IRS announces change to 2018 Schedule D Tax Worksheet

Technical topics regarding tax preparation.
#1
makbo  
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Hot off the electronic press from my software vendor (UltraTax), I have not seen a press release from IRS yet.

"IRS announces change to 2018 Schedule D Tax Worksheet
The IRS has reported to the professional tax software community that they have found that the Schedule D Tax Worksheet for Forms 1040 and 1041 were not properly taxing certain capital gains at the new lower 2018 tax rates, but instead the worksheet was taxing them at their maximum rate of 25% or 28%. The worksheets are used to figure regular tax in certain instances for Filers of Forms 1040, 1040-NR, 1041, and 990-T. The IRS has corrected these worksheets and released newer versions which have been included in UltraTax/1040 version 18.3.7 and UltraTax/1041 version 18.3.6 software updates. Refer to the User Bulletins for these updates for more information on what the IRS has changed and the tax returns affected."

[...]
"Per the IRS, only a fraction of returns meeting these specifications [not listed here] will have a different result in tax on the last line of the worksheet to carry to the tax return as the amount of regular tax."

So while the change might impact only a tiny number of taxpayers, unfortunately for those it does affect, there is a ripple effect throughout other forms on the return, such as 2210, PAL calculations, 1116, 2555.
 

#2
Chay  
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I think we all appreciate this update, thanks.

makbo wrote:So while the change might impact only a tiny number of taxpayers, unfortunately for those it does affect, there is a ripple effect throughout other forms on the return, such as 2210, PAL calculations, 1116, 2555.

I'm not sure how the amount of tax on collectibles and unrecaptured 1250 gain would affect PAL calculations or the foreign earned income exclusion. It seems to me that both of these calculations happen before the regular tax calculation. Passive activity credits would be impacted, but not losses.
 

#3
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At least UT was kind enough to add Data Mining searches specific to this update. After running the reports we found that 3.2% of our 1040 clients were affected, but out of all of those "affected" only one has a significant change. Most of the others the tax only changed by $1.
 

#4
jesella  
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Thank you for highlighting this. Apparently I skim release notes too quickly and nearly missed it. Of the 500+ returns we processed, 16 showed up in the UT data mining for this, and of those, 5 are now due refunds ranging from $200 - $1,000. If we have to look stupid to our clients for an error in tax calculation, at least we get to follow that up with their refund amount.
 

#5
makbo  
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Chay wrote: Passive activity credits would be impacted, but not losses.

I should have mentioned that I was paraphrasing the UltraTax release notes, not doing my own independent analysis. Yes, they specifically emphasized Form 8582-CR as a possible form affected by the Schedule D worksheet update.

Ironically, I would normally depend 100% on my software to determine what other forms changed in a given return as a result of this update.

jesella wrote:Apparently I skim release notes too quickly and nearly missed it. [...] If we have to look stupid to our clients for an error in tax calculation, at least we get to follow that up with their refund amount.

It was in the Product News section of the home page when you open UT, at least that's where I saw it. I don't always download updates immediately (so I don't see the release notes), but I do read the new product news and alerts on the home page.

I don't think you have to look stupid. If what UT wrote was accurate, it was clearly the IRS' mistake, not yours. I don't think a client expects you to beta test every single calculation in your software.
 

#6
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Did this have to do with the often-misunderstood tax brackets and rates for certain long-term capital gains, which go up to a maximum of 25%, but don't *start* at 25%? This calculation is clearly misunderstood, as no one seems to be able to put it in simple words. But only the software writers really *have* to, and it appears they, too, can't get it right all the time, either.

Where was that post that sorta said that if the tax rules are too complicated to explain, they are too complicated?
 

#7
Nilodop  
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"clearly misunderstood" is a catchy phrase.
 

#8
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Thank you, Len.

Here's the quote that said if something's too complicated, it's too complicated:
There is serious academic research suggesting that if tax law is too complicated to be explained to a layperson at the level of an IRS pub or form instruction, it is too complicated to be law.
-makbo, 26 Apr 2019.
 

