If you use your home computer for business purposes, knowing that you can deduct some or all of its costs can help ease the pain of the large initial and ongoing cash outlay. In today's economic climate, many individuals may be working more from home than commuting to the office. The deduction rules related to home computer costs can be complicated; some of the complexities are derived from situations in which the computer is used partly for personal use and partly for work purposes.

A tax deduction for all or part of the expense of a computer can still help lower the bottom-line price tag of a computer purchase. But despite both the widespread use of computers and the temptation to somehow "write them off" on a tax return, the business use of your home computer will need to fall within these standard rules if you want to take any related deductions.

Business reason

To claim a deduction for your home computer (and any peripheral equipment), you will need to prove that the expense occurred in connection with an active business - just as you would for any other business expense. An active business for purposes of a business expense related to a home computer will usually arise from one of two types of business activities: as a self-employed sole proprietor of an independently-run profit-making business; or as an employee doing work from home. Deductions from both types of activities are handled differently on an individual's income tax return and there are separate conditions that must be met for either scenario.

Employees. A miscellaneous itemized deduction on Schedule A is allowed for computer costs that are directly related to the "job" of being an employee. In order to claim a deduction for computer-related expenses as an employee, you must show a legitimate reason related to your employment for regularly using a computer at home. That is, you will need to demonstrate that the computer is used for the convenience of your employer and using the computer at home is a condition of your employment.

The availability of a computer in the office, the ability for you to keep your job without the home computer, the lack of telecommuting policy at work, or the lack of proof that your computer is used regularly for office work will make it more difficult to convince the IRS that a legitimate business reason exists for the deduction.

Note to employees. Computer-related business expenses taken as a miscellaneous itemized deduction are deductible only to the extent that your total miscellaneous itemized deductions exceed 2 percent of your adjusted gross income. For many taxpayers, a good strategy is to "bunch" purchases of computer equipment all in one year so that more of the cost will rise above the 2 percent floor.

Self-employed individuals. Self-employed persons generally have a less difficult time depreciating or expensing the cost of computers used exclusively in their businesses. In order for you as a self-employed person to deduct computer-related costs on Schedule C - whether for a home-based computer or one in a separate business location - it is required that your expenses relate to a profit-motivated business versus a "hobby". In the eyes of the IRS, a business will be deemed a hobby if there is no profit motive and the "business" is half-heartedly pursued simply to write off items or achieve some other personal purpose. If your Schedule C business shows a net loss year after year, you may be considerably more likely to have the IRS audit your return to inspect whether your purported business is actually legitimate under the tax law.

However, if you are self-employed and you also use the computer for personal purposes, be sure to use the computer more than 50 percent of the time for business purposes to gain the maximum deduction and to avoid recapture of prior computer-related deductions you have taken.

Other IRS considerations

Aside from applying the general rules discussed above for a for-profit business and miscellaneous itemized deductions to determine if you are able to deduct business-related computer costs, the IRS is likely to dust off other standard tax principles in evaluating whether your computer expense write off is acceptable:

Depreciation. Business items that have a useful life beyond the current tax year generally must be written off, or depreciated, over its useful life. As technological equipment, computer equipment is assumed to have a 5-year life. Accelerated depreciation of those 5 years is allowed for all but "listed property" (see below). An exception to the mandatory 5-year write off involves items that qualify for "Section 179" expensing (see below). Keep in mind that only the cost associated with the business-use portion of your computer can be expensed. Section 179 deduction. Section 179 expensing allows you to deduct each year up to $250,000 in 2009 of the cost of otherwise depreciable business equipment, including computers. As with depreciation, keep in mind that only the cost associated with the business-use portion of your computer can be expensed. "Listed property" exception. A computer used in the home is generally considered to be "listed property," which may limit the deductibility of associated costs and increase substantiation burdens on the taxpayer (unless the computer is used exclusively in your trade or business). A computer that is considered listed property may be depreciated only if you can prove that the computer is used for the convenience of your employer and is required as a condition of employment. This requires you to demonstrate that you cannot perform your job without the use of the computer.

The "listed property" exception will deny Section 179 expensing if a home computer is used only 50 percent or less for business purposes. If so, you must depreciate the computer evenly over 5 years. For example, if the business-use portion of a $10,000 computer is 80 percent, then $8,000 of its cost qualifies for direct expensing. If 45 percent is used for business, no part of the cost may be immediately expensed.

Recordkeeping. Since most home computers are "listed property," listed property substantiation rules apply. These rules require you to keep a contemporaneous log every time you use your computer to prove the percentage of your business use. Internet connectivity. If you use a modem to connect your computer to the Internet, keep in mind that the first phone line to a home office is not deductible, even on a pro-rated basis. A second line, however, may be written off as a business expense. If you connect via DSL or incur other Internet-only access service costs, be aware that the IRS has not taken a position here but some experts predict that the IRS eventually may consider the potential for personal Internet use to compromise such a deduction. Computer software. Computer software generally may be amortized using the straight-line method over a 36-month period if the costs are separately stated from the hardware. Computer repairs. Repairs that don't upgrade the useful life of the machine may be deducted immediately. However, making significant system enhancements, such as adding additional memory, would generally need to be added to basis and capitalized. If you have any questions regarding writing off the business-related costs associated with your home computer, please contact our office.

First and foremost, if you cannot pay the full amount of taxes due, you should nevertheless file your return by the April 15 deadline. Moreover, you should send in as much money as you can with your return. The IRS assesses failure-to-file penalties so you should file your return despite being unable to pay the full amount with the return. As such, it's to your benefit to file your return by its due date and pay off any outstanding balance as soon as you can in order to minimize interest and penalties.

Payment options

If you are not able to pay the full amount of tax you owe, you have options. While you can obtain an automatic six-month extension of time to file, the IRS will still assess interest on the outstanding unpaid tax liability. To do so, you must file Form 4868, Application for Automatic Extension of Time To File U.S. Income Tax Return, by the due date for filing your calendar year return (typically April 15) or fiscal year return. However, an extension of time to file is not an extension of the time to pay your taxes. Penalties and interest continue to accrue during the extension.

Second, consider paying some or all of your tax liability by credit card or obtaining a cash advance on your credit card. The interest rate your credit card or bank charges (plus applicable fees) may be lower than the total amount of interest and penalties imposed by the IRS under the Tax Code.

You may also be eligible to take advantage of the IRS's monthly installment agreement option. This option allows eligible taxpayers to pay off their tax bill over a period of time - in monthly installments - to the IRS. However, if you have entered into an installment agreement during the preceding 5 years you cannot use this option. Additionally, even while you are making payments through an installment agreement, penalties and interest continue on the unpaid portion of that debt. To request an installment plan, you can use Form 9465, Request For Installment Agreement. Or, you can use the Online Payment Agreement (OPA) application.

There are many options for paying off your tax debt. Our office can discuss the payment options that will work best in your specific circumstances. Please don't hesitate to call our office with questions.

The 2025 cost-of-living adjustments (COLAs) that affect pension plan dollar limitations and other retirement-related provisions have been released by the IRS. In general, many of the pension plan limitations will change for 2025 because the increase in the cost-of-living index due to inflation met the statutory thresholds that trigger their adjustment. However, other limitations will remain unchanged.

WASHINGTON–With Congress in its lame duck session to close out the remainder of 2024 and with Republicans taking control over both chambers of Congress in the just completed election cycle, no major tax legislation is expected, although there is potential for minor legislation before the year ends.

The IRS reminded individual retirement arrangement (IRA) owners aged 70½ and older that they can make tax-free charitable donations of up to $105,000 in 2024 through qualified charitable distributions (QCDs), up from $100,000 in past years. 

The IRS reminded individual retirement arrangement (IRA) owners aged 70½ and older that they can make tax-free charitable donations of up to $105,000 in 2024 through qualified charitable distributions (QCDs), up from $100,000 in past years. For those aged 73 or older, QCDs also count toward the year's required minimum distribution (RMD). Following are the steps for reporting and documenting QCDs for 2024:

• IRA trustees issue Form 1099-R, Distributions from Pensions, Annuities, Retirement or Profit-Sharing Plans, IRAs, Insurance Contracts, etc., in early 2025 documenting IRA distributions.
• Record the full amount of any IRA distribution on Line 4a of Form 1040, U.S. Individual Income Tax Return, or Form 1040-SR, U.S. Tax Return for Seniors.
• Enter "0" on Line 4b if the entire amount qualifies as a QCD, marking it accordingly.
• Obtain a written acknowledgment from the charity, confirming the contribution date, amount, and that no goods or services were received.

Additionally, to ensure QCDs for 2024 are processed by year-end, IRA owners should contact their trustee soon. Each eligible IRA owner can exclude up to $105,000 in QCDs from taxable income. Married couples, if both meet qualifications and have separate IRAs, can donate up to $210,000 combined. QCDs did not require itemizing deductions. New this year, the QCD limit was subject to annual adjustments based on inflation. For 2025, the limit rises to $108,000.

Further, for more details, see Publication 526, Charitable Contributions, and Publication 590-B, Distributions from Individual Retirement Arrangements (IRAs).

IR-2024-289

The Treasury Department and IRS have issued final regulations allowing certain unincorporated organizations owned by applicable entities to elect to be excluded from subchapter K, as well as proposed regulations that would provide administrative requirements for organizations taking advantage of the final rules.

The Treasury Department and IRS have issued final regulations allowing certain unincorporated organizations owned by applicable entities to elect to be excluded from subchapter K, as well as proposed regulations that would provide administrative requirements for organizations taking advantage of the final rules.

Background

Code Sec. 6417, applicable to tax years beginning after 2022, was added by the Inflation Reduction Act of 2022 (IRA), P.L. 117-169, to allow “applicable entities” to elect to treat certain tax credits as payments against income tax. “Applicable entities” include tax-exempt organizations, the District of Columbia, state and local governments, Indian tribal governments, Alaska Native Corporations, the Tennessee Valley Authority, and rural electric cooperatives. Code Sec. 6417 also contains rules specific to partnerships and directs the Treasury Secretary to issue regulations on making the election (“elective payment election”).

Reg. §1.6417-2(a)(1), issued under T.D. 9988 in March 2024, provides that partnerships are not applicable entities for Code Sec. 6417 purposes. The 2024 regulations permit a taxpayer that is not an applicable entity to make an election to be treated as an applicable entity, but only with respect to certain credits. The only credits for which a partnership could make an elective payment election were those under Code Secs. 45Q, 45V, and 45X.

However, Reg. §1.6417-2(a)(1) of the March 2024 final regulations also provides that if an applicable entity co-owns Reg. §1.6417-1(e) “applicable credit property” through an organization that has made Code Sec. 761(a) election to be excluded from application of the rules of subchapter K, then the applicable entity’s undivided ownership share of the applicable credit property is treated as (i) separate applicable credit property that is (ii) owned by the applicable entity. The applicable entity in that case may make an elective payment election for the applicable credit related to that property.

At the same time as they issued final regulations under T.D. 9988, the Treasury and IRS published proposed regulations (REG-101552-24, the “March 2024 proposed regulations”) under Code Sec. 761(a) permitting unincorporated organizations that meet certain requirements to make modifications (called “exceptions”) to the then-existing requirements for a Code Sec. 761(a) election in light of Code Sec. 6417.

Code Sec. 761(a) authorizes the Treasury Secretary to issue regulations permitting an unincorporated organization to exclude itself from application of subchapter K if all the organization’s members so elect. The organization must be “availed of”: (1) for investment purposes rather than for the active conduct of a business; (2) for the joint production, extraction, or use of property but not for the sale of services or property; or (3) by dealers in securities, for a short period, to underwrite, sell, or distribute a particular issue of securities. In any of these three cases, the members’ income must be adequately determinable without computation of partnership taxable income. The IRS believes that most unincorporated organizations seeking exclusion from subchapter K so that their members can make Code Sec. 6417 elections are likely to be availed of for one of the three purposes listed in Code Sec. 761(a).

Reg. §1.761-2(a)(3) before amendment by T.D. 10012 required that participants in the joint production, extraction, or use of property (i) own that property as co-owners in a form granting exclusive ownership rights, (ii) reserve the right separately to take in kind or dispose of their shares of any such property, and (iii) not jointly sell services or the property (subject to exceptions). The March 2024 proposed regulations would have modified some of these Reg. §1.761-2(a)(3) requirements.

The regulations under T.D. 10012 finalize some of the March 2024 proposed regulations. Concurrently with the publication of these final regulations, the Treasury and IRS are issuing proposed regulations (REG-116017-24) that would make additional amendments to Reg. §1.761-2.

The Final Regulations

The final regulations issued under T.D. 10012 revise the definition in the March 2024 proposed regulations of “applicable unincorporated organization” to include organizations existing exclusively to own and operate “applicable credit property” as defined in Reg. §1.6417-1(e). The IRS cautions, however, that this definition should not be read to imply that any particular arrangement permits a Code Sec. 761(a) election.

The final regulations also add examples to Reg. §1.761-2(a)(5), not found in the March 2024 proposed regulations, to illustrate (1) a rule that the determination of the members’ shares of property produced, extracted, or used be based on their ownership interests as if they co-owned the underlying properties, and (2) details of a rule regarding “agent delegation agreements.”

In addition, the final regulations clarify that renewable energy certificates (RECs) produced through the generation of clean energy are included in “renewable energy credits or similar credits,” with the result that each member of an unincorporated organization must reserve the right separately to take in or dispose of that member’s proportionate share of any RECs generated.

The Treasury and IRS also clarify in T.D. 10012 that “partnership flip structures,” in which allocations of income, gains, losses, deductions, or credits change at some after the partnership is formed, violate existing statutory requirements for electing out of subchapter K and, thus, are by existing definition not eligible to make a Code Sec. 761(a) election.

The Proposed Regulations

The preamble to the March 2024 proposed regulations noted that the Treasury and IRS were considering rules to prevent abuse of the Reg. §1.761-2(a)(4)(iii) modifications. For instance, a rule mentioned in the preamble would have prevented the deemed-election rule in prior Reg. §1.761-2(b)(2)(ii) from applying to any unincorporated organization that relies on a modification in then-proposed Reg. §1.761-2(a)(4)(iii). The final regulations under T.D. 10012 do not contain any rules on deemed elections, but the Treasury and the IRS believe that more guidance is needed under Code Sec. 761(a) to implement Code Sec. 6417. Therefore, proposed rules (REG-116017-24, the “November 2024 proposed regulations”) are published concurrently with the final regulations to address the validity of Code Sec. 761(a) elections by applicable unincorporated organizations with elections that would not be valid without application of revised Reg. §1.761-2(a)(4)(iii).

Specifically, Proposed Reg. §1.761-2(a)(4)(iv)(A) would provide that a specified applicable unincorporated organization’s Code Sec. 761(a) election terminates as a result of the acquisition or disposition of an interest in a specified applicable unincorporated organization, other than as the result of a transfer between a disregarded entity (as defined in Reg. §1.6417-1(f)) and its owner.

Such an acquisition or disposition would not, however, terminate an applicable unincorporated organization’s Code Sec. 761(a) election if the organization (a) met the requirements for making a new Code Sec. 761(a) election and (b) in fact made such an election no later than the time in Reg. §1.6031(a)-1(e) (including extensions) for filing a partnership return with respect to the period of time that would have been the organization’s tax year if, after the tax year for which the organization first made the election, the organization continued to have tax years and those tax years were determined by reference to the tax year in which the organization made the election (“hypothetical partnership tax year”).

Such an election would protect the organization’s Code Sec. 761(a) election against all terminating acquisitions and dispositions in a hypothetical year only if it contained, in addition to the information required by Reg. §1.761-2(b), information about every terminating transaction that occurred in the hypothetical partnership tax year. If a new election was not timely made, the Code Sec. 761(a) election would terminate on the first day of the tax year beginning after the hypothetical partnership taxable year in which one or more terminating transactions occurred. Proposed Reg. §1.761-2(a)(5)(iv) would add an example to illustrate this new rule.

These provisions would not apply to an organization that is no longer eligible to elect to be excluded from subchapter K. Such an organization’s Code Sec. 761(a) election automatically terminates, and the organization must begin complying with the requirements of subchapter K.

The proposed regulations would also clarify that the deemed election rule in Reg. §1.761-2(b)(2)(ii) does not apply to specified applicable unincorporated organizations. The purpose of this rule, according to the IRS, is to prevent an unincorporated organization from benefiting from the modifications in revised Reg. §1.761-2(a)(4)(iii) without providing written information to the IRS about its members, and to prevent a specified applicable unincorporated organization terminating as the result of a terminating transaction from having its election restored without making a new election in writing.

In addition, the proposed regulations would require an applicable unincorporated organization making a Code Sec. 761(a) election to submit all information listed in the instructions to Form 1065, U.S. Return of Partnership Income, for making a Code Sec. 761(a) election. The IRS explains that this requirement is intended to ensure that the organization provides all the information necessary for the IRS to properly administer Code Sec. 6417 with respect to applicable unincorporated organizations making Code Sec. 761(a) elections.

The proposed regulations would also clarify the procedure for obtaining permission to revoke a Code Sec. 761(a) election. An application for permission to revoke would need to be made in a letter ruling request meeting the requirements of Rev. Proc. 2024-1 or successor guidance. The IRS indicates that taxpayers may continue to submit applications for permission to revoke an election by requesting a private letter ruling and can rely on Rev. Proc. 2024-1 or successor guidance before the proposed regulations are finalized.

Applicability Dates

The final regulations under T.D. apply to tax years ending on or after March 11, 2024 (i.e., the date on which the March 2024 proposed regulations were published). The IRS states that an applicable unincorporated organization that made a Code Sec. 761(a) election meeting the requirements of the final regulations for an earlier tax year will be treated as if it had made a valid Code Sec. 761(a) election.

The proposed regulations (REG-116017-24) would apply to tax years ending on or after the date on which they are published as final.

T.D. 10012

NPRM REG-116017-24

IR-2024-292

National Taxpayer Advocate Erin Collins is criticizing the Internal Revenue Service for proposing changed to how it contacts third parties in an effort to assess or collect a tax on a taxpayer.

Current rules call for the IRS to provide a 45-day notice when it intends to contact a third party with three exceptions, including when the taxpayer authorizes the contact; the IRS determines that notice would jeopardize tax collection or involve reprisal; or if the contact involves criminal investigations.

The agency is proposing to shorten the length of proposing to shorten the statutory 45-day notice to 10 days when the when there is a year or less remaining on the statute of limitations for collection or certain other circumstances exist.

"The IRS’s proposed regulations … erode an important taxpayer protection and could punish taxpayers for IRS delays," Collins wrote in a November 7, 2024, blog post. The agency generally has three years to assess additional tax and ten years to collect unpaid tax. By shortening the timeframe, it could cause personal embarrassment, damage a business’s reputation, or otherwise put unreasonable pressure on a taxpayer to extend the statute of limitations to avoid embarrassment.

"Furthermore, the ten-day timeframe is so short, it is possible that some taxpayers may not receive the notice with enough time to reply," Collins wrote. "As a result, those taxpayers may incur the embarrassment and reputational damage caused by having their sensitive tax information shared with a third party on an expedited basis without adequate time to respond."

"The statute of limitations is an important component of the right to finality because it sets forth clear and certain boundaries for the IRS to act to assess or collect taxes," she wrote, adding that the agency "should reconsider these proposed regulations and Congress should consider enacting additional taxpayer protections for third-party contacts."

By Gregory Twachtman, Washington News Editor

The IRS has amended Reg. §30.6335-1 to modernize the rules regarding the sale of a taxpayer’s property that the IRS seizes by levy. The amendments allow the IRS to maximize sale proceeds for both the benefit of the taxpayer whose property the IRS has seized and the public fisc, and affects all sales of property the IRS seizes by levy. The final regulation, as amended, adopts the text of the proposed amendments (REG-127391-16, Oct. 15, 2023) with only minor, nonsubstantive changes.

The IRS has amended Reg. §30.6335-1 to modernize the rules regarding the sale of a taxpayer’s property that the IRS seizes by levy. The amendments allow the IRS to maximize sale proceeds for both the benefit of the taxpayer whose property the IRS has seized and the public fisc, and affects all sales of property the IRS seizes by levy. The final regulation, as amended, adopts the text of the proposed amendments (REG-127391-16, Oct. 15, 2023) with only minor, nonsubstantive changes.

Code Sec. 6335 governs how the IRS sells seized property and requires the Secretary of the Treasury or her delegate, as soon as practicable after a seizure, to give written notice of the seizure to the owner of the property that was seized. The amended regulation updates the prescribed manner and conditions of sales of seized property to match modern practices. Further, the regulation as updated will benefit taxpayers by making the sales process both more efficient and more likely to produce higher sales prices.

The final regulation provides that the sale will be held at the time and place stated in the notice of sale. Further, the place of an in-person sale must be within the county in which the property is seized. For online sales, Reg. §301.6335-1(d)(1) provides that the place of sale will generally be within the county in which the property is seized. so that a special order is not needed. Additionally, Reg. §301.6335-1(d)(5) provides that the IRS will choose the method of grouping property selling that will likely produce that highest overall sale amount and is most feasible.

The final regulation, as amended, removes the previous requirement that (on a sale of more than $200) the bidder make an initial payment of $200 or 20 percent of the purchase price, whichever is greater. Instead, it provides that the public notice of sale, or the instructions referenced in the notice, will specify the amount of the initial payment that must be made when full payment is not required upon acceptance of the bid. Additionally, Reg. §301.6335-1 updates details regarding permissible methods of sale and personnel involved in sale.

T.D. 10011

The Financial Crimes Enforcement Network (FinCEN) has announced that certain victims of Hurricane Milton, Hurricane Helene, Hurricane Debby, Hurricane Beryl, and Hurricane Francine will receive an additional six months to submit beneficial ownership information (BOI) reports, including updates and corrections to prior reports.

The Financial Crimes Enforcement Network (FinCEN) has announced that certain victims of Hurricane Milton, Hurricane Helene, Hurricane Debby, Hurricane Beryl, and Hurricane Francine will receive an additional six months to submit beneficial ownership information (BOI) reports, including updates and corrections to prior reports.

The relief extends the BOI filing deadlines for reporting companies that (1) have an original reporting deadline beginning one day before the date the specified disaster began and ending 90 days after that date, and (2) are located in an area that is designated both by the Federal Emergency Management Agency as qualifying for individual or public assistance and by the IRS as eligible for tax filing relief.

