If you aren’t in the trade or business of gambling, you should be aware that gambling winnings are fully taxable and must be reported as income on your tax return. Gambling income includes but isn’t limited to winnings from lotteries, raffles, horse races, and casinos, and also includes cash winnings and the fair market value of prizes, such as cars and trips. Here is what you need to know:

Gambling Winnings

If you receive certain gambling winnings or have any gambling winnings subject to federal income tax withholding, you will be issued a Form W-2G, Certain Gambling Winnings. Gambling winnings are reported as “Other Income” on Schedule 1 of Form 1040 or Form 1040-SR. Winnings that aren’t reported on a Form W-2G should also be included. Depending on the amount of gambling winnings, you may be required to pay an estimated tax on that additional income. For additional information on withholding gambling winnings, please contact the office.

Gambling Losses

You may deduct gambling losses only if you itemize your deductions on Schedule A (Form 1040) and have kept a record of your winnings and losses. The amount of losses you deduct can’t be more than the amount of gambling income you reported on your return. You can claim your gambling losses up to the amount of winnings as “Other Itemized Deductions.”

Nonresident Aliens

As a nonresident alien of the United States for income tax purposes and you must file a tax return for U.S. source gambling winnings, using Form 1040-NR, U.S. Nonresident Alien Income Tax Return. Generally, nonresident aliens of the United States who aren’t residents of Canada can’t deduct gambling losses.

Recordkeeping

To deduct your losses, you must keep an accurate diary or similar record of your gambling winnings and losses and be able to provide receipts, tickets, statements, or other records that show the amount of both your winnings and losses. If you need assistance with this, don’t hesitate to call.

Many small businesses have closed due to COVID-19. If yours is one of them, you should be aware that there is more to closing a business than laying off employees, selling office furniture, and closing the doors – you must also take certain actions as required by the IRS to fulfill your tax obligations. For example, if you have employees, you must file final employment tax returns as well as make final federal tax deposits of these taxes. You will need to attach a statement to your return listing the name and address of the person that keeps the payroll records (this could be you or another person) as well. If you are disposing of business property, exchanging like-kind property, and/or changing the form of your business, you must file a return to report these actions too. You must also file an annual tax return for the year you go out of business.

Depending on your type of business structure, you may need to take the some or all of the following steps:

• File final federal tax deposits
• File final quarterly or annual employment tax form (Forms 94x)
• Issue final wage and withholding information to employees (Form W-2, Wage and Tax Statement
• Report information from W-2s issued (Form W-3, Transmittal of Income and Tax Statements)
• File final tip income and allocated tips information return (Form 8027, Employer’s Annual Information Return of Tip Income and Allocated Tips)
• Report capital gains or losses
• Report partner’s/shareholder’s shares (Schedules K-1)
• File final employee pension/benefit plan
• Issue payment information to sub-contractors (Form 1099-MISC, Miscellaneous Income)
• Report information from 1099s issued Form 1096, Annual Summary and Transmittal of U.S. Information Returns)
• Report corporate dissolution or liquidation
• Consider allowing S corporation election to terminate
• Report business asset sales
• Report the sale or exchange of property used in your trade or business.

If you find yourself in the position of having to close your business, help is just a phone call away.

IRAs, or Individual Retirement Arrangements, provide tax incentives for people to make investments that can provide financial security for their retirement. To help people better understand this type of retirement savings account, here’s a basic overview of terms to know:

Contribution. The money that someone puts into their IRA. There are annual limits to contributions depending on their age and the type of IRA. Generally, a taxpayer or their spouse must have earned income to contribute to an IRA.

Distribution. The amount that someone withdraws from their IRA.

Withdrawals. Taxpayers may face a 10% penalty and a tax bill if they withdraw money before age 59 ½ unless they qualify for an exception.

Required distribution. There are requirements for withdrawing from an IRA:

• Someone generally must start taking withdrawals from their IRA when they reach age 70 1/2.
• Per the 2019 SECURE Act, if a person’s 70th birthday is on or after July 1, 2019, they do not have to take withdrawals until age 72.
• Special distribution rules apply for IRA beneficiaries.

Traditional IRA. An IRA where contributions may be tax-deductible. Generally, the amounts in a traditional IRA are not taxed until they are withdrawn.

