Explaining Capital Gains and Tax Rates

calculating capital gains with charts

During a very tough 2020 year for many, it seems that the values of properties have skyrocketed in many forms. Property is not just relating to real estate or real property. The IRS considers property anything owned by a person or entity. 

Property is divided into two types: real property is any interest in land, real estate, growing plants or the improvement on it, and personal property which is everything else. We have seen a boom in the real estate market since there is a high demand to buy properties with a lot fewer sellers. Also, it has been a good year for stocks and an especially good year for cryptocurrency. These are all considered property and may result in some painful capital gains tax bills. 

This article will discuss what capital gains are, how they are determined, how they are categorized, and how they are taxed. It is especially important that you understand these taxes whenever you sell an asset or property. By learning this basic knowledge, you will be able to better tax plan so at the end of the year you are prepared to report that income correctly.

 

What Are Capital Gains?

A capital gain is what tax laws call the profit you receive when you sell a capital asset, which is property such as stocks, bonds, mutual fund shares, and real estate. Capital gains are categorized into two different categories: short-term capital gains or long-term capital gains. The difference between these two is determined by the holding period of the asset or property. 

Short-term gains and losses are those realized from the sale of property or assets that you have held for 1 year or less. 

Long-term capital gains and losses are realized after selling investments held longer than one year.

 

Capital Gains Tax Rates

Short-term capital gains are taxed as though they are ordinary income. If you hold an asset or property for less, than one year any gains or losses will be treated as short-term gains or short-term losses. They are taxed at your maximum tax rate just like your wages or salary income. The top federal tax rate is 37%If you show a loss you can deduct up to $3000 from your regular income each year and you are also allowed to carry this over the next years if more than $3000.

Long-term capital gains are realized after selling assets or property held longer than 1 year. For long-term capital gains, the capital gains rate applies and it is typically significantly lower than your normal income tax rate. The capital gains rate is anywhere from 0-20%. 

The exact rate at which your gain is taxed is based on the amount of your income. For single tax filers, for anybody with income below $40,400 the capital gains rate would be zero. For anybody who makes incomes between $40401 and $445,850 the 15% capital gains rate would apply. Single filers with income above $445,850 will get hit with the 20% tax rate. For married filing jointly any couple with income of $80,000 or less the capital gain rate would be zero Any married couple with income of $80,000 and 501,600 will have the capital gains rate of 15%. Married couples with incomes above $501,600 will get hit with the 20% long-term capital gains rate. This is shown below on a chart by Fidelity. 

 

Long-term capital gains rate by filing status and income: 2020

Long-term capital gains tax rateSingle tax filersMarried filing jointly
0%$40,000 or less$80,000 or less
15%$40,001 – $441,450$80,001 – $496,600
20%$441,451 or more$496,601 or more

 

 

How Do I Figure Out My Gains and Losses?

This is especially important. When a property is sold, you do not have to pay taxes on all money received. You only must pay taxes on your gain or profit. To determine what your gain on the transaction is you must first determine your cost basis. This is the price you paid to purchase a property or asset. This can also include additional fees such as closing costs, broker fees, or commissions. There are two methods to calculate your cost basis.

Average Cost Method

This method takes the total cost of the shares and divides it by the number of shares in the fund. We use this method to calculate the cost basis for mutual funds and certain dividend reinvestment plans.

Actual Cost Method

With this method, your cost basis is the purchase of each share.

With real- estate the cost basis can be adjusted over time. The cost basis on real estate can be the initial purchase price and then you can increase the cost basis over time with the cost of improvements to the property. This is where it is important to know how to define the difference between a repair and an improvement.

 A general rule of thumb to differentiate is that an improvement would raise the value of the home such as a pool or addition. Repairs are general costs incurred to maintain your property. Repairs are not added to the cost basis but if this is a rental property they can be written off as an expense. So, keep track of all those home improvements or remodeling projects that you spent money on to improve your home because these can raise your cost basis.

A capital gain or capital loss is figured by subtracting this cost basis from the actual sale price plus costs. This will determine the gain or the profit or the loss. If you have multiple gains and losses, then you must do some further math. This is where it can get a little confusing. 

If you have all long-term gains or losses, you just add the gains together and subtract the losses. The result of this combined number will become your long-term gain and will be taxed by the long-term tax rate. The same thing will be done if you have all short-term gains. If you have gains from both long-term and short-term, they will stay separate, and each amount taxed by their own rules.

 If you have losses of both short-term and long-term, then they will stay separate and can be deducted up to $3000 from regular income. If the losses are greater than $3000, they can be carried over in the next years. If you have a combination of short-term losses and long-term losses, you will combine these, and the result will be based on the tax rule of the greater amount. 

With mutual funds, these rules do not apply. Gains from mutual funds are taxed as regular income and can not be offset with short-term losses.

When it comes to real estate transactions there are additional rules, and you may be able to avoid paying a substantial amount of taxes on your gains. If the property was your primary residence and you have lived in the property for at least two of the past five years, then you may be able to exclude up to $250,000 in capital gains if single and up to $500,000 if married.  

So if somebody purchases a property in 2013 for a total of $300,000 with costs included in that number then the $300,000 would be their cost basis. This has been their primary residence during the whole time they owed the property. In 2020 they sold this property for $600,000 and they are filing single that tax year then they would only be reporting a gain of $50,000.  

The math below demonstrates how you come to the actual gain on the property.

$600,000 (Sale price of property) – $300,000 (cost basis) = $300,000 – $250,000 (exclusion for primary residence) = $50,000 taxable long-term gain.

In conclusion, taxpayers have a long-standing responsibility to report gains and losses and related cost basis information when they file their income tax returns. Brokers also have a requirement to report all sales information to the IRS on Form 1099-B. 

To report capital gains on your return you must file a Schedule D with your Form 1040. Most filers need to begin with Form 8949 which provides the format for listing each individual sales transaction.  If you have multiple transactions this can become especially complex. I would highly recommend that with a return of this nature that you hire a true licensed tax professional. An Enrolled Agent or CPA is somebody who has the licensing showing that they have the required education and knowledge to help in a situation like this. 

