July 15, 2012

Employee or Independent Contractor?

by Kenneth Hoffman in Business Counsel, Tax Counsel

That was the issue in Twin Rivers Farm, Inc. (T.C. Memo. 2012-184). The taxpayer operated an horse farm and engaged two workers. The workers lived in a trailer on the property, did not appear to have paid rent, and were paid $300 and $150 per week. They cleaned the barn, barn area and grounds, groomed and watered the horses and moved them between pastures. All equipment was owned by the taxpayer. The taxpayer paid workers' compensation and employer's liability insurance, but did not file Form 943 (for agricultural workers), make deposits of employment taxes, and did not file Forms 1099 with respect to the workers.

The Tax Court examined seven factors including degree of control, investment in facilities, opportunity for profit or loss, right to discharge, whether the work was part of the principal's regular business, permanency of relationship, and the relationship the parties thought they created and held that the workers were employees of the taxpayer. The Court found the taxpayer liable for employment taxes, additions to tax under Sec. 6651(a) and penalties under Sec. 6656 for all the years at issue.

K.R. Hoffman & Co., LLC, counsels Entrepreneurs, Professionals and Select Individuals in taking control of their taxes, and businesses. Discover how we can help you overcome your tax and business challenges. For more information or to become a client, call me at (954) 591-8290 TODAY or drop me a note.

July 15, 2012

Accurate Record Keeping Is A Must!

by Kenneth Hoffman in Business Counsel, Tax Counsel

In Carl J. Mistlebauer (T.C. Memo. 2012-186) the IRS determined that the taxpayer did not maintain adequate books and records for his business reported on a Schedule C.

The IRS used the bank deposits method to reconstruct the taxpayer's income. The Court noted a bank deposit is prima facie evidence of income and the IRS need not prove a likely source of that income. The taxpayer bears the burden of proving that IRS's determinations of income based on the bank deposits method are erroneous and may satisfy that burden by establishing that the deposits that remain at issue are derived from a nontaxable source.

According to the taxpayer, none of the deposits to his bank accounts that remained at issue for each of those years was taxable because the respective sources of those remaining deposits were loans, lines of credit, proceeds from the sale of all his investments, and IRA distributions. But the only support for his position was his own testimony, which the Court found to be general, conclusory, uncorroborated, and self-serving. The Court did not rely on the testimony and sided with the IRS in finding the taxpayer had unreported income.

July 12, 2012

Show Me the Money!

by Kenneth Hoffman in Tax Counsel, Tax Planning

The week before last, while most of America was still digesting news of the Supreme Court's decision on healthcare reform, more news hit the wires. That's right, Hollywood A-listers Tom Cruise and Katie Holmes, better known as "TomKat," are calling it quits after nearly six years of marriage. Of course, Tom has been down this road twice before. But this split has already spawned far and away the biggest headlines, and tinseltown gossips are working overtime. How long has Katie planned her escape? What role does Cruise's association with the controversial Church of Scientology really play? Were Tom's lawyers really letting Katie "play the media" while they readied his reply?

News of the split came at nearly the same time as Forbes naming Cruise the world's top-earning actor. His latest blockbuster, #4 in the Mission: Impossible franchise, pulled in a whopping $700 million, powering Cruise to a $75 million year. So naturally, we want to know what the divorce means for the IRS!

Divorce is usually pretty straightforward, at least from the taxman's perspective. Property settlements between divorcing spouses are generally tax-free. Alimony or spousal support is usually deductible by the payor and taxable to the payee -- which lets the divorcing couple shift the tax burden on that income from the higher-taxed "ex" to the lower-taxed ex. Child support is both nondeductible and nontaxable -- it's strictly an after-tax obligation. And legal fees are a nondeductible personal expense, except for amounts allocated to figuring alimony payments.

But celebrity divorces can be risky business. Sometimes it's hard for outsiders to understand the stakes, which can be as different from ordinary splits as night and day. Katie hired a top gun New York attorney to represent her, one who knows all the right moves where celebrity divorce is concerned. You can be sure the tabloids were rooting for a war of the worlds -- but we were just hoping daughter Suri, age 6, wouldn't end up as collateral damage!

