Graphics by Anna Gray.
Taxpayers must know the various thresholds and incentive-related amounts as they plan their income and make investment decisions. This is why one must pay special attention to the IRS announcements of inflation adjustments for income and capital gains tax brackets in addition to new numbers for several other common tax deductions and credits. E.g. Rev. Proc. 2019-44. Employees should make adjustments on IRS Form W-4 (revised format for 2020) to avoid incorrect or over withholding. Do not fail to file as penalties tend to accumulate, including for information-only returns.
Individual Income and Capital Gains Rates & Brackets Increase Slightly in 2020
While the rates of tax for the seven marginal income tax brackets will not change in 2020, the income thresholds for each bracket will go up to keep pace with inflation. The following table shows the increases for 2020 by filing status as well as the rates at which a taxpayer’s long-term capital gains (income from dispositions of capital held for over 12 months) will be taxed.
Note, these brackets are marginal, meaning all taxpayers begin in the 0% bracket and only pay higher rates on the income at the threshold for their filing status. For example, a couple who file as married filing jointly pay no tax (0%) on the first $19,750 of income. The higher rates only apply to income in that specific bracket. So keep these income thresholds in mind as you accumulate earnings next year and determine whether to defer opportunities to earn income or invest in assets taxed at a later date.
The Standard Deduction Also Goes Up for 2020
Taxpayers who do not itemize (by filing 1040 Schedule A) may claim a standard deduction, which absorbed the personal exemption following the Tax Cuts and Jobs Act of 2017. Like ordinary and capital gains income brackets, these amounts also depend on a taxpayer’s filing status:
- $24,800 married filing jointly and surviving spouses
- $12,400 each for married filing separately
- $18,650 head of household (defined by IRC Sec. 1(j))
- $12,400 unmarried
Note, the personal exemption amount remains $0 in 2020, a major driver behind the decision to revise the W-4 from previous years. Keep these numbers in mind and save receipts for deductible expenses throughout the year to properly determine if you should itemize or take the standard deduction next year.
Corporate Flat Tax Remains 21%, QBID & Sec. 179 Bonus Depreciation More Significant
Annual inflation adjustments to tax brackets are not as significant for corporations, which pay a flat rate of 21 percent. IRC Sec. 11(b); IRS Pub. 542 “Corporations.” Other business incentives like the qualified transportation fringe benefits for employees ($270 for tolls, $279 for parking under Sec. 132(f)(2)), or the more popular Qualified Business Income Deduction (QBID) and Section 179 bonus depreciation are more significant for business entities.
QBID Continues As In 2019, Phase-Out Threshold Up to $326,600 W-2 Income for Joint Returns
The Tax Cuts and Jobs Act of 2017 created a complicated but popular new deduction: the QBID (Qualified Business Income Deduction). IRC Sec. 199A. Subject to several qualifications and limits, this allows pass through entities to deduct 20% of their qualified business income and 20% of qualified real estate investment trust (REIT) or publicly traded partnership income. See also IRS Pub. 535 “Business Expenses.” As an “above the line” deduction, this may be calculated and claimed even by those who take the standard deduction (described above).
Unfortunately, the devil is in the details with this incentive. For example, several limits with regard to qualified business income (QBI) include: those imposed for specific kinds of trades or businesses, the amount of W-2 wages (e.g. those earning over $326,600 of W-2 wages, married filing joint returns, $163,300 for married filing separate and all other returns, triggers a phase-out. ) paid by the qualified trade or business, and the unadjusted basis immediately after acquisition of qualified property owned or held by the business entity. With regard to a REIT, there are no limits due to W-2 income or the unadjusted basis immediately after acquisition, but there are limits for certain publicly traded partnerships (PTPs). Qualifying organizations and the individuals who receive pass-through income from them should contact a tax professional for further assistance with this complex topic.
Bonus Depreciation Under Section 179 Topped at $1.04 Million
The Tax Cuts and Jobs Act of 2017 beefed up bonus depreciation available for personal property used in a trade or business. A few 2020 adjustments are significant in this regard. That is, the amount of capital property a business may expense under Section 179 (rather than capitalize and depreciate) will increase to $1.04 million. IRC Sec. 179(b)(1); Rev. Proc. 2019-08. Note that some property is treated differently—sport utility vehicles may only be expensed up to $25,900. Sec. 179(b)(5)(A). Also, the phase-out limit (originally $2.5 million) is reduced by the amount that the total value of Sec. 179 property placed in service during the 2020 taxable year exceeds $2.59 million Sec. 179(b)(2).
Estate & Gift Tax Unified Credit and Annual Exclusion Increases to $11.58 Million
Returning to individual taxpayers briefly, the basic exclusion amount for 2020 is $11.58 million (up to $23.16 million for a surviving spouse with a portability election on a decedent’s final tax return), for determining the Sec. 2010 Unified Credit against estate tax. This amount increased from $11.4 million in 2019 (for readers who may be responsible for the estate of someone who died last year).
Gift taxes are closely related to estate taxes. In this regard, up to $15,000 may be gifted next year by an individual to anyone else without tax consequences. Sec. 2503. Married couples may split a gift to another person and give up to $30,000 per year per person. The first $157,000 of gifts to a spouse who is not a U.S. citizen are not included in the total amount of taxable gifts under Sections 2503 and 2523(i)(2), made during that year. Although gift and estate tax exclusions and exemptions are personal in nature, they are crucial for business owners who must eventually determine the most tax-efficient way to pass their business (or wealth generated by selling it) to the next generation.
There are Penalties for Failure to File Returns & For Failure to Pay
Forgetting or failing to file forms or pay taxes is not an option. The IRS may move slowly, but income tax protestors and others who intentionally fail to file are eventually caught and almost never shown mercy by auditors or tax court judges. The penalties for failing to file a tax return vary by status and type of return. In 2020, the penalty for failing to file and individual tax return (Form 1040) is the lesser of $215 ($210 for partnerships and S Corps), adjusted for inflation from the year it was due, or 100 percent of the tax due. IRC Sec. 6651(a)(1) for individuals, Sec.6698 for partnerships, 6699 for S Corps. In addition, five percent of the unpaid tax (less the penalty for failure to pay) is charged each month for up to five months. Failure to pay the tax owed on the return carries a half percent penalty on tax not paid prior to tax day (April 15 this year) and a quarter percent paid during the installment period. IRC Sec. 6651(a)(2). These amounts do not account for fraud penalties and interest and similar, rather draconian, flat-rate penalties that apply to informational returns like those for foreign assets or business interests.
It is important to keep an eye on inflation adjustments that apply to 2020 taxes even as you calculate and file your 2019 taxes. The income tax threshold amounts and upward adjustments for several credits and deductions will help you decide how to invest and spend money during the tax year. File a new W-4 based on next year’s ordinary income and capital gains rates brackets to avoid withholding incorrectly during the first few months of the new year.