Any errors in the reporting of the income can be caught by the IRS and they will charge you significant penalties and fees so the tax professional is well worth the money spent to make sure it is done correctly.  

Also, I cannot reiterate enough the importance of tax planning and keeping records throughout the year to make sure nothing it s missed that can either save you money to reduce taxable income or make sure you don’t set yourself up for an audit or examination by missing something.

 

An Introduction to Backup Withholding

a businesswoman handing a paycheck to one of her employees

Is your income subject to something called backup withholding? If you think you may be in this category, it’s important to understand what to expect.

If you think you can avoid payments to the IRS, think again. The Internal Revenue Service has a plethora of tools to make sure taxes are reported correctly and paid to the government. When they’re not, you can be sure the federal government is devising a plan to secure IRS-claimed money.

 

How Backup Withholding Works

Are you familiar with backup withholding? If not, then learning about this keeps you and the Internal Revenue Service on the same page, and that’s for your benefit and the government’s benefit as well. You see, backup withholding is one of those government tools used to get what’s rightfully owed to the IRS. It’s a federal taxation method that protects earnings due to the United States government after certain taxes aren’t paid correctly or on time.

A simple way to look at backup withholding is through non-conventional employers. Some employers do not take taxes from income, expecting employees to pay taxes at the end of the year. But in some situations, the IRS requires the employers or other financial institutions, being used by the investor, to withhold 24% of your wages or earnings as a backup withholding. This is just in case you do not pay those taxes. This happens more often than you may think.

This procedure is required under Chapter 61 of the Internal Revenue Code, and this same 24% is taken every year so the IRS always gets their portion of taxes due. Payers must file a Form 945 which reports all backup withholdings for the year. They also have an obligation to report these same backup amounts to the payee as well.

 

Another Circumstance That Triggers a Backup Withholding

Full-time investors and companies are always earning income, and it’s usually large amounts of money. This could be from dividends, capital gains, and interest payments. While taxes are due on these earnings, it doesn’t come due until it’s time to file taxes – all earnings and payments come due in tax season. Most investors pay taxes when the time comes. But you have those few that do not.

If an investor spends all the money they earned during the year, they have none left to pay taxes on those earnings. When this happens, it’s sometimes incredibly difficult for the IRS to get what’s owed to them. And they give the taxpayer 120 days to settle the situation. Notifications are sent out as well, giving individuals or companies time to rectify the situation.

If the government doesn’t receive their share in taxes, they can set a credit against your next income tax return, simply taking what’s owed to them, or as much as they can. This could mean receiving no refund for years to come.

Because of issues like these, the government thinks ahead. Instead of depending on investors to pay taxes as they should, a backup withholding is levied by financial institutions at the time investors are earning income. The government gets their percentage and investors get what remains.

 

Three Types of Earnings That Cause Backup Withholding

Not all payments, obviously, must have a percentage taken for tax purposes. Only certain conditions and situations are subject to this backup withholding. These reasons include:

  1. The failure to report dividend income that’s received
  2. Under-reporting or not reporting interest payments
  3. Not providing a (TIN) taxpayer identification number or your social security number for filing purposes.

 

Am I Subject to Backup Withholding?

Maybe you’re wondering if you’re at risk for backup withholding. Well, that depends on the type of income you’re receiving or have received in the recent past. There are many forms of payment subject to this withholding process such as:

  • Any government payments that require a 1099-G
  • Rent and other property gains
  • All Dividends
  • Payments from investments
  • Money won from gambling
  • Barter and broker exchange payments
  • Professional fishing boat operators
  • Cash payments of original issue discounts
  • Independent contractor’s fees, commissions, payments
  • Royalty earnings from sales
  • Patronage dividends
  • Third-party network exchanges or transactions
  • Settled disputes with a law firm

Giving the bank your TIN when you first open a business account will help prevent backup withholding as well. Any earnings or payments that require a Form 1099 will benefit greatly by contacting the bank with this information ahead of time. When it comes to dividends and interest, you must certify that you’re not guilty of under-reporting these types of earnings now and in the past. If so, there’s a good chance of backup withholding on investments and dividends in the near future.

 

Payments That Are Not Subject to Backup Withholding

Just as there are many types of transactions that are affected by backup withholding, there are also numerous payments that are not. Some Income or payments are simply immune to this type of tax law. Those include:

  • Income tax refunds
  • Various canceled debts
  • Retirement account distributions
  • Compensation from Unemployment
  • School tuition earnings
  • Abandoned or foreclosed properties
  • Archer MSA distributions
  • Cash payments for fish
  • Employee stock plan distributions
  • Transactions from Real Estate sales
  • Care benefits (long-term)

 

How to Stop Backup Withholding

It isn’t a complicated procedure to stop backup withholding. The ease of putting a stop to these proceedings depends on why the withholding took place. If you’re aware that this is happening because you didn’t provide a TIN or the correct number, simply report the correct TIN or your social security number to halt the process.

If you’ve neglected to report any portion of your income, then remedy this issue by collecting the remainder of your income statements and send them to the IRS. 

If you owe the IRS additional money, paying this debt as soon as possible can stop a backup withholding and stop interest and late fees accrued from the debt, which can add up fast. 

If there seems to be a missing return, then file one as the return as soon as possible.

 

Challenging a Backup Withholding Order

You can also challenge or appeal a backup withholding order from the IRS. You simply ask the Internal Revenue Service to review your case for mistakes or missing information. In rare situations, under-reporting never happened, and it was a mistake on the federal level. Again, this is not a common occurrence.

If you were in the process of filing an amended return, the IRS may consider lifting the backup withholding request from the financial institution that’s retaining 24% of your earnings. In other uncommon situations, the Internal Revenue Service may consider that the backup withholding procedure may cause financial hardship for you or any dependents. In this case, the IRS may stop the withholding for that reason as well.

If you succeed in stopping the backup withholding procedure, the IRS will send you a certificate of proof for the corrected situation. They will simultaneously report this new information to any financial institutions implementing the backup withholding.

At this point, no percentage will be taken from your earnings. Also, if any overpayment of backup withholding was paid to the IRS, you will receive a refund of all earnings due to you. However, you will not receive the refund until you file taxes the next year, as any backup withholdings must be reported on a 1099 form.

