Month: December 2017

What’s up with the new IRS letters asking about your 1099-K’s ?

News

Form 1099-K reports credit card sales to the IRS and also gives the IRS another audit weapon. The rules have now been around long enough to appear in court cases, the last of which prompted me to write this post.

When lawmakers enacted the rules for the 1099-K, they stated that the reason for the new 1099-K was to improve “voluntary” compliance by business taxpayers and to help the IRS determine if business tax returns are correct and complete.

There’s little question that the 1099-K has improved and will continue to improve voluntary compliance because with the 1099-K weapon, the IRS now knows how much money businesses have collected with credit cards.

The 1099-K is sent to the business and also filed with the IRS by banks and other organizations that settle payment card transactions.

Businesses should receive 1099-Ks for debit, credit, and stored-value card transactions, although transactions handled by PayPal and other third-party payers are exempt if the payments are under $20,000 and there are fewer than 200 transactions during the year.

Form 1099-K reports the gross amount of transactions settled for the business during the prior year. It includes sales tax, shipping, and other fees or charges to the customer, as well as tips in the case of a bar or restaurant. The 1099-K does not include amounts that banks and credit processors charge the business for use of its merchant cards.

On your business tax return, your business may report credit card and other card receipts on a net basis. For example, say the gross receipts you report on your tax return don’t include sales taxes. But the 1099-K forms your business receives report the gross dollar amounts, and those amounts include the sales taxes.

This means that the IRS cannot verify whether the 1099-K amounts were properly reported on a business’s tax return without requesting additional information from the business. For that reason, the IRS developed a series of three letters. It sends one of the letters to businesses with smaller-than-expected income based on its analysis of Form 1099-K.

For us, you and me, this means we should get together and review your books to see what we can do to reduce the likelihood of receiving one of those three IRS letters asking about your 1099-Ks.

 

Should children use IRA’s to pay for college? What about the kiddie tax?

Kiddie Tax

When it comes to college planning, our lawmakers created some real traps.

One big trap is the kiddie tax. This insidious tax destroys the traditional IRA as a college funding source and does much the same to your child’s interest and dividends savings.

There’s much to know here. For example, consider the three questions and answers below:

Question 1. Does the tax code penalize children who accumulate a college nest egg and currently have $7,000 in dividends and interest that they use for college?

Answer 1. Yes, more than likely!

Question 2. Does the tax code penalize children who withdraw $7,000 in funds from a traditional IRA and use that money for college?

Answer 2. Yes, more than likely, but not as you would expect.

Question 3. Does the tax code penalize children who withdraw $7,000 in funds from a Roth IRA and use that money for college?

Answer 3. No, not if the withdrawal is from contributions only.

The problem in questions 1 and 2 is the kiddie tax. It applies the parents’ highest tax rate to the under-age-24-student child’s unearned income when

  • the child’s unearned income is more than $2,100, and
  • the child’s earned income is not more than half of his or her support.

The kiddie tax applies regardless of whether your child is your dependent if the child’s earned income is not more than half of the child’s support.

Example. Jane sells stock for $90,000 that her grandmother gave her. At the time of sale, the stock has a basis of $10,000, and that produces an $80,000 capital gain. Jane uses the $90,000 for living expenses and college. Her parents provided none of her support for the year. But because of the kiddie tax, Jane pays taxes on the $80,000 capital gain at her parents’ tax rate.

To avoid the ugliness caused by the kiddie tax, we need to do some planning. Please call me and set a time that’s convenient for you so we can put plans in place.

 

Working with the IRS mileage and vehicle deduction rules.

Vehicle Rules

You have no choice if you want to deduct the business use of vehicles.

You are face-to-face with the IRS’s business and personal mileage rules. And you face the same mileage rules regardless of how you operate your business (as a corporation, proprietorship, or partnership).

You find the basic mileage rules in Revenue Ruling 99-7, which pretty much controls whether your trip from home to a location is going to be a business or personal trip.

As a business owner, you want maximum business mileage so as to create the most deductions for you whether you drive one, two, or three vehicles for business.

But you want only legitimate miles. You don’t want to put the IRS in a position where it has to deny your business mileage because you violated the mileage rules.

Mileage violations can make you look like a tax cheat. If the IRS thinks you cheat on your taxes, it is going to open you up for a full-blown examination.

Commuting to work gives you nothing but pain, let’s eliminate the pain.