FinCEN Provides Beneficial Ownership Information Reporting Relief to Victims of Hurricane Beryl; Certain Filing Deadlines in Affected Areas Extended Six Months (FIN-2024-NTC7)

FinCEN Provides Beneficial Ownership Information Reporting Relief to Victims of Hurricane Debby; Certain Filing Deadlines in Affected Areas Extended Six Months (FIN-2024-NTC8)

FinCEN Provides Beneficial Ownership Information Reporting Relief to Victims of Hurricane Francine; Certain Filing Deadlines in Affected Areas Extended Six Months (FIN-2024-NTC9)

FinCEN Provides Beneficial Ownership Information Reporting Relief to Victims of Hurricane Helene; Certain Filing Deadlines in Affected Areas Extended Six Months (FIN-2024-NTC10)

FinCEN Provides Beneficial Ownership Information Reporting Relief to Victims of Hurricane Milton; Certain Filing Deadlines in Affected Areas Extended Six Months (FIN-2024-NTC11)

National Taxpayer Advocate Erin Collins offered her support for recent changes the Internal Revenue Service made to inheritance filing and foreign gifts filing penalties.

National Taxpayer Advocate Erin Collins offered her support for recent changes the Internal Revenue Service made to inheritance filing and foreign gifts filing penalties.

In an October 24, 2024, blog post, Collins noted that the IRS has "ended its practice of automatically assessing penalties at the time of filing for late-filed Forms 3250, Part IV, which deal with reporting foreign gifts and bequests."

She continued: "By the end of the year the IRS will begin reviewing any reasonable cause statements taxpayers attach to late-filed Forms 3520 and 3520-A for the trust portion of the form before assessing any Internal Revenue Code Sec. 6677 penalty."

Collins said this change will "reduce unwarranted assessments and relieve burden on taxpayers" by giving them an opportunity to explain the circumstances for a late file to be considered before the agency takes any punitive action.

She noted this has been a change the Taxpayer Advocate Service has recommended for years and the agency finally made the change. The change is an important one as Collins suggests it will encourage more taxpayers to file corrected returns voluntarily if they can fix a discovered error or mistake voluntarily without being penalized.

"Our tax system should reward taxpayers’ efforts to do the right thing," she wrote. "We all benefit when taxpayers willingly come into the system by filing or correcting their returns."

Collins also noted that there are "numerous examples of taxpayers who received a once-in-a-lifetime tax-free gift or inheritance and were unaware of their reporting requirement. Upon learning of the filing requirement, these taxpayers did the right thing and filed a late information return only to be greeted with substantial penalties, which were automatically assessed by the IRS upon the late filing of the form 3520," which could have penalized taxpayers up to 25 percent of their gift or inheritance despite having no tax obligation related to the gift or inheritance.

She wrote that the abatement rate of these penalties was 67 percent between 2018 and 2021, with an abatement rate of 78 percent of the $179 million in penalties assessed.

"The significant abetment rate illustrates how often these penalties were erroneously assessed," she wrote. "The automatic assessment of the penalties causes undue hardship, burdens taxpayers, and creates unnecessary work for the IRS. Stopping this practice will benefit everyone."

By Gregory Twachtman, Washington News Editor

The Tax Cuts and Jobs Act modifies Section 529 qualified tuition plans to allow the plans to distribute up to $10,000 in tuition expenses incurred during the tax year for designated beneficiaries enrolled at a public, private, or religious elementary or secondary school. Section 529 plans used to only be allowed for college tuition, up to full tuition amounts. That provision for college tuition remains the same.

The Tax Cuts and Jobs Act modifies Section 529 qualified tuition plans to allow the plans to distribute up to $10,000 in tuition expenses incurred during the tax year for designated beneficiaries enrolled at a public, private, or religious elementary or secondary school. Section 529 plans used to only be allowed for college tuition, up to full tuition amounts. That provision for college tuition remains the same.

Although contributions are not tax deductible for federal tax purposes, funds within a Section 529 plan can accumulate tax-free within the plan until they are distributed tax-free to the educational institution for the child-beneficiary. The new $10,000 limitation applies on a per-student, not per-account basis. As a result, if an individual is a designated beneficiary of multiple accounts, a maximum of $10,000 in distributions will be free of income tax, regardless of whether the funds are distributed from multiple accounts. Some state plans provide a limited deduction against state income taxes for contributions to Section 529 plans. They may also provide caps on contributions.

The expansion of Section 529 plans to cover elementary and secondary school education applies to distributions made after December 31, 2017. Since existing Section 529 set up for a child-beneficiary’s college education may now be redirected earlier to primary and secondary tuition, parents, grandparents and other contributors will need to decide how best to manage each child’s combined accounts: whether amounts needed to cover college tuition should accumulate tax-free until those years, or whether they should be used earlier. Generally, if contributions are limited either by a donor’s financial resources or by state caps, use for college tuition will allow a greater amount to accumulate tax-free. If projected accumulated contributions can cover more than college tuition, then using remaining Section 529 balances for secondary and even elementary school may make sense.

These expanded rules are still young, however, with expected IRS regulations and other guidance overlaid onto the basic law under the Tax Cuts and Jobs Act sure to come. But although the tax-free growth benefits of any Section 529 plans have a long-term perspective, giving some thought to how these expanded Section 529 plans might be used in your family situation might start soon. Please contact our offices for further details.

As an economic incentive for individuals to save and invest, gains from the sale of capital assets held for at least one year unless offset by losses, as well qualified dividends received during the year, may be taxed at rates lower than ordinary income tax rates. The tax rate on long-term capital gains and qualified dividends for individuals is 20 percent, 15, percent, or 0 percent depending on their income tax bracket.

As an economic incentive for individuals to save and invest, gains from the sale of capital assets held for at least one year unless offset by losses, as well qualified dividends received during the year, may be taxed at rates lower than ordinary income tax rates. The tax rate on long-term capital gains and qualified dividends for individuals is 20 percent, 15 percent, or 0 percent depending on their income tax bracket.

The current zero, 15 percent and 20 percent rates (28 percent for collectibles) on long-term capital gains will not change under tax reform. HR 1, the Tax Cuts and Jobs Creation Act, however, does make provision to integrate these rates into the new tiered ordinary income rate structure. The Senate version, for example, provides that the 15-percent long-term capital gain rate would begin in the case of a joint return or surviving spouse, at the $77,200 income level, and the 20 percent rate begins case of a joint return or surviving spouse, at $479,000. Short-term gains would be taxed at the new, ordinary income tax rates. Year-end tax planning for capital gains –whether or not tax reform legislation passes –should therefore follow many of the time-tested techniques used in the past, with some deference to accelerating some short-term capital gains to 2018.

Where to Start

Year-end planning for capital gains should start with data collection and a review of prior year returns. This includes losses or other carryovers, estimated tax installments, and items that were unusual. Conversations about next year should include review of any plans for significant purchases or dispositions, as well as any possible life cycle plans.

When making investment decisions, economic factors in the market should take priority over tax considerations. Taxpayers should not hold assets simply to avoid paying tax on any gain. Similarly, taxpayers should not sell assets just to take a tax loss if the asset will rise in value. Only after the economic factors are considered, should taxpayers consider the tax consequences.

Capital Gains

Most types of nonbusiness property used for personal or investment reasons, such as stocks and bonds, are capital assets. As noted above, to receive the lower tax rate on capital gains, taxpayers must hold these investments for more than one year. The gain from the sale of capital assets held for one or less are ‘short-term’ capital gains are taxed at ordinary income tax rates. In addition, the long-term capital gain rates do not apply to all types of capital assets. A 28 percent rate applies to long-term gains from collectible and small business stock, while a 25 percent rate applies to unrecaptured Code Sec. 1250 gain realized on the sale of depreciable real property.

Comment.  Generally, holding capital assets for more than 12 months before taxable disposition to avoid short-term capital gain status is advisable, unless sufficient loss offsets have been recognized, or market conditions indicate otherwise.

Capital Losses

Generally, taxpayers must offset their capital gains with capital losses before applying the tax rates. Thus, cashing out stock and bonds with a built-in loss can be a simple means of providing a loss to be taken against income. If capital losses exceed capital gains for the year, individuals are only allowed to deduct up to $3,000 of the losses, whether net long-term or short-term capital gain against ordinary income. Any capital losses above $3,000 must be carried over and deducted in succeeding years.

As a result of the netting of capital gains and losses, taxpayers have an opportunity to minimize their tax liability by timing when the gains and losses occur. For example, a taxpayer could sell capital gain property before the end of the year if they have already realized capital gain losses during the year. Also, if allowable deductions for the year will exceed income, taxpayers should try to avoid realizing any additional capital losses during the year as they would be worthless or have to be carried over to the next year.

“Wash” sales. Taxpayers may want to recognize capital losses for tax purposes on stock or securities without completely abandoning their investment. One technique for maintaining the investment is to sell the stock or security at a loss, and then buy the same stock or security. The ‘wash sale’ rules, however, prevent taxpayers from claiming any loss from these types of transactions if they acquire substantially identical stock or securities within 30 days before or after the sale.

Comment. The wash sale rule can be avoided by simply waiting 31 days before purchasing substantially identical stock or securities. Even if taxpayers violate the time limits of the wash sale rule, the disallowed loss is not lost. Instead, the loss is added to cost of the new stock or securities acquired. Plus, the holding period of the new stock or securities includes the time taxpayers held the stock or securities sold for a loss.

Other Timing Rules

When dealing with capital gains, the greatest flexibility taxpayers have comes from their ability to decide when to sell assets. For example, taxpayers may know they will be in a higher income tax bracket in 2018 that would subject them to a higher capital gains rate. As a result, they could sell investments in 2017 to generate long-term capital gains to take advantage of a lower capital gains rate. In other words, spreading the recognition of income between multiple years may help minimize the total amount of tax paid in those years.

Comment. The zero percent capital gains rate creates a planning opportunity, particularly within intra-family situations. Appreciated property may be gifted to a low-bracket individual, with the gain on a subsequent sale then taxed at a zero rate to the extent that gain on top of other income does not exceed the top of the 15 percent bracket. Certain restrictions must be respected, however, including not contravening the kiddie tax rules, not exceeding the annual gift tax exclusion, and not setting up a structured transaction in which the sale after the gift has been prearranged.

Net Investment Income (NII) Tax

In addition to regular income tax liability, many individuals may be surprised to learn that they may be subject to an additional 3.8 percent tax on net investment income (NII). Recent run ups in the financial markets have increased the need to implement strategies that can avoid or minimize this tax. The NII tax is part of the Affordable Care Act and, therefore, will not be repealed under current tax-reform efforts. At least for 2017, taxpayers with income above the $200,000 threshold ($250,000 for joint filers) should assume that their net capital gains, whether long term or short term, will be subject to the additional 3.8 percent tax.

The method and systems by which a taxpayer calculates the amount of income, gains, losses, deductions, and credits and determines when these items must be reported, constitute the taxpayer's method of tax accounting. Although the Tax Code and the regulations authorize the use of several accounting methods, and permit certain combinations of methods, a taxpayer must use the accounting method on the basis of which the taxpayer regularly computes book income. Further, the method must be used consistently and must clearly reflect income.

The method and systems by which a taxpayer calculates the amount of income, gains, losses, deductions, and credits and determines when these items must be reported, constitute the taxpayer's method of tax accounting. Although the Tax Code and the regulations authorize the use of several accounting methods, and permit certain combinations of methods, a taxpayer must use the accounting method on the basis of which the taxpayer regularly computes book income. Further, the method must be used consistently and must clearly reflect income.

A taxpayer's method of accounting includes not only the overall method of accounting, but also the accounting treatment of any item. The taxpayer may not treat a particular item in a manner that differs from the overall method.

After a taxpayer has adopted a particular method of accounting, either as an overall method of accounting or as a method of accounting for a particular material item, any changes in accounting method must first be approved by the IRS. The IRS may exercise its sole discretion in accepting a taxpayer's return as computed under the new method of accounting, unless the taxpayer has properly obtained its prior consent to the change.

A change in accounting method may be requested by a taxpayer or required by the IRS. The IRS usually must approve all changes in methods and may specify conditions for implementing the change. The IRS grants automatic consent to many accounting changes. Catch-up adjustments that prevent items of income and expenses from being omitted or reported twice, thereby avoiding possible post-change distortion of income, may be required.

The IRS has provided procedures for obtaining its consent to a change in accounting method. There are two types of consent—automatic consent and advance (non-automatic) consent. Both types of consent require taxpayers to file a Form 3115, Application for Change in Accounting Method. The advance consent procedures require payment of a user fee. The current IRS List of Automatic Changes is found in Rev. Proc. 2017-30.

Holiday gifts made to customers are generally deductible as ordinary and necessary business expenses as long as the taxpayer can demonstrate that such gifts maintain or improve customer goodwill. Such gifts must bear a direct relationship to the taxpayer's business and must be made with a reasonable expectation of a financial return commensurate with the amount of the gift. However, the $25 annual limitation per recipient on deductibility is applicable to holiday gifts, unless a statutory exceptions applies.

Holiday gifts made to customers are generally deductible as ordinary and necessary business expenses as long as the taxpayer can demonstrate that such gifts maintain or improve customer goodwill. Such gifts must bear a direct relationship to the taxpayer's business and must be made with a reasonable expectation of a financial return commensurate with the amount of the gift. However, the $25 annual limitation per recipient on deductibility is applicable to holiday gifts, unless a statutory exceptions applies.

Holiday turkeys and other holiday distributions of nominal value made by an employer to employees to promote goodwill are treated as tax-free gifts to those employees instead of taxable compensation. If the employer gives cash, gift certificates or similar items of readily convertible cash value, however, the value of those gifts is considered additional compensation regardless of the amount.  But if holiday gift certificates given by an employer to its employees are redeemable only for merchandise and were not convertible to cash, they may be considered tax-free gifts.

Employers can give items worth a "nominal amount" without fear that the IRS will tax the employee. Gifts of items worth more, or a gift of any amount of cash, risks the IRS taking the view that the gift belongs in the employee's gross income. What constitutes a nominal amount is not crystal clear, but keeping a gift under $25 is erring on the safe side. It also assures a situation in which the employer can deduct the expense of the gift while not having it taxable to the employee.

Yes, however, there are special timing rules for foreign adoptions. These rules differ from the timing rules for domestic adoptions and impact when you may claim qualified adoption expenses.

Yes, however, there are special timing rules for foreign adoptions. These rules differ from the timing rules for domestic adoptions and impact when you may claim qualified adoption expenses.

The Tax Code provides a nonrefundable credit for qualified adoption expenses. The credit is subject to income limitations, which means that some taxpayers may not qualify for it. Generally, the credit covers adoption expenses such as fees, court costs, traveling expenses, and other expenses directly related to the adoption.

The Tax Code also distinguishes between domestic and foreign adoptions. This distinction is important due to timing rules. The IRS has explained that a domestic adoption is the adoption of a U.S. child, an eligible child who is a citizen or resident of the U.S. or its possessions before the adoption effort begins. Qualified adoption expenses paid before the year the adoption becomes final are allowable as a credit for the tax year following the year of payment, even if the adoption is never finalized and even if an eligible child was never identified.

A foreign adoption is the adoption of an eligible child who is not yet a citizen or resident of the U.S. or its possessions before the adoption effort begins. Qualified adoption expenses paid before and during the year are allowable as a credit for the year when the adoption becomes final.

Let’s look at an example. Julia pays qualified adoption expenses of $2,000 in 2015, $3,000 in 2016 and $4,000 in 2017 related to the adoption of Marisa, who is not a U.S. citizen or resident. The adoption becomes final on September 5, 2017. Because the adoption is foreign and not domestics, Julia may claim all $9,000 in expenses on her 2017 federal income tax return.

After an adoption becomes final, qualified adoption expenses paid during or after the year of finality are allowable as a credit for the year of payment, whether the adoption is foreign or domestic. In our example, Julia pays an additional $1,000 in qualified adoption expenses in 2018. Julia may claim the $1,000 in expenses on her 2018 return.

The adoption credit is just one personal tax preference that could be modified if Congress passes a tax reform bill. Under current law, as described above, there is a distinction between domestic and foreign adoptions. Please contact our office if you have any questions about the adoption credit and how it may help offset the expenses of an adoption, whether domestic or foreign.

A partnership is created when persons join together with the intent to conduct unincorporated venture and share profits. Intent is determined from facts and circumstances, including the division of profits and losses, the ownership of capital, the conduct of parties, and whether a written agreement exists. Despite such nuances in the process, however, distinguishing the existence of a partnership from other joint investments or ventures is often critical in determining tax liability and reporting obligations.

A partnership is created when persons join together with the intent to conduct unincorporated venture and share profits. Intent is determined from facts and circumstances, including the division of profits and losses, the ownership of capital, the conduct of parties, and whether a written agreement exists. Despite such nuances in the process, however, distinguishing the existence of a partnership from other joint investments or ventures is often critical in determining tax liability and reporting obligations.

The factors often considered in the determination of whether the participants in an enterprise intended to form a partnership include:

1. the existence of an oral or written agreement between the parties;
2. the contribution by the participants of capital, property or services;
3. the sharing of profits and/or losses;
4. any mutual control over the business;
5. the joint conduct of the business; and
6. the filing of partnership returns or representations to third parties that the participants are partners.

The presence or absence of these factors is weighed in distinguishing partners in a partnership from other business relationships. Thus, co-ownership of property may be a partnership depending on the owners' intent, the manner in which the property is held and the other facts and circumstances of the arrangement including a profit motive. Other arrangements may or may not be treated as partnerships depending upon whether the requisite intent and circumstances are present. These include:

• lessor-lessee relationships (normally, this does not make the lessor and lessee partners for tax purposes, unless the lessor also exercises control over the lessee's business beyond that necessary to protect his investment and assure the lessee's continuing ability to pay rent);
• employment or independent contractor relationships (an employment or independent contractor relationship might be characterized for tax purposes as a partnership when a person both provides services to and shares in the profits of the enterprise);
• debtor-creditor relationships (although a debtor-creditor relationship generally does not establish the existence of a partnership, an advance of funds may be treated as a contribution to the capital of, or an acquisition of an equity interest in, a partnership rather than as a loan);
• purchaser-seller relationships (a purported sale may be treated as a partnership between the seller and buyer if the terms of sale grant the seller a right to receive a share of the future profits generated by the business or asset being sold, and the seller has a continuing proprietary interest in the business or asset).

Many businesses consider the occasional wining and dining of customers and clients just to stay in touch with them to be a necessary cost of doing business. The same goes for taking business associates or even employees out to lunch once in a while after an especially tough assignment has been completed successfully. It's easy to think of these entertainment costs as deductible business expenses, but they may not be. As a general rule, meals and entertainment are deductible as a business expense only if specific conditions are met. What's more, the deduction for either type of expense generally is limited to 50 percent of the cost.

Many businesses consider the occasional wining and dining of customers and clients just to stay in touch with them to be a necessary cost of doing business. The same goes for taking business associates or even employees out to lunch once in a while after an especially tough assignment has been completed successfully. It's easy to think of these entertainment costs as deductible business expenses, but they may not be. As a general rule, meals and entertainment are deductible as a business expense only if specific conditions are met. What's more, the deduction for either type of expense generally is limited to 50 percent of the cost. 

Meals and entertainment directly connected to business. To be considered directly connected to business, the meal or entertainment event must meet three conditions:

• It must have been scheduled with more than a general expectation of deriving future income or a specific business benefit from the event. In other words, a meal or dinner date arranged for general goodwill purposes does not qualify.
• A business meeting, negotiation, or transaction must actually occur during the meal or entertainment, or immediately preceding and following it. In other words, business actually must be discussed.
• The main character of the event, considering the facts and circumstances, is the active conduct of your company's trade or business.

For example, an executive employee who treats a client to a golf game in order to discuss the general parameters of a business deal in an informal atmosphere is engaged in entertainment that is directly connected to business. So is a manager who discusses sensitive business plans with a subordinate over lunch at an off-premises restaurant.

Applicable limitations. In general, only 50 percent of expenses incurred for entertainment and meal expenses is deductible. A limited exception applies to entertainment or on-premise meals provided to employees.

Expenses with respect to entertainment facilities generally are not deductible at all. A facility includes any item of personal or real property owned, rented, or used by a taxpayer if it is used during the tax year for or in connection with entertainment. They include yachts, hunting lodges, fishing camps, swimming pools, tennis courts, bowling alleys, automobiles, airplanes, apartments, hotel suites and homes in vacation resorts.

Country club dues are not deductible (although the meals purchased with business clients at the club are, up to the 50 percent limit). Deductions for skyboxes or other private luxury boxes at sporting events are limited to the face value of a nonluxury box seat ticket multiplied by the number of seats in the box.

Record-keeping requirements. Even if a meal or entertainment expense qualifies as a business expense, none of the cost is deductible unless strict and detailed substantiation and recordkeeping requirements are met to the letter.

Please contact our offices for assistance on how to comply with these requirements at minimum cost and expense, and how your business’s typical meal and entertainment expenses fare under the deduction rules.

With the soaring cost of college tuition rising on a yearly basis, tax-free tuition gifts to children and grandchildren can help them afford such an expensive endeavor, as well as save the generous taxpayers in gift and generation skipping taxes. Under federal law, tuition payments that are made directly to an educational institution on behalf of a student are not considered to be taxable gifts, regardless of how large, or small, the payment may be.

With the soaring cost of college tuition rising on a yearly basis, tax-free tuition gifts to children and grandchildren can help them afford such an expensive endeavor, as well as save the generous taxpayers in gift and generation skipping taxes. Under federal law, tuition payments that are made directly to an educational institution on behalf of a student are not considered to be taxable gifts, regardless of how large, or small, the payment may be.

Code Sec. 2503(e) allows taxpayers the benefit of an unlimited gift tax exclusion for payment of tuition to colleges for students. In this way, a taxpayer can navigate around the annual gift tax exclusion limit. By so doing, a taxpayer can both give an unlimited amount of money for a student’s tuition costs without incurring a gift tax penalty. In addition, a taxpayer can then directly provide that same student with an outright cash gift up to the annual gift tax exclusion amount, without a tax penalty for doing so.

However, a direct tuition payment might prompt a college to reduce any potential grant award in your grandchild's financial aid package, so make sure to ask the college about the financial aid impact of your gift.

Requirements

In order to qualify for the gift tax exclusion, the tuition payments must be made directly to a qualifying organization, which is defined in Code Sec. 170(b). A qualifying organization is an institution that normally maintains a regular faculty and curriculum and normally has a regularly enrolled body of pupils or students in attendance at the place where its educational activities are regularly carried on. Therefore, such organizations are not limited to colleges and universities, but may include various types and levels of education institutions.

The donor of the gift of tuition does not have to be related to the beneficiary for the gift to be considered tax-free. However, the tuition must be directly paid to the institution. The donee may be enrolled either part-time or full-time. 

Amounts ineligible for exclusion

Of important note, reimbursements for tuition paid by someone else is ineligible for tax-free gift exclusion treatment. Further, a transfer to an irrevocable trust established to pay tuition expenses of trust beneficiaries does not qualify for the unlimited exclusion, even if the trustee makes payments directly to the educational institution. In addition, amounts paid for fees, books, supplies or the donee’s living expenses while in school do not qualify for tax-free treatment.