Warning

If you purposely give the wrong information to dodge a backup withholding, you could be subject to criminal and civil penalties. Civil court fines are usually around $500, but if you are tried in criminal court, you could pay $1,000 in fines or serve a year in prison. Criminal penalties are always worse.

Businesses or payers are also subject to penalties if they do not adhere to the backup withholding request. If the business fails to record the payee’s TIN to retain tax payments for the government, they could face a $24,000 assessment. There could also be additional penalties and interest.

 

Thinking Ahead to Avoid Backup Withholding

As a taxpayer and a citizen of the United States, it’s important to understand tax laws. The government is required to send an initial warning called the ‘B’ notice. This is your notice to get things in order and rectify the situation before it escalates. This is a prime opportunity to take.

Avoiding backup withholding and penalties is the objective. When you understand laws and penalties, then preparing for paying taxes makes the process much smoother. There are so many tax laws that cover various ways of earning money and collecting profits. Understanding these laws prevents mistakes during the year, and also during tax season.

To better prepare, learn the basic laws pertaining to your line of work or investment. If you do this, everything should fall into place when it’s time to pay or calculate taxes on your return. Or better yet, work with a tax professional to help you calculate your true tax liability. Whether you pay quarterly, or during tax season, just make sure to contribute honestly. 

And remember, the government will always retain what’s due to them. And it is your responsibility to make sure you pay your part.

 

Taxable Income: What You Should Report to the IRS

man reporting his earned income on his tax return

A quite common question that I hear a lot of is “Do I have to file taxes on my income?”. This question comes from a lot of different types of people. The confusion comes because some income is taxable, and some income is not. Also, for low-income earners there are minimum filing requirements. This can get even more confusing because these numbers change based on one’s filing status, age and the type of income received. 

A good example of a type of income with different minimum standards for filing is Social Security income. We will further explain this later in the article, but we will start by discussing these minimum filing requirements and explaining how they change with your filing status. After that we will go through the common types of income that are taxable and then the common nontaxable sources of income. 

This information is especially important and can save you a lot of money and hassle in terms of dealing with the IRS. The most highly detected error by the IRS on a tax return is unreported income.

 

What Is Taxable Income?

The IRS says income can be in the form of money property or services you receive in the tax year. The two basic forms of income are earned and unearned. Most income that you receive is fully taxable and must be reported on your federal income tax return unless it is specifically excluded by law.  

Earned income includes money received from an employer in exchange for work or money you make working for yourself. Unearned income includes money that you did not directly work for such as interest or dividends, Social Security payments or alimony.

 

Minimum Income Requirements

The minimum income requirements differ based on how you plan to file. There are five different status’ that you can use to file. They are single, married filing jointly, qualifying widower, married filing separately and head of household.  If you earn up to or less than the minimum income as determined by your filing status, you are not required to file a tax return.

Single filers are taxpayers who file their federal income tax return with the IRS under the filing status of “single”. This filing status is used by a taxpayer who is unmarried and does not qualify for any other filing status.

  • Single under age 65: $12,400
  • Single and 65 or older: $14,050 

 

Married filing jointly refers to a filing status for married couples that have wed before the end of the tax year. When filing taxes under married filing jointly status a married couple can record their respective incomes, deductions credits, and exemptions on the same tax return.

  • Married filing jointly, both spouses under 65: $24,800
  • Married filing jointly, one spouse age 65 or older: $26,100
  • Married filing jointly, both spouses 65 or older: $27,400

 

Married filing separately is a tax status used by married couples who choose to record their incomes, exemptions, and deductions on separate tax returns. Although some couples might benefit from filing separately, they may not be able to take advantage of certain tax benefits.

  • Married filing separately, any age: $5 

 

Head of household is generally an unmarried taxpayer who has dependents and paid for more than half the costs of the home. This filing status commonly includes single parents and divorced or legally separated parents by the last day of the year with custody.

  • Head of household under age 65: $18,650
  • Head of household age 65 or older: $20,300 

 

Qualifying widow is a filing status that allows you to retain the benefits of the married filing jointly status for two years after the year of your spouse’s death. You must have a dependent child to file as a qualifying widow or widower.

  • Qualifying widow(er) under the age of 65: $24,800
  • Qualifying widow(er) age 65 or older: $26,100

 

What Types of Income Are Taxable?

To figure out where you fall in terms of the above minimum requirements once you have figured out your filing status you would next need to calculate your taxable income. Remember taxable income can be earned and unearned income. Below I will break down each category of taxable income.

  • W-2 Wage or Salary or Independent Contractor
  • Alimony received if divorce decree was made on or before 12/31/2018
  • Bartering Income
  • Canceled or Forgiven Debt
  • Gambling
  • Pension and Annuity Income
  • Retirement Plan Income
  • Social Security Benefits if you had additional income on top of social security, this can become taxable. I will further discuss this later in this article.
  • Tips and Gratuities
  • Unemployment benefits
  • Awards
  • Back Pay
  • Bonus Benefits
  • Business Income
  • Capital Gains
  • Clergy Pay
  • Commissions
  • Disability Benefits
  • Dividends
  • Interest
  • IRA or 401k Distributions

 

What Types of Income Are Nontaxable?

As most income is taxable there are a few exceptions. This is very important to know. As important as it is to make sure that all taxable income is reported so you do not raise red flags with the IRS it is also important to know what income does not have to be reported. The last thing that you would want to do is pay taxes on income that you did not have to. Not to mention the more income reported the higher tax bracket you put yourself at.

Some examples of nontaxable income are:

  • Workers Comp Benefits
  • Child support
  • Life Insurance Proceeds
  • Social Security Benefits (Can be non-taxable based on if you have additional income and how much)
  • Capital Gains on the sale of primary home
  • Money received as a gift or inherited assets, go fund me accounts or other personal fundraising sites
  • Canceled debts intended as a gift
  • Scholarships or fellowship grants
  • Foster care payments
  • Federal Income Tax Refund
  • Money Rolled over from one retirement account to another

 

Are Social Security Benefits Taxed?