The IRS gives you two possible strategies for turning otherwise personal mileage into business mileage:

  1. Going to a temporary work location
  2. Establishing an office in the home as a principal office

The temporary work location strategy contains some real unknowns, such as:

  • What is a temporary work location?
  • When is work at that location performed for one year or less?

The two possible unknowns above can make it difficult or impossible to use your facts and circumstances to produce your desired business-mileage results.

The easy solution is the office in the home as a principal office.

The first reason this type of home office is an easy solution is that the rules are crystal clear, making compliance easy. The second reason is that with this office you know that all trips from home for this trade or business are business trips, including the trip from your home to your regular office outside the home.

Many business owners  have a genuine opportunity to increase their business mileage and thereby add to their  bottom line. Let’s set up a time to discuss some strategies that can work for you.

 

Do you have your 2018 expensing in place?

News

For 2018, you can elect the de minimis safe harbor to expense assets costing $2,500 or less ($5,000 with audited financial statements or something similar).

The term “safe harbor” means that the IRS will accept your expensing of the qualified assets if you properly abided by the rules of the safe harbor.

Here are four benefits of this safe harbor:

  1. Safe harbor expensing is superior to Section 179 expensing because you don’t have the recapture period that can complicate your taxes.
  2. Safe harbor expensing takes depreciation out of the equation.
  3. Safe harbor expensing simplifies your tax and business records because you don’t have the assets cluttering your books.
  4. The safe harbor does not reduce your overall ceiling on Section 179 expensing.

Here’s how the safe harbor works. Say you are a small business that elects the $2,500 ceiling for safe harbor expensing and you buy two desks costing $2,100 each. On the invoice, you see the quantity “two” and the total cost of $4,200, plus sales tax of $378 and a $200 delivery and setup charge, for a total of $4,778.

Before this safe harbor, you would have capitalized each desk at $2,389 ($4,778 ÷ 2) and then either Section 179 expensed or depreciated it. You would have kept the desks in your depreciation schedules until you disposed of them.

Now, with the safe harbor, you simply expense the desks as office supplies. This makes your tax life much easier.

To benefit from the safe harbor, you and I do a two-step process. It works like this:

Step 1. For safe harbor protection, you must have in place an accounting policy—at the beginning of the tax year—that requires expensing of an amount of your choosing, up to the $2,500 or $5,000 limit. I can help you with this.

Step 2. When I prepare your tax return, I make the election on your tax return for you to use safe harbor expensing. This requires that I attach the election statement to your federal tax return and file that tax return by the due date (including extensions).

Construction? Write Music? Here’s a tax break you might not have thought about!

News

When you think of American manufacturers, you might imagine fiery steel mills or clanking auto assembly lines. But at least when it comes to the generous “domestic production activities” deduction in the tax code—a lot more business owners qualify than you might think.

You may not think of yourself as a manufacturer, but you might nevertheless qualify as one under tax law.

There is a deduction for manufacturing that applies to a much broader array of activities than you would think. There’s no catch and no recapture associated with this deduction—it’s just extra cash for your wallet.

The deduction, in general, is for people who convert starting materials into a new finished product in their business, and if you think about it, that covers a tremendously broad array of activities, including these:

Construction
Certain dental procedures
Writing computer software
Creating music recordings
Producing crafts and other goods
Raising livestock
Farming
The deduction can be substantial—up to 9 percent of all income from qualifying activities.

Here are the basic steps to calculate the deduction:

Determine your income from qualifying production activities.
Deduct the costs attributable to the production activity, including the cost of goods sold and an allocable share of other business expenses.
Multiply the result (or, if less, your taxable income) by 9 percent. That’s your tentative deduction.
The deduction is “tentative” only because you have to factor in a wage limitation: your deduction cannot exceed 50 percent of the amount your business pays as W-2 wages for work attributable to the qualifying activity.

As I said earlier, there’s no catch, no drawback, and no recapture provision associated with the deduction. If you have qualifying activities, it’s just extra money for you to put in your pockets.

If you think you have activities that can qualify for this deduction, please call me to schedule an appointment. This could be very worthwhile.

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Could using antiques in your business help your bottom line? Read this…

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Here’s a good business rule to follow: buy low and sell high.

That’s good, but the three-step process below is even better:

1.Buy low.

2.Depreciate to zero.

3.Sell high.

And you can accomplish this by using antiques in your business.