Any contribution to a qualified tuition program on behalf of a designated beneficiary, as well as any contribution to a Coverdell Education Savings Account, is a completed gift of a present interest eligible for the annual gift tax exclusion at the time the contribution is made. However, such contributions are not treated as qualified transfers that are eligible for the educational expense unlimited gift tax exclusion.

Yes …but only if it is a medical necessity. The IRS has ruled that uncompensated amounts paid to participate in a weight-loss program as treatment for a specific disease or diseases (including obesity) diagnosed by a physician are deductible expenses for medical care. The deduction is subject to the limitations of Code Sec. 213 and its regulations.

Yes …but only if it is a medical necessity. The IRS has ruled that uncompensated amounts paid to participate in a weight-loss program as treatment for a specific disease or diseases (including obesity) diagnosed by a physician are deductible expenses for medical care. The deduction is subject to the limitations of Code Sec. 213 and its regulations.

Generally, Code Sec. 213(a) provides a deduction for uncompensated expenses for medical care of an individual, the individual’s spouse or a dependent, subject to certain limitations. The term medical care is broad and encompasses the diagnosis, cure, mitigation, treatment, or prevention of disease, or for the purpose of affecting any structure or function of the body. If an expense is merely beneficial to a person’s general health, the expense is not a qualified expense for medical care for tax purposes.

In 1979, the IRS ruled that the cost of participation in a weight loss program merely to improve appearance, general health or sense of well-being was not deductible. The individual’s participation in the weight loss program was not to cure or treat a disease or specific illness.

The IRS modified its position in 2002. That year, the IRS announced that expenses for certain weight-loss programs would qualify as a medical deduction. The IRS explained that in 2000, the World Health Organization (WHO) recognized that obesity is a disease. Where a physician has diagnosed an individual with suffering from a disease (including obesity) the cost of the individual’s participation in the weight-loss program as treatment for his obesity is an amount paid for medical care under Code Sec. 213. Uncompensated amounts paid to participate in the weight-loss program as treatment for the disease are deductible expenses for medical care, subject to the limitations of Code Sec. 213. Keep in mind that only taxpayers who itemize their deductions may claim the deduction for qualified medical expenses. Reimbursement for weight-loss expenses from a flexible spending account are also subject to the Code Sec. 213 rules, as well as review by the plan administrator.

Please contact our office for more information about deductible medical expenses.

Everyone in business must keep records. Among other things, good records will help a business prepare the business tax returns, and will support items reported on tax returns. Taxpayers also must keep their business records available for inspection by the IRS.

Everyone in business must keep records. Among other things, good records will help a business prepare the business tax returns, and will support items reported on tax returns. Taxpayers also must keep their business records available for inspection by the IRS.

In order to claim any deduction, a business owner, like any taxpayer, must prove two things: what expenses were for and that the expense was in fact paid or incurred. Supporting documents may include sales slips, paid bills, invoices, receipts, deposit slips, and canceled checks. The documents should show the amount paid and the reason for the expense. Businesses must keep their records as long as needed to qualify under the Tax Code. Generally, this means until the period of limitations for auditing the return expires.

Special expenses

There are special recordkeeping requirements and strict documentation rules for certain expenses. These expenses include:

• expenses for travel away from home (including meals and lodging while traveling),
• meal and entertainment expenses,
• business gifts, and
• cars and other means of transportation.

For these expenses, taxpayers must keep receipts and must also substantiate each individual expense as to (1) the amount, (2) time and place, and (3) business purpose. For entertainment and gift expenses, taxpayers must also provide the business relationship of the person(s) being entertained or receiving a gift. For vehicle expenses, taxpayers must keep a mileage log.

Reimbursed Expenses

Businesses that give reimbursements and allowances to their employees for employment-related travel and entertainment expenses must generally treat these amounts as income to the employees. However, there is no income inclusion if: (1) the employee is required to account for the expenses to the employer; (2) the employee does not deduct the expenses; and (3) the total expenses equal the total reimbursements and allowances.

Accounting for expenses means giving the employer documentary evidence and an account book or statement to verify each expense’s amount, time, place and business purpose. An employee is treated as having accounted for expenses if the employer provided a fixed allowance, and the employee verifies the time, place, and business purpose of each expense. A fixed allowance includes the standard mileage rate for cars and the federal per diem rate for travel away from home.

Accountable Plan

A reimbursement arrangement is considered an accountable plan if it meets the following three requirements:

1. It provides advances, allowances or reimbursements for business expenses paid or incurred by an employee;
2. Each business expense must be substantiated to the employer within a reasonable period of time; and
3. The employee must return any excess reimbursement within a reasonable period of time.

If the arrangement is an accountable plan, the reimbursements are excluded from the employee's wages and exempt from employment taxes. Any excess reimbursement that is not returned within a reasonable period is treated as paid under a nonaccountable plan.

Foreign travel expenses may be subject to allocation if the taxpayer engages in personal activities while traveling on business. A portion of the foreign travel expenses may be nondeductible if the individual engages in substantial nonbusiness activity. The allocation rules apply where the individual engages in substantial nonbusiness activity at, near, or beyond the business destination; or, when the personal destination is en route to and from the business destination.

Foreign travel expenses may be subject to allocation if the taxpayer engages in personal activities while traveling on business. A portion of the foreign travel expenses may be nondeductible if the individual engages in substantial nonbusiness activity. The allocation rules apply where the individual engages in substantial nonbusiness activity at, near, or beyond the business destination; or, when the personal destination is en route to and from the business destination.

The rules apply for travel outside the 50 states and the District of Columbia. Travel to the possessions is considered travel outside the U.S. Travel outside the U.S. does not include any travel from one point in the U.S. to another point in the United States, even though part of the trip is outside the United States.

Allocation is done on a day-to-day basis, in proportion to the number of nonbusiness days during the trip to the entire trip. Each day is considered either entirely a business day or entirely a nonbusiness day. A day spent outside the U.S. is deemed a business day, even though only part of the day was spent on business, if any of the following apply:

• The taxpayer was traveling to or returning from a destination outside the U.S. in pursuit of a trade or business.
• The taxpayer's presence outside the U.S. on that day was required at a particular place for a specific business purpose.
• During hours that are normally considered appropriate for business activity the taxpayer's principal activity was the pursuit of a trade or business.

If the trip is primarily personal in nature, travel expenses to and from the destination are not deductible, even if the taxpayer engages in business activities while at the destination.

Once the amount of travel expenses subject to the allocation and disallowance rules is determined, that amount is multiplied by a fraction, equal to the number of nonbusiness days during the trip, divided by the total number of business and nonbusiness days during the trip.

These restrictions do not apply when any of the following conditions applies:

• Travel time outside the United States do not exceed one week.
• Nonbusiness travel time is less than 25 percent of the total time.
• The individual lacks substantial control over the travel arrangements (other than the timing of the trip).
• The vacation portion of the trip is a not a major consideration of the taxpayer.

Many federal income taxes are paid from amounts that are withheld from payments to the taxpayer. For instance, amounts roughly equal to an employee's estimated tax liability are generally withheld from the employee's wages and paid over to the government by the employer. In contrast, estimated taxes are taxes that are paid throughout the year on income that is not subject to withholding. Individuals must make estimated tax payments if they are self-employed or their income derives from interest, dividends, investment gains, rents, alimony, or other funds that are not subject to withholding.

Many federal income taxes are paid from amounts that are withheld from payments to the taxpayer. For instance, amounts roughly equal to an employee's estimated tax liability are generally withheld from the employee's wages and paid over to the government by the employer. In contrast, estimated taxes are taxes that are paid throughout the year on income that is not subject to withholding. Individuals must make estimated tax payments if they are self-employed or their income derives from interest, dividends, investment gains, rents, alimony, or other funds that are not subject to withholding.

Estimated income tax payments are required from taxpayers who:

1. expect to owe at least $1,000 in tax for the year, after subtracting taxes that were paid through withholding and tax credits; and
2. expect that the amount of taxes to be paid during the year through other means will be less than the smaller of—

• 90% of the tax shown on the current year's tax return, or
• 100% of the tax shown on the previous year's return (the previous year's return must cover all 12 months). This 100-percent test increases to 110 percent if the taxpayer's AGI for the previous year exceeds $150,000.

U.S. citizens who have no tax liability for the current year are not required to make estimated tax payments.

Form 1040-ES. Taxpayers use Form 1040-ES to calculate, report and pay their estimated tax. The annual liability may be paid in quarterly installments that are due based upon the taxpayer's tax year. However, no payments are required until the taxpayer has income upon which tax will be owed. Taxpayers may also credit their overpayments from one year against the next year's estimated tax liability, rather than having them refunded.

Generally, the required installment is 25 percent of the required annual payment. However, a taxpayer who receives taxable income unevenly throughout the year can elect to pay either the required installment or an annualized income installment. The use of the annualized income installment method, provided on a worksheet contained in the instructions to Form 2210, Underpayment of Estimated Tax by Individuals and Fiduciaries, may reduce or eliminate any penalty for underpaid taxes.

Due Dates. For most individual taxpayers, the quarterly due dates for estimated tax payments are:

Penalties. A penalty generally applies when a taxpayer fails to make estimated tax payments, pays less than the required installment amount, or makes late payments. However, the IRS may waive the penalty if the underpayment was due to casualty, disaster or other unusual circumstances.

Employers generally have to pay employment taxes on the wages they pay to their employees. A fine point under this rule, however, is missed by many who themselves have full time jobs and don’t think of themselves as employers: a nanny who takes care of a child is considered a household employee, and the parent or other responsible person is his or her household employer. Housekeepers, maids, babysitters, and others who work in or around the residence are employees. Repairmen and other business people who provide services as independent contractors are not employees. An individual who is under age 18 or who is a student is not an employee.

Employers generally have to pay employment taxes on the wages they pay to their employees. A fine point under this rule, however, is missed by many who themselves have full time jobs and don’t think of themselves as employers: a nanny who takes care of a child is considered a household employee, and the parent or other responsible person is his or her household employer. Housekeepers, maids, babysitters, and others who work in or around the residence are employees. Repairmen and other business people who provide services as independent contractors are not employees. An individual who is under age 18 or who is a student is not an employee.

Payments and Withholding

As a household employer, the parent must withhold and pay Social Security and Medicare taxes if the cash wages paid to the nanny exceed the threshold amount for the year. If the amount paid is less than the threshold, the parent does not owe any Social Security or Medicare taxes. For 2017, the domestic employee coverage threshold, as adjusted for a slightly different inflation factor and subject to rounding, will be $2,000, which is the same as for 2016 after rising from $1,900 in 2015. Earnings of any domestic employee are not subject to Social Security taxes if they do not exceed that threshold for the year. If the employee earns more than $1,000 in any calendar quarter, the parent must also pay federal unemployment (FUTA) tax on wages paid, up to $7,000. Publication 926, Household Employer's Tax Guide, has more information about withholding and paying employment taxes.  

If the amount paid is more than the threshold, the parent must withhold the employee's share of Social Security and Medicare taxes unless the parent chooses to pay both the employee's and the employer's share. The taxes are 15.3 percent of cash wages, 7.65 percent each for the employee and the employer. This includes 6.2 percent for Social Security and 1.45 percent for Medicare (hospitalization insurance).

The parent is not required to withhold income tax from the nanny's wages. However, the parent and the nanny may agree to withholding income tax from the nanny's wages. The nanny must provide a filled-out Form W-4, Employee's Withholding Allowance Certificate, to the employer.

The employment taxes amounts are part of the parent's tax liability and can trigger an estimated tax penalty if not enough is paid during the year. The parent submits estimated tax payments on Form 1040-ES, Estimated Tax for Individuals.

Forms to File

If the parent must pay Social Security and Medicare taxes, or if the parent withholds income tax, the parent must file Schedule H, Household Employment Taxes, with the parent's Form 1040. The parent may also need to file a Form W-2, Wage and Tax Statement, and furnish a copy of the form to the nanny. To complete Form W-2, the parent must obtain an employer identification number (EIN) from the IRS, either by applying online or by submitting Form SS-4, Application for Employer Identification Number.

Please do not hesitate to contact this office if you have any questions regarding your “nanny tax” responsibilities.

When accelerating or deferring income or expenses at year end as part of an overall tax strategy, certain timing rules become critical. So does the ability to prove to the IRS when certain actions take place. The following timing rules, among others, should be considered especially important as year-end approaches:

When accelerating or deferring income or expenses at year end as part of an overall tax strategy, certain timing rules become critical. So does the ability to prove to the IRS when certain actions take place. The following timing rules, among others, should be considered especially important as year-end approaches:

Actual payment rule. Cash-basis taxpayers who want to maximize their deductions and credits for 2016 must make a payment of each expense giving rise to a deduction or credit by December 31. A cash-basis taxpayer generally is entitled to a deduction only when actual payment is made: irrespective of the fact that the expense has already been incurred. "Cash substitutes" under this rule include:

• Payment by check. If the check is mailed, the payment is considered made at the time of mailing, even if the check is received in the following year, as long as the check is honored in the routine course of business. If the recipient delays but ultimately cashes the check, and the date of delivery is not disputed, the payment dates back to the time the check is delivered or mailed.
• Payment by credit card. The IRS generally treats a payment by credit card as a cash equivalent. In effect, the taxpayer has borrowed funds from the bank issuing the card and has paid the seller for goods or services. However, in an adjacent rule apparently still in effect, if the taxpayer uses a card issued by the seller with no involvement by an intermediary bank, there may be no payment until the taxpayer pays the bill.

Prepayment of an expense before it is incurred, however, generally does not trigger the immediate right to a deduction in the year paid.

Paid/gifted by check. The mailing rule applicable for a charitable donation calls for any check dated and mailed via the US Post Office within the tax year to be considered deductible in that year, provided the charity cashes it in due course and sufficient funds are available.

Charitable pledges. Like unsecured promissory notes, pledges to a charitable organization are treated as unenforceable promises to pay in the future and are not deductible until payment is made to the charity. However, if the pledge is legally binding, a deduction is allowed when the pledge is made.

Trade date. Stock traded in an over-the-counter market or on a regulated national securities exchange is generally treated as sold on the date the taxpayer enters into a binding contract to sell. This is the trade date, in contrast to the settlement date, which occurs when delivery of the stock certificate and payment are made. The trade date also marks the end of the selling taxpayer's holding period, important for separating short- and long-term capital gain.

Short sale. In the case of short sales, if the stock price falls and a gain results, the gain is considered realized for tax purposes on the trade date, when the seller directed his or her broker to purchase shares. If the price rises and a loss results, the loss is not realized until the stock is delivered on the settlement date.

Wash sale. A stock (or securities) loss is not allowed to be taken if, within a period beginning 30 days before the date of the disposition and ending 30 days after that date, the individual acquired, or entered into a contract or option to acquire, substantially identical stock or securities. This wash sale rule was designed to prevent taxpayers from selling stock to establish a tax loss and then buying it back the next day. Certain techniques, however, are available to minimize its impact:

• Buy shares in the same industry rather than the same company
• Buy more of the same shares, then sell the original shares 31 days later
• Sell the original shares, then buy the same shares 31 days later.

No similar "wash sale" restriction is imposed on recognizing gain and then immediately purchasing the same shares.

FIFO stock sales. Under the automatic first-in, first-out (FIFO) rule for selling securities, the shares purchased first are considered sold first within the same brokerage account, unless a specified ID method is used by identification of a share's purchase date and cost. Identification must be made at the time of sale by the broker.

If you have any questions regarding the application of these or other timing rules to your situation, please call this office.

Taxpayers that plan to operate a business have a variety of choices. A single individual can operate as a C corporation, an S corporation, a limited liability company (LLC), or a sole proprietorship. Two or more individuals can form a partnership, a corporation (C or S), or an LLC.

Taxpayers that plan to operate a business have a variety of choices. A single individual can operate as a C corporation, an S corporation, a limited liability company (LLC), or a sole proprietorship. Two or more individuals can form a partnership, a corporation (C or S), or an LLC.

Nontax considerations

State law and nontax considerations are an important consideration in choosing the form of the business and may play a decisive role. A general partner of a partnership has unlimited liability for the debts of the business. This can be modified by using a limited partnership (LP), which must have at least one general partner and at least one limited partner. The general partner still have unlimited liability, but a limited partner's liability is limited to its contribution to the partnership. A corporation has limited liability; shareholders generally are not responsible for the liabilities of the corporation beyond their contributions to the entity.

Federal tax considerations

At the same time, it is crucial to consider federal tax requirements and consequences when choosing the form of business entity. A primary federal tax consideration is avoiding a double layer of tax on business income. This can be accomplished by operating as a passthrough entity, such as a partnership or S corporation. Income is not taxed at the entity level. It passes through to partners and shareholders and is taxed at their rates.

In contrast, C corporations are taxable entities. Furthermore, when a C corporation pays a dividend to its shareholders, this generally is taxable to the shareholder. It must be noted that income of a passthrough entity is allocable and taxable to its owners, whether or not the income is actually distributed to the partner or shareholder. Dividends are not taxed unless there is an actual distribution.

While a partnership is organized under state law, an S corporation is a creature of the federal tax system. The S corporation is a regular corporation for state law purposes.

Advantages of partnerships

Unlike an S corporation shareholder, anyone or any entity can be a partner. S corporations are limited to 100 shareholders; only certain individuals, estates and trusts are eligible to be shareholders. C corporations and nonresident aliens cannot be shareholders of an S corporation.

S corporations are limited to a single class of stock; income and losses must be allocated on the same basis to each shareholder. Having only one class of stock may affect the corporation's ability to raise capital. A partnership can have different classes of partners and has more flexibility for allocating income and losses to different types of partners.

Partnership liabilities can increase a partner's basis in the partnership, offsetting distributions of cash and reducing their taxation. The increased basis allowed partners to use losses generated by the partnership. Liabilities of an S corporation do not create stock basis; separate bases in stock and debt must be calculated. This lack of basis may limit the use of losses generated by the S corporation.

Contributions of appreciated property by a partner to the partnership generally are not taxable, even if the partner is not part of a group controlling the partnership. Contributions by a shareholder to a corporation are tax-free only if the shareholders are part of a group controlling 80 percent of the corporation after the contribution. However, a partnership must follow special allocation rules for handling built-in gain on contributed property, whereas S corporations do not have special allocation rules in this circumstance.

Conclusion

In general, a partnership offers more flexibility than an S corporation in the treatment of taxes. However, S corporation shareholders do have limited legal liability, while general partners are not insulated from the partnership's debts and liabilities.

Code Sec. 162 permits a business to deduct its ordinary and necessary expenses for carrying on the business. However, Code Sec. 274 restricts the deduction of entertainment expenses incurred for business by disallowing expenses of entertainment activities and entertainment facilities. Many expenses are totally disallowed; other amounts, if allowed under Code Sec. 274, are limited to 50 percent of the expense.

The income tax regulations define entertainment as any activity of a type generally considered to be entertainment, amusement, or recreation, such as entertaining at night clubs, lounges, theaters, country clubs, golf and athletic clubs, and sports events, as well as hunting, fishing, vacation and similar trips. There are special rules for the costs of facilities used to entertain the customer, such as a boat or a country club membership. Dues or fees for any social, athletic or sporting club or organization are treated as items involving facilities.

Deduction allowed

Expenses are allowed if the expense was either "directly related" to the active conduct of the taxpayer’s trade or business, or "associated with" the conduct of the trade or business. An activity is "associated with" business if the activity directly precedes or follows a substantial and bona fide business discussion.

Entertainment expenses are not directly related to the business if the activity occurred under circumstances with little or no possibility of engaging in the active conduct of the trade or business. These circumstances include an activity where the distractions are substantial, such as a meeting or discussion at a night club, theater, or sporting event. However, taking a customer to a meal at a restaurant or for drinks at a bar can be considered conducive to a business discussion, if there are no substantial distractions to a discussion.

Substantial business discussion

For expenses that are either directly related to or associated with business, the taxpayer must establish that the he or she conducted a substantial and bona fide business discussion with the customer. The IRS has said that there is no specified length for a discussion to be substantial; all facts and circumstances will be considered. The discussion is substantial if the active conduct of the business was the principal character of the combined business and entertainment activity, but it is not necessary that more time be devoted to business than to entertainment.

For an activity that is associated with, the discussion can directly precede or follow the activity. For a discussion to be directly before or after the activity, it generally must be on the same day as the activity. However, facts and circumstances may allow the entertainment and the discussion to be on consecutive days, for example if the customer is from out of town.

Season tickets

The special rules for facilities do not apply to season tickets. Instead, the taxpayer must allocate the cost of the season tickets to each separate entertainment event. The amount deductible is limited to the face value of the ticket. For a "skybox" or other area leased and used exclusively by the taxpayer and guests, the amount deductible is limited to the face value of non-luxury seats for the area covered by the lease.

Under these rules, it appears that the deductible costs of baseball season tickets must be determined separately for each baseball game. Attendance at a baseball game would involve a "distracting" activity that is not conducive to a business discussion, so the cost of the game would not be directly related to the conduct of the trade or business. However, attendance at a game before or after the conduct of a substantial business discussion could qualify as being associated with the business; in these circumstances, the cost of the event would be deductible.

If the taxpayer provided food to the customer at the baseball game, the cost of the food would be deductible as part of the cost of the event. Some "luxury" seats include food provided by the baseball team to the ticket user. It appears that the taxpayer would have to determine the fair market value of the ticket and the food separately, although the costs of food actually provided to the customer may still be deductible.

Taxpayers using real estate in their business often can generate significant tax savings and increase cash flow by using the technique of cost segregation. Cost segregation is the identification and separate depreciation of personal property components and land improvements. Like its predecessor, component depreciation, cost segregation allows a taxpayer to separately depreciate various elements of a building more rapidly than the underlying building itself.

Taxpayers using real estate in their business often can generate significant tax savings and increase cash flow by using the technique of cost segregation. Cost segregation is the identification and separate depreciation of personal property components and land improvements. Like its predecessor, component depreciation, cost segregation allows a taxpayer to separately depreciate various elements of a building more rapidly than the underlying building itself.

Real and personal property

Under MACRS, a building must be depreciated over 27.5 years (residential rental property) or 39 years (nonresidential real property), using the straight-line method. Cost segregation allows depreciation and recovery of the cost of personal property elements of the building over five to seven years, using an accelerated depreciation method (200-percent declining balance). Components that are not classified as personal property must be included in the building’s basis and depreciated over the appropriate period as real property.

Building elements are eligible for cost segregation if they are considered personal property under Code Sec. 1245 and under the former investment tax credit rules of Code Sec. 38. Classification as personal property under state law can also avoid state and local real property taxes.

Cost segregation study

To use cost segregation, the taxpayer must obtain a cost segregation study, which may be conducted by a cost segregation specialist. The specialist will conduct a feasibility study to determine whether a cost segregation study can provide tax savings. The building must be inspected, and the study must identify the components that may qualify as depreciable personal property. The actual installed cost of the component must be obtained.