The Cruises had a prenup, of course. It reportedly gave Katie $3 million for each year of marriage, plus a 5,878 square foot house in Montecito, CA, where Oprah Winfrey, Kevin Costner, and Rob Lowe also have homes. And last year, Cruise deeded Holmes an apartment in Manhattan. We're sure the firm that drafted TomKat's prenup did a fine job. Of course, golfer Tiger Woods also had a prenup limiting wife Elin Nordegrin to $20 million -- but she wound up walking away with five times that amount.

What sort of romantic prospects will the couple enjoy after the divorce? Well, Cruise should be fine. He's already a legend -- he can sit back with a cocktail and audition new starlets for the role of Wife #4. And as for Holmes, she's still young, so we're sure she can still attract at least a few good men who want to show her the color of their money.

So Hollywood is playing "Taps" for Tom and Katie's storytale romance. It wasn't endless love after all. Though the media had already shifted into over-drive, anticipating a public PR battle, the quick and confidential resolution makes it possible that the story may actually just fade into oblivion.

Now, if you look carefully at this email, you'll find references to seventeen Tom Cruise movies. Can't find 'em all? Give us a call. We're experts at finding hidden opportunities, especially where it comes to taxes!

July 9, 2012

Work at Home? You May Qualify for the Home Office Deduction

by Kenneth Hoffman in Business Counsel, Tax Counsel, Tax Planning

If you use part of your home for business, you may be able to deduct expenses for the business use of your home. The IRS has the following six requirements to help you determine if you qualify for the home office deduction.

    1. Generally, in order to claim a business deduction for your home, you must use part of your home exclusively and regularly:

        • as your principal place of business, or

        • as a place to meet or deal with patients, clients or customers in the normal course of your business, or

        • in any connection with your trade or business where the business portion of your home is a separate structure not attached to your home.

    2. For certain storage use, rental use or daycare-facility use, you are required to use the property regularly but not exclusively.

    3.   Generally, the amount you can deduct depends on the percentage of your home used for business. Your deduction for certain expenses will be limited if your gross income from your business is less than your total business expenses.

    4.   There are special rules for qualified daycare providers and for persons storing business inventory or product samples.

    5.   If you are self-employed, use Form 8829, Expenses for Business Use of Your Home to figure your home office deduction and report those deductions on Form 1040 Schedule C, Profit or Loss From Business.

    6.   If you are an employee, additional rules apply for claiming the home office deduction. For example, the regular and exclusive business use must be for the convenience of your employer.

July 8, 2012

Oregon Allows for Medical Marijuana Deduction

by Kenneth Hoffman in Tax Counsel, Tax Preparation

The Oregonian and the Huffington Post are reporting that Oregon is allowing a tax deduction for the costs associated with medical marijuana.

"Medical marijuana gets treated just like any other prescription drug,"

Currently, medical marijuana is not approved for a federal income tax deduction. See IRS Publication 502 for more information on what qualifies as a medical deduction for federal tax purposes.

July 8, 2012

Taking a Business Loss Deduction, Can You Prove Basis?

by Kenneth Hoffman in Business Counsel, Tax Counsel, Tax Planning

Loans made by a shareholder of his or her own funds, or those borrowed from an unrelated party and loaned directly to an S corporation increase basis.

In Yolanda Welch et al. (T.C. Memo. 2012-179) the taxpayer was an 80% shareholder in an S corporation (her husband had the remaining 20%) that provided respiratory and home healthcare services. Ms. Welch asserted that she borrowed some $600,000 from a doctor and lent all the funds to the corporation. The Court noted that all the funds, however, were either paid directly by the doctor to the corporation or else represented amounts that he charged to his credit card as payments for the corporation's expenses. The doctor wrote no checks to Ms. Welch. She contributed no personal funds to the corporation, nor did the corporation execute a loan agreement or any notes evidencing any loans from her.

Ms. Welch signed 27 promissory notes in favor of the doctor. The notes were for varying amounts totaling $598,197. The notes had various maturity dates, none more than a year after execution and were secured by receivables from the corporation; Ms. Welch did not offer any personal collateral. The corporation made some payments on the notes directly to the doctor. Ms. Welch reported no interest income or constructive dividends with respect to the payments. (The husband's situation was different, but he too could not prove his basis.)