Let’s say you narrowed the purchase of your business desk to either an antique or regular desk. Each desk sells for $5,000.

Which desk gives you the best possible business result? The antique.

Is the difference worth thinking about? Yes, the difference is absolutely worth thinking about!

Let’s say you buy the antique and Fred, your buddy, buys the new desk. You each use your desks for 10 years and then sell them.·

You sell your antique desk for $15,000.·

Fred sells his regular desk for $500.

You are kicking Fred’s you-know-what when it comes to selling results. But to see the true financial results, you need to look at the after-tax numbers.

After-Tax Numbers

Let’s say that both you and Fred are in the 35 percent income tax bracket and 15 percent capital gain bracket at the time of sale. On the $15,000 proceeds from the sale of your antique desk, your federal taxes are·

$1,500 on the $10,000 capital gain part of your profits ($15,000 selling price minus $5,000 original basis times 15 percent);·

$1,750 on the $5,000 of depreciation recapture ($5,000 original cost depreciated in full, recaptured and taxed at the ordinary income tax rate of 35 percent).

After taxes, you pocket $11,750 on the sale of your antique desk ($15,000 minus $1,500 minus $1,750).

On Fred’s sale of his regular desk, he pockets a measly $325 after taxes ($500 sales proceeds minus $175 in recapture taxes).

The antique desk gives you 36 times more cash than Fred’s desk gives him ($11,750 compared with $325). Imagine how you could beat Fred like a rug with an entire office full of antiques!

Ton of Logic

If you can buy an antique car, clock, rug, desk, cabinet, bookcase, paperweight, conference table, chair, umbrella stand, coatrack, library table, or other asset that will function in your business just as well as a new purchase, take the antique that might increase in value. It simply adds to your net worth.

How many business assets have you bought and used in your business that have gone up in value?

If you are like most businesspeople, the answer to this question is “none” or “very few.” In fact, you may not have considered antiques at all.

But now that you know their business potential, give antiques a serious look. With antiques, you can get the best of all worlds:·

beautiful assets you use in your business,·

assets you can depreciate and/or Section 179 expense against your business income, and·

assets that can increase in value.

If you were to buy antiques for your business today, you could expense up to $500,000 of qualifying costs using Section 179 expensing.

Year-end opportunity. We are closing in on the end of the year. Are you looking for some last-minute deductions? Consider antiques!

Say Thanks to the Musicians

Many years ago, antiques could not produce depreciation deductions. But that has totally changed thanks to two musicians who fought hard for us.

It began back in 1984 when a professional violinist named Brian Liddle walked into a Philadelphia antique shop and bought a $28,000 17th-century bass violin made by the famous Italian craftsman Francesco Ruggeri.  Mr. Liddle didn’t simply display his Ruggeri. He played it during performances.

Over time, the instrument began to wear down. Although he had it repaired, the Ruggeri never recovered its “voice.” So, in 1991, Mr. Liddle traded the violin for an 18th-century bass violin with an appraised value of $65,000.

Note this. Mr. Liddle depreciated the $28,000 bass violin that lost its voice to zero and then traded that fully depreciated violin even up for a $65,000 bass violin. That’s smart business—depreciable working assets that appreciate.

While all this was happening in Philadelphia, a strangely parallel series of events was unfolding up the New Jersey Turnpike in New York City. In 1985, a gentleman named Richard Simon, who played violin for the New York Philharmonic Orchestra, bought a pair of 19th-century French Tourte bows with appraised values of $35,000 and $25,000.

Like Mr. Liddle, Mr. Simon actually used his bows to perform. Like Mr. Liddle’s Ruggeri, Mr. Simon’s Tourte bows began to wear out. And like Mr. Liddle’s violin, Mr. Simon’s bows appreciated in value on the antiques market even though they were “played out” musically.

On his 1989 income tax return, Mr. Simon claimed accelerated cost recovery system (ACRS) depreciation deductions on the bows. The IRS said no. The Liddle case reached the U.S. Court of Appeals for the Third Circuit; the Simon case went to the Second Circuit. The courts decided to consolidate the cases and deal with them together.

The Courts’ Rulings

Assets qualify for ACRS depreciation as long as they’re actually used in a trade or business and suffer wear and tear.

Mr. Liddle’s Ruggeri violin and Mr. Simon’s Tourte bows met both prongs of the test, the courts reasoned. The taxpayers didn’t treat the instruments as mere showpieces or collector’s items; they actually used them as tools to earn their livelihood.

