The 2023 Individual and Family Tax Returns are due on April 15, 2024 this year. We will talk about some of the most common forms you receive and terms you will come across often when you do your taxes. Many articles online go in depth in explaining these forms but I will use short notes to try to keep this knowledge concise and easy to lookup.
There are forms you receive and forms you submit. Let's focus on forms you receive from Work and from your investment platforms/firms/brokerages:
W2
W2 is what you receive from your employer.
Box 1 - Wages, Tips
Box 2 - Federal Income Tax Withheld
Box 3 - Social Security wages (Capped by IRS every year, for 2021 it's 142,800)
Box 4 - Social Security tax withheld
Box 5 - Medicare wages and tips
Box 6 - Medicare tax withheld
FICA - Federal Insurance Contribution Act
Social security tax rate is 6.2% for employed, 12.4% for self-employed (with an amount up to $118,500, Box 3 W-2), so maximum social security is $7,374
Medicare is 1.45% for employed, and double (full amount) for self-employed with no maximum.
Box 12 Codes
C —
D — Elective deferral under a 401(k) cash or arrangement plan. This includes a SIMPLE 401(k) arrangement.
W — Employer contributions (including amounts the employee elected to contribute using a Section 125 cafeteria plan) to your health savings account (HSA). Should be same amount on Form SA-5498.
DD — Cost of employer-sponsored health coverage.
Box 14 VPDI Voluntary Plan for Disability Insurance California Voluntary Plan for Disability Insurance (VPDI) is not deductible.
Box 16 - State Wages
Box 17 - State Income Tax
1099-DIV
When you invest (either stocks or other assets), when it earns money it could either go back to the investment itself or distributed back to the investor in the form of dividends. 1099-DIV captures that.
Qualified Dividend - Dividend to which capital gains tax rates are applied. This is in contrast to Non-Qualified Dividend which uses regular income tax rates. As we know today, capital gains tax is generally lower than regular income tax rates. In general though, reinvestment instead of dividend can increase cost basis which helps reduce taxes.
Non-Dividend Distribution (1099-Div, Box 3) - "Return of capital". An amount given back part of your original investment. Not taxed right now. It reduce your cost basis by an amount in your own record when the stock is sold (in the event the company liquidates) in the future.
Non-dividend distributions are things like retained earning sent to share holders. They are not from existing earning or profit. They help reduce cost basis.
Exempt-interest Dividend (1099-Div, Box 10) - Mutual funds that invest in municipal bonds. Not subject to Fed income tax, but may still be subject to state income tax or AMT.
Section 199A
When receiving a 1099-DIV or K1 form, some of the dividends or income may be considered to be section 199A which means business owners and real estate investors (REIT investor) don't need to pay income taxes on the last 20% of the income they earn!
Section 199A deduction gives owners of pass-thru business entities (e.g. sole proprietors, partners in partnerships, some real estate investors, and S corporation shareholders) an extra deduction equal to 20% of their “qualified business income”. For Section 199A dividends (also known as REIT dividends), the required holding period is more than 45 days during the period beginning 45 days before the ex-dividend date and ending 45 days after the ex-dividend date.
Foreign Tax Paid - Some ETFs hold stock in foreign companies, and non-U.S. taxes may have been assessed on income that is then distributed to you as a dividend. To mitigate
double taxation, U.S. tax rules permit a deduction or a foreign tax credit under
certain circumstances—consult your tax advisor for details.
1099-B
This form records both long term and short term gain/losses of your investment (usually stocks) for the year based on what you sold. Long term gains are taxed at capital gains tax while short term gains are taxed at regular income tax.
Box A: Short Term covered : Basis reported to IRS
Box B: Short Term noncovered : Basis not reported to IRS
Box C: Short Term not reported to you.