There is a lot of confusion when it comes to when social security benefits are taxable and when they are not. A lot of people believe that social security is 100% not taxable. This is not true. If a taxpayer receives additional income, then a portion of the social security can become taxable. 

The next confusing part of this equation is it is not straight based on the full amount of income that you have. To figure out if or what amount of your social security benefits become taxable with the additional income you must first figure out your provisional income. 

Provisional income is determined by taking one-half of your social security benefits and all other income you receive. This does include tax-exempt interest. The percentage of benefits a taxpayer includes in income is limited to zero when below the minimum base amount, 50% when provisional income is in between the lower base amount and the upper base amount, and 85 % when provisional income is above the upper base amount.

 

Filing Status50% Lower Base85% Upper Base
Single$25,000$34,000
Head of Household$25,000$34,000
Qualifying Widow(er)$25,000$34,000
Married Filing Separately$25,000$34,000
Married Filing Jointly$32,000$44,000

 

All this income must be reported on your Form 1040 every year. It is especially important that not only all the income is reported on this form but also it is put in the right spots. You need to include W-2 income, taxable interest, and ordinary dividends on the 1040. 

Schedule 1 allows you to report other types of income such as alimony, unemployment, and business income. Schedule 1 also allows you to make adjustments to income such as contributions to health and savings accounts, contributions to a traditional IRA, interest paid on student loans, alimony paid if the divorce decree is before 2019, and more. 

For more information on where income goes on the 1040 form, visit the 1040 form page on the IRS website. 

In conclusion the more different types of income that you have the more complex the tax filing becomes. Obviously, the more sources of income that you have the more money you are making so don’t stop making money to make your tax filing easier. 

When you have multiple sources of income I would highly recommend hiring a true tax professional, a CPA or Enrolled Agent, that has the knowledge of tax law to assist you in your filing. Not only will they save you money in keeping that income down as low as legally possible but they can make sure not to set you up with the possibility of an examination or audit with the IRS because they can make sure things are done correctly.

 

A Guide to Paying Taxes on Cryptocurrency

graphic of bitcoin profits and losses

With the new craze of investing in cryptocurrency sweeping the world, questions arise about if they are taxed. The answer is yes

In this article today, I will discuss the laws that are laid out for how cryptocurrency is being taxed. I will then go into the importance of reporting all crypto transactions and how the IRS is cracking down on enforcement and reporting. The government is taking the reporting of cryptocurrency very seriously, so if you are one of these people trying to strike it rich with crypto, read on.

 

How Does the IRS View Cryptocurrency?

Cryptocurrency is considered property or an asset to the IRS. This was declared in 2014. So, you must pay taxes on cryptocurrency gains when you dispose of the asset, much like stocks. This includes when you sell the crypto, trade for another form of cryptocurrency, or use it for payment of goods or services.

These different forms of crypto activity will not have one uniform tax rate.

If you received cryptocurrency as income, by mining it or as a promotion, it will be taxed at your ordinary-income tax rate.

If you dispose of or sell cryptocurrency, the profits will be taxed at the capital gains rate.

If you held the cryptocurrency for over a year, it will be taxed at a long-term capital gains rate.

If you held the crypto for under a year, it would be qualified as a short-term loss and would be taxed at your regular income tax rate. 

This is where it is important to keep good records of transactions and determining your cost basis. The cost basis is the original value of an asset for tax purposes, usually the purchase price. This value is used to determine the capital gain, which is the equal difference between the assets cost basis and the current market value.  

The good news and why it is so important to keep track you can write off losses to offset your capital gains or claim a capital loss deduction. This means when you sell your cryptocurrency if there is a profit that profit is taxable. If you sell it for a loss, then it still needs to be reported as a loss. 

The good news is you can deduct capital losses on bitcoin just like you can do with stocks. These losses can offset other capital gains and sales. If you are showing a loss after all gains and losses are tallied up to $3000 can be written off as a loss towards your other income. Unfortunately, if you are robbed of your bitcoin new tax rules do not allow you to take this as a deduction for personal loss.

 

The IRS Is Enforcing Crypto Reporting

Over the past few years, the IRS has sent letters to crypto taxpayers and they have sent IRS summonses to Coinbase, Kraken, Circle, and other firms that handle crypto transactions to turn over their records to the IRS for clients that had more than $20,000 in transactions in any year since 2020. 

During the 2020 tax year, they have added a question on the 1040 that asks, “At any time during 202 did you receive, sell, send, exchange or otherwise acquire any financial interest in any virtual currency.” The form gives you the option of yes or no. When you sign this form, it is under the penalty of perjury. It can be viewed that adding this statement is almost like setting the trap for very severe consequences in the future if the taxpayer is untruthful. 

By checking the box incorrectly, it can be said that there is per se willfulness if found to have held bitcoin. Willful failures carry much higher penalties and have an increased threat of criminal investigation.

The latest step was the announcement by the US Treasury Department that they plan to impose reporting requirements for crypto. Banks, financial institutions, exchanges, custodians, and crypto payment services are slated to have to report the IRS. 

It seems the rules they are setting up will be like the rules surrounding cash transactions even though the IRS had stated in 2014 that crypto was property, not currency. It is expected that businesses that receive more than $10,000 in cryptocurrency in a year will have to do a transaction report. This is the same as the rules set for cash transactions. When these cash transactions are not reported the laws make it a crime and the IRS Criminal Investigations Department would become involved. 

With the suspicion that people will try to structure around the reporting of crypto as they have been doing with cash income laws may be set in place with similar consequences for crypto making it quite dangerous not to report. With the possible consequences ranging from substantial penalties and fines to possible jail time, I cannot reiterate enough the importance of keeping good records.

 

How to Keep Good Cryptocurrency Records for Tax Purposes

With record keeping being of such importance, there is a need to know what you should be keeping track of throughout the year. It all starts from the initial acquisition of the crypto. Make sure to keep track of how much you paid for the crypto or mined it, this is the cost basis. When you are buying and selling stocks your broker would send you a 1099-b with all this information. With crypto at this point, this is not always done. The IRS is pushing for further enforcement, so this type of reporting begins to happen but for the time being, you must keep your own records to be safe. 