The items of personal property must be identified in the study. The study should also provide the legal authority (regulations, cases, rulings, etc.) for treating an item as personal property or a land improvement, and should explain the methodology for determining the property’s depreciable basis.

Ideally, the study should be conducted before the building is placed in service (e.g. when the building is under construction or at the time of purchase), although the study can be conducted after a building is placed in service. The building does not have to be new. If the building is being purchased, the sales contract can allocate the sales price between real and personal property.

Good recordkeeping is essential for individuals and businesses before, during, and after the upcoming tax filing season.

Good recordkeeping is essential for individuals and businesses before, during, and after the upcoming tax filing season.

First, the law actually requires taxpayers to retain certain records for a specified number of years, for example tax returns or employment tax records (for employers).

Second, good recordkeeping is essential for taxpayers while preparing their tax returns. The Tax Code frequently requires taxpayers to substantiate their income and claims for deductions and credits by providing records of various profits, expenses and transactions.

Third, if a taxpayer is ever audited by the IRS, good recordkeeping can facilitate what could be a long and invasive process, and it can often mean the difference between a no change and a hefty adjustment.

Finally, business taxpayers should maintain good records that will enable them to track the trajectory of their success over the years.

Here you will find a sample list of various types of records it would be wise to retain for tax and other purposes (not an exhaustive list; see this office for further customization to your particular situation):

Individuals

Filing status:

Marriage licenses or divorce decrees – Among other things, such records are important for determining filing status.

Determining/Substantiating income:

State and federal income tax returns – Tax records should be retained for at least three years, the length of the statute of limitations for audits and amending returns. However, in cases where the IRS determines a substantial understatement of tax or fraud, the statute of limitations is longer or can remain open indefinitely.

Paystubs, Forms W-2 and 1099, Pension Statements, Social Security Statements – These statements are essential for taxpayers determining their earned income on their tax returns. Taxpayers should also cross reference their wage and income reports with their final pay stubs to verify that their employer has reported the correct amount of income to the IRS.

Tip diary or other daily tip record – Taxpayers that receive some of their income from tips should keep a daily record of their tip income. Under the best circumstances, taxpayers would have already accurately reported their tip income to their employers, who would then report that amount to the IRS. However, mistakes can occur, and good recordkeeping can eliminate confusion when tax season arrives.

Military records – Some members of the military are exempt from state and/or federal tax; combat pay is exempt from taxation, as are veteran’s benefits. (In many cases, a record of military service is necessary to obtain veteran’s benefits in the first place.)

Copies of real estate purchase documents – Up to $500,000 of gain from the sale of a personal residence may be excludable from income (generally up to $250,000 if you are single). But if you own a home that sold for an amount that produces a greater amount of gain, or if you own real estate that is not used as your personal residence, you will need these records to prove your tax basis in your home; the greater your basis, the lower the amount of gain that must be recognized.

Individual Retirement Account (IRA) records – Funds contributed to Roth IRAs and traditional IRAs and the earnings thereon receive different tax treatments upon distribution, depending in part on when the distribution was made, what amount of the contributions were tax deferred when made, and other factors that make good recordkeeping desirable.

Investment purchase confirmation records – Long-term capital gains receive more favorable tax treatment than short-term capital gains. In addition, basis (generally the cost of certain investments when purchased) can be subtracted from gain from any sale. For these reasons, taxpayers should keep records of their investment purchase confirmations.

Substantiating deductions:

Acknowledgments of charitable donations – Cash contributions to charity cannot be deducted without a bank record, receipt, or other means. Charitable contributions of $250 or more must be substantiated by a contemporaneous written acknowledgment from the qualified organization that also meets the IRS requirements.

Cash payments of alimony – Payments of alimony may be deductible from the gross income of the paying spouse . . . if the spouse can substantiate the payments and certain other criteria are met.

Medical records – Disabled taxpayers under the age of 65 should keep a written statement from a qualified physician certifying they were totally disabled on the date of retirement.

Records of medical expenses – Certain unreimbursed medical expenses in excess of 10 percent of adjusted gross income may be deductible. Caution: a pending tax-reform proposal may change the deductibility of these expenses.

Mortgage statements and mortgage insurance – Mortgage interest and real estate taxes have generally deductible for taxpayers who itemize rather than claim the standard deduction. Caution: a pending tax-reform proposal may change the deductibility of these expenses.

Receipts for any improvements to real estate – Part or all of the expense of certain energy efficient real estate improvements can qualify taxpayers for one or more tax credits.

Keeping so many records can be tedious, but come tax-filing season it can result in large tax savings. And in the case of an audit, evidence of good recordkeeping can get you off to a good start with the IRS examiner handling the case, can save time, and can also save money. For more information on recordkeeping for individuals, please contact our offices.

Businesses

Taxpayers are required by law to keep permanent books of account or records that sufficiently substantiate the amount of gross income, deductions, credits and other amounts reported and claimed on any their tax returns and information returns.

Although, neither the Tax Code nor its regulations specify exactly what kinds of records satisfy the record-keeping requirements, here are a few suggestions:

State and federal income tax returns – These and any supporting documents should be kept for at least the period of limitations for each return. As with individual taxpayers, the limitations period for business tax returns may be extended in the event of a substantial understatement or fraud.

Employment taxes – The Tax Code requires employers to keep all records of employment taxes for at least four years after filing for the 4th quarter for the year. Generally these records would include wage payments and other payroll-related records, the amount of employment taxes withheld, reported tip income, identification information for employees and other payees; employees’ dates of employment; income tax withholding allowance certificates (Forms W-4, for example), fringe benefit payments, and more.

Business income – These would go toward substantiating income, and could include cash register tapes, bank deposit slips, a cash receipts journal, annual financial statements, Forms 1099, and more.

Inventory costs – Businesses should keep records of inventory purchases. For example, if an electronics company purchases a certain number of widgets for resale or a manufacturer purchases a certain number of ball bearings for use in the production of industrial equipment that it manufactures and sells. The costs of these goods, parts, or other materials can be deducted from sales income to significantly reduce tax liability.

Business expenses – Ordinary and necessary expenses for carrying on business, such as the cost of rental office space, are also generally deductible from business income. Such expenses can be substantiated through bank statements, canceled checks, credit card receipts or other such records. The cost of making certain improvements to a business, such as through buying equipment or renovating property, can also be deductible.

Electronic back-up

Paper records can take up a great deal of storage space, and they are also vulnerable to destruction in fires, floods, earthquakes, or other natural phenomena. Because records are required to substantiate most income, deductions, property values and more—even when they no longer exist—taxpayers (and especially business taxpayers) should digitize their records on an electronic storage system and keep a back-up copy in a secure location.

Business taxation can be extremely complicated, and the requirements for recordkeeping vary greatly depending on the size of the business, the form of organization chosen, and the type of industry in which the business operates. For more details on your specific situation, please call our offices.

Vacation homes offer owners tax breaks similar-but not identical-to those for primary residences. Vacation homes also offer owners the opportunity to earn tax-advantaged and even tax-free income. This combination of current income and tax breaks, combined with the potential for long-term appreciation, can make a second home an attractive investment.

Vacation homes offer owners tax breaks similar-but not identical-to those for primary residences. Vacation homes also offer owners the opportunity to earn tax-advantaged and even tax-free income. This combination of current income and tax breaks, combined with the potential for long-term appreciation, can make a second home an attractive investment.

Homeowners can deduct mortgage interest they pay on up to $1 million of "acquisition indebtedness" incurred to buy their primary residence and one additional residence. If their total mortgage indebtedness exceeds $1 million, they can still deduct the interest they pay on their first $1 million. If one mortgage carries a substantially higher rate than the second, it makes sense to deduct the higher interest first to maximize deductions.

Vacation homeowners don't need to buy an actual house (or even a condominium) to take advantage of second-home mortgage interest deductions. They can deduct interest they pay on a loan secured by a timeshare, yacht, or motorhome so long as it includes sleeping, cooking, and toilet facilities.

Gains from selling a vacation home are generally taxed as short-term or long-term capital gains.  While gain on the sale of a principal residence can be excludable, gain on the sale of a vacation home is not. Recent rules limit the amount of prior gain on a vacation residence that can be sheltered if a vacation home is converted into a primary residence.

Vacation home rentals. Many vacation home owners rent vacation homes to draw income and help finance the cost of owning the home. These rentals are taxed under one of three sets of rules depending on how long the homeowner rents the property.

• Income from rentals totaling not more than 14 days per year is nontaxable.
• Income from rentals totaling more than 14 days per year is taxable and is generally reported on Schedule E (Form 1040), Supplemental Income and Loss. Homeowners who rent their properties for more than 14 days can deduct a portion of their mortgage interest, property taxes, maintenance, utilities, and other expenses to offset that income. That deduction depends on how many days they use the residence personally versus how many days they rent it.
• Owners who use their home personally for less than 14 days and less than 10% of the total rental days can treat the property as true "rental" property if certain rules are followed.

If you are considering the purchase of a vacation home, our offices can help compute your true, "after-tax" cost of ownership in determining whether such a purchase makes sense.

An LLC (limited liability company) is not a federal tax entity. LLCs are organized under state law. LLCs are not specifically mentioned in the Tax Code, and there are no special IRS regulations governing the taxation of LLCs comparable to the regulations for C corporations, S corporations, and partnerships. Instead, LLCs make an election to be taxed as a particular entity (or to be disregarded for tax purposes) by following the check-the-box business entity classification regulations. The election is filed on Form 8832, Entity Classification Election. The IRS will assign an entity classification by default if no election is made. A taxpayer who doesn't mind the IRS default entity classification does not necessarily need to file Form 8832.

An LLC (limited liability company) is not a federal tax entity. LLCs are organized under state law. LLCs are not specifically mentioned in the Tax Code, and there are no special IRS regulations governing the taxation of LLCs comparable to the regulations for C corporations, S corporations, and partnerships. Instead, LLCs make an election to be taxed as a particular entity (or to be disregarded for tax purposes) by following the check-the-box business entity classification regulations. The election is filed on Form 8832, Entity Classification Election. The IRS will assign an entity classification by default if no election is made. A taxpayer who doesn't mind the IRS default entity classification does not necessarily need to file Form 8832.

"Check-the-Box" Election

An LLC with more than one member can elect tax status as:

• Partnership
• Corporation
• S corporation (accomplished by electing to be taxed as a corporation, then filing an S corporation election)

An LLC with only one member can elect tax status as:

• Disregarded entity
• Corporation
• S corporation (accomplished by electing to be taxed as a corporation, then filing an S corporation election)

The IRS will assign the following classifications if no entity election is filed for an LLC (the default rules):

• any business entity that is not a corporation is classified as a partnership
• any entity that is wholly-owned by a single person will be disregarded as an entity separate from its owner (taxed as a sole proprietorship).

Typically, an LLC with more than one member will elect to be taxed as a partnership, whereas a single-member LLC will elect to be disregarded and taxed as a sole proprietorship.

If you have any questions relating to LLCs, their benefits, drawbacks, or their treatment under the Tax Code, please contact our offices.

Certain planning techniques involve the use of interest rates to value interests being transferred to charity or to private beneficiaries. While the use of these techniques does not necessarily depend on the interest rate, low interest rates may increase their value.

Certain planning techniques involve the use of interest rates to value interests being transferred to charity or to private beneficiaries. While the use of these techniques does not necessarily depend on the interest rate, low interest rates may increase their value.

Taxpayers can obtain a deduction by giving a partial interest in property to a charity, using a trust. Two types of trusts for this purpose are charitable lead trusts and charitable remainder trusts. In a charitable lead trust, the taxpayer funding the trust gives an income interest to charity and the remainder interest to a family member or other preferred beneficiary. In a charitable remainder trust, an individual receives trust income and a charity is entitled to the remainder interest.

AFRs

The IRS’s applicable federal rate (AFR) is used to value these different interests in trusts. Right now, AFRs are relatively low. For example, for May 2017, the AFR for determining the present value of an annuity, an interest for life or a term of years, or a remainder or reversionary interest is only 2.4 percent, a low rate when compared to many past years.

CLTs

When AFRs are low, certain transfer mechanisms become even more useful. In a charitable lead trust (CLT), a low AFR increases the present value of the charity’s income interest. This increases the value of the charitable deduction for the income interest, and reduces the value of the remainder interest passing to private individuals. (For a charitable remainder trust, the same mechanism increases the present value of the individual beneficiary’s income interest, and reduces the value of the remainder interest going to charity.)

PRTs

Another device is a personal residence trust (PRT), where the grantor retains the right to live in the house, instead of receiving income payments, and gives the remainder interest in the property to charity. This provides a current charitable deduction. The amount of the charitable contribution is the fair market value of the property, discounted by the AFR. The lower the AFR, the higher is the value of the remainder interest, and the greater the charitable deduction.

A PRT can also be used to give the remainder interest to a family member or other individual. In this case, the transfer of the remainder interest is subject to gift tax. The lower the AFR, the greater is the value of the remainder interest, and the greater the gift tax.

Loans to family members

Another situation in which low interest rates can work to a taxpayer’s advantage is a loan between family members. For the loan to be bona fide, interest generally must be charged on the loan. However, the lower the AFR, the lower will be the market rate for interest that has to be charged to the borrower. If the interest rate is too low, the IRS may impute a higher rate of interest on the loan, which could result in a gift of the foregone interest to the borrower. Again, when the AFR is low, the lender can make a loan at a lower interest rate.

If you are interested in exploring further how any of the above-mentioned planning techniques can benefit your tax situation especially while interest rates remain low, please do not hesitate to contact this office.

Although it is generally not considered prudent to withdraw funds from a retirement savings account until retirement, sometimes it may appear that life leaves no other option. However, borrowing from certain qualified retirement savings account rather than taking an outright distribution might prove the best solution to getting you through a difficult period. If borrowing from a 401(k) plan or other retirement savings plan becomes necessary, for example to pay emergency medical expenses or for a replacement vehicle essential to getting to work, you should be aware that there is a right way and a number of wrong ways to go about it.

Although it is generally not considered prudent to withdraw funds from a retirement savings account until retirement, sometimes it may appear that life leaves no other option. However, borrowing from certain qualified retirement savings account rather than taking an outright distribution might prove the best solution to getting you through a difficult period. If borrowing from a 401(k) plan or other retirement savings plan becomes necessary, for example to pay emergency medical expenses or for a replacement vehicle essential to getting to work, you should be aware that there is a right way and a number of wrong ways to go about it.

When a plan loan is not a taxable distribution

In general, a loan from a qualified employer plan, such as a 401(a) or 401(k) account, must be treated as a taxable distribution unless you can meet certain requirements with respect to amount, repayment period, and repayment method.

First, however, the terms of the employer-plan must allow for plan loans. Due to administrative costs and other considerations, plan loans are made optional for employer plans. If permitted, however, loans must be made available to all employees.

A loan to a participant or beneficiary is generally not treated as a taxable distribution if:

• The loan is evidenced by a legally enforceable written agreement that specifies the amount and term of the loan and the repayment schedule;
• The amount of the loan does not exceed $50,000 or half of the participant's vested accrued benefit under the plan (whichever is less);
• The loan, by its terms, requires repayment within five years, except for certain home loans; and
• The loan is amortized in level installments over the term of the loan.

Plan loans may be made only from employer-based plans. Individual retirement accounts (IRAs) cannot be used as collateral for a loan, nor can a direct loan be made from the IRA to the account holder.

Calculating the amount of the plan loan

In addition to the $50,000 or 50 percent vested benefit rule, several other provisions apply to the amount of the plan loan. First, a plan participant may take out a loan of up to $10,000, even if that $10,000 is more than one-half of the present value of his vested accrued benefit. Second, if a plan participant decides to take out another plan loan, the new maximum amount of the total plan loans will be determined by the following method:

($50,000 − (highest outstanding loan balance during the preceding 12-month period − outstanding balance on the date of the new loan)) = new plan loan maximum.

That new plan maximum must be reduced further by any outstanding loan balance.

Repayment period

Participants must repay a loan within five years. There is one exception, however, for a loan used to make a purchase of a first-time home that is a principal residence. The loan term may then be as long as 30 years.

If a participant defaults on a loan payment, the entire principal may become due under the terms of the plan. In addition, most plan terms require that you repay the loan within 60 days if you leave or lose your job. If you cannot repay at that time, the balance of the loan is usually considered a taxable distribution deducted from your remaining retirement plan account balance. That deemed distribution may also incur a 10 percent early distribution penalty.

Repayment method

Loan repayments must be made at least every quarter, and are generally deducted automatically from a participant’s paycheck. Defaulting on a loan causes the IRS to treat the entire outstanding loan balance as a premature (and therefore a taxable) distribution from the employer plan. A deemed distribution occurs at the time of the failure to pay an installment, but the plan administrator can allow a grace period. The deemed distribution then becomes subject to both income tax and the 10 percent early withdrawal penalty.

There are benefits to borrowing from an employer retirement plan, such as providing a ready-made source of credit and the benefit of returning interest paid back into the plan account rather than into the pockets of a third-party lender. There are also many drawbacks to taking out a plan loan. To learn more, please contact our offices.

Stock is a popular and valuable compensation tool for employers and employees. Employees are encouraged to stay with the company and to work harder, to enhance the value of the stock they will earn. Employers do not have to make a cash outlay to provide the compensation, yet they still are entitled to a tax deduction.

Stock is a popular and valuable compensation tool for employers and employees. Employees are encouraged to stay with the company and to work harder, to enhance the value of the stock they will earn. Employers do not have to make a cash outlay to provide the compensation, yet they still are entitled to a tax deduction.

Employers may make a direct transfer of stock to an employee as compensation for services performed. In the simplest case, the employee's rights in the stock are vested upon receipt. Under Code Sec. 83, the employee has income, equal to the fair market value of the stock, less any amount paid for the stock. The employer can take a compensation deduction under Code Sec. 162 for the amount included in the employee's income.

Risk of forfeiture

The employer may decide to impose certain conditions on the employee's right to the stock (such as a requirement that the employee continue to work for the company for two years before the stock "vests"). In this situation, the stock is subject to a substantial risk of forfeiture (or is "nonvested") until the two-year period elapses. After two years, the stock vests, and the employee recognizes income for the excess of the stock's value (at the time of vesting) over the amount paid. If the employee leaves the company within two years, the employee forfeits the stock.

An employee who receives stock subject to a substantial risk of forfeiture may anticipate that he or she will stay with the company for the required two years. The employee may also anticipate (or at least hope) that the stock will appreciate in value. Rather than wait two years and have to recognize income when the stock vests, an employee may elect under Code Sec. 83(b) to treat the property as vested upon receipt and to recognize compensation income (if any) at the time of receipt.

83(b) election

The employee may be required to pay for the stock when received. If the employee paid the fair market value of the stock, making a Code Sec. 83(b) election is particularly advantageous, because the employee will not recognize any income on the election.

Example.  Widget Corporation transfers 10 shares of its common stock to Hal, an employee, subject to a requirement that Hal work for two years before the stock vests. The stock is worth $5 a share. Hal is required to pay $5 a share upon receipt of the stock. By making a Code Sec. 83(b) election, Hal will not recognize any income, because the value and the cost of the stock are the same. If Hal did not have to pay any money for the shares, and made an election, Hal would have $50 of compensation income (10 shares times $5 a share).

After making an election, if the employee then works for two years, and the stock appreciates, the employee does not recognize any further compensation income, because the employee has already been taxed under Code Sec. 83.  By making the election, the employee is treated as owning the stock. When the employee sells the stock, the employee will recognize capital gain or loss, measured by the difference between the amount received and the value of the stock when it vested.

Election formalities

To make an election under Code Sec. 83(b), an employee must file a statement with the IRS, within 30 days of the transfer of the property to the employee. The statement must be filed with the Internal Revenue Service Center where the employee would file his or her income tax return. A copy of the statement must be provided to the employer, who is entitled to a compensation deduction when the election is made. A copy must also be attached to the employee's income tax return.

IRS regulations prescribe the requirements for an election. In Rev. Proc. 2012-29, the IRS also provided sample language for employees to use to make the election. The IRS advised that the sample language is not required. The election must identify the taxpayer, the property being transferred, the date of the transfer, the restrictions on the property, the property's value at the time of transfer (generally determined without the restrictions), the amount paid by the employee, and the amount of compensation income (the value minus the amount paid). The employee must also sign the election.

The election cannot be revoked without the IRS's consent. The IRS will not ordinarily grant consent unless there has been a mistake of fact as to the underlying transaction.

If you have any questions about making a Code Sec. 83(b) election, please contact our office.

Some individuals must pay estimated taxes or face a penalty in the form of interest on the amount underpaid. Self-employed persons, retirees, and nonworking individuals most often must pay estimated taxes to avoid the penalty. But an employee may need to pay them if the amount of tax withheld from wages is insufficient to cover the tax owed on other income. The potential tax owed on investment income also may increase the need for paying estimated tax, even among wage earners.

Some individuals must pay estimated taxes or face a penalty in the form of interest on the amount underpaid. Self-employed persons, retirees, and nonworking individuals most often must pay estimated taxes to avoid the penalty. But an employee may need to pay them if the amount of tax withheld from wages is insufficient to cover the tax owed on other income. The potential tax owed on investment income also may increase the need for paying estimated tax, even among wage earners.

The trick with estimated taxes is to pay a sufficient amount of estimated tax to avoid a penalty but not to overpay. The IRS will refund the overpayment when you file your return, but it will not pay interest on it. In other words, by overpaying tax to the IRS, you are in essence choosing to give the government an interest-free loan rather than invest your money somewhere else and make a profit.

When do I make estimated tax payments?

Individual estimated tax payments are generally made in four installments accompanying a completed Form 1040-ES, Estimated Tax for Individuals. For the typical individual who uses a calendar tax year, payments generally are due on April 15, June 15, and September 15 of the tax year, and January 15 of the following year (or the following business day when it falls on a weekend or other holiday).

Am I required to make estimated tax payments?

Generally, you must pay estimated taxes in 2012 if (1) you expect to owe at least $1,000 in tax after subtracting tax withholding (if you have any) and (2) you expect your withholding and credits to be less than the smaller of 90 percent of your 2012 taxes or 100 percent of the tax on your 2011 return.  There are special rules for higher income individuals.

Usually, there is no penalty if your estimated tax payments plus other tax payments, such as wage withholding, equal either 100 percent of your prior year's tax liability or 90 percent of your current year's tax liability. However, if your adjusted gross income for your prior year exceeded $150,000, you must pay either 110 percent of the prior year tax or 90 percent of the current year tax to avoid the estimated tax penalty. For married filing separately, the higher payments apply at $75,000.

Estimated tax is not limited to income tax. In figuring your installments, you must also take into account other taxes such as the alternative minimum tax, penalties for early withdrawals from an IRA or other retirement plan, and self-employment tax, which is the equivalent of Social Security taxes for the self-employed.

Suppose I owe only a relatively small amount of tax?

There is no penalty if the tax underpayment for the year is less than $1,000. However, once an underpayment exceeds $1,000, the penalty applies to the full amount of the underpayment.