#9
makbo  
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Per UltraTax user bulletin, "The IRS changes are limited to renumbering line 18 on the Form 1040 Schedule D Tax worksheet as line 18a, adding new lines 18b and 18c, and updating the line references accordingly on line 19." My first take is that some taxable income amounts that used to be in the 28% and 33% tax rate brackets pre-TCJA are now in the 24% bracket, so yes, less than 25% maximum rate. And lots of taxpayers even with capital gains income don't use Schedule D tax worksheet, they use the Qualified Dividends and Capital Gains Tax Worksheet, which was not mentioned as having any changes.

"But only the software writers really *have* to, and it appears they, too, can't get it right all the time, either."

It's not the fault of the software programmers (not "writers"). Their job is to implement officially published IRS forms and worksheets as they exist. Now, perhaps they should have alerted the IRS to a possible bug in the worksheet, but it would still not be good for them to implement a change on their own that didn't match official IRS publications. And equally, those who still fill out their income tax returns by hand on paper should also have caught the problem. Maybe they did; we don't know what brought the error to the attention of the IRS -- internal or external reporting.

The phrase "maximum rate of 25%" is pretty clear, but people don't always pay close attention.

And let's not forget to allocate appropriate blame to Congress. In their effort to "simplify" taxes, they assigned explicit brackets to cap gains rates under TCJA, instead of the previous method of simply tying them to the regular tax brackets. So, this made the calculation more complicated.

As for the mention of tax law complexity, I actually posted the link to the research paper that addressed this somewhere around here in the last year or two, but no time to go look for it right now. My more recent comment was just paraphrasing what I had posted and linked to previously.
 

#10
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I discovered this Back in March, but as a lowly new CPA, no one seemed to listen to me, or really, they had no time. I sent in a form request submission to the IRS then and informed our tax software providers. I don't know what has gone on behind the scenes, whether there were a lot of people that realized this, or if it was just me. But I haven't found any professionals talking about it, and I just posted it to Facebook and a general intellectual discussion board because I had no clue about any professional discussion sites. I found this one by searching for the text of the software update to see if there was anything out there yet.

http://boards.straightdope.com/sdmb/sho ... p?t=871932
https://www.facebook.com/steven.l.glowacki - just publicly reposted my March post on the subject.

I would like *some* credit from *someone*. I'm not sure if I'm going to get it.
 

#11
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The IRS has reported to the professional tax software community...


The IRS has corrected these worksheets and released newer versions which have been included in this update.


The Schedule D instructions on the IRS website still show the revision date as Dec. 21, 2018 and the tax worksheet is still the old one. Has anyone found anything from the IRS regarding this?
 

#12
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Glowacks: Kudos, and welcome to the best tax forum I've been on today!
 

#13
JAD  
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glowacks, excellent catch!
 

#14
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I just did the UT data mining, and found it to be overly broad. Now I can understand returning the results for people with only a few dollars of 1250 gain, but why is it returning those in the 12% ordinary bracket and those with net capital losses? I guess they searched by taxable income, compared that to the ordinary income tax levels this bug affected, and returned all of those with any 1250 gain. So if the (normal) capital gain put them above the 22% threshold for ordinary income if it had all been ordinary, it would be returned, as well as those with no capital gain tax because of a loss - so long as they were in the right ordinary tax bracket.

Still, I did find another that I hadn't worked on that will be getting a sizable sum back when we amend, and I doubt my boss would have found it, nor would I have without the UT data mining. It looks like on that one all the 1250 gains came in on K-1s after I had worked on it, so I hadn't flagged it for special handling.

Another hilarious part about this is that the worksheet actually worked perfectly on one occasion: when all the capital gain was 1250. The reason it worked there is that there's a sanity check at the end of the worksheet so that you don't end up paying a dollar more because of rounding issues when you have a very small amount of capital gain. That sanity check might have been the reason the IRS didn't catch it before, because they may have thought the sanity check would *always* fix that problem, forgetting that it wouldn't if there was actually a significant capital gain (which there very often is when there's 1250 gain, but in one case there was no other capital gain because the only gain was due to depreciation taken on a home converted from primary residence to rental and sold within the time frame to have the non-depreciated gain excluded still).
 

#15
Chay  
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glowacks wrote:there's a sanity check at the end of the worksheet so that you don't end up paying a dollar more because of rounding issues when you have a very small amount of capital gain.

