 2021, the deduction threshold for deductible medical expenses is 7.5 percent of adjusted gross income (AGI), made permanent by the Consolidated Appropriations Act, 2021.

Eligible Long-Term Care Premiums
Premiums for long-term care are treated the same as health care premiums and are deductible on your taxes subject to certain limitations. For individuals age 40 or younger at the end of 2021, the limitation is $450. Persons more than 40 but not more than 50 can deduct $850. Those more than 50 but not more than 60 can deduct $1,690 while individuals more than 60 but not more than 70 can deduct $4,520. The maximum deduction is $5,640 and applies to anyone more than 70 years of age.

Medicare Taxes
The additional 0.9 percent Medicare tax on wages above $200,000 for individuals ($250,000 married filing jointly) remains in effect for 2021, as does the Medicare tax of 3.8 percent on investment (unearned) income for single taxpayers with modified adjusted gross income (AGI) more than $200,000 ($250,000 joint filers). Investment income includes dividends, interest, rents, royalties, gains from the disposition of property, and certain passive activity income. Estates, trusts, and self-employed individuals are all liable for the tax.

Foreign Earned Income Exclusion
For 2021, the foreign earned income exclusion amount is $108,700 up from $107,600 in 2020.

Long-Term Capital Gains and Dividends
In 2021 tax rates on capital gains and dividends remain the same as 2020 rates (0%, 15%, and a top rate of 20%); however, threshold amounts have increased: the maximum zero percent rate amounts are $40,400 for individuals and $80,800 for married filing jointly. For an individual taxpayer whose income is at or above $445,850 ($501,600 married filing jointly), the rate for both capital gains and dividends is capped at 20 percent. All other taxpayers fall into the 15 percent rate amount (i.e., above $40,400 and below $445,850 for single filers).

Estate and Gift Taxes
For an estate of any decedent during calendar year 2021, the basic exclusion amount is $11.70 million, indexed for inflation (up from $11.58 million in 2020). The maximum tax rate remains at 40 percent. The annual exclusion for gifts remains at $15,000.

Individuals – Tax Credits

Adoption Credit
In 2021, a non-refundable (only those individuals with tax liability will benefit) credit of up to $14,440 is available for qualified adoption expenses for each eligible child.

Earned Income Tax Credit
For tax year 2021, the maximum Earned Income Tax Credit (EITC) for low and moderate-income workers and working families rises to $6,728 up from $6,660 in 2020. The credit varies by family size, filing status, and other factors, with the maximum credit going to joint filers with three or more qualifying children.

Child Tax Credit
For tax years 2020 through 2025, the child tax credit is $2,000 per child. The refundable portion of the credit is $1,400 so that even if taxpayers do not owe any tax, they can still claim the credit. A $500 nonrefundable credit is also available for dependents who do not qualify for the Child Tax Credit (e.g., dependents age 17 and older).

Child and Dependent Care Tax Credit
The Child and Dependent Care Tax Credit also remained under tax reform. If you pay someone to take care of your dependent (defined as being under the age of 13 at the end of the tax year or incapable of self-care) to work or look for work, you may qualify for a credit of up to $1,050 or 35 percent of $3,000 of eligible expenses in 2021. For two or more qualifying dependents, you can claim up to 35 percent of $6,000 (or $2,100) of eligible expenses. For higher-income earners, the credit percentage is reduced, but not below 20 percent, regardless of the amount of adjusted gross income. This tax credit is nonrefundable.

Individuals – Education

American Opportunity Tax Credit and Lifetime Learning Credit
The maximum credit is $2,500 per student for the American Opportunity Tax Credit. The Lifetime Learning Credit remains at $2,000 per return. To claim the full credit for either, your modified adjusted gross income (MAGI) must be $80,000 or less ($160,000 or less for married filing jointly). Prior to the passage of the Consolidated Appropriations Act, 2021, taxpayers with MAGI of $139,000 (joint filers) or $69,500 (single filers) were not able to claim the Lifetime Learning Credit.

