Tax

Good news.

The new Paycheck Protection Program (PPP) law enacted with the stimulus package adds dollars to your pockets if you have or had PPP money.

Before we go further, please note the PPP money comes to you in what appears to be a loan. We say “appears” because you typically pay back a loan.

Done right, however, the PPP loan is 100 percent forgiven. The word “loan” makes some businesses leery of this arrangement. Don’t be. The PPP monetary arrangement is a true “have your cake and eat it too” deal.

And this remarkable deal applies to your past PPP loan, the PPP loan you have outstanding, and the PPP loan you are about to get if you have not had one before. Here are the details.

Loan Proceeds Are Not Taxable

The COVID-related Tax Relief Act of 2020 reiterates that your PPP loan forgiveness amount is not taxable income to you.

Expenses Paid with Forgiven Loan Money Are Tax-Deductible

As you may remember, the IRS took the position that expenses paid with PPP loan forgiveness monies were not deductible.

Lawmakers disagreed but were unable to get the IRS to change its position. The IRS essentially told lawmakers, “If you want the expenses paid with a PPP loan to be deductible, change the law.” 

And that’s precisely what lawmakers did. The COVID-related Tax Relief Act of 2020 states that “no deduction shall be denied, no tax attribute shall be reduced, and no basis increase shall be denied, by reason of the exclusion from gross income.”

In plain English, the expenses paid with monies from a forgiven PPP loan are now tax-deductible, and this change goes back to March 27, 2020, the date the Coronavirus Aid, Relief, and Economic Security (CARES) Act was enacted.

There’s more to this, of course. If you would like my help with your PPP loan or simply would like to talk about it, please call me on my direct line at 408-778-9651.

• By Leon Clinton
• January 6, 2021

The Ponzi scheme is an investment fraud where the schemer uses invested money to create fake investment returns. 

According to an article at CNBC.com, authorities uncovered 60 alleged Ponzi schemes last year involving a total of $3.25 billion in investor funds—the highest amount since around the time of the Great Recession.

The Great Recession (2007–2009) revealed the famous Bernie Madoff Ponzi scheme and led both lawmakers and the IRS to create helpful actions for taxpayers, such as the safe harbor described in this article. Thank goodness.

And here’s more good news: the Tax Cuts and Jobs Act (TCJA), which crushed most theft losses for tax years 2018–2025, allowed the IRS tax-favored Ponzi scheme loss deduction rules to remain in place.

What the Safe Harbor Does for the Taxpayer

The IRS will not challenge a Ponzi scheme victim who uses the IRS tax relief safe harbor as to the following treatments of the loss:

1. The Ponzi scheme loss is deductible as a theft loss.
2. The loss is deductible in the year of discovery, which (under this tax relief safe harbor) is the year a lead figure in the Ponzi scheme is
   • charged by indictment with the commission of fraud, embezzlement, or a similar crime; 
   • the subject of a state or federal criminal complaint and either (a) admits guilt or (b) has his, her, or its assets frozen by a court-appointed receiver or trustee; or
   • the subject of the fraudulent arrangement but (due to his or her death) faces no charge by indictment, information, or criminal complaint (this condition also requires either that a receiver or trustee was appointed with respect to the arrangement or that assets of the arrangement were frozen).
3. The loss amount is computed using the safe-harbor formula, which allows either 95 percent or 75 percent of the loss in the year the Ponzi scheme victim files the safe harbor, as explained below.

The tax relief safe harbor truly simplifies the Ponzi scheme theft-loss deduction for the victim. 

The IRS frequently disagrees with theft-loss deductions. The rules for deduction and the different interpretations of the facts generate a good number of conflicts and enough litigation to make this safe harbor appealing.

How Individuals and Businesses Claim the Ponzi Scheme Loss Deduction

Say a thief breaks into your home and steals $100,000 worth of your belongings. Your personal theft-loss deduction is zero if the loss is not attributable to a federally declared disaster. That’s the way it is under the TCJA rules for 2018–2025.

But the individual who mistakenly invested in a Ponzi scheme did so for the purpose of making a profit. Tax law treats this theft differently from the theft that occurs when someone breaks into your home and steals your jewelry.