Box D: Long Term basis reported to IRS
Box E: Long Term basis not reported to IRS
Box F: Long Term not reported to you
FIFO stock selling
Pro: Using shares acquired first, more likely to get long-term capital gains treatment
Con: Because stock prices tend to rise over time, shares bought typically had lowest cost basis which means taxable gain is higher.
LIFO stock selling
Pro: Shares owned shortest period of time tend to have smallest taxable gain, smaller tax bill.
Con: More likely to incur short term tax which is likely higher than long term-capital gain tax
HIFO - Highest In, First Out. This usually refers to stock or asset trading where the highest cost asset are sold first. It helps the asset holder (individual or organization) to decrease their taxable income since they will realize their highest cost items/assets first.
Covered vs. Non-Covered Shares - Shares with its cost basis reported to both IRS and you are called covered (which historically shares purchased since 2012 will have broker cover the cost basis). Shares with its cost basis only reported to you but not IRS is called Non-Covered. Some RSU vested stocks when sold with lot allocation could have non-covered scenario that investor needs to resolve themselves (figure out its cost basis).
Crypto trading is a touchy subject when it comes to Tax reporting. Generally speaking, you are responsible for making the income/loss correctly in your tax return. However, not all trading platforms (such as Coinbase) will issue a 1099 for the activity. IRS has a minimum activity requirement which is $600 and customers that don't earn more than will not receive a 1099 so you are on your own to do the reporting.
NFT (Non Fungible Token) - Well we are talking about 2022 and so we should definitely talk about NFT right? You might think that only selling an NFT makes you pay taxes on the income you receive; but actually acquiring an NFT is also considered a taxable event. This is because the crypto you use to purchase the NFT is considered "Sold" so you may need to report that as well.
Transactions reported in 1099-B are generally transferred to Form 8949 when submitting to the IRS.
For calculating tax, if your Control Adjusted Gross Income is about 413k below (changes every year) for 33% bracket it will use 15% long term capital gain. Above this income it will be 20% on long term capital gain.
Let's talk about LOSSES! Generally speaking, one strategy that many use towards the year end is to sell stocks that went down to offset the gain they had over the year from other more profitable investment. Many do this including myself but there are some gotchas. One is that even though anyone's stock loss could lose a large amount, the individual is allow to only deduct $3000; however!, the extra losses can be carried over to the future years. So your major loss are not "loss" forever :)
Some ADR shares (foreign companies), holding them has an extra cost of charging what is called the Depository Bank Fee, for doing registration, inventorying and compliance. This doesn't affect tax much but it's something that anyone that buys ADR shares should know.
Wash Sale : Sale less than 3 months. Can't be used to calculate loss.
1099-INT
Interest from US obligations such as US Treasury bills, notes and bonds issued by any agency or instrumentality of the United States is subject to federal income tax.
1099-K reports the gross amount of payment transactions from credit cards, digital payments via third-party networks (like Venmo and PayPal), and other freelance platforms that manage payments between two parties.
1099-G - Government Income such as your state income tax refund. So after your tax return, your state may return you a check to refund your money and that will be reported on 1099-G. In most cases, this doesn't need to be included as your income for tax.
1099-R - Retirement Income
1099-R Codes:
U - Dividend distribution. An example would be from ESOP
G- Direct rollover of a distribution
1099-MSIC - These miscellaneous payment can come in any form. One example is that let's say you downloaded some financial app and they say they will reward you some "free stocks" after you deposit certain amount to invest. This is not a dividend (and thus not 1099-DIV) not a stock trade transaction (1099-B) and so they use 1099-MISC to categorize those.
1099-NEC- A form used to report payment to individual contractor and freelancer. This is most common for when you paid a contractor above $600 (required for filing) doing some work for your rental property (or home). If I paid someone, such as contractor for home repair more than this amount (and that person is not an employee of a company and just by themselves) then I will need to file a 1099-NEC to pass to that person whom would need report the income in their own tax return.
1099-S - Proceeds from Real Estate Transaction
1099-OID - Original Issue Discount, used for reporting bond income sold at a discount.