A lot of the investing platforms and exchanges are already starting to do this, so it may make sense to use those for your trading. If you are not using one of these platforms or exchanges, some software companies are emerging with programs that will scrub blockchains to detect transfers between your wallets whether on an exchange or not and will give you reports of all transactions related to those wallets. With these types of records, the tax filing process for cryptocurrency is still complex but these records will make it easier. Also keeping these detailed records and putting in the effort will limit your risk with the IRS.

 

How Do I File Cryptocurrency on My Taxes?

When filing your taxes with cryptocurrency income I would highly recommend hiring a true tax professional. As you see the laws are constantly changing and this income on tax returns is being watched by the IRS. Also, there are many ways that tax liability can be legally minimized by somebody who knows tax law. Enrolled Agents and CPAs are the ones who can act as tax preparers and are required to have the educational background to best serve you. 

If you decide to file this on your own it is especially important to know where and what forms are needed for the filing.  A great article in Forbes has listed and described these forms as follows:

Form 8949: This form logs every purchase or sale of crypto as an investment. This should include the total number of coins, the day and price you bought, the day and price you sold, and your gain or loss for each transaction.

Schedule D: This form summarizes your total capital gains and capital losses from all investments, including crypto.

Schedule C: If you received coins from mining, you need to disclose whether you received them as a business or as a hobby. If you are running a crypto mining business, you would report this income on Schedule C, and deduct your expenses. Your expenses might have to be extremely high, though, to offset any extra self-employment tax you would face if you counted your mining as a business instead of a hobby.

Schedule 1: If you report your crypto mining as a hobby, you will report this income on Line 8 of Schedule 1. You will not owe self-employment tax, but you become more limited on what you can deduct as an expense. 

It is not only important to make sure the correct forms are used but it is especially important to hire a tax professional to make sure that you are utilizing everything within tax law to limit your exposure to tax debt.  As discussed earlier in this article one thing that can be done is correctly offsetting any gains with losses to keep the taxable portion as low as possible. 

Another thing you would not want to miss would be the possibility to utilize expenses. If you are mining crypto, there are some expenses involved in this process. These expenses can be considered such as computers, servers, electricity, and internet. These expenses can be deducted from your income before being taxed saving you a lot on what you owe.

In conclusion, the once thought of as the “wild west” world of crypto is slowly becoming very monitored and regulated. The one thing that has not seemed to change is there is still a lot of money to be made in the acquisition and sale of cryptocurrency. I by no means am not trying to dissuade anybody from dabbling into this market. 

The major point of this article was to prepare and make people aware of the ever-growing seriousness of reporting this income made in this market. Keep on making that money, but make sure to shield yourself by hiring the proper tax professional and making sure things are done 100% correctly to enjoy the profits with no future worries about the IRS coming after you in the future.

 

A Guide to Where Tax Money Goes

woman calculating her paycheck taxes

Every time you receive a paycheck, I am sure you see a nice portion of it being taken by the federal & state governments. If you do not have that money withheld on a paycheck you really notice when tax time comes, and you owe a good amount of money to the IRS.  

We all know we must pay taxes and if you don’t there can be trouble with the IRS, but the big question is why we pay these taxes and where do these taxes go? 

In this article, we will start by explaining exactly what income taxes are. I will then give you a little history of how our tax system was put in place and finally we will discuss where the money is being spent. Hopefully, with this information, it does not hurt so bad when you see that portion taken from your paycheck.

 

What Is Income Tax?

Income tax is a direct tax that a government levies on the income of its citizens. Paying a portion of income to the government is mandatory for anybody who meets minimum income amounts.

2020 tax filing requirements for most people

  • Single filing status: $12,400 if under age 65.
  • Married filing jointly: $24,800 if both spouses under age 65.
  • Married filing separately — $5 for all ages.
  • Head of household: $18,650 if under age 65.
  • Qualifying widow/widower with dependent child: $24,800 if under age 65.

Even though the United States was founded to avoid paying high taxes to England taxes have crept into our system over many years. In 1862 Abraham Lincoln signed into law the nation’s first-ever income tax on personal income to pay for the Union war effort. At this point, the Bureau of Internal Revenue was established. This was repealed 10 years later. 

Congress once again tried in 1894 but this tax was ruled unconstitutional. Then in 1909, the 16th amendment to the Constitution was ratified allowing the federal government to tax individual personal income.  Congress used the power granted by the constitution and the 16th amendment and made laws requiring all individuals to pay taxes. They have delegated the IRS the responsibility of administering tax laws known as the Internal Revenue Code. 

Income tax is the primary source of cash flow for the federal government. Income taxes include three separate categories: individual, payroll, and corporate income tax. 

In 2020 individual and payroll tax revenue accounted for 85% of the government’s revenue. The US has a progressive tax system which means you are taxed a certain percentage based on your income. It is progressive because the more money you make the higher percentage of tax you must pay. The tax brackets are laid out below as seen directly on the IRS website. 

  • 35%, for incomes over $209,425 ($418,850 for married couples filing jointly)
  • 32% for incomes over $164,925 ($329,850 for married couples filing jointly)
  • 24% for incomes over $86,375 ($172,750 for married couples filing jointly)
  • 22% for incomes over $40,525 ($81,050 for married couples filing jointly)
  • 12% for incomes over $9,950 ($19,900 for married couples filing jointly)
  • The lowest rate is 10% for incomes of single individuals with incomes of $9,950 or less ($19,900 for married couples filing jointly).

Where Does Tax Money Go?

A lot of people are of the opinion that the government mismanages and overspends our tax dollars. I will not be addressing this in this article. I will get more into the basics of where and how the money is spent. 

As much as it hurts to lose that chunk of the paycheck a lot of our tax money pays for things very necessary such as the roads we drive on, making sure our infrastructure is maintained, and giving citizens access to services they need to survive. They fund many government programs such as Social Security, Medicaid & Medicare, and the military. 

The money also goes towards benefits for veterans and federal retires, education, transportation, international affairs, and science and medical research.

Government spending by the US can be divided into 3 different categories: mandatory spending, discretionary spending, and interest on the federal debt. Every year a budget is submitted and approved by the president and the Senate and the House. Mandatory spending accounts for the majority of where the money goes followed by discretionary funding. 