And such use caused the instruments to wear down. In this way, the antiques were just like any other business asset that wears down as a result of use.

CAVEAT
The IRS has never officially accepted the Liddle and Simon cases. See the IRS position discussion below to find out about the IRS’s official opposition and why that opposition shouldn’t discourage you from depreciating or expensing antiques.

In the Liddle and Simon cases, the appeals courts agreed with the majority opinions of the Tax Court that these two professional musicians who used antique and collector violins and bows in their businesses as musicians for the orchestras could depreciate the antique and collector violins and bows as business assets.

The musical instruments in these cases were almost 300 years old when they were purchased for about $30,000. After being used in business for less than 10 years and depreciated to zero by the musicians, the instruments were worth about $60,000.

The courts noted that before the Economic Recovery Tax Act of 1981 (ERTA) changed the depreciation rules, antiques could not be depreciated, no matter how often they were used in business.

According to the Tax Court, the Second Circuit Court of Appeals, and the Third Circuit Court of Appeals, you and these musicians may now depreciate and Section 179 expense antiques.

ERTA eliminated the useful-life rules and put in their place statutory depreciation periods that we use today with MACRS depreciation. That change means that you now qualify for tax-favored expensing and depreciation when you·

physically use the antiques in the normal course of business; and·

subject the antiques to wear and tear as you do any other assets.

The IRS Position

The IRS did not agree with the results in the Liddle and Simon cases and issued a formal nonacquiescence in 1996, stating that it would attack taxpayers seeking antique depreciation in the other seven circuits.5 This was 21 years ago. The IRS has not attacked anyone yet, and if it did, we think that the IRS would surely lose.

Your Position

As we discuss below, we think it unlikely that the IRS will attack any depreciation on an antique physically used in your business.

The IRS certainly is not going to attack antique depreciation if you live in Vermont, Connecticut, New York, New Jersey, Pennsylvania, Delaware, or the Virgin Islands. Why? These are the areas covered by the Second and Third Circuit Courts of Appeals where Liddle and Simon had their Tax Court wins affirmed at the appellate levels.

Further, beginning shortly after ERTA, lawmakers improved taxpayer rights. Now the courts can order the payment of attorney fees when the IRS brings a case that is “not substantially justified”6 and you or your business meets the net worth requirements. The IRS, in its Publication 556, explains “not substantially justified” as follows:

The position of the United States is presumed not to be substantially justified if the IRS·

did not follow its applicable published guidance (such as regulations, revenue rulings, notices, announcements, and private letter rulings and determination letters issued to the taxpayer); or·

has lost in courts of appeal for other circuits on substantially similar issues.

If you live in a jurisdiction outside the Second or Third Circuits, you are not likely to face an IRS attack on your antique depreciation, for two reasons:

1. The IRS has already lost in other courts of appeal—the Second and Third Circuit Courts. (Thus, bringing a case along the lines of Liddle and Simon and losing would clearly be “not substantially justified” and could require the IRS to pay lawyer fees.)
2. The IRS has not made any new challenges since it issued its nonacquiescence in 1996.

Your Tax Preparer’s Position

Your tax preparer can rely on Liddle and Simon as meeting the “more likely than not” standard for tax deductions. This is the standard that’s met when there is a likelihood greater than 50 percent that the deduction position will be upheld.

The “more likely than not” standard is better than the “substantial authority” standard, albeit your preparer also gains substantial authority with Liddle and Simon and thus has both standards met for antique depreciation and/or Section 179 expensing.

All of this means that your tax preparer has no exposure to tax law penalties because of your antique deductions.

Artwork Doesn’t Make the Deduction Grade

Antiques are deductible when they suffer wear and tear from physical use in the business. In Noyce, the court found a painting not deductible, because it did not suffer substantial wear and tear through its regular, active, and physical use in a trade or business.

You Beat the Antique Dealer

When you can use an antique in your business, you pocket more cash than the antique dealer would pocket.

At the time of sale, the antique dealer deducts the cost of the antique as a cost of sale. The profit is subject to ordinary income taxes and, if the dealer is self-employed, to self-employment taxes.

As a businessperson, you have the following advantages over the antique dealer:·

You can deduct your cost of the antique at the time of purchase using Section 179 expensing (the dealer has to treat the antique as inventory, and gets no deduction for the antique’s cost until the sale takes place—maybe a year or so after purchasing it).·

The profit in excess of your purchase price is a Section 1231 gain (because the asset is used in your business). Assuming no offset with Section 1231 losses, your Section 1231 gains on the sale of antiques used in the business for over a year are treated as tax-favored long-term capital gains.

