Beware of the American Rescue Plan’s cliffs
The IRS has been described as the defender of the “fisc,” that is the federal revenue stream that funds the government.
Students of history know well the value of a cliff to a defender.
The Allied invasion of Normandy in 1944 included a famous ascent by Army Rangers at La Pointe du Hoc. As the Rangers scaled a 100-foot cliff, they were met with machine gun fire and grenades. At great cost, they finally secured the cliffs.
Similarly, the last great battle of the war included a perilous ascent of a 400foot cliff on the island of Okinawa called Hacksaw Ridge. This cliff was so challenging that Japanese defenders were unable to establish positions to fire at those scaling the cliff. They instead waited at the top of the cliff.
The 1987 movie “The Princess Bride” also made use of a cliff. After Fezzik carried himself and three others up the vertical cliff, the swordsman Inigo waited for the “Man in Black” to finally ascend. Demonstrating his sportsmanship, Inigo allowed his pursuer a chance to recover before beginning their battle.
While lives are not at risk, tax laws that construct cliffs can be perilous to those who seek the benefits of the law.
The American Rescue Plan relies on cliffs.
The plan offers tax relief to unemployment benefits received in 2020, but only to those who can scale a vertical cliff. A single taxpayer with adjusted gross income (AGI) below $75,000 can exclude as much as $10,200 of unemployment benefits from income.
This means that if a single person has $74,000 of W-2 wages, $10,000 of unemployment benefits, and no other income or deductions, he can exclude the entire $10,000 of benefits.
If a single person instead has $75,000 of W-2 wages and $10,000 of unemployment benefits, then all of the unemployment is subject to tax. That additional $1,000 of income translates into $11,000 of additional taxable income. The culprit is an income cliff.
The new law also provides for a $1,400 stimulus payment for qualifying taxpayers and each of their dependents. This benefit has a small phase-out window. If married filing joint (MFJ), the payment is reduced as AGI exceeds $150,000 and is gone when AGI reaches $160,000.
So travel back with me to my family situation of yesteryear. I have four children who once were younger and qualified as my tax dependents. I filed using the MFJ tax status. Using me as an example for the 2021 stimulus, let’s determine my family benefit.
To begin, assume I compute the family AGI to be $150,000. I properly compute my stimulus to be $8,400. That’s $1,400 times six.
Unable to contain my enthusiasm, as is often the case for a CPA presented with an interesting calculation, I quickly gather the family for a presentation. Family, I say, I am taking all of us to Disney World for a week’s stay at a Disneyrun resort.
Excitement follows. The tiniest of the children pronounces, “God bless us everyone!” That very day they present me with a T-shirt that says “World’s Greatest Dad.” It is indeed a day to remember.
That night, as I clean up the confetti that surrounds the dining room table where my great tax computations were performed, I notice a piece of paper wedged under the seat cushion. It is a Form 1099-MISC. It reports $10,000 of income paid to me.
Must have dropped this, I think. Yet it does not look familiar. I compare it to the calculations done earlier. I’ve omitted this income. My pulse quickens. The World’s Greatest Dad T-shirt darkens with perspiration.
Adding the income to my earlier work raises AGI to $160,000. The stimulus payment drops to zero. My tax liability also goes up by $2,200 based on the added income. This $10,000 of omitted income has cost me $10,600 in tax.
Cliffs are perilous. Try to return a World’s Greatest Dad T-shirt stained with perspiration. Try to raise money with GoFundMe using a heartstring-tugging story of cliffs and needing the funds available before the kids wake up the next morning.
The 18th century poet Robert Burns said, “Suspense is worse than disappointment.” Now you know what to expect from the new law.