Unfortunately, currently, there is a gap between government spending and government revenue. This means they are spending more money than they have coming in through taxes creating a deficit. This deficit creates the national debt on which interest must be paid.

 

Mandatory Spending

Mandatory government spending is all the spending that does not take place through appropriations, legislation. Mandatory spending includes entitlement programs such as social security, Medicare, and other programs required by law. It also includes smaller programs such as food stamps, housing assistance, earned income tax credits, and temporary assistance for needy families.  

These are all permanent programs that the government cannot set the amount they wish to spend. They can only set eligibility rules for who qualifies for these programs. The only way they can manipulate mandatory spending is by changing these eligibility rules. They may make changes to exclude or include more people or offer more or less generous benefits to those eligible, but they cannot do direct budget cuts.  

Mandatory spending continues to grow every year. Congress has a hard time making cuts to these entitlement programs because making these cuts guarantees voter opposition. Also, with the aging of America and the advancement in medicine prolonging life the costs of Medicare and social security are constantly on the rise. 

Expectations have been set that with these two programs alone spending will almost double in the next ten years. In 2021 mandatory spending was estimated to be $2.966 trillion.

Mandatory Spending Categories and Amounts
Mandatory Spending (billions of dollars)20202021
Social Security1,0911,142
Medicare862810
Medicaid466537
Income Security Programs1,132499
Federal Civilian and Military Retirement173179
Veteran’s Programs122132

Source: https://www.cbo.gov/about/products/budget-economic-data#3

 

Discretionary Spending

Discretionary spending is spending that is subject to the appropriations process, whereby Congress sets a new funding level each fiscal year for programs covered in appropriations bills. There are twelve separate appropriation bills that are supposed to be pushed through Congress and be signed by the President annually. 

Discretionary spending can be broken down into 2 categories: defense and non-defense. Defense spending includes the Department of Defense, the State Department, and Homeland Security. Defense spending represents more than half of all discretionary spending. 

Nondefense spending includes education, Veterans Assistance, and Housing and Urban Development. Historically most government spending was discretionary. In the 1960s two-thirds of total government spending was discretionary. Over time with the increases discussed above on mandatory spending, this has changed. Discretionary spending is projected to be about 32 percent of the budget. This decrease is expected to continue in the following decade.

Discretionary Spending Categories and Amounts
Discretionary Spending (billions of dollars)20202021
Defense757752
Nondefense1,139668

Source: https://www.cbo.gov/about/products/budget-economic-data#3

 

Net Interest

The interest on the national debt is how much the federal government must pay on the outstanding public debt each year. Interest on the debt is currently exceptionally low but is projected to increase. With these increases, interest costs have become the fastest-growing program in the federal budget. 

Even with the low rates, the federal government is projected to spend just over $300 billion on net interest payments in the fiscal year 2021. This is more than it will spend on food stamps and Social Security Disability combined.

Fiscal YearInterest on the Debt (in billions)Percent of Budget
2018$3257.9%
2019$3758.4%
2020$3767.8%
2021$3787.8%

 

In conclusion, taxes taken every year are necessary for all the programs out there and supporting our infrastructure. Also, there is an intricate system set up for the decision-making into where the money is spent. Decisions are not made by one person. Each year the budget is submitted by the president outlining plans for mandatory and discretionary payment. 

This is just the beginning of the process.  From there they must still be voted on and approved by Congress. To get through Congress there are also a lot of changes made before it gets final approval. To keep the government running the budget must be approved by September 30th. Many years September 30th comes, and the President and Congress can not come to an agreement. At this point, there are either temporary measures approved, or the government shuts down. 

This is not a perfect system, and it may seem that some things need to be drastically changed with the system in the near future with the projections on necessary spending and the national debt but as you see a lot of the things that we really take for granted are made available because of the tax money taxpayers contribute. Without this funding, many things that everybody in our population depends on would not be available and many programs that people need to live would no longer exist. 

Hopefully, with this knowledge, it may not hurt so much each time you see that pay stub with that chunk of taxes removed.

 

What the IRS Considers as Tax Evasion

businessman with a lot of cash

In the tax industry when clients first start dealing with the IRS there is always the fear and question “Am I going to jail?”. The truth is that very few people go to jail for tax evasion.

The IRS mainly targets people who understate what they owe by either under-reporting income or misreport credits or deductions on their tax returns. They do not typically go after, criminally at least, people who just cannot pay their taxes.

 

The Definition of Tax Evasion

Under Federal law of the United States of America, tax evasion is the purposeful illegal attempt of a taxpayer to evade assessment or payment of a tax imposed by Federal Law. Conviction of tax evasion may result in fines and imprisonment.  The biggest definer of tax evasion is intent.

Innocent mistakes on your tax return do not officially label you a tax evader. Tax evasion is when you intend to evade taxes.

A genuine good faith belief that one is not violating the Federal tax law based on a misunderstanding caused by the complexity is a defense to the charge of tax evasion. A belief that the federal income tax is invalid or unconstitutional is not a misunderstanding caused by the complexity of the law.

 

How Does the IRS Handle Tax Evasion?

As seen on the IRS website, the Internal Revenue Service-Criminal division conducts criminal investigations regarding alleged violations of the Internal Revenue Code, the Bank Secrecy Act, and various money laundering statutes. The findings of these investigations are then referred to the Department of Justice for recommended prosecutions. These criminal investigations can be initiated by the IRS when a revenue agent (auditor) or revenue officer(collections) detects possible fraud.

The IRS also receives tips from the public as well as from law enforcement and United States Attorney offices across the country.

 

Famous Cases of Tax Evasion & Lessons Learned

Probably the most famous time that outside law enforcement reached out to the IRS during an ongoing investigation was in 1931 when the IRS went after Al Capone.  Capone was alleged to be the mastermind behind 30 deaths and government agents had spent years trying to take him down, but he always avoided conviction. On 17 October 1931, he was found guilty of tax evasion and sentenced to 11 years in prison. Before this, he was quoted “They can’t collect legal taxes on illegal money.” 

