Small Business Taxes & ManagementTM--Copyright 2018, A/N Group, Inc.
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July 20, 2018
NewsThe IRS (and tax law) is particularly fussy when it comes to documentation for auto expenses. In Paul O. Martin and Cynthia M. Montes Martin (T.C. Memo. 2018-109) the taxpayers submitted mileage logs to substantiate the auto expenses. The logs for 2012 and 2013 appeared to show how many miles the taxpayers traveled each week, but not the individual dates of travel or the places that they traveled to. The log for 2014 does not show the places the taxpayers traveled to. As a result the Court denied the taxpayers any of the auto expense deductions disallowed by the IRS for 2012, 2013, or 2014. In addition, the taxpayers did not provide documentation for all of the travel expenses. The documentation they did provide consisted of a smattering of receipts and credit card statements, none of which show the business purpose of the expenses. Additionally, the taxpayers appeared to have reported an expense for a trip to Puerto Rico that seems entirely unrelated to their rental properties. The Court held the taxpayers were not entitled to any of the disallowed travel expense deductions for 2012, 2013, or 2014. The taxpayers claimed that under the terms of the lease on their rental property they had to pay the utilities, but the taxpayers provided no evidence regarding the lease or whether they actually paid the utilities expense.
Tip of the DayDe-risking . . . There can be a number of reasons for dropping product lines, services, customers, vendors, etc. They range from loss products or services, trouble with suppliers or customers, etc. There's another reason that's not so obvious--reducing risk. For example, dropping a product or service where there's a high chance of being sued, dropping a product that's difficult to manufacture, etc. Reducing risk is more difficult to quantify than dropping a loss product, and it may not be the decisive factor, but you should take it into consideration.
July 19, 2018
NewsRevenue Procedure 2018-38 (IRB 2018-31) modifies the information to be reported to the IRS by organizations exempt from tax under Sec. 501(a) of the Code, other than organizations described in Sec. 501(c)(3), that are required to file an annual Form 990 or Form 990-EZ information return. These organizations are no longer required to report the names and addresses of their contributors on the Schedule B of their Forms 990 or 990-EZ. These organizations, however, must continue to collect and keep this information in their books and records and to make it available to the IRS upon request.
Whether you can substantiate a deduction is usually the first question the IRS and courts look at, generally because many taxpayers can't pass that test. But an expense, once substantiated, has to be ordinary and necessary. In Mark E. Balocco and Patricia A. Balocco (T.C. Memo. 2018-108) the taxpayer husband and his brother started a business flipping properties. In the first year at issue the taxpayer looked at several properties but did not purchase any. He purchased a small single-engine aircraft to allow him to examine potential properties quicker. An airplane is listed property and the stricter substantiation rules apply. The Court noted whether an expenditure is ordinary and necessary is generally a question of fact. A taxpayer must show a bona fide business purpose for the expenditure; there must also be a proximate relationship between the expenditure and his or her business. In general, where an expense is primarily associated with profit-motivated purposes and personal benefit can be said to be distinctly secondary and incidental, it may be deducted. The IRS challenged both the ordinary and necessary as well as the substantiation issue. The Court noted the taxpayer used the airplance to fily to locations that he could have driven to or flown to commercially. The Court found that the taxpayer did not show that maintaining and flying his own airplane provided any cost savings or was necessary for his business. The Court went on to say that even if the aircraft was ordinary and necessary, it would have failed the substantiation requirements.
What triggers an IRS audit? An often asked question. For individuals taking big Schedule A deductions for charitable contributions and miscellaneous itemized deductions is one trigger. In Magloire K. Ayissi-Etoh and Katrina D. Sharpe (T.C. Memo. 2018-107) the taxpayers took $21,300 in cash charitable contributions for one year and $55,400 for the next. In addition, they took $14,000 in noncash contributions for one year and $9,280 the next. They also took $23,288 and $15,282 in unreimbursed employee expenses for the respective years. They also claimed deductions on a Schedule C of $35,889 for one year and $40,287 the next with no income in either year. The Court noted the bulk of the cash contributions were purported made to a charity not recognized by the IRS and taxpayers' records for the other contributions were inadequate. The documentation for the noncash contributions did not come close to meeting the enhanced requirements for larger gifts. The Court also disallowed the Schedule C deductions finding them to be unsubstantiated and noting that there was no evidence any business activity was carried on during the years at issue.
Tip of the DayWiping data on your copier . . . By now you've probably heard the warning to wipe the data from computers you sell, give away or discard. Actually, the best way is to destroy the hard drive. But higher end copiers now often contain hard drives with information that was scanned in or copied. Such machines are often on lease and are returned to the lessor only to be re-leased or sold. There may be other devices such as smartphones, tablets, etc. that contain information that should be removed before getting rid of the device. Not sure whether data has been stored on a device? If you don't know a competent IT person, contact the manufacturer.
July 18, 2018
NewsTaxpayers residing in or who have a business in the Massachusetts counties of Barnstable, Bristol, Essex, Nantucket, Norfolk and Plymouth who sustained losses as a result of a severe winter storm and flooding from March 2 to March 3, 2018 may deduct losses on their 2018 or 2017 tax returns.