While the phaseout limits for Lifetime Learning Credit increased, taxpayers should note that the qualified tuition and expenses deduction has been repealed starting in 2021.

Interest on Educational Loans
In 2021, the maximum deduction for interest paid on student loans is $2,500. The deduction begins to be phased out for higher-income taxpayers with modified adjusted gross income of more than $70,000 ($140,000 for joint filers) and is completely eliminated for taxpayers with modified adjusted gross income of $85,000 ($170,000 joint filers).

Individuals – Retirement

Contribution Limits
The elective deferral (contribution) limit for employees who participate in 401(k), 403(b), most 457 plans, and the federal government’s Thrift Savings Plan remains at $19,500. Contribution limits for SIMPLE plans also remain at $13,500. The maximum compensation used to determine contributions increases to $290,000 (up from $285,000 in 2020).

Income Phase-out Ranges
The deduction for taxpayers making contributions to a traditional IRA is phased out for singles and heads of household who are covered by an employer-sponsored retirement plan and have modified AGI between $66,000 and $76,000.

For married couples filing jointly, in which the spouse who makes the IRA contribution is covered by an employer-sponsored retirement plan, the phase-out range increases to $105,000 to $125,000. For an IRA contributor who is not covered by an employer-sponsored retirement plan and is married to someone who is covered, the deduction is phased out if the couple’s modified AGI is between $198,000 and $208,000.

The modified AGI phase-out range for taxpayers making contributions to a Roth IRA is $125,000 to $140,000 for singles and heads of household, up from $124,000 to $13999,000. For married couples filing jointly, the income phase-out range is $198,000 to $208,000, up from $196,000 to $206,000. The phase-out range for a married individual filing a separate return who makes contributions to a Roth IRA is not subject to an annual cost-of-living adjustment and remains $0 to $10,000.

Saver’s Credit
In 2021, the AGI limit for the Saver’s Credit (also known as the Retirement Savings Contribution Credit) for low and moderate-income workers is $66,000 for married couples filing jointly, up from $65,000 in 2020; $49,500 for heads of household, up from $48,750; and $33,000 for singles and married individuals filing separately, up from $32,500 in 2020.

Businesses

Standard Mileage Rates
In 2021, the rate for business miles driven is 56 cents per mile, down 1.5 cents from the rate for 2020.

Section 179 Expensing
In 2021, the Section 179 expense deduction increases to a maximum deduction of $1,050,000 of the first $2,620,000 of qualifying equipment placed in service during the current tax year. This amount is indexed to inflation for tax years after 2018. The deduction was enhanced under the TCJA to include improvements to nonresidential qualified real property such as roofs, fire protection, and alarm systems and security systems, and heating, ventilation, and air-conditioning systems. Also, of note is that costs associated with the purchase of any sport utility vehicle, treated as a Section 179 expense, cannot exceed $26,200.

Bonus Depreciation
Businesses are allowed to immediately deduct 100% of the cost of eligible property placed in service after September 27, 2017, and before January 1, 2023, after which it will be phased downward over a four-year period: 80% in 2023, 60% in 2024, 40% in 2025, 20% in 2026, and 0% in 2027 and years beyond.

Qualified Business Income Deduction
Eligible taxpayers are able to deduct up to 20 percent of certain business income from qualified domestic businesses, as well as certain dividends. To qualify for the deduction business income must not exceed a certain dollar amount. In 2021, these threshold amounts are $164,900 for single and head of household filers and $329,800 for married taxpayers filing joint returns.

Research & Development Tax Credit
Starting in 2018, businesses with less than $50 million in gross receipts can use this credit to offset alternative minimum tax. Certain start-up businesses that might not have any income tax liability will be able to offset payroll taxes with the credit as well.