The Court noted the taxpayers failed to show that on the relevant dates they had any remaining basis in the corporation; that it was impossible to reconcile the taxpayer's asserted bases as of yearends at issue with the corporations books and tax returns. The taxpayers admitted that in the corporation's early years they did not consistently keep contemporaneous records of basis. The Court sided with the IRS in disallowing the taxpayers' claimed passthrough losses. The Court also held the taxpayers failed to show the burden of proof shifted to the IRS.

July 5, 2012

IRS Does Not Have to Approve Valuation Method for Qualified Appraisal

by Kenneth Hoffman in Tax Counsel, Tax Planning

Although the Internal Revenue Code expressly provides for tax benefits for the donation of historic preservation easements that are made in the manner set out in the Code and Treasury Regulations, the Internal Revenue Service (the “IRS”) has identified easement donations as an area in which taxpayers may act in a manner that is abusive. In recent years, the IRS has increased its enforcement efforts associated with the donation of historic preservation easements. As a result, the IRS has conducted, and is continuing to conduct, examinations of a number of taxpayers who have made historic preservation easement donations to the Trust and to other easement-holding organizations throughout the country.

In general, the IRS has been challenging the value of the easement as determined by the taxpayer’s appraiser, and has frequently focused on whether the appraiser adequately considered the impact of local preservation ordinances restricting the property. Other issues that have been raised by the IRS have included whether the supporting appraisal is a “qualified appraisal” as defined by the Treasury Regulations, and whether the language of the specific easement properly preserves the property for conservation purposes in perpetuity.

Some taxpayers have elected to challenge unfavorable determinations by the IRS. Some cases have been tried in the Tax Court and are awaiting a decision, others will be heard in the coming months, and others have not yet received a trial date. Below are links to court decisions and publicly available documents in pending cases before the Tax Court, which the Trust is including on this site by permission of the donor.

In Scheidelman v. Commissioner of Internal Revenue, 2nd Circuit Court of Appeals (6/15/12) the Court ruled:

For the purpose of gauging compliance with the reporting requirement, it is irrelevant that the IRS believes the method employed was sloppy or inaccurate, or haphazardly applied—it remains a method, and Drazner described it. The regulation requires only that the appraiser identify the valuation method “used”; it does not require that the method adopted be reliable.

The taxpayers appealed the 2010 Tax Court decision regarding tax deficiencies, and the IRS filed a cross-appeal on penalties. Oral argument was held on December 15, 2011, in New York. On June 15, 2012, the Second Circuit issued an opinion vacating the Tax Court decision and remanding the case for further proceedings.

July 4, 2012

The Cost of Reform

by Kenneth Hoffman in Business Counsel, Tax Counsel, Tax Planning

By now, of course, you've heard the news that the U.S. Supreme Court upheld the Affordable Care Act, also known as "Obamacare." Ironically, the Court ruled that the controversial individual mandate is constitutional under the government's power to tax, rather than its power to regulate commerce.

We're not here to debate the merits of the Court's decision. If that's what you want, turn on any cable news network and you'll find various assorted bloviators from both sides, bloviating right now. (Try it. It's fun!)

What we are here to discuss is how the Court's decision affects your tax bill. That's because the original legislation that the Court upheld makes care affordable in part by imposing several new taxes -- in addition to the "tax" or "penalty" imposed by the individual mandate -- that will now go into effect as already scheduled:

On January 1, 2013, the Medicare tax on earned income, currently set at 2.9%, jumps to 3.8% for individuals earning over $200,000 ($250,000 for joint filers, $125,000 for married individuals filing separately).
Also on January 1, there's a new "Unearned Income Medicare Contribution" of 3.8% on investment income of those earning more than $200,000 for individuals or joint filers earning more than $250,000. (Doesn't that sound better than "tax"?)
Beginning January 1, 2014, there's a $2,500 cap on tax-free contributions to flexible spending accounts.
Also beginning January 1, 2014, employers with more than 50 employees face a penalty of $2,000 per employee for not offering health insurance to full-time employees.
Finally, the threshold for deducting medical and dental expenses rises from 7.5% of your adjusted gross income to 10%. You probably don't get to deduct your out-of-pocket medical expenses anyway -- but the new, higher threshold will just make it that much harder.