Roth IRA. This type of IRA that is subject to the same rules as a traditional IRA but with certain exceptions:

• A taxpayer cannot deduct contributions to a Roth IRA.
• Qualified distributions are tax-free.
• Roth IRAs do not require withdrawals until after the death of the owner.

Savings Incentive Match Plan for Employees. This is commonly known as a SIMPLE IRA. Employees and employers may contribute to traditional IRAs set up for employees. It may work well as a start-up retirement savings plan for small employers.

Simplified Employee Pension. This is known as a SEP-IRA. An employer can make contributions toward their own retirement and their employees’ retirement. The employee owns and controls a SEP.

Rollover IRA. This is when the IRA owner receives a payment from their retirement plan and deposits it into a different IRA within 60 days.

It’s essential to understand the tax implications of your retirement planning choices. If you haven’t started saving for retirement, call the office and speak to a tax professional who will help you figure out a plan that works for you.

Individuals with significant assets should take advantage of proven tax strategies such as gifting and direct payments to educational institutions to transfer wealth to heirs tax-free, as well as minimize estate taxes. Additional opportunities are available as well, thanks to low interest rates and a volatile stock market. Let’s take a look at some of them:

Gifting

The annual gift tax exclusion provides a simple, effective way of cutting estate taxes and shifting income to heirs. For example, in 2021, you can make annual gifts of up to $15,000 ($30,000 for a married couple) to as many donees as you desire. The $15,000 is excluded from the federal gift tax so that you will not incur gift tax liability. Furthermore, each $15,000 you give away during your lifetime reduces your estate for federal estate tax purposes. However, any amounts above this limit will reduce an individual’s federal lifetime exemption and require filing a gift tax return.

Direct Payments

Direct payments for medical or educational purposes indirectly shift income to heirs; however, it only works if the payments are made directly to the qualifying educational institution or medical provider. This strategy allows you to give more than the annual gifting limit of $15,000 per donee. For example, if you’re a grandparent, you can pay tuition directly to your grandchild’s boarding school, college, or university. Room and board, books, supplies, or other nontuition expenses are not covered. Similarly, they can make direct payments to a hospital or medical provider, but medical expenses reimbursed by insurance are not covered, however.

Loans to Family Members

This strategy works by loaning cash to family members at low interest rates, which is then invested with the goal of reaping significant profits down the road. With mid and long-term applicable federal rates (AFR) rates for October 2021, as low as 0.91 and 1.72 percent, respectively, heirs can lock in these rates for many years – three to nine years (mid-term) and nine to more than 20 years (long-term).

Grantor Retained Annuity Trust (GRAT)

Another relatively low-risk strategy is the grantor retained annuity trust (GRAT), where the donor transfers assets to an irrevocable trust and receives an annuity payment back from the trust each year. This strategy enables heirs to profit from their investments long-term if returns are higher than the IRS interest rate. Now that IRS interest rates are so low, this is easier than ever to do. In October 2021, the interest rate used to value certain charitable interests in trusts such as the GRAT is 1.00 percent.

Roth IRA Conversions

Contributions to a traditional IRA are made pre-tax, which means distributions are considered taxable income; however, the tax is paid upfront with a Roth IRA, and distributions are completely exempt from income tax. This feature makes converting a traditional IRA to Roth IRA and rolling it over to an heir an attractive option, especially during a financial crisis. The conversion is treated as a rollover where the trustee of the traditional IRA is directed to transfer an amount from the traditional IRA to the trustee of the Roth IRA. The account owner pays income tax on the amount rolled over in the year the account is converted, which allows the account to accumulate assets tax-free and future distributions are tax-free.

To learn more about these and other tax strategies related to wealth management, please call the office and speak to a tax professional who can assist you.

If you’re a savvy investor, you probably know that you must generally report as income any mutual fund distributions, whether you reinvest them or exchange shares in one fund for shares of another. In other words, you must report and pay any capital gains tax owed.

But if real estate’s your game, did you know that it’s possible to defer capital gains by taking advantage of a tax break that allows you to swap investment property on a tax-deferred basis?

What Is Section 1031?

Named after Section 1031 of the tax code, a like-kind exchange generally applies to real estate and was designed for people who wanted to exchange properties of equal value. If you own land in Montana and trade it for a shopping center in Rhode Island, as long as the values of the two properties are equal, nobody pays capital gains tax even if both properties may have appreciated since they were originally purchased.