You not only found the error but you also understand the deeper meaning of each line? How do you know so much about this worksheet, especially considering you seem to be relatively new to the profession?
 

#16
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I guess they searched by taxable income, compared that to the ordinary income tax levels this bug affected, and returned all of those with any 1250 gain.


The UltraTax search criteria is limited to those with either net 1250 gain or 28% gain, and Schedule D Tax Worksheet (original version) Line 18 below 157,500 (315,000 for MFJ or QW).

I attempted to further restrict the data mining to only those with net capital gain but gave up in quick order. While the data mining tool is quite powerful it is also horrendously cumbersome to use. Much easier to just open each of the clients and compare the recalculated worksheet to the original version in the file.
 

#17
makbo  
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As of today 5/14, the UltraTax product news display, when starting the software, states:

"Important! The updated worksheet will also be posted to IRS.gov on May 16th, 2019 but is already included in UltraTax/1040 version 18.3.7 and UltraTax/1041 version 18.3.6 software updates. The IRS will review returns filed prior to May 16th, 2019 to determine any needed corrections. These taxpayers do not need to file an amended return, call the IRS, or take any other action at this time."
 

#18
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And, Glowacks, you spelled "threshold" correctly, too. Well done! You'll find this forum to be a great place on which to do many things... Stick around!!
 

#19
makbo  
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Chay wrote:
glowacks wrote:there's a sanity check at the end of the worksheet so that you don't end up paying a dollar more because of rounding issues when you have a very small amount of capital gain.

You not only found the error but you also understand the deeper meaning of each line? How do you know so much about this worksheet, especially considering you seem to be relatively new to the profession?

I finally got around just now to following the early March 2019 link that Glowacks posted.

I don't want to take away from Glowacks, as full credit for this helpful follow-through is due to them, it is of great value to many of us and our clients --

BUT, the concept that the 25% rate that pertains to Sec 1250 gain (ditto for collectibles 28% rate) is a MAXIMUM rate is just not that difficult or complicated to understand. In fact, I would expect someone newer to taxes to have a better grasp of this, I know I did in my first few years as a tax pro. It was one of my H&R office mates in my first few years who pointed out to me that the rate was a max only, and you would not be taxed on capital gains at > your regular tax rate. As one in the early years of the profession might agree, you are more open minded and skeptical when it comes to asking whether something is correct than someone who is comfortable with a wide variety of tax returns, and thus is lulled into a false sense of confidence.

The other piece of this is actually working through the Schedule D Capital Gains worksheet, which of course includes the AMT version as well. (I hope IRS remembers to fix that? Or does the AMT version need fixing?) I must confess, the one year I sold some real estate that was subject to multiple tax rates, I went through the worksheet line by line myself, but that was before I was a tax pro, and I haven't gone through it with such attention to detail since then.
 

#20
Chay  
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makbo wrote: the concept that the 25% rate that pertains to Sec 1250 gain (ditto for collectibles 28% rate) is a MAXIMUM rate is just not that difficult or complicated to understand. In fact, I would expect someone newer to taxes to have a better grasp of this, I know I did in my first few years as a tax pro.

I don't think glowacks is looking for credit for having understood this. I agree it's pretty basic, and in fact I'm surprised to hear you suggest that any tax pros with more than a couple years of experience might not have an intuitive understanding of it.

makbo wrote:The other piece of this is actually working through the Schedule D Capital Gains worksheet, which of course includes the AMT version as well. (I hope IRS remembers to fix that? Or does the AMT version need fixing?) I must confess, the one year I sold some real estate that was subject to multiple tax rates, I went through the worksheet line by line myself, but that was before I was a tax pro, and I haven't gone through it with such attention to detail since then.

And I'm sure that if you actually sat down with the 2018 IRS worksheet and went through it line by line with a return affected by the mistake, you would have caught it too. I'm know I would have.

The difference is that neither of us actually did. And I seriously wouldn't expect anyone to. Like you said, this stuff is so basic it's beyond thinking about. But glowacks did. Somehow it came to his attention, and I doubt it was the pure dumb luck of just happening to study a particular worksheet just a few months after the IRS happened to make a mistake on that worksheet.
 

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