These new taxes raise new planning questions. How can we structure your investment portfolio to avoid the new "Unearned Income Medicare Contribution"? (Doesn't that sound better than "tax"?) What role should flexible spending accounts play in your finances? Should we look at a Health Savings Account or Medical Expense Reimbursement Plan to write off newly-disallowed medical expenses?

And the new healthcare taxes aren't the only challenge we face this Independence Day. We're six months away from what some wags are calling "Taxmageddon." On January 1, the Bush tax cuts are scheduled to expire. And the 2% payroll tax "holiday" expires as well. These mean higher taxes for everyone, not just "the 1%." But with Washington geared up for elections, there's little hope for quick or easy resolution.

Together, these new developments make for some real planning challenges. But when the going gets tough . . . the tough get going. So count on us to get going on today's most pressing planning questions. And remember, we're here for everyone at your July 4th barbecue!

July 2, 2012

Business Expenses 101

by Kenneth Hoffman in Business Counsel, Tax Counsel, Tax Planning

For small business owners, tax breaks often come in the form of tax deductions – which can offer a nice little instant cash savings – if you know how to navigate tax law and claim the deductions you deserve (not what you believe you are entitled to).

Large tax deductions are a notorious red flag for the IRS, with home-based businesses, in particular, facing an increase in tax audits due to suspicious deduction activity on income tax returns.

To help you navigate the complex world of business tax deductions, here is some foundational guidance that will help you take the deductions that you deserve.

Recordkeeping - Whatever the deductible expense may be, it is essential to maintain adequate records. There are many bookkeeping and accounting computer software programs available that will provide the basics for tracking expenses. But it is also important to keep receipts, invoices, etc., to back up the numbers. Some types of expenses require additional documentation, such as a log book or diary for business use of your personal vehicle or notations as to the business purpose of the expense (see Entertainment Expenses below). Keeping these records up-to-date will be a time-saver in the long run, especially if the IRS selects your return for audit.

Business Expenses vs. Capital Expenses - One of the first concepts a small business owner needs to understand is the difference between what can be expensed and what must be capitalized.

Business expenses are expenses that can be deducted in the current year, such as: business travel, rents, utilities, supplies, insurance, wages, customer entertainment and tangible items with a useful life of no more than one year or cost less than $100. If you are a for-profit, these expenses are usually tax-deductible.
Capital expenses are those associated with purchasing fixed business assets, such as property and equipment that has a useful life of more than one year, and must be capitalized and depreciated over a period of years rather than be deducted as current year expenses. The number of depreciable years depends on the type of property. Here are some examples: office furnishings – 7 years, autos and light trucks – 5 years, computer equipment - 5 years, residential rental – 27.5 years, commercial rental – 39 years.

Sometimes even capital items can be expensed all in one year by electing to use a special provision of the tax code that allows personal tangible property, such as computers, office equipment, tools and machinery, to be deducted in full in the year the property is placed into service. The maximum amount that can be expensed for 2012 is $139,000, subject to certain limitations. This is down from the 2011 $500,000 limit.

A special provision for 2011 permits certain real property, such as qualified leasehold improvements, restaurant property and retail improvements, to be expensed, although no more than $250,000 of the $500,000 expense limit can be applied to these real property assets. For 2012, the special first-year bonus depreciation drops back to 50% (was 100% in 2011).

Although repairs are generally considered to be currently deductible expenses, there are occasions when that may not be true. If a repair or replacement increases the value of the property, makes it more useful, or lengthens its life, then it must depreciated. If not, it can be deducted like any other business expense.

Common Business Expenses - Below are some typical types of business expenses that qualify for deductions and special rules associated with them.