Because of the profit motive, the Ponzi scheme theft is fully deductible as an itemized deduction. Note the “fully” deductible part. The loss is not a capital loss that’s limited to the $3,000 ceiling. It’s a fully deductible theft loss—and as you see below, it can produce an NOL.

The business treatment of the Ponzi scheme loss produces a full deduction as well, albeit as a business casualty loss.

Subsequent Years

Once you make the safe-harbor calculation and deduct the 95 percent or 75 percent, you may collect a different amount in a subsequent year. That’s no problem. If you receive additional income, you report that additional income in the year of recovery under the tax benefit rule (to the extent that you received a benefit from the earlier deduction).

Should the amount of your loss increase because you collect less than the amount of the claim that you established as a reasonable prospect of recovery, you deduct the additional loss in the year that you can identify that additional loss with reasonable certainty.

Ponzi Scheme Loss Carryback as an NOL

The individual taxpayer who becomes a theft-loss victim may treat his or her theft loss as a loss from a sole proprietorship for purposes of computing the NOL deduction.

Planning note. If you qualify for a 2020 Ponzi scheme loss deduction and that deduction produces an NOL, you carry that loss to your 2015 tax year—or you can elect to forgo the carryback and instead carry the loss forward.

If you have had the misfortune of investing in a Ponzi scheme, please call me so that we can get on top of this early on.

• By Leon Clinton
• January 3, 2021

College is expensive. Data for the 2019–2020 academic year indicates that the average cost of tuition, fees, room, and board was $30,500. Tax law has provisions to help you cover the costs, including Coverdell, Section 529 savings, and Section 529 tuition plans. 

Contribute to a Coverdell Education Savings Account

You can contribute up to $2,000 per year to the child’s CESA. If you have several children, you can set up a CESA for each of them. 

Contributions are non-deductible, but earnings are allowed to accumulate free of any federal income tax. You can then take tax-free withdrawals to pay for the account beneficiary’s post-secondary tuition, fees, books, supplies, and room and board.

Maybe not for you. Your right to contribute is phased out between modified adjusted gross income (MAGI) of $95,000 and $110,000 if you are unmarried, or between $190,000 and $220,000 if you are a married joint-filer.

Contribute to a Section 529 College Savings Plan

Section 529 college savings plans are state-sponsored arrangements named after the section of our beloved Internal Revenue Code that authorizes very favorable treatment under the federal income and gift tax rules. 

You as the parent of a college-bound child begin by making contributions into a trust fund set up by the state plan that you choose. The money goes into an account designated for the beneficiary whom you specify (your college-bound child). 

You can then make contributions via a lump-sum pay-in or via installment pay-ins stretching over several years. The plan then invests the money using the investment direction option that you select. 

When your child reaches college age, you can take federal-income-tax-free withdrawals to pay eligible college expenses, including room and board under most plans. Plans will generally cover expenses at any accredited college or university in the country (not just schools within the state sponsoring the plan). Community colleges qualify as well.

In essence, a Section 529 college savings plan account is a tax-advantaged way to build up a college fund for your child.

Don’t Confuse Savings Plans with Prepaid Plans

Don’t mix up Section 529 college savings plans with Section 529 prepaid college tuition plans—which we will give only a brief mention here. Both types of plans are properly called “Section 529 plans” because both are authorized by that section of the Internal Revenue Code. Both receive the same favorable federal tax treatment. But that’s where the resemblance ends.

The big distinction is that prepaid tuition plans lock in the cost to attend certain colleges. In other words, the rate of return on a prepaid tuition plan account is promised to match the inflation rate for costs to attend the designated school or schools—nothing more, nothing less. That’s okay if that’s what you really want.

No Kiddie Tax on Section 529 Plan

You don’t have to worry about the kiddie tax if you set up a custodial 529 plan in the child’s name. The 529 plan is an investment plan where the monies remain in the plan. You make contributions with after-tax dollars.

When the child takes the money out of the plan for college, he or she does so tax-free when the funds are used to pay for qualified higher education expenses.

If you want to discuss your college-planning strategies, please call me on my direct line at 408-778-9651.

• By Leon Clinton
• December 31, 2020