What if I realize I have miscalculated my tax before the year ends?

An employee may be able to avoid the penalty by getting the employer to increase withholding in an amount needed to cover the shortfall. The IRS will treat the withheld tax as being paid proportionately over the course of the year, even though a greater amount was withheld at year-end. The proportionate treatment could prevent penalties on installments paid earlier in the year.

What else can I do?

If you receive income unevenly over the course of the year, you may benefit from using the annualized income installment method of paying estimated tax. Under this method, your adjusted gross income, self-employment income and alternative minimum taxable income at the end of each quarterly tax payment period are projected forward for the entire year. Estimated tax is paid based on these annualized amounts if the payment is lower than the regular estimated payment. Any decrease in the amount of an estimated tax payment caused by using the annualized installment method must be added back to the next regular estimated tax payment.

Determining estimated taxes can be complicated, but the penalty can be avoided with proper attention. This office stands ready to assist you with this determination. Please contact us if we can help you determine whether you owe estimated taxes.

Everybody knows that tax deductions aren't allowed without proof in the form of documentation. What records are needed to "prove it" to the IRS vary depending upon the type of deduction that you may want to claim. Some documentation cannot be collected "after the fact," whether it takes place a few months after an expense is incurred or later, when you are audited by the IRS. This article reviews some of those deductions for which the IRS requires you to generate certain records either contemporaneously as the expense is being incurred, or at least no later than when you file your return. We also highlight several deductions for which contemporaneous documentation, although not strictly required, is extremely helpful in making your case before the IRS on an audit.

Everybody knows that tax deductions aren’t allowed without proof in the form of documentation.  What records are needed to “prove it” to the IRS vary depending upon the type of deduction that you may want to claim.  Some documentation cannot be collected “after the fact,” whether it takes place a few months after an expense is incurred or later, when you are audited by the IRS.  This article reviews some of those deductions for which the IRS requires you to generate certain records either contemporaneously as the expense is being incurred, or at least no later than when you file your return.  We also highlight several deductions for which contemporaneous documentation, although not strictly required, is extremely helpful in making your case before the IRS on an audit.

Charitable contributions.  For cash contributions (including checks and other monetary gifts), the donor must retain a bank record or a written acknowledgment from the charitable organization. A cash contribution of $250 or more must be substantiated with a contemporaneous written acknowledgment from the donee.  “Contemporaneous” for this purpose is defined as obtaining an acknowledgment before you file your return.  So save those letters from the charity, especially for your larger donations.

Tip records.  A taxpayer receiving tips must keep an accurate and contemporaneous record of the tip income.  Employees receiving tips must also report the correct amount to their employers.  The necessary record can be in the form of a diary, log or worksheet and should be made at or near the time the income is received.

Wagering losses.  Gamblers need to substantiate their losses. The IRS usually accepts a regularly maintained diary or similar record (such as summary records and loss schedules) as adequate substantiation, provided it is supplemented by verifiable documentation.  The diary should identify the gambling establishment and the date and type of wager, as well as amounts won and lost. Verifiable documentation can include wagering tickets, canceled checks, credit card records, and withdrawal slips from banks.

Vehicle mileage log.  A taxpayer can deduct a standard mileage rate for business, charitable or medical use of a vehicle.  If the car is also used for personal purposes, the taxpayer should keep a contemporaneous mileage log, especially for business use.  If the taxpayer wants to deduct actual expenses for business use of a car also used for personal purposes, the taxpayer has to allocate costs between the business and personal use, based on miles driven for each.

Material participation in business activity.  Taxpayers that materially participate in a business generally can deduct business losses against other income.  Otherwise, they can only deduct losses against passive income.  An individual’s participation in an activity may be established by any reasonable means.  Contemporaneous time reports, logs, or similar documents are not required but can be particularly helpful to document material participation.  To identify services performed and the hours spent on the services, records may be established using appointment books, calendars, or narrative summaries.

Hobby loss.  Taxpayers who do not engage conduct an activity with a sufficient profit motive may be considered to engage in a hobby and will not be able to deduct losses from the activity against other income.  Maintaining accurate books and records can itself be an indication of a profit motive.  Moreover, the time and activities devoted to a particular business can be essential to demonstrate that the business has a profit motive.  Contemporaneous records can be an important indicator.

Travel and entertainment.  Expenses for travel and entertainment are subject to strict substantiation requirements. Taxpayers should maintain records of the amount spent, the time and place of the activity, its business purpose, and the business relationship of the person being entertained. Contemporaneous records are particularly helpful.

A disregarded entity refers to a business entity with one owner that is not recognized for tax purposes as an entity separate from its owner.  A single-member LLC ("SMLLC"), for example, is considered to be a disregarded entity. For federal and state tax purposes, the sole member of an SMLLC disregards the separate legal status of the SMLLC otherwise in force under state law.

A disregarded entity refers to a business entity with one owner that is not recognized for tax purposes as an entity separate from its owner.  A single-member LLC ("SMLLC"), for example, is considered to be a disregarded entity. For federal and state tax purposes, the sole member of an SMLLC disregards the separate legal status of the SMLLC otherwise in force under state law.

As the result of being “disregarded,” the SMLLC does not file a separate tax return.  Rather, its income and loss is reported on the tax return filed by the single member.

• If the sole owner is an individual, the SMLLC's income and loss is reported on his or her Form 1040, U.S. Individual Income Tax Return. This method is similar to a sole proprietorship.
• If the owner is a corporation, the SMLLC's income or loss is reported on the corporation's Form 1120, U.S. Corporation Income Tax Return (or on Form 1120S in the case of an S Corporation). This treatment is similar to that applied to a corporate branch or division.

An SMLLC is not the only entity treated as a disregarded entity. Two corporate forms are also disregarded: a qualified subchapter S subsidiary and a qualified REIT subsidiary. However, SMLLCs are by far the most common disregarded entity currently in use.

For federal tax purposes, the SMLLC does not exist. All its assets and liabilities are treated as owned by the acquiring corporation.

Even though a disregarded entity’s tax status is transparent for federal tax purposes, it is not transparent for state law purposes. For example, an owner of an SMLLC is not personally liable for the debts and obligations of the entity. However, since the entity is disregarded, the owner is generally treated as the employer of disregarded entity employees for employment tax purposes.

For further details on disregarded entities or how this tax strategy may fit into your business operations, please contact our offices. 

In light of the IRS’s new Voluntary Worker Classification Settlement Program (VCSP), which it announced this fall, the distinction between independent contractors and employees has become a “hot issue” for many businesses. The IRS has devoted considerable effort to rectifying worker misclassification in the past, and continues the trend with this new program.  It is available to employers that have misclassified employees as independent contractors and wish to voluntarily rectify the situation before the IRS or Department of Labor initiates an examination.

The distinction between independent contractors and employees is significant for employers, especially when they file their federal tax returns. While employers owe only the payment to independent contractors, employers owe employees a series of federal payroll taxes, including Social Security, Medicare, Unemployment, and federal tax withholding. Thus, it is often tempting for employers to avoid these taxes by classifying their workers as independent contractors rather than employees.

If, however, the IRS discovers this misclassification, the consequences might include not only the requirement that the employer pay all owed payroll taxes, but also hefty penalties. It is important that employers be aware of the risk they take by classifying a worker who should or could be an employee as an independent contractor.

“All the facts and circumstances”

The IRS considers all the facts and circumstances of the parties in determining whether a worker is an employee or an independent contractor. These are numerous and sometimes confusing, but in short summary, the IRS traditionally considers 20 factors, which can be categorized according to three aspects: (1) behavioral control; (2) financial control; (3) and the relationship of the parties.

Examples of behavioral and financial factors that tend to indicate a worker is an employee include:

• The worker is required to comply with instructions about when, where, and how to work;
• The worker is trained by an experienced employee, indicating the employer wants services performed in a particular manner;
• The worker’s hours are set by the employer;
• The worker must submit regular oral or written reports to the employer;
• The worker is paid by the hour, week, or month;
• The worker receives payment or reimbursement from the employer for his or her business and traveling expenses; and
• The worker has the right to end the employment relationship at any time without incurring liability.

In other words, any existing facts or circumstances that point to an employer’s having more behavioral and/or financial control over the worker tip the balance towards classifying that worker as an employee rather than a contractor. The IRS’s factors do not always apply, however; and if one or several factors indicate independent contractor status, but more indicate the worker is an employee, the IRS may still determine the worker is an employee.

Finally, in examining the relationship of the parties, benefits, permanency of the employment term, and issuance of a Form W-2 rather than a Form 1099 are some indicators that the relationship is that of an employer–employee.

Conclusion

Worker classification is fact-sensitive, and the IRS may see a worker you may label an independent contractor in a very different light. One key point to remember is that the IRS generally frowns on independent contractors and actively looks for factors that indicate employee status.

Please do not hesitate to call our offices if you would like a reassessment of how you are currently classifying workers in your business, as well as an evaluation of whether IRS’s new Voluntary Classification Program may be worth investigating.

Charitable contributions traditionally peak at the end of the year-end. While tax savings may not be your prime motivator for making a gift to charity, your donation could help your tax bottom-line for 2015. As with many tax incentives, the rules for tax-deductible charitable contributions are complex, especially the rules for substantiating your donation. Also important to keep in mind are some enhanced charitable giving incentives scheduled to expire at the end of 2015.

Year-end charitable giving can benefit your 2015 tax bottom-line

Charitable contributions traditionally peak at the end of the year-end. While tax savings may not be your prime motivator for making a gift to charity, your donation could help your tax bottom-line for 2015. As with many tax incentives, the rules for tax-deductible charitable contributions are complex, especially the rules for substantiating your donation. Also important to keep in mind are some enhanced charitable giving incentives scheduled to expire at the end of 2015.

Tips

The IRS has posted tips for deducting charitable contributions on its website. The tips are a good refresher of the fundamental rules for deducting charitable contributions:

• To be tax-deductible, a contribution must be made to a qualified organization.
• To deduct a charitable contribution, you must file Form 1040 and itemize deductions on Schedule A.
• If you receive a benefit because of your contribution such as merchandise, tickets to a ball game or other goods and services, then you can deduct only the amount that exceeds the fair market value of the benefit received.
• Donations of clothing and household items must generally be in good used condition or better to be tax-deductible.
• Special rules apply to donations of motor vehicles.
• Many donations must be substantiated; the substantiation rules vary for different donations.

Qualified organizations

Some individuals are surprised to learn that their donation is not tax-deductible because the recipient is not a qualified charitable organization. Generally, churches, temples, synagogues, mosques, and other religious organizations are qualified charitable organizations. Nonprofit community service, educational, and health organizations are also generally qualified charitable organizations. Special rules apply to foreign charities. If you have any questions whether the organization is a qualified charitable organization, please contact our office.

Substantiation rules

Unless a charitable contribution is properly substantiated, the IRS may deny your deduction.

Regardless of the amount, to deduct a contribution of cash, check, or other monetary gift, you must maintain a bank record, payroll deduction records or a written communication from the organization containing the name of the organization, the date of the contribution and amount of the contribution. Remember, this rule applies to all cash contributions, even contributions of small monetary amounts. The IRS will not accept certain personal records. For example, you cannot substantiate a contribution by reference to a diary or notes made at the time of the donation.

In recent years, text message donations have grown in popularity. For text message donations, a telephone bill will meet the record-keeping requirement if it shows the name of the receiving organization, the date of the contribution, and the amount given.

To claim a deduction for contributions of cash or property equaling $250 or more you must have a bank record, payroll deduction records or a written acknowledgment from the qualified organization showing the amount of the cash and a description of any property contributed, and whether the organization provided any goods or services in exchange for the gift.

One document may satisfy both the written communication requirement for monetary gifts and the written acknowledgement requirement for all contributions of $250 or more. If your total deduction for all noncash contributions for the year is over $500, you must complete and attach IRS Form 8283, Noncash Charitable Contributions, to your return.

Additional rules apply for donations valued at more than $5,000. These donations generally require an appraisal and you must advise the IRS of that appraisal by filing a special form.

Expiring provisions

Under current law, certain IRA owners can directly transfer tax-free, up to $100,000 annually from the IRA to a qualified charitable organization. The benefit is limited. The IRA owner must be age 70 ½ or older. Additionally, the contribution does not qualify for the deduction for charitable donations. To qualify, the IRA funds must be contributed directly by the IRA trustee to the qualified charitable organization. You can also take advantage of this tax incentive if you itemize or do not itemize deductions.

Unless extended, this incentive will have officially expired after December 31, 2014. It is unclear if Congress will extend the incentive retroactively for 2015 or beyond. If you are considering a charitable contribution from your IRA, please contact our office so we can review the rules in detail.

Several other enhanced charitable giving incentives will no longer be available for the 2015 tax year and beyond. They include special rules for contributions of food inventory.

Clothing and household items

Cleaning out your closet can help generate year-end tax savings. However, not all charitable contributions of clothing and household items are deductible. Generally, clothing and household items donated to a charitable organization must be in good used or better condition. Other rules also apply to donations of clothing and household items. Properly valuing the items to withstand any IRS examination is also important.

Motor vehicles and other types of donations

The tax deduction for a motor vehicle, boat or airplane donated to charity is fraught with complexity. The substantiation requirements depend on the amount of your claimed deduction. If you are considering donating a motor vehicle, boat or airplane to charity, please contact our office so we can help you navigate the substantiation rules to maximize your tax benefits.

The rules for donations of conservation easements, intellectual property and other items likewise require expert planning. Otherwise, you could miss the tax benefit.

Limitations

The Tax Code includes a number of provisions limiting tax-deductible contributions. Limitations may be based on the individual’s income, the type of donation and the nature of the recipient organization. Our office can describe how these limitations may impact you.

As in past years, a provision known as the limitation on itemized deductions applied to higher-income individuals. This provision reduces the total amount of a higher-income individual's allowable deductions; however, some deductions are not impacted. For purposes of the limitation on itemized deduction, a taxpayer's total, itemized deductions do not include deductions for medical expenses, investment interest expenses, casualty or theft losses, and allowable wagering losses; charitable deductions do count, however.

If you have any questions about the mechanics of tax-deductible charitable contributions, please contact our office.

Taxpayers who wish to withdraw funds from a retirement account such as an IRA before they reach the age of 59 and a half, can do so without their distributions becoming subject to the additional 10 percent tax but only if certain carefully-defined rules are followed. One option is to have distributions made in substantially equal periodic payments, as outlined in Sec. 72(t) of the IRC. Taxpayers can use one of three methods to calculate these substantially equal payments:

Taxpayers who wish to withdraw funds from a retirement account such as an IRA before they reach the age of 59 and a half, can do so without their distributions becoming subject to the additional 10 percent tax but only if certain carefully-defined rules are followed. One option is to have distributions made in substantially equal periodic payments, as outlined in Sec. 72(t) of the IRC. Taxpayers can use one of three methods to calculate these substantially equal payments:

(1)  Required minimum distribution method. Under this method, a taxpayer divides the retirement account's principal by the appropriate number on the IRS's life expectancy table for the year in which distributions will begin. That number depends upon the taxpayer's age. Payment amounts will be predetermined each year by dividing the remaining principal by the number corresponding to the taxpayer's age.
Note: Although this method of computation is much simpler than the second and third, it results in lower annual distributions. The length of time, however, over which the distributions are made is generally greater than for the amortization and annuitization methods.

(2)  Fixed amortization method. Under the amortization method, the annual amount of payments is fixed at the time the first payment is made. The amount of the annual distribution is determined by amortizing the taxpayer's account balance using the appropriate reasonable interest rate released by the IRS over a number of years, which equals the life expectancy of the account owner.

(3)  Fixed annuitization method. As with the amortization method, all resulting annual payments remain the same for each succeeding year. The amount of the payments is determined by dividing the account principal by the appropriate annuity factor, which is based on the IRS's mortality table and an interest rate of not more than 120% of the federal mid-term rate.

Payments made calculated through the annuitization method are generally the highest. Taxpayers electing to use this method should be aware that higher annual payments will more quickly exhaust their principal.
So long as the distribution payment scheme remains unmodified for a five year period beginning from the first payment date, the distributions will not be subject to the additional 10 percent tax.

For further information on whether this option might make sense for you or a family member, please contact our office.

Whether for a day, a week or longer, many of the costs associated with business trips may be tax-deductible. The tax code includes a myriad of rules designed to prevent abuses of tax-deductible business travel. One concern is that taxpayers will disguise personal trips as business trips. However, there are times when taxpayers can include some personal activities along with business travel and not run afoul of the IRS.

Business travel

You are considered “traveling away from home” for tax purposes if your duties require you to be away from the general area of your home for a period substantially longer than an ordinary day's work, and you need sleep or rest to meet the demands of work while away. Taxpayers who travel on business may deduct travel expenses if they are not otherwise lavish or extravagant. Business travel expenses include the costs of getting to and from the business destination and any business-related expenses at that destination.

Deductible travel expenses while away from home include, but are not limited to, the costs of:

• Travel by airplane, train, bus, or car to/from the business destination.
• Fares for taxis or other types of transportation between the airport or train station and lodging, the lodging location and the work location, and from one customer to another, or from one place of business to another.
• Meals and lodging.
• Tips for services related to any of these expenses.
• Dry cleaning and laundry.
• Business calls while on the business trip.
• Other similar ordinary and necessary expenses related to business travel.

Business mixed with personal travel

Travel that is primarily for personal reasons, such as a vacation, is a nondeductible personal expense. However, taxpayers often mix personal travel with business travel. In many cases, business travelers may able to engage in some non-business activities and not lose all of the tax benefits associated with business travel.

The primary purpose of a trip is determined by looking at the facts and circumstances of each case. An important factor is the amount of time you spent on personal activities during the trip as compared to the amount of time spent on activities directly relating to business.

Let’s look at an example. Amanda, a self-employed architect, resides in Seattle. Amanda travels on business to Denver. Her business trip lasts six days. Before departing for home, Amanda travels to Colorado Springs to visit her son, Jeffrey. Amanda’s total expenses are $1,800 for the nine days that she was away from home. If Amanda had not stopped in Colorado Springs, her trip would have been gone only six days and the total cost would have been $1,200. According to past IRS precedent, Amanda can deduct $1,200 for the trip, including the cost of round-trip transportation to and from Denver.

Weekend stayovers

Business travel often concludes on a Friday but it may be more economical to stay over Saturday night and take advantage of a lower travel fare. Generally, the costs of the weekend stayover are deductible as long as they are reasonable. Staying over a Saturday night is one way to add some personal time to a business trip.

Foreign travel

The rules for foreign travel are particularly complex.  The amount of deductible travel expenses for foreign travel is linked to how much of the trip was business related.  Generally, an individual can deduct all of his or her travel expenses of getting to and from the business destination if the trip is entirely for business.

In certain cases, foreign travel is considered entirely for business even if the taxpayer did not spend his or her entire time on business activities. For example, a foreign business trip is considered entirely for business if the taxpayer was outside the U.S. for more than one week and he or she spent less than 25 percent of the total time outside the U.S. on non-business activities. Other exceptions exist for business travel outside the U.S. for less than one week and in cases where the employee did not have substantial control in planning the trip.

Foreign conventions are especially difficult, but no impossible, to write off depending upon the circumstances. The taxpayer may deduct expenses incurred in attending foreign convention seminar or similar meeting only if it is directly related to active conduct of trade or business and if it is as reasonable to be held outside North American area as within North American area.

Tax home

To determine if an individual is traveling away from home on business, the first step is to determine the location of the taxpayer’s tax home. A taxpayer’s tax home is generally his or her regular place of business, regardless of where he or she maintains his or her family home. An individual may not have a regular or main place of business. In these cases, the individual’s tax home would generally be the place where he or she regularly lives.  The duration of an assignment is also a factor. If an assignment or job away from the individual’s main place of work is temporary, his or her tax home does not change. Generally, a temporary assignment is one that lasts less than one year.

The distinction between tax home and family home is important, among other reasons, to determine if certain deductions are allowed. Here’s an example.

Alec’s family home is in Tucson, where he works for ABC Co. 14 weeks a year.  Alec spends the remaining 38 weeks of the year working for ABC Co. in San Diego. Alec has maintained this work schedule for the past three years. While in San Diego, Alec resides in a hotel and takes most of his meals at restaurants.  San Diego would be treated as Alec’s tax home because he spends most of his time there. Consequently, Alec would not be able to deduct the costs of lodging and meals in San Diego.

Accountable and nonaccountable plans

Many employees are reimbursed by their employer for business travel expenses. Depending on the type of plan the employer has, the reimbursement for business travel may or may not be taxable. There are two types of plans: accountable plans and nonaccountable plans.

An accountable plan is not taxable to the employee. Amounts paid under an accountable plan are not wages and are not subject to income tax withholding and federal employment taxes. Accountable plans have a number of requirements:

• There must be a business connection to the expenditure. The expense must be a deductible business expense incurred in connection with services performed as an employee. If not reimbursed by the employer, the expense would be deductible by the employee on his or her individual income tax return.

• There must be adequate accounting by the recipient within a reasonable period of time. Employees must verify the date, time, place, amount and the business purpose of the expenses.

• Excess reimbursements or advances must be returned within a reasonable period of time.

Amounts paid under a nonaccountable plan are taxable to employees and are subject to all employment taxes and withholding.  A plan may be labeled an accountable plan but if it fails to qualify, the IRS treats it as a nonaccountable plan. If you have any questions about accountable plans, please contact our office.

As mentioned, the tax rules for business travel are complex. Please contact our office if you have any questions.

With school almost out for the summer, parents who work are starting to look for activities for their children to keep them occupied and supervised. The possibilities include sending a child to day camp or overnight camp. Parents faced with figuring out how to afford the price tag of these activities may wonder whether some or part of these costs may be tax deductible. At least two possible tax breaks should be considered: the dependent care credit in most cases, and the deduction for medical expenses in certain special situations.

Dependent care credit. To qualify for the dependent care credit, expenses must be employment-related. The child also must be under age 13 unless he or she is disabled.

The child care expenses must enable the parent to work or to look for employment. The IRS has indicated that the costs of sending a child to overnight camp are not employment-related. However, the costs of sending a child to day camp are treated like day-care costs and will qualify as employment-related expenses (even if the camp features educational activities). At the same time, the costs of sending a child to summer school or to a tutor are not employment-related and cannot be deducted even though they also watch over your child while you are at work..

In some situations, the IRS requires that expenses be allocated between child care and other, nonqualified services. However, the full cost of day camp generally qualifies for the dependent care credit, without an allocation being required. If the parent works part-time, camp costs may only be claimed for the days worked. However, if the camp requires that the child be enrolled for the entire week, then the full cost qualifies.

Example. Tom works Monday through Wednesday and sends his child to day camp for the entire week. The camp charges $50 per day and children do not have to enroll for an entire week. Tom can only claim $150 in expenses. However, if the camp requires that the child be enrolled for the entire week, Tom can claim $250 in expenses.