Car Expenses – To take the business deduction for the use of your car, you must determine what percentage of the vehicle was used for business, based on a ratio of business miles to total miles driven. Deductible costs can include the cost of traveling from one workplace to another, making business trips to visit customers or to attend meetings, or traveling to temporary workplaces. Be sure to maintain complete mileage records. However, commuting to and from your regular place of business is not a business expense. When it comes to claiming car expenses, there are two methods:

a) Actual Expenses – Add your annual car operating expenses including gas, oil, tires, repairs, license fees, lease payments, interest on vehicle loans, registration fees, insurance and depreciation). Multiply the car operating expenses by the percentage of business usage to get your deductible expense. Business-related parking and road/bridge tolls are fully deductible and don't have to be reduced by the percentage of business use. Note: the interest paid on vehicle loans is not deductible by employees who use their personal vehicles on the job.

b) Standard Mileage Rate – The standard rate changes each year. For 2012, it is 55.5 cents per mile for each business mile driven. Business-related parking costs, road/bridge tolls, and the business-use portion of interest paid on vehicle loans (for other than employees) are also deductible when the standard mileage rate method is used.
Business Use of Your Home - If you use part of your home for your business, you may be able to deduct expenses for items such as mortgage interest, insurance, utilities, repairs, and depreciation. To qualify, you must meet the following criteria:

a) The business part of your home must be used exclusively and regularly for your trade or business. However, there are exceptions for daycare facilities or storage of inventory/product samples.

b) The business part of your home must be:
- The principal place of business, or
- A place where you meet or deal with patients, clients, or customers in the normal course of your business, or
- A separate structure (not attached to your home) used in connection with your business.
Entertainment Expenses – This includes any activity considered to provide entertainment, amusement or recreation. To be deductible, you must generally show that entertainment expenses (including meals) are directly related to, or associated with, the conduct of your business. Recordkeeping is essential – you will need to keep a history of the business purpose, the amount of each expense, the date and place of the entertainment, and the business relationship of the persons entertained. Entertainment expenses are usually subject to a 50 percent limit.
Travel Expenses – These are “ordinary” and “necessary” expenses while away from home when the primary purpose is conducting business. Your home is generally considered to be the entire city or general area where your principal place of business or employment is located. Out-of-town expenses include transportation, meals, lodging, tips, and miscellaneous items like laundry, valet, etc.

Document away-from-home expenses by noting the date, destination and business purpose of your trip. Record the business miles if you drove to the out-of-town location. In addition, keep a detailed record of your expenses - lodging, public transportation, meals, etc. Always list meals and lodging separately in your records. Receipts must be retained for each lodging expense (proves you were out-of-town). However, if any other business expense is less than $75, a receipt is not necessary if you record all the information in a timely diary. You must keep track of the full amount of meal expenses, even though only 50% of the amount will be deductible.
Local Lodging - In a change of position, in April 2012, the IRS proposed regulations that allow the costs of certain lodging when not traveling away from home (local lodging) as a business deduction. The lodging, which cannot be lavish or extravagant, must be necessary to participate fully in or be available for a business-related meeting, conference, training session or other business function. The lodging period can be no more than 5 calendar days and is limited to once per quarter. The lodging cannot provide any significant element of personal pleasure, recreation or benefit. The new rules apply to expenses paid in prior years where the statute of limitations for claiming refunds is still open.
Conventions – It is not coincidental that most conventions are held in resort areas during the spring through early fall months. Convention planners know quite well that convention timing and location is the key to its success. If planned properly, attendees can deduct a portion of the expenses for establishing business relationships and gaining business knowledge while enjoying a mini-vacation. Even without a convention, business travel can be married with some personal relaxation while still providing a partial or complete deduction. It is important to be aware of when the deductions are legitimate as well as when they are not.

Where a companion, such as a spouse, accompanies the taxpayer, the companion's meals and travel expenses are generally not deductible. In addition, deductible-lodging expense is based upon the single occupancy rate.

There are special rules related to the deductibility of cruise ship conventions, and the meeting must be directly related to the active conduct of the taxpayer's trade or business. The cruise ship must be a vessel registered in the United States. All ports of call must be located in the U.S. or any of its possessions.