1099-SA are forms that show how much you use from the Health Saving Account to pay for your health saving. HSA Overfunded - Maximum contribution to HSA in the past was $3,350
5498 forms are informational forms only; they are to be kept for your own records and not to be reported as part of the tax filing. HSA distribution (when I use the money for medical expense) is reportable (needs to report to IRS) but it’s not taxable.
1095 A/B/C - These forms verified that someone had a 12 month health insurance and so no need to pay penalty for not having health care insurance. 1095-A are for people who purchased insurance through marketplace; for those in California, if you got Covered California you might be getting 1095-A. Form 1095-B are for people whom got insured by an insurer that's usually not the employer (such as Medicare / Government) while 1095-C are for people whom got insured through their employer (usually 50+ size companies).
Form 2439 - Used to notify shareholders about undistributed long-term capital gains. These are gains that are realized (and taxes that they already paid on behalf of the holder) but not yet distributed to the share holders. This form usually helps share holders to adjust (like reduce) the cost basis of their gain and then claim a refund of income tax paid by the company on their behalf.
K1 / K3
K1 are forms you receive when you are part of an investment partnership. There are a few types of K1s, such as Form 1065 for partnerships, and Form 1120-S for S Corp for reporting income/loss.
Box 13 code L (deductions) could be management fee, or professional services fee. These are considered "investment expenses", usually linked with Box 20 B, and can be deducted from your taxes. Great!
Statement A—QBI Pass-through Entity Reporting
K3 is sometimes attached to your K1 if the investment also involve international and K3 reports international tax.
QBI (Qualified Business Income)
If you are self-employed, some of your income is from partnerships, or even for your rental properties, you may have income that qualifies as a QBI. The benefit of qualifying as QBI is to deduct up to 20% of the income from taxes. QBI came in the recent years as a result of the Tax and Job Cuts Act (TJCA). You might wonder if your business is at a loss or already whether that matters. Well it's not completely trivial either way (as if the U.S. Tax Law is not already so....) and you have do some homework,: You can still claim QBI Loss, the upside is that the loss disallowed this year can be carried over into future years if you expect a profit in your QBI; the downside however is that by qualifying it now you actually may increase your tax because you also have "less" to be able to deduct from your taxes now. Basically that 20% doesn't count for either income or loss for now. As to what qualified a QB I am not a tax advisor and so you should look up further information online. But for example, one requirement is the trade or business with enough regularity/continuity. For rental specifically, AirBnB with frequent enough visitors all year round where you have to do a lot of work may be considered a QBI. But for a more passive regular home or unit lease it depends and may not qualify.
SSTB - Specified Service Trade or Business where the primary asset of the business is the skill or reputation of its owners/employees.
Next we will talk about Forms you actually submit as part of your tax return (i.e. in addition to your 1040):
Schedule-A - Itemized Deductions. This varies a lot year by year recently due to law changes but majority of people put their state/local deductions and mortgage interest here.
The max federal deduction for itemized state and local taxes is $10,000. Any entries over the $10,000 limit won't impact your federal tax outcome, but may still benefit you on your state tax return. One thing people may not know is that they could buy something large and paid sales tax that sales tax could be bigger than state tax and can be used for deductions. For those in California, if you are trying to figure out your DMV Registration Calculation:
For Mortgage interest, while it used to be you could use interest on loan up to one million dollars, after 2017 with the new law you can only deduct interest paid on up to $750,000 in loans for your first or second home.
Example: Let's say you have a loan of $1,300,000. And your mortgage interest paid shown on 1098 is $25,000. The actual interest you are then allowed to deduct would be 25,000 * (750,000 / 1,300,000) ~= $14423.
For Child Care, the child care dependent credit is 35% eligible expenses up to $3,000 per child. However, if you are a high income earner, you can't get the full $3,000. Based on your income level, you could get only something like 20% of the eligible expense. So for example even though you have $3,000 eligible expense your credit is only allowed to be $600.