Amount of Credit. The maximum amount of employment-related expenses to which the child care credit may be applied is $3,000 if one qualifying individual is involved or $6,000 if two or more qualifying individuals are involved. If you earn over a certain amount, the credit may be reduced. The credit amount is equal to the amount of qualified expenses times the applicable percentage, as determined by the taxpayer's adjusted gross income (AGI). Taxpayers with an AGI of $15,000 or less use the highest applicable percentage of 35 percent. For taxpayers with an AGI over $15,000, the credit is reduced by one percentage point for each $2,000 of AGI (or fraction thereof) over $15,000 The minimum applicable percentage of 20 percent is used by taxpayers with an AGI greater than $43,000. Bottom line: those with higher incomes are entitled to a maximum child care credit for one qualifying dependent is $1,050 and $2,100 for two or more qualifying dependents.

Dependent care costs also may be reimbursed by a flexible spending account (FSAs) under an employer-sponsored arrangement. FSAs allow pre-tax dollars to fund the account up to specified maximum. Each FSA may limit what it covers so check with your employer before assuming the day camp or similar child care is on its list of reimbursable expenses.

Medical expenses. The cost of camp generally is not deductible as a medical expense. The cost of providing general care to a healthy child is a nondeductible personal expense.

Example. The child's mother works; the child's father is ill and cannot take care of the child. The cost of sending the child to summer camp is not deductible as a medical expense; however, the costs may still qualify for the dependent care credit.

However, camps specifically run for handicapped children and operated to assist the child may come under the umbrella of medical expenses. The degree of assistance is usually determinative in these situations.

Dependency exemption. In any case, the cost of sending a child to camp can be treated as support, for claiming a dependency exemption. For a parent to claim a dependency exemption, the child cannot provide more than half of its own support. The parent must provide some support but does not necessarily have to provide over half of the child's support. If the child is treated as a qualifying relative (because he or she is too old to be a qualifying child), the parent must still provide over half of the child's support.

The rules on the deductibility of camp costs are somewhat complicated, especially in borderline situations. Please check with this office if you have any questions.

Most people are familiar with tax withholding, which most commonly takes place when an employer deducts and withholds income and other taxes from an employee's wages. However, many taxpayers are unaware that the IRS also requires payors to withhold income tax from certain reportable payments, such as interest and dividends, when a payee's taxpayer identification number (TIN) is missing or incorrect. This is known as "backup withholding."

Backup Withholding in General

A payor must deduct, withhold, and pay over to the IRS a backup withholding tax on any reportable payments that are not otherwise subject to withholding if:

• the payee fails to furnish a TIN to the payor in the manner required;
• the IRS or a broker notifies the payor that the TIN provided by the payee is incorrect;
• the IRS notifies the payor that the payee failed to report or underreported the prior year's interest or dividends; or
• the payee fails to certify on Form W-9, Request for Taxpayer Identification Number and Certification, that he or she is not subject to withholding for previous underreporting of interest or dividend payments.

The backup withholding rate is equal to the fourth lowest income tax rate under the income tax rate brackets for unmarried individuals, which is currently 28 percent.

Only reportable payments are subject to backup withholding. Backup withholding is not required if the payee is a tax-exempt, governmental, or international organization. Similarly, payments of interest made to foreign persons are generally not subject to information reporting; therefore, these payees are not subject to backup withholding. Additionally, a payor is not required to backup withhold on reportable payments for which there is documentary evidence, under the rules on interest payments, that the payee is a foreign person, unless the payor has actual knowledge that the payee is a U.S. person. Furthermore, backup withholding is not required on payments for which a 30 percent amount was withheld by another payor under the rules on foreign withholding.

Reportable Payments

Reportable payments generally include the following types of payments of more than $10:

• Interest;
• Dividends;
• Patronage dividends (payments from farmers' cooperatives) paid in money;
• Payments of $600 or more made in the course of a trade or business;
• Payments for a nonemployee's services provided in the course of a trade or business;
• Gross proceeds from transactions reported by a broker or barter exchange;
• Cash payments from certain fishing boat operators to crew members that represent a share of the proceeds of the catch; and
• Royalties.

Reportable payments also include payments made after December 31, 2011, in settlement of payment card transactions.

Failure to Furnish TIN

Payees receiving reportable payments through interest, dividend, patronage dividend, or brokerage accounts must provide their TIN to the payor in writing and certify under penalties of perjury that the TIN is correct. Payees receiving other reportable payments must still provide their TIN to the payor, but they may do so orally or in writing, and they are not required to certify under penalties of perjury that the TIN is correct.

A payee who does not provide a correct taxpayer identification number (TIN) to the payer is subject to backup withholding. A person is treated as failing to provide a correct TIN if the TIN provided does not contain the proper number of digits --nine --or if the number is otherwise obviously incorrect, for example, because it contains a letter as one of its digits.

The IRS compares TINs provided by taxpayers with records of the Social Security Administration to check for discrepancies and notifies the bank or the payer of any problem accounts. The IRS has requested banks and other payers to notify their customers of these discrepancies so that correct TINs can be provided and the need for backup withholding avoided.

A limited liability company (LLC) is a business entity created under state law. Every state and the District of Columbia have LLC statutes that govern the formation and operation of LLCs.

The main advantage of an LLC is that in general its members are not personally liable for the debts of the business. Members of LLCs enjoy similar protections from personal liability for business obligations as shareholders in a corporation or limited partners in a limited partnership. Unlike the limited partnership form, which requires that there must be at least one general partner who is personally liable for all the debts of the business, no such requirement exists in an LLC.

A second significant advantage is the flexibility of an LLC to choose its federal tax treatment. Under IRS's "check-the-box rules, an LLC can be taxed as a partnership, C corporation or S corporation for federal income tax purposes. A single-member LLC may elect to be disregarded for federal income tax purposes or taxed as an association (corporation).

LLCs are typically used for entrepreneurial enterprises with small numbers of active participants, family and other closely held businesses, real estate investments, joint ventures, and investment partnerships. However, almost any business that is not contemplating an initial public offering (IPO) in the near future might consider using an LLC as its entity of choice.

Deciding to convert an LLC to a corporation later generally has no federal tax consequences. This is rarely the case when converting a corporation to an LLC. Therefore, when in doubt between forming an LLC or a corporation at the time a business in starting up, it is often wise to opt to form an LLC. As always, exceptions apply. Another alternative from the tax side of planning is electing "S Corporation" tax status under the Internal Revenue Code.

Estimated tax is used to pay tax on income that is not subject to withholding or if not enough tax is being withheld from a person's salary, pension or other income. Income not subject to withholding can include dividends, capital gains, prizes, awards, interest, self-employment income, and alimony, among other income items. Generally, individuals who do not pay at least 90 percent of their tax through withholding must estimate their income tax liability and make equal quarterly payments of the "required annual payment" liability during the year.

Estimated tax is used to pay tax on income that is not subject to withholding or if not enough tax is being withheld from a person's salary, pension or other income. Income not subject to withholding can include dividends, capital gains, prizes, awards, interest, self-employment income, and alimony, among other income items. Generally, individuals who do not pay at least 90 percent of their tax through withholding must estimate their income tax liability and make equal quarterly payments of the "required annual payment" liability during the year.

Basic rules

The "basic" rules governing estimated tax payments are not always synonymous with "straightforward" rules. The following addresses some basic rules regarding estimated tax payments by corporations and individuals:

Corporations. For calendar-year corporations, estimated tax installments are due on April 15, June 15, September 15, and December 15. If any due date falls on a Saturday, Sunday or legal holiday, the payment is due on the first following business day. To avoid a penalty, each installment must equal at least 25 percent of the lesser of:

• 100 percent of the tax shown on the corporation's current year's tax return (or of the actual tax, if no return is filed); or
• 100 percent of the tax shown on the corporation's return for the preceding tax year, provided a positive tax liability was shown and the preceding tax year consisted of 12 months.

A lower installment amount may be paid if it is shown that use of an annualized income method, or for corporations with seasonal incomes, an adjusted seasonal method, would result in a lower required installment.

Individuals. For individuals (including sole proprietors, partners, self-employeds, and/or S corporation shareholders who expect to owe tax of more than $1,000), quarterly estimated tax payments are due on April 15, June 15, September 15, and January 15. Individuals who do not pay at least 90 percent of their tax through withholding generally are required to estimate their income tax liability and make equal quarterly payments of the "required annual payment" liability during the year. The required annual payment is generally the lesser of:

• 90 percent of the tax ultimately shown on your return for the 2015 tax year, or 90 percent of the tax due for the year if no return is filed;
• 100 percent of the tax shown on your return for the preceding (2014) tax year if that year was not for a short period of less than 12 months; or
• The annualized income installment.

For higher-income taxpayers whose adjusted gross income (AGI) shown on your 2014 tax return exceeds $150,000 (or $75,000 for a married individual filing separately in 2015), the required annual payment is the lesser of 90 percent of the tax for the current year, or 110 percent of the tax shown on the return for the preceding tax year.

Adjusting estimated tax payments

If you expect an uneven income stream for 2015, your required estimated tax payments may not necessarily be the same for each remaining period, requiring adjustment. The need for, and the extent of, adjustments to your estimated tax payments should be assessed at the end of each installment payment period.

For example, a change in your or your business's income, deductions, credits, and exemptions may make it necessary to refigure estimated tax payments for the remainder of the year. Likewise for individuals, changes in your exemptions, deductions, and credits may require a change in estimated tax payments. To avoid either a penalty from the IRS or overpaying the IRS interest-free, you may want to increase or decrease the amount of your remaining estimated tax payments.

Refiguring tax payments due

There are some general steps you can take to reconfigure your estimated tax payments. To change your estimated tax payments, refigure your total estimated tax payments due. Then, figure the payment due for each remaining payment period. However, be careful: if an estimated tax payment for a previous period is less than one-fourth of your amended estimated tax, you may be subject to a penalty when you file your return.

If you would like further information about changing your estimated tax payments, please contact our office.

A business can deduct ordinary and necessary expenses paid or incurred in carrying on any trade or business. The expense must be reasonable and must be helpful to the business.

Gifts to a business client, customer or contact can be deductible business expenses. However, the maximum deduction for gifts to any individual is $25 per year (Code Sec. 274(b)). A gift is any item that is excluded from income under Code Sec. 102. Gifts that cost $4.00 or less, as well as promotional items, are not subject to the $25 limitation.

Gifts by individuals to co-workers are normally considered nondeductible personal expenses. However, employee achievement awards ($400 limit) and qualified plan awards are not subject to the $25 limitation.

Substantiation

Taxpayers must be able to substantiate certain business expenses by adequate records or sufficient evidence to take them as a deduction. Substantiation is required for business gifts, as well as traveling, lodging and entertainment expenses, because they are considered more susceptible to abuse (Tax Code Sec. 274(d)).

For business gifts, IRS regulations require that taxpayers substantiate the following elements of the gift:

- Amount (the cost to the taxpayer);
- Time (the date of the gift);
- Description of the gift;
- Business purpose - the business reason for the gift, or the nature of the business benefit derived or expected to be derived as a result of the gift; and
- Business relationship - occupation or other information relating to the recipient, including name, title and other designation, sufficient to establish the business relationship to the taxpayer.

The IRS provides substantiation rules in Treasury Reg. 1.274-5T(c). The taxpayer must maintain and produce, on request, "adequate records" or "sufficient evidence" that corroborate the taxpayer's own statement. Written evidence has "considerably more probative value" than oral evidence alone. While a contemporaneous log is not required, written evidence is more effective the closer in time it relates to the expense. Support by sufficient documentary evidence is highly credible.

Adequate records

Adequate records include an account book, diary, log, statement of expenses or similar records, as well as documentary evidence, which in combination establish each element of the expense. However, it is not necessary to record information that duplicates information on a receipt. The record should be prepared at or near the time of the expenditure, when the taxpayer has full present knowledge of each element. A statement, such as a weekly log, submitted by an employee to his employer in the regular course of good business practice is considered an adequate record.

An adequate record of business purpose generally requires a written statement of business purpose. However, the degree of substantiation will vary depending on the facts and circumstances.

Sufficient evidence

A taxpayer that does not have adequate records may establish an element by other sufficient evidence, such as the taxpayer's written or oral statement with specific, detailed information, and other corroborative evidence. A description of a gift shall be direct evidence, such as a detailed statement by the recipient or documentary evidence otherwise required as an adequate record.

If the taxpayer loses records through circumstances beyond the taxpayer's control, the taxpayer may substantiate the deduction by reasonably reconstructing his expenditures.

If one of your children received a full scholarship for all expenses to attend college this year, you may be wondering if this amount must be reported on his or her income tax return. If certain conditions are met, and the funds are used specifically for certain types of expenses, your child does not have to report the scholarship as income.

Qualified educational institution

Any amount received as a “qualified scholarship” or fellowship is not required to be reported as income if your child is a candidate for a degree at an educational institution.  For the college that your child attends to be treated as an educational organization, it must (1) be an institution that has as its primary function the presentation of formal instruction, (2) normally maintain a regular faculty and curriculum, and (3) have a regularly enrolled body of students in attendance at the place where the educational activities are regularly carried on.  Your child has received a qualified scholarship if he or she can establish, that in accordance with the conditions of the scholarship, the funds received were used for qualified tuition and related expenses. Therefore, the entire amount is generally taxable if your child is not a candidate for a degree. Athletic scholarships are also tax-free if they meet the above-mentioned requirements.

Qualified tuition and expenses

Qualified tuition and related expenses include tuition and fees required for enrollment or attendance at the educational institution, as well as any fees, books, supplies, and equipment required for courses of instruction at the educational institution.  To be treated as related expenses, the fees, books supplies, and equipment must be required of all students in the particular course of instruction.  Incidental expenses, such as expenses for room and board, travel, research, equipment, and other expenses that are not required for either enrollment or attendance at the educational institution are not treated as related expenses. Any amounts that are used for room, board and other incidental expenses are not excluded from income.

Example. Assume this year your son received a scholarship in the amount of $20,000 to pay for expenses at a qualified educational institution.  His expenses included $12,000 for tuition; $1,100 for books; $900 for lab supplies and fees; and $6,000 for food, housing, clothing, laundry, and other living expenses.

The $14,000 that your son paid for tuition, books and lab supplies and fees is considered to be qualified educational expenses and therefore would not have to be reported as income.  The $6,000 that he spent on housing and the other living expenses is considered to be incidental expenses and would have to be reported in his income.

A note on student loans. “Financial aid” in the form of student loans is not counted as a scholarship. However, student loans are not included in income, generally, and student loan interest can be deducted up to $2,500 a year. If a student loan is partly or wholly forgiven, however, the amount forgiven by the lender is included in income unless specific exceptions apply.

Reduced tuition

If you or your spouse is or was an employee of the school, your child may be entitled to reduced tuition. If so, the amount of the reduction is not taxable as long as the tuition is not for education at the graduate level.

While the economy continues to slowly recover, many businesses continue to face customers struggling to pay outstanding bills for services or goods. The Tax Code provides relief to businesses faced with the inability to collect on accounts receivable. Businesses that are unable to get customers to pay the bill can claim a deduction for the “bad debt.”

While the economy continues to slowly recover, many businesses continue to face customers struggling to pay outstanding bills for services or goods. The Tax Code provides relief to businesses faced with the inability to collect on accounts receivable. Businesses that are unable to get customers to pay the bill can claim a deduction for the “bad debt.”

 Business bad debt deduction

 Taxpayers may deduct any business receivable that becomes totally or partially worthless during the tax year under Tax Code Sec. 166(a). However, the business bad debt deduction is limited to the taxpayer’s adjusted basis in the receivable.

 The deduction allowed for bad debts is an ordinary deduction. To claim the deduction, you must establish that the debt is genuine and that the amount cannot be recovered from the debtor. You must also make a reasonable attempt to collect the debt (however, you do not have to turn the debt over to a collection agency or file a lawsuit in an attempt to collect on the debt if doing so has little probability of success). The law requires most taxpayers to use the specific charge-off method of accounting for bad debts. Under the specific charge-off method, the taxpayer must specifically identify the accounts or notes charged off as partially or completely worthless (it is also referred to as the direct write-off method).

 If you meet these conditions, you can take the deduction in the year in which the debts became worthless. This includes certain previous years since, for some debts, worthlessness may not be immediately apparent. You can deduct a bad debt before the debt is due if you can establish the partial or complete worthlessness of the debt.

 Partially worthless. If you failed to claim the bad debt deduction for a receivable that became partially worthless in a prior tax year, you have until the later of (1) three years after you file the tax return (including extensions) or (2) two years from the time you paid the tax to file an amended return and deduct the bad debt.

 Totally worthless. If you failed to claim a deduction for a receivable that became completely worthless in a previous tax year, you have until the later of (1) seven years after the due date of the tax return (not including extensions) or (2) two years from the time you paid the tax to file an amended return and claim a deduction for the worthless receivable.

 Cash basis taxpayers

 Cash basis taxpayers cannot claim a bad debt deduction for accounts receivable that are not collectible. However, notes received by a cash basis taxpayer in the ordinary course of business are treated as the equivalent of cash to the extent of the note’s fair market value (FMV) at the time received. Thus, the initial basis in such a note is its FMV. Cash basis taxpayers may claim a bad debt deduction for uncollectible notes receivable if they have included the FMV of the notes in gross income.

 Accrual and hybrid taxpayers

 Accrual basis taxpayers may claim a bad debt deduction for accounts receivable that become partially or completely worthless during the tax year. Accrual basis taxpayers must include the face value of a note receivable in gross income if a reasonable expectancy of collection exists at the time it is received. Taxpayers that use a hybrid method of accounting may deduct bad debts if they have included the revenue from the receivable in gross income.

 Reporting

 For self-employed taxpayers, the bad business debt deduction is reported on Schedule C, Profit or Loss from Business (Sole Proprietorship), or Schedule F (Profit or Loss from Farming (for self-employed farmers)).Corporations report bad debts on Line 15 of Form 1120, U.S. Corporation Income Tax Return. S corporations report bad debts on Line 10 of Form 1120S, U.S. Income Tax Return for an S Corporation. Partnerships report bad debts on Line 12 of Form 1065, U.S. Return of Partnership Income.

 Recovering bad debts

 If you recover a bad debt during the year, the amount recovered is gross income to the extent that you claimed the deduction for the bad debt in a previous tax year, reducing your taxable income. This is called the tax benefit rule. The bad debt you recovered may not be offset against the bad debt deduction for the tax year of the recovery.

Q. I spend 20 hours every week cooking meals and delivering them to an organization that feeds the hungry and homeless. Am I entitled to a deduction for my time and the food I pay for out of my own money?

A. Generally, if you do volunteer work for a charity, you are not entitled to deduct the cost of services you perform for the charity. However, if in connection with the volunteer work you incur out-of-pocket expenses, you may be entitled to deduct some of those expenses.

Qualifying expenses

If the amounts that you pay for food and other supplies used in the preparation and packaging of the meals are not reimbursed by the charity, generally you may deduct these expenses as contributions to the charity.

In addition, if the amounts that you pay to travel by car or other means to deliver the meals are not reimbursed by the charity, and you derive no personal benefit from the travel, the expenses are deductible. Qualifying expenses include gasoline for your car and fares for taxis or public transportation.

Special mileage rate

If you drive your own vehicle to deliver the meals, you can use a special IRS mileage rate to calculate charitable contribution deductions involving use of your car. This special rate is 14 cents per mile, which is statutorily set.

Other expenses

Other out-of-pocket expenses incurred in connection with services you provide to a charity that are deductible include costs related to uniforms, travel, meals, and lodging. Sometimes, expenses incurred while serving as a charity’s delegate to a convention may be deducted.

Keep receipts

Debt that a borrower no longer is liable for because it is discharged by the lender can give rise to taxable income to the borrower. Debt forgiveness income or cancellation of debt income ("COD" income) is the amount of debt that a lender has discharged or canceled. However, in many situations, the canceled debt is excluded from taxable income.

Credit cards, car loans and mortgage debt are three of the most common consumer debts, yet many individuals don't know the tax rules surrounding discharges of these debts by lenders. In general, almost all types of discharged debt will be includable in the borrower's taxable income, unless a specific exclusion applies.

The creditor will generally report COD income to the IRS and to the debtor, using Form 1099-C, Cancellation of Debt, even if an exclusion applies. The creditor may not be aware that the debtor can exclude the COD income. We can help you determine whether an exclusion applies.

Exclusions and reduction of attributes

There are four situations where cancelled debt does not result in taxable income:

1. The debt has been discharged through a bankruptcy proceeding under Title 11; 2. Insolvency (your total debts exceed your total assets); 3. The debt is due to a qualified farm expense ("qualified farm indebtedness"); and 4. The debt is due to certain real property business losses ("qualified real property business indebtedness").

When canceled debt is excluded from income, the debtor may be required to reduce tax attributes, such as a net capital loss or the basis of property. The reduction of attributes must be reported on Form 982, Reduction of Tax Attributes Due to Discharge of Indebtedness, and attached to your federal income tax return.

Other exclusions may apply to student loans, disaster victims, gifts, general welfare payments, and payments that would have been deductible.

Mortgage debt forgiveness

For a limited period of time, certain mortgage debt that is discharged by the lender is excludable from COD income and therefore does not result in taxable income to homeowners. This debt is generally referred to as "qualified principal residence indebtedness." The cancellation of qualifying mortgage debt is excludable from income if it is incurred with respect to the taxpayer's principal residence for "acquisition" debt forgiven on or after January 1, 2007 and before January 1, 2013. Acquisition debt is indebtedness secured by the residence and incurred in the acquisition, construction or substantial improvement of the residence.

Certain debt used to refinance the debt is also eligible. Debt forgiven on a second home or rental property does not qualify for the exclusion.

Example. Anne's principal residence is subject to a $300,000 mortgage debt. Anne's creditor forecloses on the property in September 2010. Due to the depressed real estate market, Anne's home sold for $220,000. The creditor forgives the other $80,000 of debt. Anne has COD income totaling $80,000 ($300,000 - $220,000).

Credit card and car loan debt

Noticeably absent from the specific exceptions to COD income are two of the biggest consumer debt items: credit cards and car loans. Credit card debt or an unpaid debt on a car loan that is forgiven by the lender is includable in gross income, unless the debtor is bankrupt or insolvent. The lender will report the amount of forgiven debt on Form 1099-C, Cancellation of Debt.

Example. Michael has an outstanding credit card bill of $7,400. Michael cannot pay the total amount but reaches a compromise with his credit card company in which he settles the debt for $4,000. Assuming the debtor is not bankrupt or insolvent, the Internal Revenue Code treats him as having realized a personal net gain (and COD income) of $3,400, even though he did not actually receive any money. The credit card company will report the $3,400 as COD income on Form 1099-C, and the debtor must include it in his gross income.