Note that a higher standard is applied to foreign conventions than to conventions and seminars held within the North American area. Various factors are considered to determine the reasonableness of the location and convention, including, but not limited to, the meeting's purpose, the sponsor's purpose and activities, the residence of the organization's members, the locations of past and future seminars.
Marketing and Advertising Expenses - Although marketing and advertising is generally thought of in terms of print ads, flyers and radio and television advertising, they also can include marketing that is intended to portray a business positively. Such marketing creates a long-term potential for business and falls within the ordinary and normal requirements of the tax code.

Examples of such marketing include sponsoring local youth sports teams, distributing samples of your business product, and costs associated with prizes offered by your business in a contest. As long as your marketing expenses can be reasonably related to the promotion of your business, they can be deducted.

The foregoing is a brief overview of some of the many deductions available to the small business owner. However, every business is different and has its own unique expenses. If you have questions related to deductible expenses for your business, please give us a call at 954-591-8290.

July 1, 2012

Inactive Business? Must I File a Tax Return?

by Kenneth Hoffman in Business Counsel, Tax Counsel

Do you have to file a return? What if you've picked a name, filed the papers for an LLC, etc. but haven't started the business and have no income for the year? Whether or not you have to file any returns depends on the circumstances.

Please keep in mind that the discussion below assumes that the business has no sales or expenses. There is no threshold for reporting sales. Even if you have only $1 of revenue you must file a return reporting the income. And once you begin filing returns you must continue to do so unless you advise the federal or state government you are no longer required to file.

Sole Proprietorship

This is the simplest way of doing business. Many businesses operate under their own name or file for a DBA (doing business as). If you have no sales or expenses for the year, you don't have to file a Schedule C. (That's one of the advantages of starting as a sole proprietorship and later moving on to an LLC, S corporation, etc.)

If you signed up for sales, employment, or other taxes, the state or IRS will be expecting to see a return. Just because you had no sales doesn't mean you don't have to file a sales tax return. Most states require a return even if the return would show all zeros. And many states assess a minimum penalty for not filing. If you haven't signed up for those taxes, you generally need file no returns. The same is true for unemployment insurance returns if they're filed separately from employment tax returns.

In some states you may be required to have a business license and file annual reports. If you applied for a business license, the reports must generally be filed even if you have no activity. Again, there may be penalties for failure to file.

If you don't think you're going to be doing business immediately, don't sign up to collect sales, or for employment taxes. In most cases it should take no more than a month (probably much less) from signing up to receive the necessary paperwork.

Single-Member LLC

Here the answer is similar to that for sole proprietorship, above. The IRS and most states consider a single-member LLC as a disregarded entity. That is, for tax purposes it's the same as being a sole proprietorship. The difference here is that you've got a separate entity registered with your home state. In most cases, no return is required. But check the rules in the state in which you're doing business.

The rules on other returns are like those of a sole proprietorship. For example, if you signed up to collect sales taxes, you've got to file returns.

LLC, Partnership, S Corporation, Corporation

These are all separate entities. You'll need to file federal returns (Form 1065 for LLCs and partnerships; Form 1120S for S corporation; Form 1120 for a corporation) even if you had no income or expenses. The state and the IRS will be looking for these returns and will be assessed penalties for not filing.

The rules with respect sales and employment (and unemployment insurance) returns are similar to those of a sole proprietorship. If you didn't sign up, no return is due. There may be exceptions on the state level. Check the rules for your state. If you did sign up, you'll have to file returns.

Many states have annual report or similar required filings. Filings may be required by the tax department and/or the secretary of state. Failure to file may cause the entity to lose it's status with the state.

Dormant Entities

What happens if your business goes dormant for a tax year? Even if you have no revenue, you must file LLC, partnership, S corporation and corporate returns. Filing a Schedule C may not be required, check with your tax advisor.

Other returns, such as sales tax and employment, and unemployment insurance returns, once started, must still be filed. If you no longer have employees, and don't expect to have them in the near future, you may be able to discontinue filing federal returns by checking a box on Form 941. The same should be true for your state return; check the requirements in your state.

If you don't expect to collect sales tax in the future, you may be able to check a box on your return to discontinue filing. In some cases there may be more paperwork with the state.

If you expect the business to be dormant for only a short period of time you may not want to discontinue filing employment or sales to save the trouble of reapplying when you do restart activities.