There's a time limit on filing a refund claim. In Joshua Rosner (U.S. District Court, S.D. New York) the taxpayer, in March 2013, filed refund claims for 2006 and 2008. The date his 2007 refund was filed was not clear. The IRS denied the claims because the claims were filed more than 3 years after the tax years ended. The taxpayer filed documents claiming financial disability. (A claim of financial disability means the taxpayer was unable, because of a mental or physical condition to take care of his tax obligations.) The IRS reasons for disallowing his claims was that the claims were time-barred. The IRS appeals officer did grant a refund claim for 2007 finding he did qualify for financial disability. The Court found that the original notice of disallowance satisfied the statutory requirement of providing an explanation. The Court the taxpayer was not entitled to equitable relief and that he did not qualify for financial disability for 2006 and 2008.
Tip of the DayLitigation settlements . . . Awards for personal physical injury or sickness are not taxable. But in many cases a lawsuit involves more than one issue or the reason for the settlment isn't clear. And awards for other reasons such as sexual harassment, age discrimination, etc. are taxable. Make sure the settlement clearly spells out what the award, or the relevant portion of the award, is for. Get good advice from a tax professional before signing off on the settlement. A mistake here could be very costly.
July 17, 2018
NewsThe IRS has issued proposed regulations (REG-103474-18, NPRM REG-103474-18) that amend portions of previously proposed regulations related to the tax return preparer penalty under Section 6695(g) of the Code. These amendments to the previously proposed regulations are necessary to implement a recent law change that expands the scope of the tax return preparer due diligence penalty under Section 6695(g) so that it applies with respect to eligibility to file a return or claim for refund as head of household. The proposed regulations affect tax return preparers.
You may be able to have your tax debts discharged in bankrutpcy court, but not if you haven't filed returns or tried to evade the taxes. In Tyrone A. Conard and Joyce L. Conard (U.S. Bankruptcy Court, E.D. Virginia) the Court found that the husband willfully attempted to evade payment of his taxes. The Court's conclusion with respect to the wife was different. The Court noted that in order for the IRS to prevail it must prove by a preponderance of the evidence that she knew her taxes were due and not paid and that she chose not to pay them. The Court also noted to satisfy one requirement, the IRS “must prove that the debtor (1) had a duty to file income tax returns; (2) knew that he had a such a duty: and (3) voluntarily and intentionally violated that duty.” At trial the wife testified that her husband told her he was paying the taxes and that she believed him. The Court found her credible. All of her testimony substantiated that she had no control over her husband's expenditures and that she depended on her husband to fulfill all of their tax obligations. Further, and importantly, her testimony established that she did not know that the taxes were not being paid. She did not have the requisite mental state to willfully evade the taxes. The Court found that the wife was discharged from her debt to the IRS.
Tip of the DayIs this meeting necessary? . . . During World War II the question was "is this trip necessary?". The idea was to stop people from using gas and rubber, two items in short supply. Your business may be able to save time by reducing the number of meetings. Some managers like meetings simply because it makes them feel important. But it also takes time from other, possibly more productive, activities. There's no denying that some meetings are important. But before calling the meeting, consider if you really need it, or can the same objective be accomplished in another way? A one-on-one meeting with the engineer, for example. You can also save time by keeping the number of participants to a minimum. That might ruffle some feathers, but it could be worth it. One key is to make sure you have an agenda and follow it. Don't let people digress. Finally, after the meeting is over, consider what it accomplished. You should ask yourself two questions. Was it worth it? How can you do better next time?
July 16, 2018
NewsNotice 2018-61 (IRB 2018-31) announces that the Treasury Department and the IRS intend to issue regulations providing clarification of the effect of Section 67(g), enacted on December 22, 2017, by “An Act to provide for reconciliation pursuant to titles II and V of the concurrent resolution on the budget for fiscal year 2018,” P.L. 115-97, on the deductibility of certain expenses described in Section 67(b) and (e) that are incurred by estates and non-grantor trusts. These regulations will clarify that estates and non-grantor trusts may continue to deduct each expense that is described in Section 67(e)(1) or is allowable under Section 642(b), 651 or 661, in determining the estate or non-grantor trust’s adjusted gross income for all taxable years, even while the application of Section 67(a) is suspended pursuant to Section 67(g).
The IRS has issued final regulations (T.D. 9834) that address transactions that are structured to avoid the purposes of Sections 7874 and 367 of the Code and certain post-inversion tax avoidance transactions. These regulations affect certain domestic corporations and domestic partnerships whose assets are directly or indirectly acquired by a foreign corporation and certain persons related to such domestic corporations and domestic partnerships. This document finalizes proposed regulations, and removes temporary regulations, published on April 8, 2016.
Tip of the DayCorrect entity for income and expenses . . . It's not unusual to do business using several entities. For example, Madison Contractors has two separate corporations--Madison Contractors of Albany and Madison Contractors of Hudson. Some customers do business with both entities, and sometimes customers write checks to the wrong entity. Or a vendor issues an invoice to the wrong entity. You should make sure the errors are corrected. Failure to do so can cause a number of tax and financial statement problems down the road. The issue is even more critical if the ownership of the different entities is different or the entities are organized differently such as a partnership and a C or S corporation. This issue also pops up when a taxpayer has a sole proprietorship and another entity such as an S corporation. In more than a few situations you may need the help of your tax advisor or CPA.