Section 1031 transactions don’t have to involve identical types of investment properties. You can swap an apartment building for a shopping center or a piece of undeveloped raw land for an office or building. You can even swap a second home that you rent out for a parking lot.

There’s also no limit as to how many times you can use a Section 1031 exchange. It’s entirely possible to roll over the gain from your investment swaps for many years and avoid paying capital gains tax until a property is finally sold. Keep in mind that gain is deferred but not forgiven in a like-kind exchange, and you must calculate and keep track of your basis in the new property you acquired in the exchange.

Section 1031 is not for personal use. For example, you can’t use it for stocks, bonds, and other securities, or personal property (with limited exceptions such as artwork).

Properties of Unequal Value

Let’s say you have a small piece of property, and you want to trade up for a bigger one by exchanging it with another party. You can make the transaction without having to pay capital gains tax on the difference between the smaller property’s current market value and your lower original cost.

That’s good for you, but the other property owner doesn’t make out so well. Presumably, you will have to pay cash or assume a mortgage on the bigger property to make up the difference in value. In the tax trade, this is referred to as “boot,” and your partner must pay capital gains tax on that part of the transaction.

To avoid that, you could work through an intermediary who is often known as an escrow agent. Instead of a two-way deal involving a one-for-one swap, your transaction becomes a three-way deal.

Your replacement property may come from a third party through the escrow agent. Juggling numerous properties in various combinations, the escrow agent may arrange evenly valued swaps.

Under the right circumstances, you don’t even need to do an equal exchange. You can sell a property at a profit, buy a more expensive one, and defer the tax indefinitely.

You sell a property and have the cash put into an escrow account. Then the escrow agent buys another property that you want. They get the title to the deed and transfers the property to you.

Mortgage and Other Debt

When considering a Section 1031 exchange, it’s important to consider mortgage loans and other debt on the property you are planning to swap. Let’s say you hold a $200,000 mortgage on your existing property but your “new” property only holds a mortgage of $150,000. Even if you’re not receiving cash from the trade, your mortgage liability has decreased by $50,000. In the eyes of the IRS, this is classified as “boot,” and you will still be liable for capital gains tax because it is still treated as “gain.”

Advance Planning Required

A Section 1031 transaction takes advance planning. You must identify your replacement property within 45 days of selling your estate. Then you must close on that within 180 days. There is no grace period. If your closing gets delayed by a storm or by other unforeseen circumstances, and you cannot close in time, you’re back to a taxable sale.

Find an escrow agent specializing in these types of transactions and contact your accountant to set up the IRS form ahead of time. Some people sell their property, take the cash, and put it in their bank account. They figure that all they have to do is find a new property within 45 days and close within 180 days, but that’s not the case. As soon as “sellers” have cash in their hands or the paperwork isn’t done right, they’ve lost their opportunity to use this provision of the code.

Personal Residences and Vacation Homes

Section 1031 doesn’t apply to personal residences, but the IRS lets you sell your principal residence tax-free as long as the gain is under $250,000 for individuals ($500,000 if you’re married).

Section 1031 exchanges may be used for swapping vacation homes but present a trickier situation. Here’s an example of how this might work. Let’s say you stop going to your condo at the ski resort and instead rent it out to a bona fide tenant for 12 months. In doing so, you’ve effectively converted the condo to an investment property, which you can then swap for another property under the Section 1031 exchange.

However, if you want to use your new property as a vacation home, there’s a catch. You’ll need to comply with a 2008 IRS safe harbor rule that states in each of the 12-month periods following the 1031 exchange, you must rent the dwelling to someone for 14 days (or more) consecutively. In addition, you cannot use the dwelling more than the greater of 14 days or 10 percent of the number of days during the 12-month period that the dwelling unit is rented out for at a fair rental price.

You must report a section 1031 exchange to the IRS on Form 8824, Like-Kind Exchanges and file it with your tax return for the year in which the exchange occurred. If you do not precisely follow the rules for like-kind exchanges, you may be held liable for taxes, penalties, and interest on your transactions.

Help is Just a Phone Call Away

While they may seem straightforward, like-kind exchanges can be complicated, and you need to be careful of all kinds of restrictions and pitfalls. If you’re considering a Section 1031 exchange or have any questions, don’t hesitate to call.