Work Opportunity Tax Credit (WOTC)
Extended through 2025 (The Consolidated Appropriations Act, 2021), the Work Opportunity Tax Credit is available for employers who hire long-term unemployed individuals (unemployed for 27 weeks or more) and is generally equal to 40 percent of the first $6,000 of wages paid to a new hire.

Employee Health Insurance Expenses
For taxable years beginning in 2021, the dollar amount of average wages is $27,800 ($27,600 in 2020). This amount is used for limiting the small employer health insurance credit and for determining who is an eligible small employer for purposes of the credit.

Business Meals and Entertainment Expenses
Taxpayers who incur food and beverage expenses associated with operating a trade or business are able to deduct 100 percent (50 percent for tax years 2018-2020) of these expenses for tax years 2021 and 2022 (The Consolidated Appropriations Act, 2021) as long as the meal is provided by a restaurant.

Employer-provided Transportation Fringe Benefits
If you provide transportation fringe benefits to your employees in 2021, the maximum monthly limitation for transportation in a commuter highway vehicle as well as any transit pass is $270. The monthly limitation for qualified parking is $270.

While this checklist outlines important tax changes for 2021, additional changes in tax law are likely to arise during the year ahead. Don’t hesitate to call if you have any questions or want to get a head start on tax planning for the year ahead:

San Jose: (408) 252-1800

Watsonville: (831) 726-8500

Starting December 13, 2020, the IRS began masking sensitive data on business tax transcripts. Previously, only sensitive data on individual tax transcripts was masked.

Here’s what you need to know about this new initiative to protect business taxpayers from identity theft:

What is a tax transcript?

A tax transcript is a summary of a tax return and is often used by tax professionals to prepare prior year tax returns or when representing a client before the IRS. Lenders and others use tax transcripts for income verification purposes.

What is visible on the new tax transcript?

• Last four digits of any Employer Identification Number listed on the transcript: XX-XXX1234
• Last four digits of any Social Security number or Individual Tax Identification Number listed on the transcript: XXX-XX-1234
• Last four digits of any account or telephone number
• First four characters of the first, and last name for any individual (first three characters if the name has only four letters)
• First four characters of any name on the business name line
• First six characters of the street address, including spaces
• All money amounts, including wage and income, balance due, interest and penalties

Customer File Number

For both the individual and business tax transcript, there is space for a Customer File Number. The Customer File Number is an optional 10-digit number that can be created usually by third parties that allow them to match a transcript to a taxpayer. The Customer File Number field will appear on the transcript when that number is entered on Line 5 of Form 4506-T, Request for Transcript of Tax Return, and Form 4506T-EZ.

What happens when a taxpayer seeks to verify income for a lender?

1. The lender will assign a 10-digit number, for example, a loan number, to Form 4506-T. The Form 4506-T may be signed and submitted by the taxpayer or signed by the taxpayer and submitted by the lender.
2. The Customer File Number assigned by the requestor on Form 4506-T will populate on the transcript. The requestor may assign any number except the taxpayer’s Social Security number or Employer Identification Number.
3. Once received by the requester, the transcript’s Customer File Number serves as the tracking number to match it to the taxpayer.

If you have any questions or need more information about this topic, please contact the office:

San Jose: (408) 252-1800

Watsonville: (831) 726-8500

By Matt Wheeler

Equity compensation is a popular tool for attracting the brightest and best talent in innovation hot spots like the Silicon Valley, Austin, Denver, and Boston, to name a few. It is also increasingly used in smaller companies as a retention tool for high quality employees. Tax principles require a taxpayer to recognize into income the value of any property received in exchange for services performed, including equity awards, and for US income tax purposes, the type and structure of equity compensation will dictate how the employee is taxed upon grant, exercise, vest, and sale of the option or award. Equity awards are generally taxed partially as compensation income (ordinary) and partially as portfolio income (capital gain). The key goal of the employee taxpayer is to maximize the amount of income recognized that is taxed at capital gain rates and minimize the amount taxed at ordinary income rates.