July 13, 2018
NewsIn general, a notice of deficiency must be mailed within three years of the date the return is filed, but the IRS has six years to mail the notice if the gross income omitted from the return exceeds 25% of the amount of gross income reported on the return. However, the omitted income for purposes of this calculation does not include the amount of any omitted income insofar as the taxpayer discloses the omitted amount “in the return, or in a statement attached to the return, in a manner adequate to apprise the IRS of the nature and amount of such item.” In Robert Manashi and Nahrin Manashi (T.C. Memo. 2018-106) the omitted income from an S corporation wholly owned by the taxpayers easily exceeded 25% and the taxpayers conceded the issue. However, the taxpayers claimed that the statute of limitations was not extended because they adequately disclosed the understatement. They argued that adequate disclosure occurred by virtue of the fact that the S corporation reported some amount of gross receipts on its returns for each year. In the taxpayers' view, the IRS, “through internal data”, would have had knowledge of the amounts deposited into their bank accounts and could have discovered that gross receipts were erroneously reported for each year. The Court held the taxpayers were mistaken. Simply put, reporting some amount of gross receipts offers no “clue” that other gross receipts have been omitted. The Court also rejected the taxpayers' second argument that the IRS should have discovered the underreporting by Forms 1099 that were filed for payments made to the corporation. The Court held the six-year statute applied.
S corporations can have only a single class of stock (nonvoting stock is allowed). Generally a corporation will be treated as having only one class of stock “if all outstanding shares of stock of the corporation confer identical rights to distribution and liquidation proceeds.” In Craig P. Mowry and Cricket U. Mowry (T.C. Memo. 2018-105) the taxpayers discovered that the other shareholders were paying personal expenses out of the corporation and withdrew large sums of money. The taxpayers contended that the election to be an S corporation was terminated because the requirement of having a single class of stock was no longer satisfied. The Court noted that the single class of stock requirement was determined by the corporate charter, articles of incorporation, bylaws, applicable state law, and binding agreements relating to distribution and liquidation proceeds. The unequal distributions did not establish a separate class of stock. The Court held that the S corporation did not, by default, become a C corporation and the taxpayers had to report the flowthrough income.
Tip of the DayBack property taxes may not be deductible . . . You buy a home, commercial property, etc. with delinquent back taxes (and other charges such as interest, etc.) at a foreclosure sale. Can you deduct all the taxes? No. Your deduction is limited to the portion of the taxes attributable to the time since you owned the property. Those prior accumulated taxes are part of the purchase price. If the property includes a building, a portion of the taxes, interest, etc. should be allocated to the building for which you can claim depreciation.
July 12, 2018
NewsWhere's your residence? For most taxpayers, the answer is easy. But for more than a few, they spend time in a number of places. Usually this question arises with respect to state taxation. You have homes in New York and in Massachusetts and spend considerable time in both, in addition to traveling to job sites in other states. There's a good chance both New York and Massachusetts will try to claim you as a resident and tax you as such. In Estate of Travis L. Sanders, Deceased, Thomas S. Hogan, Jr., Personal Representative, Petitioner, and The Government of the United States Virgin Islands, Intervenor (T.C. Memo. 2018-104) the taxpayer claimed to be a resident of the U.S. Virgin Islands (USVI). He spent time in both Florida and the USVI. The IRS claimed he was not a Virgin Islands resident and the transactions he engaged in on the Virgin Islands lacked economic substance. The acid test is present in the USVI for at least 183 days during the tax year and no other tax outside the possession. Here the taxpayer could not meet those criteria so the Court looked to other factors outlined in an earlier case (Sochurek) and focused on physical presence, intent, social, family and professional relationships and the taxpayer's own representations. The Court found the taxpayer was a bona fide resident of the USVI for the last two of the three years at issue.
You can deduct a portion of the expenses of maintaining a home if the space qualifies for a home office deduction. The space qualifies if it's your principal place of business, you have no other space to perform administrative tasks, or you regularly meet with clients or patients there. The space may also qualify if you sell products at retail or wholesale and you use the space to store inventory. In Mohammad Najafpir (T.C. Memo. 2018-103) the taxpayer used his garage to store business records. The Court found that did not fit the exceptions because he was not in the trade or business of selling products at retail or wholesale, and his business records and invoices do not constitute inventory.
Tip of the DayHome loans under new law . . . The rules for mortgage interest have changed under the new law. Interest on a home equity loan is no longer deductible. But you've got to understand what a home equity loan is. It's any loan on your residence where the proceeds aren't used for the acquisition of the property. Clearly, going to the bank and taking out a loan to pay down credit card debt is a home equity loan. But so is refinancing your existing mortgage and adding to the original principal. For example, refinancing a $250,000 mortgage with a $290,000 loan with $5,000 of the closing costs as part of the loan and $35,000 used to pay off credit card debt. On the other hand, if the $40,000 additional debt were used to add a room to your home, interest on the full amount would be deductible. The same would be true if you took out a $40,000 home equity loan to finance the addition. Does it make sense to borrow on your home to pay off high interest debt? Almost assuredly yes. You're not getting a tax deduction for the interest either way, but at least the rate is lower. Keep in mind that there are other implications here. For example, you're substituting long-term debt for short-term debt that probably financed short-term assets such as an ATV, furniture, or even a vacation. Get good financial advice before committing.