Capone had been living a lavish lifestyle and was worth up to $100 million yet he had never filed a tax return. Agents began gathering information by following the money and proving that Capone had made millions of dollars of income that was never taxed. He was indicted on 22 counts of federal income tax evasion. Capone reached a plea deal where he would only get 2 years, but the judge refused to accept the deal and the case went to trial where he was sentenced to 11 years in prison, fined $50,00, charged court costs, and ordered to pay back $215,000 in back taxes.

Another way the IRS begins an investigation is when there is reported income and a taxpayer fails to file their tax returns every year. When an employer sends out income forms, W-2 or 1099, to their employees or contracted individuals they also send these to the IRS. So, the IRS is very aware of the income a person is making when they are employed. 

A lot of these W-2 employees who fail to file either has exceptionally low withholdings or go exempt from their employer. With a self-employed person unless they set up estimated payments throughout the year with the IRS no taxes are being turned over throughout the year. This type of taxpayer is not only not filing their taxes but they are also not paying their taxes. This will raise red flags with the IRS and at some point, they will begin filing these taxes on behalf of the taxpayer. These are called substitutes for returns. If the amounts owed are substantial, this is where the IRS may pursue criminal charges.

A case of this nature that a lot have heard about was with actor Wesley Snipes. In 2006 Snipes was indicted on charges of attempting to claim nearly $12 million in fraudulent tax refunds and not filing any tax returns for several years. In the court proceedings, IRS agent Steward Stich testified that Snipes earned almost $40 million in the years 1999 and 2004 and failed to file tax returns or have any money withheld for taxes on any of that income. He also alleged that Snipes also tried to file returns to have taxes refunded to him from years before that in the amount of almost $12 million. 

During his defense, Snipes tried to claim that the IRS was an illegitimate government agency. He also blamed bad tax advisors and challenged his actual residency. None of these excuses worked on the charges of failure to file his tax returns. He was acquitted of tax fraud but was sentenced to up to three years in prison on the charges of failure to file.

After a person serves prison time for an outstanding tax debt the debt is not cleared. They still owe the money and are required to pay it back. Once released Snipes claimed to not have the money to pay it back and filed for an Offer in Compromise.  Everyone has heard the commercials that you can settle your debts for less through the different programs. While these programs do exist and I will discuss them in a later article, they are all “hardship” and “inability to pay” driven. Snipes learned this the hard way as his bid for a reduction was denied. When this failed Snipes even went one step further and petitioned the tax courts with an appeal to this decision. This case dragged on for years and his offer was ultimately rejected.

Another type of tax evasion, which is probably the most common, is when one receives cash income and does not report it to the IRS. All earned income is required to be reported to the IRS, so when one leaves this off a tax filing it would be considered tax evasion. A lot of people call this “working under the table.” This nonreporting of income is very illegal. Some industries where this type of tax evasion is common are barbershops, hairdressers, and the hospitality industry.

There was a major case of this nature recently with MTV reality celebrity Mike “Situation” Sorrentino. In the tax year of 2011, Sorrentino had earned additional cash income on top of his reported income. He not only failed to report this income, but he also admitted to taking certain actions to conceal some of this income to avoid paying taxes. He had deposited this money into his accounts in small deposits less than $10,000 to avoid the IRS becoming aware of them. Sorrentino was sentenced to eight months in prison and forced to pay $123,913 in restitution and a criminal fine of $10,000.

With the IRS and its depleted budget, many of these types of cases go undetected. Studies are showing that many wealthy tax evaders are going undetected and that there is substantial tax evasion at the top. New proposals to hike the budget of the IRS may provide for additional IRS staff for audits of these situations; they may help close what they call the tax gap.

 

Tax Evasion Through Child Tax Credits

Another common practice of tax evasion that has been highly regulated as of late is the claiming of dependents for the child tax credit or the earned income credit. Many people use the social security numbers of people’s children who they may know or even relatives that they do not support so they can receive refunds on their tax returns from the different credits.

Because of the rampant fraud in the use of these credits, the IRS admits that an audit of a return using one of these credits is 4 times more likely than one not.

 

What Does the IRS Typically Do In Cases of Tax Evasion?

Now, these examples that I mentioned had harsh consequences for their actions. They do not typically go after, criminally at least, people who just cannot pay their taxes. These were all high-profile cases of celebrities that had huge media attention. It can be said that they were made an example of. 

In most cases of tax evasion, the IRS simply goes in and fixes the errors and hits the taxpayer with fines of a percentage of the tax debt. These fines can be substantial and if a taxpayer does not comply with collections, then the IRS can pursue enforced collections.

In some cases, in these audits and examinations, a taxpayer can hire the correct representation to refile the tax years correctly like they should have been done the 1st time to reduce what the IRS is saying that they owe.

In conclusion, once the debt is in collections the taxpayer does have rights and a lot of other programs available if they cannot pay the debt off. These I will discuss in future articles. If you are dealing with this situation, it is well worth the investment of hiring a licensed tax professional to get involved.

The best-suited representative for these types of cases is the Enrolled Agent. They are recognized by the IRS as the highest level of representation and are typically former IRS agents that know the in and outs of this process.

 

FAQs: Stimulus Checks and Taxes

an example of a stimulus check

Your taxes determine whether you get a stimulus check or not, even if you do not file at all. Below are some commonly asked questions about stimulus checks and how they may or may not affect your tax return.

 

What do I need to qualify for a stimulus (or economic income payment) check?

You need to have a valid SSN (Social security Number) and not be a dependent of somebody else. It is also paramount that you meet the following income eligibility requirements to receive 100% payment:

  • Joint tax filers (income up to $150,000).
  • Head of households (income up to $112,500).
  • Individual tax filers (income up to $75,000)

If the AGI (adjusted gross income) exceeds the applicable threshold, the total payment amount is reduced by 5%.

 

Who is NOT eligible for the stimulus checks?

Joint filers with no offspring and income more than $198,000, and single filers earning over $99,000.

 

How much money will I get from a stimulus check?

The first stimulus check was $1200, and the second was $600. Also, taxpayers that have filed their 2019 tax returns will get up to $1,200 (married couples) and up to $600 for every eligible child or up to $600 (individual filers) automatically.