There are many types of equity compensation, and equally as many strategies for maximizing tax efficiency for each. We will briefly touch on the rules for incentive stock options, but this article will more specifically focus on non-qualified stock options.

INCENTIVE STOCK OPTION RULES

Incentive stock options (ISOs) have specifically defined qualities in the tax code. Some of the more common requirement are

• They may only be issued to employees, not non-employees or contractors
• They are non-transferrable
• An award of ISOs is limited to an annual vesting value amount of no more than $100,000 per year based on the grant price (the $100,000 rule), and
• The options must be exercisable while the taxpayer is still employed by the employer or not more than 90 days thereafter.

Non-qualified stock options are anything other than incentive stock options. The easiest way to identify your equity award option types is to review the grant document or check with your HR department.

BASIC NQSO RULES

Non-qualified stock options (NQSOs) have the most straightforward tax-treatment: upon exercise of an NQSO the entire “spread”, or difference between the fair value on exercise date and the strike price, is considered compensation income for tax purposes. At the time of exercise, the employer is required to collect the strike price per share from the employee and impose statutory withholdings for income taxes and payroll taxes on the spread amount. The entire gain is taxed at ordinary income rates. NQSOs may have more limited planning opportunities, but there are a few key considerations which can greatly impact the tax efficiency of this form of income. It is important to understand the following:

• Timing Considerations for Sale of Shares
• Estimated Tax Requirements
• Marginal Tax Rate Arbitrage, and
• Stock Price Risk Considerations

TIMING CONSIDERATIONS FOR SALE OF SHARES

The best time to sell your shares depends on a few factors, like employment status and type of employer.

Due to the significant cash layout required by the employee, the most tax advantageous and practical move for NQSO of publicly traded companies is generally to execute a same-day-sale or cashless exercise. The employee walks away with cash for the sale of the shares less required withholdings. For non-employee option holders, there are more tax strategies available, which we will discuss later in more detail.

For privately held NQSO shares where the current spread may be significantly less than the expected future value of the shares, the risk of exercising and holding the NQSOs, even at the cost of paying the required tax withholdings and strike price out of pocket, may be worth consideration.

In all scenarios, the key is to be aware of withholding shortfalls and the estimated tax requirements for individuals, understand how an income spike from the exercise and sale will affect your tax bracket compared to surrounding tax years, and remain conscious of the upcoming expiration dates of remaining options.

ESTIMATED TAX REQUIREMENTS

Non-qualified stock option holders must understand the estimated tax requirements for individual taxpayers and the statutory withholding rates for supplemental wage payments such as for income from stock option exercises.

Employers are required to withhold both social security and medicare taxes (social security up to the maximum wage cap in effect for the year) as well as income taxes on the gain portion of an exercise of non-qualified stock options. The tax code requires withholding on these supplemental wage payments at statutory rates—currently 22% for federal income taxes and 10.23% for California state income taxes. Other states may have other flat withholding rates required. The federal 22% rate applies to the first $1 million in supplemental wage payments made for the year. After the $1 million threshold has been reached, the statutory rate raises to 37%. Current maximum federal and California ordinary income tax rates are 37% and 13.3% respectively. This creates a potential withholding shortfall for taxpayers exercising NQSOs, which often results in additional taxes owed at the time of filing.

The timing requirements for estimated payments play an important role in your tax efficiency. Underpayment penalties are imposed on taxpayers that do not meet either the prior year or current year safe harbor requirements. While the IRS refers to them as penalties, leaving open the potential for abatement in certain circumstances, the underpayment penalty is essentially a form of interest charged to the taxpayer by the government for use of the funds throughout the year. Current underpayment penalty rates are at historical lows of 3% on an annualized basis.