Reporting

If you had debt discharged in 2009 that does not qualify for an exception, you must include the amount of cancelled debt in your gross income on your tax return. If you have questions about COD income, the exclusions from income, or your reporting responsibilities, please contact our office.

If you are finally ready to part with those old gold coins, baseball cards, artwork, or jewelry your grandmother gave you, and want to sell the item, you may be wondering what the tax consequences will be on the disposition of the item (or items). This article explains some of the basic tax consequences of the sale of a collectible, such as that antique vase or gold coin collection.

If you are finally ready to part with those old gold coins, baseball cards, artwork, or jewelry your grandmother gave you, and want to sell the item, you may be wondering what the tax consequences will be on the disposition of the item (or items). This article explains some of the basic tax consequences of the sale of a collectible, such as that antique vase or gold coin collection.

Collectibles

You must pay tax on any gain you realize from the sale of a collectible item (or the entire collection), such as a gold watch or other jewelry, antique coins, artwork, figurines, and even baseball cards. Capital gains on collectibles are taxed at a rate of 28 percent, rather than the regular long-term capital gains rate, currently at 15 percent (zero for those in the 10 or 15 percent income tax brackets). Gain on collectibles is reported on Schedule D of Form 1040. To calculate capital gains on the sale or other disposition you need to determine what your basis in the item is.

If you purchased the item, your basis is generally what you paid for the item as well as certain expenses related to the purchase. Fees related to the sale itself should also be included, such as a broker's or auctioneer's fee or an appraisal or authentication fee.

If you inherited the item, then your basis is the item's fair market value (FMV) at the time you inherited it. There are two principal methods for determining FMV: an appraisal, such as used for estate purposes, or valuing the item based on contemporaneous sales of comparable items. However, this can be tricky because the condition of a collectible item plays significantly into its value.

If the item was a gift, then your basis is the same as the basis of the person who gave you the item.

If you buy and sell collectibles on a regular basis, devote a substantial amount of time and effort to the activity and have developed a degree of skill in identifying profitable transactions, you may be engaged in a trade or business. In this case, you may be engaged in a trade or business in the eyes of the IRS, and therefore your stock of collectibles may be "inventory" and your profits taxable as ordinary income.

Precious metals

Gold and silver, like stamps and coins, are treated by the IRS as capital assets except when they are held for sale by a dealer. Any gain or loss from their sale or exchange is generally a capital gain or loss. If you are a dealer, the amount received from the sale is ordinary business income. However, metals like gold and silver are classified by the Internal Revenue Code as collectibles, and gain recognized from the sale of gold or silver held for more than one year - whether or not in the form of jewelry or sold simply for its market content - is taxed at the maximum rate of 28 percent.

For all sales of more than $600, an information return generally must be filed with the IRS.

The small business corporation (S corp) is one of the most popular business entities today, offering its shareholders the flow-through tax treatment of a partnership and the limited liability of a corporation. The S corp has become an even more prominent entity in the small business community, in part, because the IRS has relaxed certain requirements for electing S corp status. A small business corporation does not need to elect to be treated as an S corp each year to maintain S corp status.

Special election

To be treated as an S corp, a small business must make a special election under subchapter S of the Tax Code. This special election requires the proper and timely filing of Form 2553, Election by a Small Business Corporation, under Code Sec. 1362. An S corp election is valid only if all shareholders on the date of the election consent to it. For example, if the election is made prior to the start of the tax year for which it is effective, new shareholders between the date of the election and the beginning of the tax year need not also consent to maintain S corp status.

Once a small business corporation properly and timely elects to be treated as an S corp, however, the election remains valid and does not need to be made every year, even if new shareholders do not consent. An S corp election remains effective unless, or until, the election is formally revoked by the shareholders or S corp status is terminated because the corporation no longer meets all requirements necessary to maintain S corp status (for example, there are more than 100 shareholders of the S corp or the S corp has more than one class of stock outstanding).

Filing timeline

An initial S corp election must be made on or before the 15^th day of the third month (i.e. March 15) of the taxable year in order for the election to be effective for that year. If the election is not made until after the 15th day of the third month of the tax year, the election is effective for the following year. A newly formed corporation, on the other hand, that has missed the March 15^th deadline may file Form 2553 any time during its tax year as long as the filing is made no later than 75 days after the corporation has begun conducting business as a corporation, acquired assets, or issued stock to shareholders (whichever is earlier). If an untimely election causes an S corp election to terminate, the IRS possesses discretionary authority to retroactively waive the timely failing requirement.

If you would like more information about electing S corp status, or about the benefits and drawbacks of other business entities, please call our office. We would be glad to assist you.

With the holidays quickly approaching, you as an employer may not only be wondering what type of gift to give your employees this season, but the tax consequences of the particular gift you choose. The form of gift that you give this holiday season not only has tax consequences for your employees, but for your business as well. If you plan on giving your employees a gift that can be basted or baked this holiday season, such as a traditional turkey or ham, you should understand how that gift will be treated by the IRS for tax purposes.

With the holidays quickly approaching, you as an employer may not only be wondering what type of gift to give your employees this season, but the tax consequences of the particular gift you choose. The form of gift that you give this holiday season not only has tax consequences for your employees, but for your business as well. If you plan on giving your employees a gift that can be basted or baked this holiday season, such as a traditional turkey or ham, you should understand how that gift will be treated by the IRS for tax purposes.

De minimis fringe benefit

Gifts of holiday turkeys and hams given to employees are considered non-taxable de minimis employee fringe benefits. They are excluded from employees' income and are fully deductible as a non-wage business expense by the employer. Moreover, the value of the turkey and ham is 100 percent deductible; that is, it is not subject to the 50 percent deductible limitation that generally applies to meals.

Generally, gifts provided to employees are treated as supplemental wages subject to income and payroll taxes unless the benefit is specifically excluded from tax by law. However, gifts considered to be a "de minimis" fringe benefit are not taxable to the employee. Code Sec. 132(a)(4) provides that gross income does not include a fringe benefit that qualifies as a "de minimis" fringe benefit. A de minimis fringe benefit is defined in Code Sec. 132(e)(1) as any property or service the value of which is so small as to make accounting for it unreasonable or administratively impracticable after taking into account the frequency with which similar fringe benefits are provided by the employer to the employer's employees.

Generally, de minimis fringe benefits must satisfy the following requirements:

• The value of the gift must be nominal;
• Accounting for the gift would be administratively impractical;
• The gift is provided only occasionally; and
• The gift is given to promote the good will or health of employees.

In Treasury Reg. Sec. 1.132-6(e)(1), the IRS has specifically included traditional holiday gifts (not cash) with a low fair market value as a de minimis fringe benefit excludable from tax. The gift to employees of a holiday turkey or ham has long been recognized as falling within the rules for de minimis employee fringe benefits, and is not taxable to employees.

Gift certificates are taxable

If you give your employees a gift certificate or gift card (or similar item that can readily be converted into cash) for a turkey or ham in lieu of the actual food item itself, the value of the gift certificate or gift card is considered to be additional salary or wages and subject to income and payroll taxes. Gift certificates and gift cards are "cash equivalents" and taxable to employees even though the turkey itself, if provided in kind directly to the employee, is excludable from tax as a de minimis fringe benefit.

If you use your car for business purposes, you may have learned that keeping track and properly logging the variety of expenses you incur for tax purposes is not always easy. Practically speaking, how often and how you choose to track expenses associated with the business use of your car depends on your personality; whether you are a meticulous note-taker or you simply abhor recordkeeping. However, by taking a few minutes each day in your car to log your expenses, you may be able to write-off a larger percentage of your business-related automobile costs.

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If you use your car for business purposes, you may have learned that keeping track and properly logging the variety of expenses you incur for tax purposes is not always easy. Practically speaking, how often and how you choose to track expenses associated with the business use of your car depends on your personality; whether you are a meticulous note-taker or you simply abhor recordkeeping. However, by taking a few minutes each day in your car to log your expenses, you may be able to write-off a larger percentage of your business-related automobile costs.

Regardless of the type of record keeper you consider yourself to be, there are numerous ways to simplify the burden of logging your automobile expenses for tax purposes. This article explains the types of expenses you need to track and the methods you can use to properly and accurately track your car expenses, thereby maximizing your deduction and saving taxes.

Expense methods

The two general methods allowed by the IRS to calculate expenses associated with the business use of a car include the standard mileage rate method or the actual expense method. The standard mileage rate for 2017 is 53.5 cents per mile. In addition, you can deduct parking expenses and tolls paid for business. Personal property taxes are also deductible, either as a personal or a business expense. While you are not required to substantiate expense amounts under the standard mileage rate method, you must still substantiate the amount, time, place and business purpose of the travel.

The actual expense method requires the tracking of all your vehicle-related expenses. Actual car expenses that may be deducted under this method include: oil, gas, depreciation, principal lease payments (but not interest), tolls, parking fees, garage rent, registration fees, licenses, insurance, maintenance and repairs, supplies and equipment, and tires. These are the operating costs that the IRS permits you to write-off. For newly-purchased vehicles in years in which bonus depreciation is available, opting for the actual expense method may make particularly good sense since the standard mileage rate only builds in a modest amount of depreciation each year. For example, for 2017, when 50 percent bonus depreciation is allowed, maximum first year depreciation is capped at $11,160 (as compared to $3,160 for vehicles that do not qualify). In general, the actual expense method usually results in a greater deduction amount than the standard mileage rate. However, this must be balanced against the increased substantiation burden associated with tracking actual expenses. If you qualify for both methods, estimate your deductions under each to determine which method provides you with a larger deduction.

Substantiation requirements

Taxpayers who deduct automobile expenses associated with the business use of their car should keep an account book, diary, statement of expenses, or similar record. This is not only recommended by the IRS, but essential to accurate expense tracking. Moreover, if you use your car for both business and personal errands, allocations must be made between the personal and business use of the automobile. In general, adequate substantiation for deduction purposes requires that you record the following:

• The amount of the expense;
• The amount of use (i.e. the number of miles driven for business purposes);
• The date of the expenditure or use; and
• The business purpose of the expenditure or use.

Suggested recordkeeping: Actual expense method

An expense log is a necessity for taxpayers who choose to use the actual expense method for deducting their car expenses. First and foremost, always keep your receipts, copies of cancelled checks and bills paid. Maintaining receipts, bills paid and copies of cancelled checks is imperative (even receipts from toll booths). These receipts and documents show the date and amount of the purchase and can support your expenditures if the IRS comes knocking. Moreover, if you fail to log these expenses on the day you incurred them, you can look back at the receipt for all the essentials (i.e. time, date, and amount of the expense).

Types of Logs. Where you decide to record your expenses depends in large part on your personal preferences. While an expense log is a necessity, there are a variety of options available to track your car expenditures - from a simple notebook, expense log or diary for those less technologically inclined (and which can be easily stored in your glove compartment) - to the use of a smartphone or computer. Apps specifically designed to help track your car expenses can be easily downloaded onto your iPhone or Android device.

Timeliness. Although maintaining a daily log of your expenses is ideal - since it cuts down on the time you may later have to spend sorting through your receipts and organizing your expenses - this may not always be the case for many taxpayers. According to the IRS, however, you do not need to record your expenses on the very day they are incurred. If you maintain a log on a weekly basis and it accounts for your use of the automobile and expenses during the week, the log is considered a timely-kept record. Moreover, the IRS also allows taxpayers to maintain records of expenses for only a portion of the tax year, and then use those records to substantiate expenses for the entire year if he or she can show that the records are representative of the entire year. This is referred to as the sampling method of substantiation. For example, if you keep a record of your expenses over a 90-day period, this is considered an adequate representation of the entire year.

Suggested Recordkeeping: Standard mileage rate method

If you loathe recordkeeping and cannot see yourself adequately maintaining records and tracking your expenses (even on a weekly basis), strongly consider using the standard mileage rate method. However, taking the standard mileage rate does not mean that you are given a pass by the IRS to maintaining any sort of records. To claim the standard mileage rate, appropriate records would include a daily log showing miles traveled, destination and business purpose. If you incur mileage on one day that includes both personal and business, allocate the miles between the two uses. A mileage record log, whether recorded in a notebook, log or handheld device, is a necessity if you choose to use the standard mileage rate.

If you have any questions about how to properly track your automobile expenses for tax purposes, please call our office. We would be happy to explain your responsibilities and the tax consequences and benefits of adequately logging your car expenses.

In order to be tax deductible, compensation must be a reasonable payment for services. Smaller companies, whose employees frequently hold significant ownership interests, are particularly vulnerable to IRS attack on their compensation deductions.

In order to be tax deductible, compensation must be a reasonable payment for services. Smaller companies, whose employees frequently hold significant ownership interests, are particularly vulnerable to IRS attack on their compensation deductions.

Reasonable compensation is generally defined as the amount that would ordinarily be paid for like services by like enterprises under like circumstances. This broad definition is supplemented, for purposes of determining whether compensation is deductible as an ordinary and necessary expense, by a number of more specific factors expressed in varying forms by the IRS, the Tax Court and the Circuit Courts of Appeal, and generally relating to the type and extent of services provided, the financial concerns of the company, and the nature of the relationship between the employee and the employer.

Why IRS Is Interested

A chief concern behind the IRS's keen interest in what a company calls "compensation" is the possibility that what is being labeled compensation is in fact a constructive dividend. If employees with ownership interests are being paid excessive amounts by the company, the IRS may challenge compensation deductions on the grounds that what is being called deductible compensation is, in fact, a nondeductible dividend.

Another area of concern for the IRS is the payment of personal expenses of an employee that are disguised as businesses expenses. There, the business is trying to obtain a business expense deduction without the offsetting tax paid by the employee in recognizing income. In such cases, a business and its owners can end up with a triple loss after an IRS audit: taxable income to the individual, no deduction to the business and a tax penalty due from both parties.

Factors Examined

The factors most often examined by the IRS in deciding whether payments are reasonable compensation for services or are, instead, disguised dividend payments, include:

1. The salary history of the individual employee
2. Compensation paid by comparable employers to comparable employees
3. The salary history of other employees of the company
4. Special employee expertise or efforts
5. Year-end payments
6. Independent inactive investor analysis
7. Deferred compensation plan contributions
8. Independence of the board of directors
9. Viewpoint of a hypothetical investor contemplating purchase of the company as to whether such potential investor would be willing to pay the compensation.

Failure to pass the reasonable compensation test will result in the company's loss of all or part of its deduction. Analysis and examination of a company's compensation deductions in light of the relevant listed factors can provide the company with the assurance that the compensation it pays will be treated as reasonable -- and may in the process prevent the loss of its deductions.

Note: In the case of publicly held corporations, a separate $1 million dollar per person cap is also placed on deductible compensation paid to the CEO and each of the four other highest-paid officers identified for SEC purposes. (Certain types of compensation, including performance-based compensation approved by outside directors, are not included in the $1 million limitation.)

The S Corp Enigma

The opposite side of the reasonable compensation coin is present in the case of some S corporations. By characterizing compensation payments as dividends, the owners of these corporations seek to reduce employment taxes due on amounts paid to them by their companies. In these cases, the IRS attempts to recharacterize dividends as salary if the amounts were, in fact, paid to the shareholders for services rendered to the corporation.

Caution. In the course of performing the compensation-dividend analysis, watch out for contingent compensation arrangements and for compensation that is proportional to stock ownership. While not always indicators that payments are distributions of dividends instead of compensation for services, their presence does suggest the possibility. Compensation plans should not be keyed to ownership interests. Contingent and incentive arrangements are also scrutinized by the IRS. The courts have frequently ruled that a shareholder has a built-in interest in seeing that the company is successful and rewarding him for increasing the value of his own property is inappropriate. Similar to the reasonable compensation test, however, this rule is not hard and fast. Accordingly, the rules followed in each jurisdiction will control there.

Conclusions

Determining whether a shareholder-employee's compensation is reasonable depends upon many variables, such as the contributions that employee makes to your business, the compensation levels within your industry, and whether an independent investor in your company would accept the employee's compensation as reasonable.

Please call our office for a more customized analysis of how your particular compensation package fits into the various rules and guidelines. Further examination of your practices not only may help your business better sustain its compensation deductions; it may also help you take advantage of other compensation arrangements and opportunities.

No, taxpayers may destroy the original hardcopy of books and records and the original computerized records detailing the expenses of a business if they use an electronic storage system.

Business often maintain their books and records by scanning hardcopies of their documents onto a computer hard drive, burning them onto compact disc, or saving them to a portable storage device. The IRS classifies records stored in this manner as an "electronic storage system." Businesses using an electronic storage system are considered to have fulfilled IRS records requirements for all taxpayers, should they meet certain requirements. And, they have the freedom to reduce the amount of paperwork their enterprise must manage.

Record-keeping requirements

Code Sec. 6001 requires all persons liable for tax to keep records as the IRS requires. In addition to persons liable for tax, those who file informational returns must file such returns and make use of their records to prove their gross income, deductions, credits, and other matters. For example, businesses must substantiate deductions for business expenses with appropriate records and they must file informational returns showing salaries and benefits paid to employees.

It is possible for businesses using an electronic storage system to satisfy these requirements under Code Sec. 6001. However, they must fulfill certain obligations.

Paperwork reduction

In addition, using an electronic storage system may allow businesses to destroy the original hardcopy of their books and records, as well as the original computerized records used to fulfill the record-keeping requirements of code Sec. 6001. To take advantage of this option, taxpayers must:

(1) Test their electronic storage system to establish that hardcopy and computerized books and records are being reproduced according to certain requirements, and

(2) Implement procedures to assure that its electronic storage system is compliant with IRS requirements into the future.

Our firm would be glad to work with you to meet the IRS's specifications, should you want to establish a computerized recordkeeping system for your business. The time spent now can be worth considerable time and money saved by a streamlined and organized system of receipts and records.

Ordinarily, you can deduct the fair market value (FMV) of property contributed to charity. The FMV is the price in an arm's-length transaction between a willing buyer and seller.  If the property's value is less than the price you paid for it, your deduction is limited to FMV.  In some cases, you must submit an appraisal with your tax return.

Record-keeping requirements vary for noncash contributions, depending on the amount of the deduction. Similar items should be combined to determine the amount of the contribution:

• If the claimed deduction is less than $250, the charitable recipient must give you a receipt that identifies the recipient, the date of the contribution, and provides a detailed description of the property. You should keep a written record with a description of the property, its FMV, and how you determined the FMV, including a copy of any appraisals. 
  
  
• If the property's value is between $250 and $500, the requirements are similar. In addition, the recipient must give you a written acknowledgment that describes and values any goods or services provided to you. 
  
  
• If the value is between $500 and $5,000, your records must describe how the property was obtained, the date it was obtained or created, and the basis of the property.
  
  

• If the value is between $5,000 and $500,000, you must obtain a qualified appraisal by a qualified appraiser, retain that appraisal in your records, and attach to your income tax return a completed Form 8283, Section B.

• If you donate property and claim a deduction of more than $500,000, or donated art and deducted $20,000 or more, you must submit a "qualified appraisal" with your tax return.

If total noncash contributions exceed $500, you must fill out Section A of Form 8283, Noncash Charitable Contributions. If the contributions exceed $5,000, you must fill out Section B of the form. Publicly-traded securities must be listed on Section A, even if the value exceeds $5,000.

Form 8283 indicates that an appraisal generally must be submitted for amounts described in Section B. The IRS will deny the deduction if there is no appraisal, unless the failure to get an appraisal was due to reasonable cause and not willful neglect. If the IRS asks you to file Form 8283, the taxpayer will have 90 days to submit a completed form.

For property over $5,000, the appraiser and the charitable recipient must sign Form 8283. The form advises the recipient to file Form 8282, Donee Information Return, with the IRS and to give a copy to the donor if the property is sold within two years. This is not required if the item (or group of similar items) has a value of $500 or less, or if the property is transferred for a charitable purpose.

You must obtain a "qualified appraisal" no earlier than 60 days before you contributed the property and before the due date of your return, including extensions. If you first report the contribution on an amended return, you must obtain an appraisal before you filed the amended return.

The appraisal must describe the property in detail so that it can be identified; give its condition; provide the date of contribution; describe any restrictions on the use of the property; and identify the appraiser. The appraisal also must provide the appraiser's qualifications; the date the property was valued; the FMV on the date of contribution; and the valuation method for determining value, including any comparable sales used.

A separate appraisal and a separate Form 8283 are required for each item or group of similar items. Only one appraisal is required for a group of similar items contributed in the same year. If similar items are contributed to more than one recipient and the items' value exceeds $5,000, a separate Form 8283 must be filed for each recipient.

Here's an example:

You donate $2,000 of books to College A, $2,500 of books to College B, and $1,000 of books to a public library. A separate Form 8283 must be submitted for each recipient.

Generally, a family member or a party who sold the property to the donor cannot be the appraiser.  An appraiser who is regularly used by the donor or recipient must have performed the majority of his or her appraisals for other persons. Form 8283 requires that the appraiser either publicize his (or her) services or else perform appraisals on a regular basis. The appraisal fee cannot be based on a percentage of the appraised property value or of the deduction allowed by the IRS.

Fees that you pay for an appraisal are a miscellaneous itemized deduction and cannot be included in the charitable deduction.

More small businesses get into trouble with the IRS over payroll taxes than any other type of tax. Payroll taxes are a huge source of government revenue and the IRS takes them very seriously. It is actively looking for businesses that have fallen behind in their payroll taxes or aren't depositing them. When the IRS finds a noncompliant business, it hits hard with penalties.

Your most important responsibility is depositing all of your payroll taxes on time. Before you do that, however, you have to know:

• Who are your taxable workers?
• What payroll taxes apply?
• What compensation is taxable?
• When are your payroll taxes due?
• What payroll and other returns should you file?

 Taxable workers

The first step is to determine who is a taxable worker. If you hire only independent contractors, they, and not you, are responsible for paying federal payroll taxes.

It's more likely that you hire employees.  In that case, you are responsible for withholding federal income tax and Social Security and Medicare taxes. You are also responsible for federal unemployment (FUTA) taxes along with any state taxes.

There are some exceptions to who is an employee for payroll taxes but they are few. The most common are real estate agents and direct sellers.

If you have any questions about the status of your workers, give our office a call. Misclassifying workers is a common mistake. If you treat an employee as an independent contractor, and your treatment is wrong, you will be liable for federal income tax and Social Security and Medicare taxes. They add up very quickly.

What taxes apply

Once you've determined that your workers are taxable employees, you have to determine what federal payroll taxes apply. Most employers must withhold federal income tax and Social Security and Medicare taxes. You are also liable for federal unemployment taxes (FUTA) but these are not withheld from an employee's pay. Only you pay FUTA taxes.

You have to withhold at the correct rate. Form W-4, which your employee fills out, tells you how much federal income tax to withhold for an employee. The Social Security, Medicare and FUTA tax rates are set by statute.

Failing to withhold at the correct rate is a surprisingly common mistake. Sometimes, an employee completes a new W-4 but the employer forgets to adjust his or her withholding. It's a good idea to review the W-4s of all your employees and make sure they are current.