July 11, 2018
NewsIt's not unusual for two or more individuals to operate a business together. C or S corporations require formal incorporation granted by a state. An LLC is also set up through the state. But a joint venture, tenancy in common (for a real estate venture), or a partnership can exist informally. In Marc White and Kelly White (T.C. Memo. 2018-102) the married taxpayers joined with another couple in two real estate ventures. There was no formal agreement and no partnership papers were drafted. The business operations were reported on the individual couples' Schedule Cs. The taxpayers did not maintain adequate books and records-sometimes paying personal expenses out of the business and business expenses out of their personal accounts. The IRS reconstructed their income using the specific-item mthod. It was left to the Court to determine if a partnership existed. The Court looked at eight factors from the regulations and concluded that the business was not properly classified as a partnership.
In the past individual taxpayers could deduct theft losses that were not associated with a trade or business. That's no longer true under the new law. In Gregory Raifman and Susan Raifman (T.C. Memo. 2018-101) the taxpayers claimed a theft loss on two investments. The courts ascertain whether theft has occurred based on the law of the State where the loss was sustained. As a result, the Court looked to California law. Here the taxpayers allege theft through fraudulent misrepresentations, that is theft by false pretenses. Theft by false pretenses consists of three conjunctive elements: (1) the perpetrator must, knowingly and with the specific intent to defraud the property owner, (2) have made a false representation or pretense which (3) materially influenced the owner to part with his or her property in reliance on those representations. In the case of both investments the Court did not find an intent to defraud and, thus, there was no theft loss.
Tip of the DayOutsourced payroll? . . . Outsourcing payroll duties makes sense for a number of reasons. But on a $30,000 payroll the federal taxes (withheld and employer's FICA portion) can easily top $10,000 and could be considerably more. That's a great incentive for a unscrupulous payroll firm to deposit those taxes in its own account. It wouldn't take many payrolls to accumulate enough for a long vacation in another country. And you'd be responsible for the unpaid amount. If you're dealing with one of the big national firms, there isn't much need to worry. But there are small providers where you should be more cautious. There are a number of simple steps you can take to insure the money is being deposited with the IRS. First make sure any correspondence goes to you, not the payroll service. Second, make sure the payroll service is using EFTPS (Electronic Federal Tax Payroll System) and get a PIN number that will allow you to check up to make sure the deposits are made. The IRS has provided a web page with detailed steps you can take. Go to Outsourcing Payroll Duties.
July 10, 2018
NewsVictims of severe storms and flooding that began on June 19, 2018 in parts of Texas may qualify for tax relief from the IRS. The President has declared that a major disaster exists in the State of Texas. Following the recent disaster declaration for individual assistance issued by the FEMA, the IRS announced today that affected taxpayers in certain Texas counties will receive tax relief. Individuals who reside or have a business in Cameron and Hidalgo counties may qualify for tax relief. The declaration permits the IRS to postpone certain deadlines for taxpayers who reside or have a business in the disaster area. For instance, certain deadlines falling on or after June 19, 2018 and before Oct. 31, 2018, are granted additional time to file through Oct. 31, 2018. This includes an additional filing extension for individuals with valid extensions due to run out on Oct. 15, 2018, and businesses with extensions due to run out on Sept. 17, 2018. It also includes the Sept. 17, 2018 deadline for making quarterly estimated tax payments. For businesses, it also includes the July 31 deadline for filing quarterly payroll and excise tax returns. In addition, penalties on employment and excise tax deposits due on or after June 19, 2018 and before July 5, 2018, will be abated as long as the deposits were made by July 5, 2018. For more information, go to Tax relief for severe storms and flooding victims in Texas.
Taxpayers have the right to structure their transactions in a manner which decreases the amount of what otherwise would be their taxes. However, even if a transaction is in formal compliance with the Code, the economic substance of the transaction determines what is and what is not income to the taxpayers. Courts generally use a two-prong test to decide whether a transaction has economic substance. In determining whether a transaction has economic substance the Court of Appeals for the Ninth Circuit has stated that a taxpayer must show that the transaction had: (1) economic substance beyond the creation of tax benefits (objective analysis) and (2) a nontax business purpose (subjective analysis). In Roy E. Hahn and Linda G. Montgomery (T.C. Memo. 2018-100) the taxpayers, through an S corporation, invested in a Custom Adjustable Rate Debt Structure (CARDS) transaction. The Court sided with the IRS in disallowing the losses, finding the taxpayers did not show the transactions had economic substance and a nontax business purpose.
If a deficiency notice has been issued, you may still have options, such as an installment agreement, offer-in-compromise, etc. In Michael Rosendale and Tamara D. Rosendale (T.C. Memo. 2018-99) the taxpayers sought to be placed in currently not collectible (CNC) status because their claimed expenses exceeded their income. The IRS settlement officer (SO) did not allow an increase in their actual housing expenses (which were artificially low because they were living with relative3s) or vehicle expenses to account for depreciation. Only out-of-pocket costs were allowed. The SO determined the taxpayers' monthly income would exceed their allowable monthly expenses by $14,951 once certain State liabiklities were paid off and denied CNC status. The SO prposed a partial pay installment agreement (PPIA) at a reduced amount for the first three months (to enable them to pay off a portion of their state liability) and $14,591 per month for 111 months. The taxpayers rejected the offer. The Court noted that to be entitled to have his account placed into CNC status, the taxpayer must demonstrate that, on the basis of his assets, equity, income, and expenses, he has no apparent ability to make payments on the outstanding tax liability. The Court found the SO did not abuse her discretion in making any of the determinations. The Court also noted the taxpayers were not in full compliance with their current tax obligations. The Court held their was no abuse of discretion on the part of the SO.