Parents can also allocate part of their paycheck into an FSA (Flexible Spending Account tax free for their child care. However, money you put into the FSA can not be used to deduct for the child care credit. (Otherwise you are really taking double advantage!!). So use your own judgement and check availability with your employer to see how best to allocate your money for your children.
For Child Tax Credit, it's $2,000 per child for age under 17, including newborn. But you have to have income between $2,500 (earned income) and $440,000 (can't make too much either).
Deductible
Medical expenses need to total more than 10% of total income to be deductible
Job Expenses can only be used for deduction if the expenses accumulated together is above 2% of total income.
Schedule-B - Interest and Ordinary Income
Schedule-C - Income from a simple business or profession you operate in as a sole proprietor.
Schedule-1 - Additional Income and Adjustments to Income (Schedule C, K-1 from partnership, S corp. etc.)
Schedule-2 - Additional Taxes (Government taxing more on additional Medicare Tax and Net Investment Tax)
Schedule-3 - Additional Credits and Payments
Form 8949 tells the IRS all of the details about each stock trade you make during the year, not just the total gain or loss that you report on Schedule D.
Schedule-E
This is for reporting what's considered "Supplemental Income" from things like Rental property, Royalties, Partnerships, Estates, Trusts, etc. Commonly those that buys a house and rented it (or part of it) out will report the income here. Those invested in investment partnerships may also receive income here.
When you spend money to buy your rental property or to make improvements, you might think of those as expenses. However, the IRS treats those costs as assets and may allow only a portion of those costs as deductions against your rental income in the current year. You expect to get benefits from those assets for many years, so the cost is recovered over time to help reduce your taxes in future years.
Less than 14 days of rental the rental income can be tax free!
Passive Activity Limits
As defined by the Investopedia article, "Passive income is earnings derived from a rental property, limited partnership, or other enterprise in which a person is not actively involved." And while some people may think that stock investment or stock gain could be considered passive, in most cases, they are unfortunately not considered passive and as a result your loss in some crowd funded limited parternship can not be used to offset gains you made in the public traded stock market.
You can't use your passive losses reported on a K-1 to offset capital gains from investments. You can only use your passive losses to offset passive gains (stock investments are not passive).
Rental activities are considered "passive" activities, and a loss on passive activity is not deductible against non-passive income, such as wages (or even stock gains). You are allowed to deduct up to $25,000 of losses but the requirement is that your MAGI (Modified Adjusted Gross Income) needs to be $100,000 or less. Losses not deductible for a particular tax year because there is insufficient passive activity income to offset them (suspended losses) are carried forward indefinitely and are allowed as deductions against passive income in sbusequent years.
Under the passive activity rules you can deduct up to $25,000 in passive losses against your ordinary income (W-2 wages) if your modified adjusted gross income (MAGI) is $100,000 or less. This deduction phases out $1 for every $2 of MAGI above $100,000 until $150,000 when it is completely phased out. So if your AGI is above $150,000 your rental loss for example can not be used to reduce your taxes. These limits apply to both those filing single or married filing joint.
To take losses against your ordinary income, you must demonstrate active participation in the activity. This is less stringent than the material participation requirement for real estate professionals, and generally means you play a role in making management decisions of the business.
The passive activity limits are spread proportionally to the items that incur losses. For example, let's say your total net income of passive activity is $1,000. And there are three pass activity that generate losses, one lost $8,000, one lost
Example
Your MAGI is $100,000 for the year and your rental properties produce a net loss of $30,000. As long as you materially participate in your rental activities, you’ll be able to deduct $25,000 of this loss against your ordinary income. The remaining $5,000 will be carried forward.
Additional Forms
Gifts
Some gifts are taxable. Within U.S., gift cash is about $14,000. From foreign gift cash, the limit is $100,000 The IRS Form 3520 is an informational form but it is required to be submitted to the IRS before the due date of your tax return.