The prior year safe harbor states that a taxpayer is required to pay in at least 100% or 110% of their prior year tax liability during the current year to avoid underpayment penalties. The payments can be in the form of any combination of withholding or estimated tax payments. The current year safe harbor states that a taxpayer is required to pay in at least 90% of the estimated current year tax during the year to avoid underpayment penalties, again via any combination of withholding or quarterly tax payments.  In the case of an income spike from the exercise of non-qualified stock options, most taxpayers will find themselves relying on the prior year safe harbor. Due to the required withholdings on exercise, there is often sufficient tax paid in based on the exercises that no additional payments are required during the year.

One way taxpayers can maximize their tax efficiency here is by reducing future regular salary withholdings or eliminating future quarterly tax payments for the rest of the year and investing that money instead to earn a return before the money must be paid to the government. However, for taxpayers experiencing a sideways or down income year compared to the prior year, more care must be taken to ensure the proper amount of taxes have been paid in to avoid being penalized.

MARGINAL TAX RATE ARBITRAGE

Non-qualified stock option holders triggering income from the exercise and sale of options must also understand the impact it will have on their expected marginal tax rate compared to their expected tax rate for the following tax year. Utilizing the principals of tax rate arbitrage, you want to be strategic about triggering additional income or incurring deductions such that you are maximizing tax efficiency.

Additional income recognition should be deferred to the subsequent year, when possible, assuming a similar or lower marginal tax rate than the current year. Deductions should generally be accelerated into the current year rather than postponing them or waiting until the following year. Being strategic here can result in permanent tax savings on the rate differential.

While taxpayers may not have control over the timing of all income or deduction items, there are a few common strategies that may be available.

On the income side:

• Cashing out PTO or vacation pay
• Sale of assets at gains
• Invoicing of customers for self-employed taxpayers
• Roth conversions

On the deduction side:

• Prepayment of January mortgage payments in the current year
• Charitable contributions
• Business expenses for self-employed taxpayers
• Recognition of losses on the sale of assets or bad debts
• The freeing up of suspended passive losses on disposition of assets

There may be more tools at your disposal, depending on your specific situation, but this touches on some of the most common scenarios.

STOCK PRICE RISK CONSIDERATIONS

The last strategy available to employee NQSO holders relates to stock price risk. Non-qualified options have a maximum term of 10 years from the grant date, sometimes less. The specifics of your equity grant document should be reviewed.

As the expiration date looms closer for unexercised non-qualified stock options, the window of time in which the taxpayer can exercise and sell the option narrows. As this period approaches, the taxpayer runs increasing risk that a black swan style event, events outside the control of the underlying company, or perhaps poor execution on events within its control, could dramatically reduce the stock price. Even if the reduction is temporary, a narrowing exercise window means the taxpayer may be forced to cash out these options at a depressed price.

Medium term time horizon planning of multiple years can ensure that taxpayers are being smart about executing NQSO exercise and sale transactions at opportune times, minimizing pricing risk as execution windows narrow, and reserving equity awards with longer expiration time horizons for future years. While we always strive to maintain tax efficiency on our equity award transactions, paying more tax on higher income due to a high sale price is always preferable to paying less tax on lower income due to sale at a much lower price.

NON-EMPLOYEE OPTION HOLDERS

Non-employee NQSO holders have access to additional strategic options since any income recognized is considered income from self-employment. This is most commonly the case for directors of businesses who receive equity awards as compensation for director services.

Directors may utilize business expenses to reduce income, including

• Home office deductions (even carried over from prior years where no income was recognized but director services were still being performed)
• Communication expenses, such as cell phone and internet
• Travel and vehicle expenses
• And, perhaps most significantly, retirement plan expenses for the self-employed business. Certain retirement plans permit deductions well into five and even six figures, depending on the circumstances, which can result in significant tax savings.

SUMMARY

While non-qualified stock option holders may often feel there are limited tax planning and strategic tools available, there are still important considerations to keep in mind which can lead to significant four, five or six figure tax savings. Understanding estimated tax requirements and statutory withholding rates to take advantage of time value of money principles, utilizing tax rate arbitrage concepts to generate permanent tax savings, being aware of pricing risk in relation to upcoming option expirations, and maximizing business deductions for non-employee option holders can result in material savings.