Tip of the DayCharitable contributions . . . It sounds like a good idea. You rent your vacation home during the season, but just after peak you've got a week vacancy. So you donate a week's use to your church for use in a raffle. Bad move--for two reasons. First, the use of the home is deemed personal, not business. That means you won't be able to deduct the expenses during that time. Second, you'll get no charitable contribution deduction. That's because the gift of the right to use property doesn't qualify as a deductible contribution.
July 9, 2018
NewsIn Benton Williams, Jr. (151 T.C. No. 1) the taxpayer failed to file a return for 2012. The IRS prepared a substitute for return (SFR) and determined a deficiency along with a penalty (in the form of a tax) for early distributions from a qualified plan and a penalty for failure to file or pay. The taxpayer filed a petition containing frivolous arguments and then filed a series of frivolous pretrial motions and made frivolous posttrial arguments. The Tax Court can impose a penalty of up to $25,000 on a taxpayer whenever it appears that the proceeding was instituted primarily for delay or that the taxpayer's position is frivolous or groundless. Penalties imposed by the IRS generally must be personally apporved by an immediate supervisor. The Tax Court held that the taxpayer was liable for the deficiency, additional tax, and additions to tax and that the authority of the Tax Court to impose a penalty under Sec. 6673(a)(1) is not subject to the approval requirement. Finally, the Tax Court held the taxpayer was liable for a $2,000 penalty under Sec. 6673(a)(1).
In Edgar G.E. Morgan (T.C. Memo. 2018-98) the taxpayer failed to file tax returns for several years. When he did file the returns he failed to do so in chronological order. The return showed a balance due and IRS assessed the tax along with a late filing penalty. The taxpayer, in a collection due process hearing, argued that he had overpayments of some $22,000 for one year and $26,000 for another and should be given credit for those amounts. However, the IRS had processed those returns and carried the overpayments back to 1999, the earliest year with a balance due. The carryforward was applied to the 2000 tax year which showed an amount due that eliminated the carryforward. The balance due on that return was determined by the IRS when it filed a substitute for return. The taxpayer claimed he filed an amended return for that year and when that return was processed his 2000 liability would be eliminated, freeing up the credit balance. The Court held the IRS Settlement Officer was not required to consider the merits of the position he took on that return when determining whether to sustain the proposed collection action.
Tip of the DaySelling or buying a business? Applying for a loan? . . . You may be understating your income on your tax return and overstating it on your loan application or when presenting the business for sale. The IRS can use the information from a loan application or financials you present to a buyer as a basis for a more detailed audit. And, if you're overstating your income on a loan application, that's considered fraud. And today it's easy for parties to cross check. As a buyer of a business, you should question financials that don't match the tax returns. Can you really trust someone who's willing to cheat on their taxes? They could be even more willing to cheat you.
July 6, 2018
NewsIn the case of a false or fraudulent return with the intent to evade tax, tax may be assessed, or a proceeding in court for collection of such tax may be begun without assessment, at any time. In L. Donald Guess (T.C. Memo. 2018-97) the Tax Court noted that the burden is on the IRS to show fraud by clear and convincing evidence on the part of the taxpayer. To establish fraud, the IRS must prove via clear and convincing evidence for each year: (1) an underpayment of tax exists and (2) the taxpayer had a fraudulent intent, i.e., that the taxpayer intended to evade taxes known to be owing by conduct intended to conceal, mislead, or otherwise prevent the collection of taxes. Because the taxpayer lost an earlier case in a district court (and in the Court of Appeals) involving the issue giving rise to the underpayment (the donation of stock in the taxpayer's company), leaving the issue of whether a portion of the underpayment was due to fraud. The Court did find fraudulent intent, leaving the statute of limitations open and finding the deficiency notice timely. Finally, the Court allowed the imposition of the fraud penalty.
The IRS can challenge transactions that have no economic substance. In Endeavor Partners Fund, LLC, Delta Currency Trading, LLC, Tax Matters Partner, et al. (T.C. Memo. 2018-96) the Tax Court noted that all of the transactions at issue involved paired foreign-currency options. The IRS challenged these transactions on various grounds, including their alleged lack of economic substance. Disallowing all of the claimed loss deductions, the IRS made adjustments to the partnerships' income that exceed $300 million in the aggregate. The Tax Court agreed, finding the transactions lacked any economic substance whatsoever, and disallowed the loss deductions. The Tax Court went on to say that although the partnerships' conduct was plainly deserving of penalty, the IRS has conceded that the it did not secure, prior to the issuance of the final partnership administrative adjustment (FPAAs), written supervisory approval of the penalties as required by Section 6751(b)(1). As a result, the Court did not sustain the accuracy-related penalties.
