This blog was prepared with the assistance of Peter A. Weitsen, CPA, partner at WithumSmith+Brown, PC.
Much of what you do when
you prepare your income tax return does not require making choices. For
instance, your income is what your income is. But there also are plenty of
categories that involve choosing among various options—so-called tax elections.
It’s not always evident
which elections you should make. Some need to be made before you engage in a
transaction, some during and some afterward. Some elections are made by
declaring them on your return, and some by filing a form or letter with the
IRS.
Following are some of the
more common tax elections for individuals. Not included are elections specific
to businesses that are not reported on a client’s individual tax return. Some
of these are extremely technical, and the advice of a knowledgeable tax adviser
should be obtained prior to the transaction.
Section
83b election. This is an election to have the current
value of employer stock with a delayed vesting schedule taxed when received and
not when the employee can sell it. This election is made by a letter filed with
the IRS within 30 days of receiving the employer stock. This election would be
made for shares that are expected to greatly increase in value between the
grant date and the vesting date. This also can apply to stock options that are
granted to an employee.
Section
754 election. This is made when an inherited partnership
interest in real estate has a value greater than the basis of the property on
the partnership’s books. This also can be made when a partnership interest is
purchased at a cost much greater than the basis of the underlying assets in the
partnership. This election is made on the first tax return filed by the partnership
for the year in which the transfer of ownership occurred. The election is made
by attaching a statement to the return making the election. Eligible entities
include partnerships, LLCs and any other entity eligible to file a Form 1065.
Employer’s
publicly held stock received from a 401(k). You can make an election
to pay tax on an employer’s publicly held stock received from the employer’s
401k plan and not roll it over to a traditional IRA. When this is done, the
amount taxed will be the value of the stock when it was contributed by the
company to the plan—not its current value. The net unrealized appreciation
(NUA) will be taxed at capital gains rates when the stock is eventually sold.
There are also other
benefits that should be kept in mind. The holding period for these shares is
automatically considered as long term, so it can be immediately sold and the
capital gains tax rates will apply. However, any appreciation after receipt
would not be subject to the capital gains rates until the stock is held for
more than a year. The amount distributed will be subject to withholding taxes
by the employer. If the recipient is under age 55 when the recipient leaves the
job, he/she will be subject to the early withdrawal penalty. This election is
simply made by recording the value on the taxpayer’s individual return for the
year the distribution was made. Caution: This only applies if the
employee terminated his service and the employer made a full distribution of
the 401(k) account in a single calendar year.
IRA
rollover. When a lump-sum distribution is received from an
employer’s retirement plan and it is rolled over within 60 days to an IRA, it
will not be taxed at that time. The election is made by reporting the entire
distribution on the return and showing the taxable amount as zero. Such a
rollover can be done only once in a 365-day period. The better way to do this
is to have a direct distribution to the IRA by the employer’s retirement plan.
Investment
interest can be deducted to the extent there is investment
income. Where there is insufficient investment income in a year, the excess
interest can be carried forward to a later year. An election can be made on
Form 4952 that is attached to the taxpayer’s individual return to treat some of
the qualified dividends and long-term capital gains as investment income to get
a full deduction for the investment interest in the current year and not have
to carryover the unused investment interest.
Bond
premium election to amortize the premium paid on taxable
bonds can be made and applies to all bonds held at the beginning of the year in
which the election is made and all bonds acquired thereafter. The amortized
premium can be deducted from the interest received during each year, thereby
reducing the taxable interest income. If the election is not made, the loss on
the premium when the bond is redeemed or disposed of would be a capital loss.
Dealers in bonds cannot make this election. The election is made by attaching a
statement to the return and by claiming the deduction on the return. For
tax-exempt bonds, the amortization of the premium is mandatory.
401(k)
participants that are still employed past age 70½ and who are
less than a 5% owner do not have to start their required minimum distributions
(RMDs) until their employment is terminated. The election is made simply by not
taking the RMD.
Section
1031 exchange. An election can be made to roll over
gains on real estate under Section 1031 by acquiring like kind property of an
equal or greater value. This applies to investment or business property only.
There is a strict timeline for this transaction that must be followed. There
must be written agreements and binding contracts as applicable between the
seller, buyer, seller of the replacement property and a qualified intermediary.
The election is made by filing Form 8824 with the tax return for the year in
which the exchange occurred.
Qualified
business income (QBI) deduction aggregation election to
qualify more fully for the 20% deduction permitted under Section 199A. When a
taxpayer has more than one trade or business (including sole proprietorships,
partnerships, LLCs and S corporations), aggregation may allow better
utilization of wages and other factors in the calculating of the QBI deduction.
This is done by providing detailed information on the tax return claiming the
deduction. No special form is required, but follow-up statements must be
attached each year.
Qualified
joint venture. An election for married couples jointly
owning an unincorporated business can be made to not file a partnership return
but instead to have each spouse report their portions of the transactions on
separate Schedule Cs that are included with their individual tax returns. The
election is made by filing the separate Schedule Cs. The Schedule Cs are easier
to prepare and do not require a balance sheet as does the Form 1065 partnership
tax returns. This does not apply to an LLC or limited partnership.
Installment
sale election is made when property or stock in a
nonpublicly traded company is sold. This enables the gain to be taxed in the
years that payments are received and not in the year of sale. The election is
made on Form 6252 filed with the return for the year in which the sale took
place.
The above is a sampling
of some of the more common elections that taxpayers seem to overlook and is
certainly not a complete listing. There are many other elections that taxpayers
should be aware of. Some of these are made when starting a business, when
depreciable equipment is acquired, when shares in a small business corporation
are acquired, when certain tax credits are applicable and many other
circumstances.
Elections must all be
made on timely filed returns, including extensions, and must follow the exact
IRS procedures. It is best to use a knowledgeable tax adviser to assure the
rules are being followed.
If an election is being
considered, you should run the numbers and see the effect with and without the
election before making the decision. A final tip is to read all the questions
on the tax form and the instructions and make sure they are understood and
determine which are applicable for you.