Compensation

Almost every type of compensation, and not just wages, is taxable. The IRS wants its share of tips, bonuses, employee stock options, severance pay, and many other forms of compensation. This includes non-cash or in-kind compensation.

There are exceptions. Health insurance plans generally are not subject to federal payroll taxes. Per diem payments and other allowances, if they do not exceed rates set by the government, are generally not taxable as wages. Some fringe benefits are not taxable, such as employee discounts, an occasional taxi ride when an employee must work overtime and inexpensive holiday gifts.

Determining what compensation is taxable and what is not is often difficult. The complex tax rules are easy to misinterpret and you may be failing to withhold taxes on taxable compensation. It's a mistake that can be avoided with our help.

Deposit schedule

Most small employers deposit payroll taxes monthly. Large and mid-size businesses make semi-weekly deposits. Very small employers may make annual deposits.

Your deposit schedule is based on the total tax liability that you reported during a four-quarter "lookback" period. The lookback period begins July 1 and ends June 30. If you reported $50,000 or less of taxes for the lookback period, you make monthly deposits. If you reported more than $50,000, you make semi-weekly deposits.

Determining the lookback period is tricky. If the IRS finds that your lookback period is wrong, you could be heavily penalized for not making timely deposits. Your deposit schedule can also change and you have to know what can trigger a change.

Forms

If you withhold federal payroll taxes, you must file Form 941 quarterly. Of course, there are exceptions. The most important one is for very small employers. They file their returns annually instead of quarterly.

The IRS encourages employers to file Form 941 electronically. Depending on how large your business is, you may have no choice but to file electronically. A common mistake is filing more than one Form 941 quarterly. This only causes unnecessary delays.

Penalties are costly

Often, a small business just doesn't have the cash on hand to make a timely deposit. The owner thinks that he or she will double-up the next time and make things right. More often than not, that doesn't happen and the unpaid liability snowballs.

The penalties for failing to withhold or deposit federal income tax and Social Security and Medicare taxes are severe and they can be personal. If your business cannot pay the unpaid taxes, the IRS will go after you personally.

You may be using a payroll agent to pay your taxes. Keep in mind that you are still liable for those taxes if your agent doesn't pay them. Reliance on a payroll service, or anyone else, does not excuse your failure to pay.

Reporting obligations

Your payroll tax obligations also do not end with filing tax returns and depositing payments. You have reporting obligations to your employees and, in some cases, to your independent contractors.

Staying out of trouble with the IRS

Even if you believe you understand and are compliant with the federal payroll tax rules, give our office a call. The rules are riddled with exceptions that we haven't even touched on in this brief article. We'll take a look at your operations and make sure you are 100 percent compliant. It's worth avoiding any costly mistakes down the road.

Information returns usually arrive in January or February and consist of either Form 1099 or Form 1098. For some, they seem as ubiquitous as their holiday mail in December. Form 1099s are especially likely to populate your mailbox, being used to report a whole array of income other than wages, salaries and tips. While a Form 1099 is not needed to record every taxable transaction, one Form 1099 can record multiple transactions; for example, from your broker for dividends and stock trades. The payer will send a Form 1099 to you by the end of January and will file the form with the IRS by the end of February. Typical forms are sent out for dividend and interest income, self-employment or independent contractor's income, student loan interest and mortgage interest statements.

Information returns usually arrive in January or February and consist of either Form 1099 or Form 1098. For some, they seem as ubiquitous as their holiday mail in December. Form 1099s are especially likely to populate your mailbox, being used to report a whole array of income other than wages, salaries and tips. While a Form 1099 is not needed to record every taxable transaction, one Form 1099 can record multiple transactions; for example, from your broker for dividends and stock trades. The payer will send a Form 1099 to you by the end of January and will file the form with the IRS by the end of February. Typical forms are sent out for dividend and interest income, self-employment or independent contractor's income, student loan interest and mortgage interest statements.

If you happen to receive an incorrect information return, there is no need to panic. However, you do need to act quickly to prevent a bigger problem; namely, having your tax return not match what your information returns say. Therefore, the first step to take when receiving any Form 1099 or 1098 is to open it immediately and take a look at whether it reflects the amount that you think should be reported. If the Forms just sit unopened in your shoe box until you bring it for return preparation, valuable time has been lost.

Should you determine that you have received an incorrect information return, first contact the entity providing the form and ask for a corrected form. Use the number the sender provides on the form. You should receive a revised form that has "corrected" marked on it. Sometimes the information provider itself catches a mistake and sends you a corrected form without your having to ask.

Sometimes, the discrepancy on an information return may be the result of a difference of opinion in interpreting the tax law. This can occur, for example, when determining in which tax year a transaction falls, or whether forgiveness of indebtedness income exists on a contested loan. In those cases, it is best to first try to persuade the information return provider to change its mind rather than just reporting the transaction on your return based on your interpretation. Once the IRS becomes aware of a difference of opinion, the issue usually will take a lot more effort to resolve.

If all else fails in your trying to correct an information return with the return provider, after February 15, 2013 you should contact the IRS at (800) 829-1040. An IRS agent will assist in filing a complaint by sending Form 4598 to the payer requesting that a corrected form be sent out. If no corrected Form is issued, you will have to file a Form 4852 which will allow for you to claim the true amount on your tax return. If you have already filed and have received a form not reported or forget to report income, you are obligated to file a Form 1040X to report income that was not previously reported.

Penalties do exist for payers who fail to provide you with the correct payee statements when they cannot show reasonable cause for the failure. However, if you operate a business and also wear the hat of an information provider, you'll be glad to know that inconsequential error or omission will not be considered a failure to include the correct information.

Nevertheless, both the party who provides and who receives an information return have obligations under the tax law that must be met in good faith and with reasonable efforts to comply. Otherwise, the IRS will not hesitate to use its penalty powers.

Please feel free to contact this office if you have any concerns over an incorrect information return over this coming tax season.

One of the easiest ways for a business to limit liability is to use independent contractors instead of employees. Of course, merely calling employees "independent contractors" will not make those individuals independent contractors.

Control

The determination of whether a worker will be considered a contractor or an employee is a question of control. If the worker determines his or her own fees (usually per job), sets his or her own working hours, and provides his or her own tools, he can reasonably be considered an independent contractor. If the worker does not control his or her hours worked or wages, and uses tools provided for him or her by the employer, the worker is probably an employee.

There is a 20-factor common law test that can help determine if a worker is an independent contractor. It is important to work through the factors to determine the correct classification for the worker has been chosen, as the classifications have distinct consequences.

Benefits

The difference between independent contractors and employees is stark, and is not simply limited to the label of the worker.

Independent contractors need not be included in retirement plans. You will only have to pay the contractor gross pay, rather than withholding wages for tax purposes. As you need not pay Social Security, Medicare or unemployment insurance for an independent contractor, record keeping is much simpler.

Independent contractors are also responsible for their own tort and contract liability. If an independent contractor commits a tort, in most cases the contractor will be solely liable.

Proceed with caution

Use extreme caution when labeling workers. Mislabeling workers can lead to serious problems.

You could be responsible for back employment taxes, which are often considerable when interest and penalties attach. You could also be liable for damages in a tort claim decided against the mislabeled worker.

Tort liability for a mislabeled worker can have repercussions beyond the payment of the damages. If the worker is deemed to be an employee, the use of contractors instead of employees for liability limitation is lost, which can impact whether the business was operated in such a manner as to limit liability on the whole.

Using independent contractors can be a smart business move but without careful planning, you could be in for some expensive tax consequences. Give our office a call and we'll take a look at your options.

Entertaining business clients and employees at sports events or arts performances can be good for the bottom line; and tax deductible, too. Whether to maintain contacts with existing customers, woo new business, or reward your employees; footing the bill at the ball game or hosting an evening at the theater can go a long way to generate positive returns.

General rule

In general, you can deduct ordinary and necessary expenses to entertain a client, customer, or employee if the expenses are either directly related or associated with your business. An "ordinary" expense is one that is common and accepted in your trade, business, or profession. For example, a contractor may have the ordinary expense of taking clients to lunch to discuss the business deal.

A "necessary" expense is one that is helpful and appropriate for your business. However, an expense does not have to be required to be considered "necessary." For example, the cost of fresh flowers, periodically sent to a business contact's office, may help maintain your professional network. Likewise, basketball tickets may be appropriate for keeping business communication lines open.

"Directly-related" test

Ordinary and necessary entertainment expenses must also be directly related to, or associated with, your trade or business. To satisfy the "directly-related" test, you must show that:

-- The active conduct of business was the entertainment's main purpose;

-- You engaged in business with the person during the entertainment period; and

-- There was an expectation of garnering specific business or income in the future.

You do not have to spend more time on business than on entertainment, but if business is only incidental, then the entertainment expenses do not meet the "directly-related" test.

Entertainment expenses are not directly related to business if you do not attend the event with your client. In addition, costs are not considered "directly-related" if the event is so distracting that you are prevented from actively conducting business.

"Associated" test

Although the theater or sporting events may be too riveting for continued business talk, these activities may still qualify as deductible business entertainment expenses. Even if they do not meet the directly-related test, expenses may still be deductible as "associated" with the active conduct of your trade or business if the expenses are incurred either directly before, or after, a substantial business discussion. A business presentation just before the game, or a meeting right after the concert, can qualify the recreational activities as business entertainment expenses.

Deductible amount

In general, the deductible amount is 50 percent of un-reimbursed entertainment expenses. Generally, you cannot deduct more than the face value of an entertainment ticket, even if you paid a higher price. Handling fees are not included in the amount you can deduct. Deductions for sky boxes and other luxury seats that are rented for more than one event are limited to the price of regular, non-luxury seats (subject to the 50 percent rule). Luxury seats are for "more than one event" if they are rented for a series of games or performances.

Expenses for non-business guests are not deductible as entertainment expenses. The cost of the entire outing must be pro- rated if it's difficult to separate the costs for business and non-business guests. However, if a business contact's spouse attends the event because it would be inconvenient not to, the cost for the spouse's ticket is also a business expense.

Q: What tax deductions am I entitled to as an investor?

A: Certain investment-related expenses are deductible, others are specifically restricted. Still others won't get you a deduction, but you will be able to add them to your tax basis in the underlying investment, or net them from the amount you are otherwise considered to have received on its sale.

Certain investment-related expenses are deductible, while others are specifically restricted. Still other expenses likely will not provide you with a deduction, but you will be able to add them to your tax basis in the underlying investment, or net them from the amount you are otherwise considered to have received on its sale.

Investor expenses

Investment counsel fees, custodian fees, fees for clerical help, office rent, state and local transfer taxes, and similar expenses that you pay in connection with your investments are deductible as an itemized deduction on Schedule A of Form 1040, subject to the 2% floor for all such itemized deductions.

Travel expenses related to the production or collection of income are deductible if you provide proof both of the expenses and the necessity for incurring them. Deductions for travel expenses related to attending investment seminars, however, are specifically prohibited. Travel expenses to attend stockholder meetings are permissible deductions only if travel is not for personal reasons and expenses are reasonable in relation to value of the investment.

Interest expenses

If you take out a loan to carry investment property, you are entitled to an itemized deduction for the interest you pay, reported on Form 4952, which is limited to your net investment income (dividends, interest, rents, etc.) Margin interest paid connected with your stock portfolio qualifies. The investment interest deduction is not subject to the 2% floor - you can start with deducting the first dollar of interest paid. Any disallowed interest over the net investment income limit can be carried over to a succeeding tax year.

Caution. Net capital gain from the disposition of investment property is not considered investment income. However, you may elect to treat all or any portion of such net capital gain as investment income by paying tax on the elected amounts at their ordinary income rates. This is usually not advisable.

Brokerage commissions

Brokerage commissions related to a particular stock purchase or sell, on the other hand, are considered a cost of the sale itself. As such, any commissions paid to buy a stock are added to your tax basis in the shares, which will later determine the amount of taxable gain you have when the property is sold. Any commission on the sale of the shares is netted from the amount you will be considered to realize on that sale.

Apart from wages, one of the most common sources of taxable income is from investments. While investment income from non-exempt sources is generally fully taxable to individuals under the Internal Revenue Code, many of the expenses incurred in producing that income are deductible. Knowing the rules governing investment expenses can reduce -- sometimes significantly -- the tax impact of investment income.

Apart from wages, one of the most common sources of taxable income is from investments. While investment income from non-exempt sources is generally fully taxable to individuals under the Internal Revenue Code, many of the expenses incurred in producing that income are deductible. Knowing the rules governing investment expenses can reduce -- sometimes significantly -- the tax impact of investment income.

Deductible investment expenses

Investment interest. A significant source of investment-related costs is investment interest expense. Investment interest paid related to the generation of taxable investment income is generally deductible on Schedule A of Form 1040, however certain limitations may reduce the amount deductible. For example, your deduction for investment interest paid may not exceed your net investment income. "Net investment income" is arrived at by subtracting your investment expenses (other than interest expense) from your investment income. Interest paid in excess of that amount determined to be deductible can be carried over and deducted in subsequent years (after application of these rules, of course).

Other investment expenses. Qualified investment expenses (other than interest) can be claimed as miscellaneous itemized deductions on Schedule A of your federal Form 1040 and are generally subject to the 2% threshold imposed on miscellaneous itemized deductions. If you itemize your deductions on your return, to the extent that these and other miscellaneous itemized deductions exceed 2% of your adjusted gross income (AGI), they are deductible from income.

The list of investment expenses approved for inclusion as miscellaneous itemized deductions (by the IRS or the courts) is a long one -- and one worth reviewing by you as a taxpayer, as unexpected ways to reduce your taxable income can be found. Some of the investment expenses that have been determined to be deductible as miscellaneous itemized deductions subject to the 2% floor include:

• Investment counsel or advisory fees, including managers or planners.
• Subscriptions to publications offering investment advice.
• Legal expenses for the maintenance, conservation or management of investment property.
• Legal expenses incurred in recovering investment property or amounts earned by such property.
• Guardian fees and expenses incurred in the production or collection of income of a ward or minor or in the management of the ward or minor's investments.
• Clerical help and office rent connected with the management of investments and/or the collection of the income they generate.
• Accounting fees for keeping investment income records.
• Depreciation of home computers used to manage investments that produce taxable income.
• Costs of premiums and other expenses for indemnity bonds for the replacement of missing securities.
• Dividend reinvestment plan (DRIP) service charges, such as charges for holding the shares acquired through the plan, collecting and reinvesting cash dividends, keeping individual records, and providing detailed statements of accounts.
• Proxy fight expenses if incurred in connection with a legitimate corporate policy dispute
• Investment expenses connected with the purchase, sale or ownership of securities
• Fees paid to a broker, bank, trustee, or other investment-related agent to collect interest or dividends on taxable investments.
• Losses on non-federally insured deposits in an insolvent or bankrupt financial institution, if the loss is treated as an ordinary loss by the taxpayer but is not treated as a casualty loss; and subject to a $20,000 limit on losses from any one institution.
• Allocable investment expenses of privately offered mutual funds.
• Custodial fees.
• Safe deposit box rent so long as the box is used for the storage of (taxable) income-producing stocks, bonds, or papers and documents related to taxable investments^.
• Travel costs incurred in making trips away from home to check on your property or to confer with investment advisors about your income-producing investments. But be careful -- if your investment property is in Vail or Maui, make sure your records establish that your trip was primarily made to check on your investment, not to take a personal vacation.

The expenses generated in connection with the management of investment property are deductible even if the property isn't currently producing income -- so long as the property is held for the production of income. And expenses incurred in reducing additional loss or to prevent anticipated losses with respect to investment property are also deductible.

Nondeductible investment expenses

What kinds of investment-related expenses are not deductible? A nonexclusive list of such expenses includes:

• Fees charged by a broker to acquire securities. These costs are instead added to the basis of the securities. Similarly, fees paid on the sale of securities reduce the selling price.
• Fees for establishing or administering an IRA, unless billed and paid separately and apart from the regular IRA contribution.
• Expenses related to tax-exempt investments.
• Trips to attend seminars or conventions connected with investment or financial planning.
• Trips to stockholder meetings. Although an exception has been made where a taxpayer with significant holdings traveled to a meeting to protest specific practices that were hurting his investment.
• Home office expenses, unless investing is actually the taxpayer's business.

Remember, for purposes of the rules governing investment expenses, rental and royalty income-related properties are not considered. These investments are subject to their own rules and reporting requirements, and are not included in the category of investment expenses limited by the 2% threshold.

While this discussion related to the tax treatment of investment-related expenses may appear comprehensive, other limitations and exceptions exist that may apply to your tax situation. For more information regarding how you can make the most of your investment-related expenditures, please feel free to contact the office for assistance.

Maintaining good financial records is an important part of running a successful business. Not only will good records help you identify strengths and weaknesses in your business' operations, but they will also help out tremendously if the IRS comes knocking on your door.

Maintaining good financial records is an important part of running a successful business. Not only will good records help you identify strengths and weaknesses in your business' operations, but they will also help out tremendously if the IRS comes knocking on your door.

The IRS requires that business owners keep adequate books and records and that they be available when needed for the administration of any provision of the Internal Revenue Code (i.e., an audit). Here are some basic guidelines:

Copies of tax returns. You must keep records that support each item of income or deduction on a business return until the statute of limitations for that return expires. In general, the statute of limitations is three years after the date on which the return was filed. Because the IRS may go back as far as six years to audit a tax return when a substantial understatement of income is suspected, it may be prudent to keep records for at least six years. In cases of suspected tax fraud or if a return is never filed, the statute of limitations never expires.

Employment taxes. Chances are that if you have employees, you've accumulated a great deal of paperwork over the years. The IRS isn't looking to give you a break either: you are required to keep all employment tax records for at least 4 years after the date the tax becomes due or is paid, whichever is later. These records include payroll tax returns and employee time documentation.

Business assets. Records relating to business assets should be kept until the statute of limitations expires for the year in which you dispose of the asset in a taxable disposition. Original acquisition documentation, (e.g. receipts, escrow statements) should be kept to compute any depreciation, amortization, or depletion deduction, and to later determine your cost basis for computing gain or loss when you sell or otherwise dispose of the asset. If your business has leased property that qualifies as a capital lease, you should retain the underlying lease agreement in case the IRS ever questions the nature of the lease.

For property received in a nontaxable exchange, additional documentation must be kept. With this type of transaction, your cost basis in the new property is the same as the cost basis of the property you disposed of, increased by the money you paid. You must keep the records on the old property, as well as on the new property, until the statute of limitations expires for the year in which you dispose of the new property in a taxable disposition.

Inventories. If your business maintains inventory, your recordkeeping requirements are even more arduous. The use of special inventory valuation methods (e.g. LIFO and UNICAP) may prolong the record retention period. For example, if you use the last-in, first-out (LIFO) method of accounting for inventory, you will need to maintain the records necessary to substantiate all costs since the first year you used LIFO.

Specific Computerized Systems Requirements

If your company has modified, or is considering modifying its computer, recordkeeping and/or imaging systems, it is essential that you take the IRS's recently updated recordkeeping requirements into consideration.

If you use a computerized system, you must be able to produce sufficient legible records to support and verify amounts shown on your business tax return and determine your correct tax liability. To meet this qualification, the machine-sensible records must reconcile with your books and business tax return. These records must provide enough detail to identify the underlying source documents. You must also keep all machine-sensible records and a complete description of the computerized portion of your recordkeeping system.

Some additional advice: when your records are no longer needed for tax purposes, think twice before discarding them; they may still be needed for other nontax purposes. Besides the wealth of information good records provide for business planning purposes, insurance companies and/or creditors may have different record retention requirements than the IRS.

The Internet has taken investing to a whole different level: inexpensive online trading and real-time stock market data have made many of us 'armchair investors'. As you actively manage your investments, you will no doubt incur additional expenses. Many of these expenses are deductible investment expenses.

Tax law allows taxpayers to deduct investment expenses if those expenses are ordinary and necessary for the production or collection of income, or for the management, conservation or maintenance of property held for the production of income.

What are investment expenses? Investment expenses are any expenses that you incur as you manage your investments. Some of these expenses are deductible (e.g. professional fees you paid related to investment activities; custodian fees, safe deposit rental; and subscriptions to investment-oriented publications), and some are not (e.g. costs related to tax-exempt securities; trading commissions (these increase the basis of the investment); and certain convention/seminar costs).

Who can deduct investment expenses? Investment expenses can be deducted by most individuals on their personal income tax returns. How these expenses are claimed depends on what type of investor a person is. Generally, investors fall into two categories: casual investor and professional trader.

Casual Investor

This category of investor describes most people actively managing their own investments. Investment expenses (except interest) are claimed on the taxpayer's return as miscellaneous itemized deductions. These expenses can be deductible on the return to the extent that they, when added to other "miscellaneous itemized deductions", exceed 2% of your adjusted gross income (AGI). The actual tax benefits derived from these excess miscellaneous itemized deductions may be further reduced due to AGI limitations for all itemized deductions and the alternative minimum tax (AMT).

In addition to the expenses noted above, if you use your computer extensively in the management of your investments, there are some other expenses to be aware of:

Online fees: You may deduct the portion of your monthly charges paid to your Internet Service Provider (ISP) incurred to manage your investments. If you subscribe to additional online services geared towards investors (e.g. The Wall Street Journal Interactive Edition) where you can follow your investments, these fees are also deductible investment expenses. Trading fees paid to online brokerages (e.g. E*Trade) are not currently deductible but are added to the basis of your investment, which will result in a reduced gain (or increased loss) upon disposition of the asset.

Software: If you purchase software that helps you manage and/or track your investments, the cost of the software may be depreciated over three years, and written off completely in the year of obsolescence. Programs that are useful for one year or less should be expensed in the year purchased, rather than depreciated.

Depreciation: Since the casual investor's investment-related use of a personal computer (and related equipment) is probably less than 50%, the cost of this equipment must be depreciated over five years using the straight-line method. The Section 179 expense deduction is not available for this type of investor.

A word of caution for self-employed individuals: if you use your home office for both business and investment purposes, you run the risk of losing your home office deduction for business purposes. A home office deduction is not available for the investment-related expenses for the casual investor. To claim a deduction for a home office for business purposes, your home office must be used exclusively for business; if you are performing investment activities in the same office space, you've just violated the "exclusive use" test.

Professional Trader

A professional trader is defined by the courts someone in between a dealer and an investor. A professional trader is a person that conducts trading activity focusing on short-term investments in large volumes on a regular and consistent basis, receives no compensation for his services, and does not have any customers. Participating in an investment club or partnership does not qualify a person as a professional trader.

If you meet the tough definition of a professional trader, you will be treated as a self-employed individual and all your investment expenses may be claimed on Schedule C of your return. You can also deduct all of your home office expenses, and you can claim Section 179 expenses for computers and other equipment used more than 50% in your business as a professional trader.