Working with an advisor that understands the intricacies of these strategies should more than pay for itself in comparison to less experienced and expensive advisors or a DIY approach. If you have significant equity compensation awards, there is no time like the present to develop your tax minimization strategy.

Reach out to us at email@wheelercpa.com if you have questions or would like to know more about our tax planning and preparation services.

Matt Wheeler, CPA is the Managing Partner of Wheeler Accountants LLP, a full service accounting firm located in the heart of Silicon Valley. Matt works primarily with individuals on comprehensive tax strategies, specializing in equity compensation, serial entrepreneurs, venture capitalists and ultra high net worth individuals. He is also the co-host of the Avocado Toast Podcast – a Podcast targeting HENRYs (high earner not rich yet) and millennials helping them make smart financial decisions.

Applications are now open for California small businesses and nonprofits to apply for a COVID-19 Relief Grant. Applications for Round 1 closes on January 13, 2021 at 11:59 PM. There is $475 million of funding available for this program. Half of the funds will be awarded in Round 1 and the other half will be awarded in Round 2. If an eligible business applies in Round 1 and is not selected, they will join a waitlist for Round 2. The grant amounts are based on eligible business annual revenue as documented in the most recent tax return.

Eligible Businesses Annual Revenue	Grant Amount Available Per Business
$1,000 to $100,000	$5,000
Greater than $100,000 up to $1,000,000	$15,000
Greater than $1,000,000 up to $2,500,000	$25,000

Revenue is determined based on the IRS tax form definition of “Gross Sales” (less any returns and allowances) as reported on the most recently filed tax returns (2019 or 2018)

• Line 1.c. on both the 1120 (corporate return) or 1120S (S-Corp return)
• Line 3 on IRS Schedule C for single member LLCs and sole proprietorships
• Line 1.c. on Form 1065, for partnerships
• Line 1.c. and Line 2 on Form Schedule F for farming businesses
• Line 12 on Form 990 for non-profits
• Schedule E is not eligible

Eligibility

A small business or small nonprofit must satisfy all of the following criteria to be eligible to receive a grant award:

1. Must meet the definition of an “eligible small business”
   • Sole proprietor, independent contractor, 1099 work, and or registered “for-profit” business entity, C-corporation, S-corporation, limited liability company, or partnership that has yearly gross revenue of $2.5 million or less (but at least $1,000 in yearly gross revenue) based on most recently filed tax return
   • Registered 501(c)(3), 501(c)(19), or 501(c)(6) nonprofit entity having yearly gross revenue of $2.5 million or less (but at least $1,000 in yearly gross revenue) based on most recently filed Form 990
2. Active business or nonprofit operating since at least June 1, 2019
3. Businesses must currently be operating or have a clear plan to re-open once the State of California permits re-opening of the business
4. Business must be impacted by COVID-19 and the health and safety restrictions such as business interruptions or business closures incurred as a result of the COVID-19 pandemic
5. Business must be able to provide documents including
   • 2018 or 2019 tax returns or Form 990
   • copy of official filing with the California Secretary of State, if applicable, or local municipality for the business such as one of the following: Articles of Incorporation, Certificate of Organization, Fictitious Name of Registration or Government-Issued Business License
   • acceptable form of government-issued photo ID
6. Applicants with multiple business entities, franchises, locations, etc. are not eligible for multiple grants and are only allowed to apply once using their eligible small business with the highest revenue

How will grant recipients be determined?