If you received a gift from a foreign individual greater than $100,000 then that needs to be reported to the IRS using Form 3520 and its instructions. Form 3520 may not need to be submitted along with your tax return but may need to be submitted to the Internal Revenue Service Center, P.O. Box 409101, Ogden, UT 84409.
HSA
HSA (Health Savings Account) is an important way to help save taxes. If I have an HSA, I should be covered by a HDHP (High Deductible Health Plan). Your insurance card should say HSA or HDHP on it but if not you could use a curent rule (which can be updated per year) whether it's high deductible such as whether the you have a minimum deductible of $1,400 and out-of-pocket maximum of $7,050 for in-network providers. For family coverage, check for A minimum deductible of $2,800 and out-of-pocket maximum of $14,100 for in-network providers.
As you use your medical expenses over the year, the final accumulated amount will be mailed to you in the 1099-SA form while the balance of the account will be mailed to you in 5498-SA.
I made this mistake myself before where I was trying to put money into an HSA account so that my family could take advantage of tax deductions but I forgot that I could only do so under a current plan of HDHP.
Sole Proprietor Ship v.s. S. Corporation
Setting up a Non-profit can have income but it can’t help with expenses, S. Corp can be used to deduct expenses (check for red flags).
S corp profit can be broken into shareholder wages and distributive share.
For shareholder wages, the self-employement tax is roughly 15.3%. But there is no tax on distributive share.
If an S corp loses money, that loss become a tax deduction on individual tax return.
S corp pays no corporate taxes.
Rent current home as a meeting place and have the company pays itself for the rental for 14 days max and you get tax free income. The income paid to myself for the rental is tax-free, and further more, that expense can be deducted from the business income as well. But you need to document the business meeting!! have your corporation issue a 1099 for rents paid to you; you will then report the 1099 amount on your personal income taxes on Schedule E, showing a deduction under other expenses for non-taxable income
Tax Rate
CA highest marginal tax rate is 13.3% for capital gain. So this is different than Federal which is 20% top.
Surprising Fact: Based on multiple sources of report, almost half of the household in the United States actually paid no federal income tax!
Second Home
Can write off 100% of the interest pay up to 1.1 million of total combined home debts. Second home rule.
Unlike mortgage interest, can deduct property taxes paid on any number of homes you own.
Misc Knowledge
If you have investments, such as stocks, bonds, IRAs, or other income-producing ventures, you might be able to deduct some of your miscellaneous investment expenses. To qualify for this deduction, your investment expenses must exceed 2% of your income. If you qualify, you can take deductions for the following investment-related expenses:
- Safe deposit box fees
- IRA custodial fees
- Investment advisory fees (such as a financial planner or tax advisor)
- Depreciation of equipment to manage your portfolio (such as a computer)
- Investment publications (including magazine subscriptions)
- You can deduct safe deposit box rental fees when you use the box to store documents for taxable income-producing investments, such as stocks and bonds. If you also use the box to store tax-exempt investment documents or personal belongings, such as jewelry, then prorate the portion of the box that is used for your taxable income-producing investments.
- You can deduct fees paid to a trustee to administer your IRA if the fees are billed separately for the IRA and are considered ordinary and necessary. Fees paid from funds in the IRA account are not deductible.
- You can deduct advisory fees and expenses used to manage your investments that produce taxable income. Examples: Fees paid to a financial planner, tax advisor, or attorney for advice, and services to produce or collect taxable income.
Investment Interest Expense Deduction - If you borrow money to finance investments, the interest you pay is considered investment interest. Examples include margin interest your broker charges you on loans to buy stocks, and interest you pay on money you borrowed to buy raw land for speculation. If you have investment interest expense, you can deduct it up to the amount of your net investment income.
Traditional IRA limitation is $5,500 but you cannot deduct any of your IRA contribution if your MAGI is $72,000 or more.
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