Retroactive Deductions

You may already own antiques that you are using in your business and that you have not deducted because you were following the old rules.

You may now claim the benefits from the overlooked depreciation this year by retroactively claiming what you missed, using IRS Form 3115.

Example. Fifteen years ago, Sam Aspen bought an antique clock to dress up the entryway to his office. At that time, he and his tax preparer decided that they would not depreciate the clock, because it was an antique.

Today, realizing that he can deduct this antique clock because he physically uses it in his business, winding it every week, Mr. Aspen files IRS Form 3115. This puts all of that clock’s prior years’ depreciation on this year’s tax return. Mr. Aspen is very happy with these newfound tax deductions.

 

Takeaways

You have to love the two musicians who took on the IRS to win depreciation deductions on their antique musical instruments. There must be something about orchestras. Over the years, musicians from orchestras have won a variety of court cases on business issues ranging from the home-office deduction to violin depreciation.

If you have the type of business in which you can choose an antique as a functioning asset in your business, the antique is the best choice because a properly acquired antique will increase in value and produce tax-favored long-term capital gains when sold, and is eligible for immediate expensing under Section 179 or, if you prefer, depreciation over time.

Antiques likely beat your non-antique assets by 5, 10, 15, 25, 35, or more times in adding to your net worth. Antiques are definitely tax-favored assets that add extra cash to your business. You owe it to yourself to give antiques serious consideration as asset purchases for use in your business.

Passive-loss rules and rental properties. Ways around the rules.

News

Two scary words in tax reform are “fairness” and “simplification.”

In most cases, this combination raises your taxes and makes the law more complex.

As you likely know, tax reform is in the air again, and it will bring its share of good and bad news. But for your rental real estate loss deductions, the good news is that the reform being considered does not alter the beneficial strategies here.

In general, rental properties are passive activities subject to the dreaded passive-loss rules. IRS regulations contain six non-rental exceptions to the definition of rentals. In most cases, the non-rental exceptions are, for tax purposes, businesses. To deduct losses from any of the six exceptions, you simply need to materially participate in the activity.

Exception 1—Seven Days or Less

Properties that you rent for customer use for an average period of seven days or less are not rental properties subject to the rental real estate rules. Examples of this type of property include ski cabins, condo rentals, beach homes, lake cabins, tuxedo rental companies, car rental companies, and tool and equipment rental companies.

Exception 2—30 Days or Less

You have a business, like a hotel or motel, when your average period of customer use is 30 days or less and you provide significant personal services with the rental.

Exception 3—Extraordinary Personal Services

You do not have a rental property when you provide extraordinary personal services when making the property available for use by customers (without regard to the average period of customer use).

You provide extraordinary personal services only if the services are performed by individuals and if the use by customers of the property is incidental to the receipt of such services (for example, in hospitals, nursing homes, and boarding schools).

Exception 4—Incidental

You do not have a rental property when the principal purpose for holding the property during a taxable year is to realize gain from the appreciation of the property, and when the gross rental income from the property for such taxable year is less than 2 percent of the lesser of

  • the unadjusted basis of such property or
  • the fair market value of such property.

Similarly, you do not have a rental property activity when you rent property to a business in which you have an interest and when the property was predominantly used in the business during the taxable year (or during at least two of the five years immediately preceding the taxable year) and the gross rental income from the property for such taxable year is less than 2 percent of the lesser of

  • the unadjusted basis of such property or
  • the fair market value of such property.

Exception 5—Rental for Customer Use of Facility

Under this exception, you customarily make the property available during defined business hours for nonexclusive use by various customers (for example, golf courses, health clubs, spas).

Exception 6—Providing Property

You do not have a rental property activity when you provide (not rent) property for use in a non-rental activity of your own S corporation or joint venture. The key phrase here is “provide, not rent.”

Example. A shareholder provides property for use by an S corporation in which he has an interest. This non-leasing transaction with the corporation is not a rental. (Also, it is likely a mess for tax purposes because the corporation is a separate legal entity.)

If you have any of the properties above, we should examine the special rules that apply to ensure that you are getting your best tax benefits. If this sounds like a good idea to you, please call me so I can help you with this.