Applications will be reviewed to determine whether the applicant meets the eligibility requirements. Eligible businesses will then be scored based on COVID-19 impact factors incorporated into the Program’s priority criteria so that distribution can take into account priority key factors, including the following:

• Geographic distribution based on COVID-19 health and safety restrictions following California’s Blueprint for a Safer Economy and county status and the new Regional Stay at Home Order
• Industry sectors most impacted by the pandemic
• Underserved small business groups served by the State supported network of small business centers including businesses:
  • Majority owned and run on a daily basis by women
  • Majority owned by minorities/specific racial and ethnic groups
  • Majority owned by veterans
  • Located in low-to-moderate income and rural communities

Ineligible Businesses

• Businesses without a physical location in California
• Nonprofit businesses not registered as either a 501(c)(3), 501(c)(19), or 501(c)(6)
• Government entities (other than Native American tribes) or elected official offices
• Businesses primarily engaged in political or lobbying activities (regardless of whether such entities qualify as a 501(c)(3), 501(c)(19), or 501(c)(6))
• Passive businesses, investment companies and investors who file a Schedule E on their personal tax returns
• Churches and other religious institutions (regardless of whether such entities qualify as a 501(c)(3), 501(c)(19), or 501(c)(6))
• Financial businesses primarily engaged in the business of lending, such as banks, finance companies and factoring companies
• Businesses engaged in any activity that is illegal under federal, state, or local law
• Businesses of a prurient sexual nature, including businesses which present live performances of a prurient sexual nature and businesses which derive directly or indirectly more than de minimis gross revenue through the sale of products or services, or the presentation of any depictions or displays, of a prurient sexual nature
• Businesses engaged in any socially undesirable activity or activity that may be considered predatory in nature such as rent-to-own businesses and check cashing businesses
• Businesses that restrict patronage for any reason other than capacity
• Speculative businesses
• Businesses of which any owner of greater than 10% of the equity interest in it (i) has within the prior three-years been convicted of or had a civil judgment rendered against such owner, or has had commenced any form of parole or probation (including probation before judgment), for commission of fraud or a criminal offense in connection with obtaining, attempting to obtain, or performing a public (federal, state or local) transaction or contract under a public transaction; violation of federal or state anti-trust or procurement statutes or commission of embezzlement, theft, forgery, bribery, falsification or destruction of records, making false statements, or receiving stolen property, or (ii) is presently indicted for or otherwise criminally or civilly charged by a government entity, (federal, state or local) with commission of any of the offenses enumerated in subparagraph (i) above
• “Affiliated” companies (as such term is defined in 13 C.F.R. § 121.103)
• Multiple business entities, franchises, locations, etc. are not eligible for multiple grants and are only allowed to apply once using their eligible small business with the highest revenue

Required Documents to Apply

• Application Certification – Signed certification used to certify your business. This is also when you indicate if you are an underserved small business group.
  • For Profit Application Certification
  • Nonprofit Application Certification
• Government Issued Photo ID – Such as a Driver’s License or Passport
• Most recent tax return filed (2019 or 2018) – provided in an electronic form for online upload, such as PDF/JPEG or other approved upload format

Required Documentation for Applicants Chosen for a Grant

• Local municipality for the business such as one of the following: Articles of Incorporation, Certificate of Organization, Fictitious Name of Registration, or Government-Issued Business License
• Copy of official filing with the California Secretary of State, if applicable,

How to Apply

Go to www.careliefgrant.com and select the link “Find a Partner”, select “By County”, select your county, and finally select one of the partners in your county. Do not apply more than once.

Wheeler is here to help

Please contact us if you have any questions about this grant program or any other relief programs available to small businesses. There is a long list of them that we can help you navigate eligibility and application requirements.

The holidays have arrived and, as in past years, Wheeler Accountants will be matching employee contributions to the charity of each participant’s choice.

This proud Wheeler tradition is held in place of sending holiday cards to our clients and referral sources, and we believe it is a great way to honor the spirit of giving during what can be a tough time of year for many. The process this year will be the same as last year: any employee can choose a qualifying public charity or private foundation and make their donation, which the firm will then match (up to $50).

We thank our participating employees for their generosity and for keeping this tradition alive!