Tip of the DayDeducting warranty expense . . . If you purchase an extended warranty for an auto used for business purposes, you can't deduct the full amount in the year of purchase. You've got to amortize the cost of the life of the warranty. Take the full cost and divide by the number of months in the warranty period. Multiply the number of months the warranty was in effect for the year by the monthly amount. For example, if you purchased the warranty September 1, 2018, deduct 4 months of the cost in 2018, 12 months in 2019, etc. If the auto isn't used 100% for business, you can only deduct the portion that applies to the business.
July 5, 2018
NewsTalk has resurfaced about a phase two to to tax reform. The objective is to reduce the corporate tax rate to 20% and make the individual tax cuts permanent. There isn't much time before the mid-term elections and this time there could be more trouble in the Senate.
The IRS Large Business and International division (LB&I) has announced the approval of five additional compliance campaigns. LB&I is moving toward issue-based examinations and a compliance campaign process in which the organization decides which compliance issues that present risk require a response in the form of one or multiple treatment streams to achieve compliance objectives. This approach makes use of IRS knowledge and deploys the right resources to address those issues. These five additional campaigns were identified through LB&I data analysis and suggestions from IRS employees. LB&I's goal is to improve return selection, identify issues representing a risk of non-compliance, and make the greatest use of limited resources. The first area is the restoration of sequestered AMT credit carryforwards. Taxpayers may not restore the sequestered amounts to their AMT credit carryforward. Soft letters will be mailed to taxpayers who are identified as making improper restorations of sequestered amounts. Taxpayers will be monitored for subsequent compliance. The second area is S corporation distributions. Three issues have been identified--when an S corporation fails to report gain upon the distribution of appreciated property; when a distribution is properly taxable as a dividend; and non-dividend distributions in excess of stock basis. The third area is virtual currency. The Virtual Currency Compliance campaign will address noncompliance related to the use of virtual currency through multiple treatment streams including outreach and examinations. Taxpayers with unreported virtual currency transactions are urged to correct their returns as soon as practical. The compliance activities will follow the general tax principles applicable to all transactions in property, as outlined in Notice 2014-21. The fourth area is repatriation via foreign triangular reorganizations and the fifth area is Section 965 transition tax.
If you report a stock sale, your gain (or loss) is measured by the difference between the selling price and your basis. In Michael Amelsberg and Christina Amelsberg (T.C. Memo. 2018-94) the taxpayers failed to report income from the sale of stocks that was reported on Forms 1099-B. The IRS claimed the unreported income was equal to the full amount of the proceeds, some $56,892. The taxpayers claimed the gain should be reduced by their cost basis. However, the Court noted there was no evidence in the record that establishes the basis that the taxpayer had in each of the stocks that he sold during the year. The Court held that the full amount of the proceeds had to be reported as gain. The taxpayers also claimed a net operating loss carryover from an S corporation. The Tax Court disallowed the loss, noting that the IRS had shown that the corporation had unreported income in excess of the amount of the net operating loss. In effect the unreported income eliminated the net operating loss.
Tip of the DayThrowing good money after bad . . . Does it make sense to continue funding a project that's gone way over budget? Should you invest more time in a project that's behind schedule? This isn't any easy question to answer. If you abandon the project now you'll lose your investment. But that money is gone already. Continue on and you could still lose and have wasted more money. The question becomes even more difficult because there's often a personal attachment to the project. If it's your project and you're the boss, it could be humiliating; if you're an employee it could be that and worse. The first thing to do is take a step back. Find out how much more it'll cost to complete the project. What have you learned to date from the work? Can you use what you learned to better estimate how long it will take or cost to complete? What's the effect on other projects? Are they dependent on completing this project? If so, the analysis will be even tougher. Will spending more on this project mean you won't have the capital for another project? You should strongly consider new, outside expertise.
July 3 , 2018
NewsVictims of severe storms, flooding, landslides and mudslides that occurred starting on April 13, 2018 in Hawaii may qualify for tax relief from the IRS. The President has declared that a major disaster exists in the State of Hawaii. Following the recent disaster declaration for individual assistance issued by the FEMA, the IRS announced that affected taxpayers in Hawaii will receive tax relief. Individuals who reside or have a business in the City and County of Honolulu and Kauai County may qualify for relief. The declaration permits the IRS to postpone certain deadlines for taxpayers who reside or have a business in the disaster area. For instance, certain deadlines falling on or after April 13, 2018, and before Aug. 15, 2018, are granted additional time to file through Aug. 15, 2018. In addition, penalties on employment and excise tax deposits due on or after April 13, 2018, and before April 30, 2018, will be abated as long as the deposits were made by April 30, 2018. For more information, go to Tax relief for victims of storms, flooding, landslides and mudslides in Hawaii.
A spouse may be able to receive innocent spouse relief from joint liability. In Kimberly R. Hale (T.C. Memo. 2018-93) the petitioner and her husband filed joint returns for the years 2004 through 2009 but did not pay the amount due on the returns. The petitioner did not become aware of the unpaid liability until her husband's death. While the probate assets of the estate were insufficient to satisfy the debt, the petitioner received life insurance proceeds of some $8 million which she did not report on Form 8857, Request for Innocent Spouse Relief. The Court held that because the petitioner and the husband's tax liabilities for the years in issue were necessarily paid out of the proceeds of life insurance H purchased and funded with his own income, the fact that the petitioner did not suffer economic hardship as a result of the satisfaction of those liabilities weighs against granting relief notwithstanding Rev. Proc. 2013-34. The Court also held the insolvency of the husband's probate estate and the IRS's likely inability to collect from other sources any amount refunded to the petitioner also weigh against her claim for relief, as does her failure to disclose on her Forms 8857 the life insurance proceeds she received.
