Tom Talks Taxes - April 2, 2021

Updates on the unemployment exclusion and the employee retention credit

Community Property Conundrum

Unemployment compensation is generally community property; therefore, on separate returns, one-half of the amount paid to one spouse is allocated the other spouse. See Calhoun v. Comm., T.C. Memo 1992-408.

There are unanswered questions related to the application of new §85(c) to married couples in community property states. There will be no clear answer for a statute passed just a few weeks ago; however, if we look to other authority related to exclusions of community property income, I think we find some insight.

Revenue Ruling 55-246 poses this scenario: A and B are married and are subject to community property law. If A meets the §911 foreign earned income requirements, can B exclude his or her share of A’s foreign earned income on a separate return if B does not meet the §911 requirements?

The IRS ruled that B reports his or her one-half share of both the excluded and taxable foreign earned income from A, but B does not get his or her own exclusion based on A’s income.

Next, let’s look at Renoir v. Comm., 37 T.C. 1180 (3/30/1962). In this case, both spouses lived abroad, but only one spouse had foreign earned income. They each tried to exclude the maximum under §911 on a joint return based on a community property allocation of foreign earned income to the non-working spouse.

The Tax Court did not agree with this position:

“The interpretation urged by the petitioners would favor taxpayers in community property States. Without a clear-cut statutory mandate, we would not attribute to the Congress an intention to authorize a double exclusion of such income for taxpayers in community property States as compared with other taxpayers.” (emphasis added)

The Ninth Circuit affirmed the Tax Court, stating

“Respondent concedes that the money was community property, but argues that there is no language in the statute that would support the contention that the limited exclusion from gross income expressly written into section 911(a)(2) may be doubled in a joint income tax return of a husband and wife, solely because they are domiciled in a community property state. We agree with respondent… We think that it was the intent of Congress that there be one exclusion in any one taxable year from the total amount received abroad in that year, regardless of how that amount is subsequently reported by the individual taxpayers involved.”

If we apply this authority (and it is all still authority, despite its age) to the §85(c) exclusion, then it points to the following treatment:

  1. Each spouse applies the $10,200 exclusion to the unemployment compensation received by that spouse.

  2. Each spouse then splits one-half of the taxable and excluded unemployment compensation amounts with the other spouse.

  3. Each spouse then reports his or her total taxable and excluded unemployment compensation on either a joint or separate return.

Example. TP1 and TP2 are married in a community property state. TP1 received $8,000 in unemployment compensation and TP2 received $12,000 in unemployment compensation. Of those amounts, TP1 has $8,000 of excluded income and TP2 has $10,200 of excluded income and $1,800 of taxable income.

Therefore, on a joint return, TP1 and TP2 report $18,200 of excluded income and $1,800 of taxable income.

On separate returns, TP1 and TP 2 individually report $9,100 of excluded income and $900 of taxable income, which represents one-half of their individual income plus one-half of their spouse’s income.

Absent a specific ruling by the IRS or the Tax Court on new §85(c), we do not have a definitive answer. I believe the above approach has, at a minimum, a reasonable basis in the law, allowing it to be taken as a tax return position under Circular 230. I do not believe the Tax Court would ultimately uphold a tax return position related to §85(c) that would allow spouses in community property states additional tax benefits not available to similarly situated spouses in non-community property states.

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New Tax Credit for Post-COVID Start-Ups

The American Rescue Plan Act of 2021 extended the COVID-19 employee retention through December 31, 2021. For the 3rd and 4th quarters of 2021 only, Congress also created a new category of eligible business: a recovery start-up business.

§3134(c)(5) defines a recovery start-up business as any employer:

  • Which began carrying on any trade or business after February 15, 2020,

  • For which the average annual gross receipts of such employer does not exceed $1,000,000, and

  • Which, with respect to such calendar quarter, does not meet either the gross receipts test or the suspended operations test, which are the normal tests to qualify for the COVID-19 employee retention credit.

A recovery start-up business can take a maximum employee retention credit of $50,000 per quarter using the normal credit calculation formula for 2021 quarters.

Example. Paula starts a sole proprietorship business in October 2021. During the 4th quarter of 2021, she hires E1, who is paid $8,000 total in the quarter, and E2, who is paid $12,000 total in the quarter. Paula can receive a $12,600 employee retention credit for that quarter: $5,600 for E1 (70% of $8,000), plus $7,000 for E2 (70% of $10,000).

Paula will reduce her 2021 Schedule C wage deduction by $12,600 due to §280C(a), which applies to the COVID-19 employee retention credit. If we assume a 40% combined federal and state income tax on that amount, including self-employment tax, she is ahead $7,560 by claiming the credit, which is equal to the $12,600 credit received less the additional $5,040 in tax paid due to the lost deduction amount.

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Articles I Recommend

In Think Outside the Tax Box, a new subscription tax newsletter, I discuss the taxation of crowdfunding proceeds in GoFundMe & Kickstarter: Taxable? Deductible? and First Time Abate for IRS penalties in Get Automatic, No Questions Asked Penalty Relief.

The Biden White House released an outline for the American Jobs Plan. There are several significant proposed changes to Tax Cuts and Jobs Act provisions, including increasing the C corporation tax rate to 28%. While these are mere proposals without any proposed statutory language, expect significant movement on this in the next few months.

My Upcoming Education Events

Compass Tax Educators, of which I am a co-owner, is offering its annual all-access pass for all live webinar events from May 1, 2021 through April 30, 2022. We guarantee we will offer at least 30 CE/CPE. You can see the courses planned (I am teaching quite a few of them) and purchase a pass here.

Oregon Society of Tax Consultants - May 21, 2021 - Newport, OR

  • American Rescue Plan Act of 2021 (3 CE)

  • Advanced Rental Property Tax Issues (2 CE)

  • Tax Planning Strategies for Business Owners (2 CE)

Virginia Society of Enrolled Agents Spring Seminar - June 2-4, 2021 - Virtual

  • Introduction to IRS Representation (2 CE)

Arizona Society of Enrolled Agents Southwest Fest- June 14-16, 2021 - Avondale, AZ

  • Advanced Rental Property Tax Issues (4 CE)

  • COVID-19 Hot Topics for 2020 Tax Returns (2 CE)

  • Penalty Abatement Strategies (2 CE)

National Association of Enrolled Agents (NAEA) National Tax Practice Institute - June/July 2021 - Virtual

  • Level 1: Statutes of Limitations (2 CE); Ethics (2 CE)

  • Level 2: Penalty Abatement Strategies (2 CE); Capstone Course (co-teaching with Clarice Landreth) (2 CE)

Spidell Summer Tax Webinar Series - July 2021 - Virtual

  • Update on IRC §199A (2 CE)

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