 

Will I need to submit an application to receive the stimulus check?

No, this is not required. The process is automated for those that qualify. The IRS will calculate your payment after using your tax return information. You will then receive the payment on the same bank account from the tax return. In any other case, the IRS will send you an Economic Income Payment (EIP) card, which is a type of debit card, using the most recent mailing address filed with them.

 

The bank account on my 2019 tax return is closed/inactive. Where will I receive the payment?

You will need to file your 2020 tax returns electronically. Then, claim the Recovery Rebate Credit on your tax return.

 

I have not received my payment. What should I do?

You can claim the Recovery Rebate Credit when filing your 2020 income taxes. Then, you will get a voucher for your 2020 tax return as a credit, saying that your stimulus is part of your tax return refund money.

 

How are vouchers different from checks?

The voucher makes the stimulus money part of your refund, whereas checks go to everybody even if they owed the IRS money. This also means that the IRS can keep the voucher if you owe them tax money, as it (the voucher) is part of the return.

 

What if I have received the wrong amount?

Again, initiate the procedure to get the Recovery Rebate Credit when filing your 2020 income taxes.

 

I don’t have a bank account. How will I receive the payment?

You can expect your payment to be made by check or a prepaid debit card. The IRS will use the mail address on your file (the most recent tax return) to send you the payment. For more information about your EIP card or report a stolen/missing EIP card, you can visit this link.

 

I am not required to file a tax return. Will I get any money?

Yes. Those not required to file a tax return will receive payments generated by the IRS, provided they have used the RRB-1099 or the SSA-1099 form before November 2020. Otherwise, the Recovery Rebate Credit can be claimed on your 2020 tax return (line 30).

 

When are stimulus payments made?

Stimulus payments started in late December 2020. Those that have direct deposit details on file will be paid first. Mailed payments (debit card and checks) are the next in line. You may use this link to check the status of your payment. If you have NOT provided the IRS with your banking information, visit this online portal so you can do whatever necessary to receive immediate payments rather than checks in the mail.

 

I have missed the deadline to file a claim for the 1st stimulus check? Now what?

Non-filers that have missed the November 21st deadline to provide their personal details to claim the 1st stimulus check can claim the additional sum after filing their 2020 tax return.

 

Is my stimulus payment taxable?

According to the IRS, taxpayers are not required to owe tax on their stimulus payments, as they (the payments) are not regarded as income. This also means that your refund will NOT be reduced or otherwise affected by the payment. Plus, the stimulus payments will NOT raise the due sum when you file your 2020 tax return (or your 2021 tax return). Finally, stimulus payments will NOT have any impact on your income for purposes of determining your eligibility for benefit programs or federal government assistance programs.

 

Is a stimulus payment a tax credit?

Technically, yes. However, it is not your average tax credit as it won’t reduce your future tax refund or generate a larger tax bill when you file your tax return the following year. Here is some more explaining. In the tax world, a tax credit lowers your tax bill. So, if you owe $1,700 in federal income taxes and receive a $900 tax credit, your total due amount drops to $800 ($1,700-$900). Now, a refundable tax credit can turn your tax bill into a tax refund. Therefore, if you owe $1,500 in taxes and have a refundable tax credit of $1,900, you will receive a $400 tax refund.

Given that you do not wait to receive money from the credit in 2022 (when you file your 2021 tax return) but are getting sums to a refundable tax credit now in the form of a stimulus payment (the 3rd one) instead, you are actually receiving an advanced refundable tax credit.

 

The stimulus payment was more than I was allowed. What happens now?

Any adjustments to your 2020 tax returns rebate are in your favor. If, for instance, the IRS has calculated your stimulus payment based on your 2019 tax return (you had a lower income then), but  your income is higher this year, then you won’t need to pay the credit back.

 

I owe federal taxes. Will the IRS use my stimulus check money to cover them?

If you have past-due child support, the IRS will NOT use your stimulus payment to cover it. This also means that your stimulus payment can NOT be garnished by debt collectors. This applies to the second check, though.

Nevertheless, if you are claiming your missing stimulus check on your tax returns, you are no longer protected from the Consolidated Appropriations Act. In other words, the IRS can, in this case, garnish your stimulus check for unpaid taxes.

So, all in all, if you have qualified for EIP and have not received your full payment (and have outstanding debts), the IRS will withhold some or all of your unpaid stimulus payment to offset those debts.

 

I have unemployment income. Do I pay taxes on it?

According to the new guidelines, up to $10,200 is tax-exempt. So, if you collected unemployment in 2020, you could be exempt from paying taxes on it if you meet the criteria of the economic impact/stimulus. For married individuals filing jointly, the adjusted gross income is set at $150K while for singles, it is $75K.

 

How much money will I get from the 3rd stimulus, based on my 2020 taxes? Will they affect the amount I will receive?

If your situation has changed dramatically between 2019 and 2020, you may receive the full amount of the third stimulus check, which is based on your 2020 or 2019 taxes (depending on what the IRS has on file when it determines the amount you will receive). However, tax season could affect your 3rd check, as you may need to be patient until next year (2022) to claim the difference in the taxes. Truth be told, things are quite complicated with the third stimulus at the moment, considering that the tax season merges with the timeline for sending the check.

 

What if I file for an extension or wait until the April 15 tax due date?

Having to pay owed taxes will NOT be postponed if you file for an extension. Doing this will delay your stimulus payment. In general, it is advised to file your taxes sooner than the due date for your 2020 tax returns as it could speed up the delivery of any tax refund you might be eligible for. On top of that, you will help boost the process of getting any missing stimulus money by weeks or even months.

 

I have already filed my 2020 tax return. How will the government rectify my tax bills?

Unfortunately, the current landscape is blurry in regards to this particular situation. It is still unclear how the IRS will address this issue, at least at the moment of this writing.

 

I have received a stimulus payment on behalf of a family member that has deceased.  What do I do?

If you filed jointly with your spouse, and they have passed away before January 1, 2020, then the IRS will not issue a payment for the deceased spouse. This means that you won’t get the $600 payment for them. However, you will continue to receive up to $600 for you and an additional $600 for any qualifying offspring (provided you meet all the other eligibility criteria).