An employee stock ownership plan (ESOP) can be one way of transferring ownership of your business; it can also accomplish other management and tax goals. In Val Lanes Recreation Center Corporation (T.C. Memo. 2018-92) the taxpayer challenged the IRS's retroactive revocation of a favorable determination letter on the status of the ESOP. The IRS challenged the plan on several grounds, but the Tax Court found that because of the resolution allowing the taxpayer's board of directors to amend the ESOP retroactively to its effective date and the fact that the proposed amendments were previously approved during the FDL process, and that those amendments were adopted shortly after the taxpayer received the favorable determination letter, the Court found the IRS abuszed its discretion in determining that the plan had not been timely amended for the required language.
Tip of the DayResponsibility for sales tax . . . A shareholder, LLC member, etc. can be a responsible party for federal employment tax purposes. You won't be afforded the protection of the corporation or LLC. The same is usually true for state sales tax purposes. There may be exceptions for minority shareholders or members who aren't active in the business. Check the rules for your state.
July 2, 2018
NewsThe IRS has released a draft copy of the 2018 Form 1040. As promised, the form is indeed the size of a postcard (albeit a somewhat oversized one), and will replace Forms 1040, 1040-A and 1040-EZ. The form is shorter because there's a good chance you'll need one or more of the new, additional schedules. If all you've got for income is wages, interest, dividends, pensions (and IRAs), and social security benefits, you claim the standard deduction and have no credits, the new 1040 is all you'll need. However, if you taxable refunds, capital gains, Schedule C income, rental real estate, etc., you'll need to attach Schedule 1. Schedule 1 is also where you claim deductions toward adjusted gross income such as educator expenses, SEP or IRA deduction, student loan interest, etc. Schedule 4 is for other taxes such as the self-employment tax, social security and medicare tax on tip income not reported to employer, net investment income tax, etc. Schedule 2 is for certain other taxes such as the alternative minimum tax and the tax on child's unearned income. Schedule 3 is for nonrefundable credits and Schedule 5 for other payments and refundable credits. Keep in mind that these schedules are summary forms. For example, the self-employment tax is still computed on Schedule SE, but the result is reported on Schedule 4. Taxpayers who have a complex return and prepare it by hand may find it somewhat more confusing. Those who prepare the returns on computer probably won't notice much of a difference until they go to review the return. To view the draft copies of the forms and schedules, go to Draft Tax Forms at irs.gov.
Tip of the DayState newsletters . . . We cover what most small business owners need to know about changes in the federal tax law, but state law changes too. Sometimes it's a change in the sales tax rate. You're not going to miss that since it'll be in all the media. But that's not true about a subtle change in the form looking for more information, a change in the deadline for a filing, etc. The states we're familiar with have either a newsletter, send emails to registered subscribers or automatically send them to taxpayers who have an online account or file returns electronically. Make sure you're on the list--in every state you do business.
June 29, 2018
NewsYou've got to show more than a bill to secure a tax deduction. In Edgar Perry and Isa Perry (T.C. Memo. 2018-90) the Tax Court disallowed a deduction for property taxes on two properties because the taxpayers couldn't show if the taxes were paid and who paid the taxes. In addition the tax bills showed a parcel number, but no street address. The Court noted that nothing in the record established what addresses of the respective properties. The Court also denied expenses related to a property they claimed was rented to relatives. The taxpayers failed to show that the property was not rented at a fair market rental, and thus not a rental property for the time at issue.
A raw invoice with little surrounding evidence may not secure you a deduction. In Little Mountain Corporation (U.S. Court of Appeals, Ninth Circuit) the Court affirmed the Tax Court's decision disallowing amounts paid to a related party. The Court noted the invoices provided no detail on the work done, the checks in question were made out to "cash" not the parties doing the work and were cashed by unrelated parties. There were no indications the intended party actually received the funds and the checks were endorsed by individuals unrelated to the vendors. Testimony as to the work performed was contradicted by records presented. Finally, no Forms 1099 were issued.
Tip of the DayExpense report fraud . . . If your employees incur expenses outside the company and you reimburse, there's a good chance one or more of them are padding their expenses. Sometimes it's small or maybe inadvertent (e.g., putting a small personal expense on the company card by accident), but if you've got 5 employees with company cards, there's a good chance at least one of them is taking some serious money out of your business. The first step is to make sure employees produce expense reports on a regular basis, at least monthly. Second, make sure someone is checking them, at least on a random basis. If an employee thinks no one is checking, you're asking for trouble. Third, make sure they turn in receipts to support the expense, with the IRS requirements as a minimum. If you're audited the IRS will be checking and missing receipts often means a lost deduction. That means you not only are out the cash, you're out a tax deduction. Who performs the review function depends on a number of factors, but routine reviews are often done by the accounts payable staff. Don't ignore upper management, owners, or relatives. Have something in your employment, partnership, etc. agreement. Touchy area? Get your CPA to review them. In one case an employee who was the son of one of the owners ran up $60,000 in personal travel, entertainment, and purchases.
June 28, 2018
NewsIn Gary Gaskin and Jessie Gaskin (T.C. Memo. 2018-89) the taxpayers petitioned the Tax Court to dispute fraud penalties. The taxpayers originally filed returns were fraudulent; the taxpayers admitted to that. While under criminal investigation the taxpayers filed amended returns. The IRS computed the deficiencies and fraud penalties based on the original returns. The taxpayers argued the penalties should be based on any underpayment resulting from the amended returns. The Tax Court did not agree. It noted the U.S. Supreme Court held that “a taxpayer who submits a fraudulent return does not purge the fraud by subsequent voluntary disclosure; the fraud was committed, and the offense completed, when the original return was prepared and filed.”
Just because your business is organized as an LLC or S corporation doesn't mean the IRS can't challenge whether you have a profit motive in operating the activity. In Shane V. Robison and Robin S. Robison (T.C. Memo. 2018-88) the taxpayers each had a 50% interest in an LLC that began with horse breeding but switched to cattle in the year 2000. The 410-acre ranch was purchased for $2 million. From 2000 to 2015 the activity sustained substantial losses each year. Until 2012 gross income never broke $100,000, but expenses were consistently above $400,000 and reached $800,000 one year. For the remaining few years gross income broke $100,000, reaching $215,000 for one year. Over the 16-year period the LLC reported over $9 million in losses. The taxpayers were well paid in their regular jobs. The Court examined six factors used to determine whether an activity was undertaken with an intent to turn a profit and found the Court sided with the taxpayers. It helped that losses narrowed in recent years (the years at issue); they conducted the activity in an busines-like manner; the husband had a background in farming and ranching and they sought the advice of experts; and they devoted considerable time to the activity. In addition, there was a genuine expectation that the ranch would appreciate in value. Indeed they had put it up for sale for a far higher price they what they bought it for. However, the IRS also argued the taxpayers did not materially participate in the activity, which would mean the losses would be disallowed. The Court noted much of the total time spent in the activty was in a capacity as investors which does not count towards meeting the material participation test. The Court found they failed the material participation test.
Tip of the DayPick a charity . . . We're seeing more warnings from the IRS and the FTC concerning charities. There are really two major issues. The first is that some "charities" are nothing more than complete scams. Some arise to specifically take advantage of disasters such as hurricanes, floods, etc. You can often check whether such a charity is legitimately registered with the IRS at Tax Exempt Organization Search on the IRS website. You may also be able to check state listings. It's probably best to steer clear of any "pop-up" organizations. They may be legitimate--they may not. But unless they're listed on the IRS website, you can't be assured of a tax deduction. You're probably better off with the recognized national organizations that mobilize for such events. The second issue are charities that spend a disproportionate amount on fund raising, staffing, etc. They won't be flagged in the IRS database, and making a decision here is much more difficult. There are several sites that do that research and analyze charities. But often making a contribution is a spur of the moment decision. Best approach? Do your research ahead of time and compile a list of charities that meet your goals.
June 27, 2018
NewsThe IRS is reminding any residents of Puerto Rico, the U.S. Virgin Islands and American Samoa affected by last year’s hurricanes and tropical storms who are required to file a 2017 federal income tax return or pay their 2017 tax, to be sure to do so by June 29. This special extended deadline is available regardless of whether a taxpayer’s residence changed during 2017. No interest, late-filing penalty or late-payment penalty will be due. Further, bona fide residents of Puerto Rico, the U.S. Virgin Islands and American Samoa, who permanently relocated to the U.S. mainland due to last year’s hurricanes and tropical storms may need to file Form 8898, Statement for Individuals Who Begin or End Bona Fide Residence in a U.S. Possession, with the IRS along with their Form 1040 or Form 1040NR. Due to the disaster-related extensions granted by the IRS to residents of these three U.S. territories, Form 8898 will generally be due by Friday, June 29, 2018. In addition, anyone who files for an income-tax-filing extension will also have until Oct. 15, 2018, to file Form 8898. This requirement to file Form 8898 applies to anyone who had total gross income exceeding $75,000 for the year, ceased to be, or became, a bona fide resident of a U.S. territory during 2017 and met other requirements. There is a substantial penalty for failure to file Form 8898. For more information, go to IR-2018-142.
Employee vs. independent contractor. That was the first question addressed in Hampton Software Development, LLC (T.C. Memo. 2018-87). The worker served as the manager of an apartment complex. The Court examined the factors normally reviewed in such cases and found the worker was and employee and not an indepent contractor. The Court then looked to the second question, could the taxpayer qualify for relief from the penalties of misclassifying the worker. Section 530 for the Revenue Act of 1978 provides a principal (employer) relief from employment taxes and unemployment tax where the relationship between the principal and the worker is an employer and employee relationship, provided that the principal satisfies all of the following requirements: (1) the principal has not treated the worker as an employee for any period; (2) the principal has consistently treated the worker as not being an employee in all tax returns for periods after December 31, 1978; and (3) the principal had a reasonable basis for not treating the worker as an employee. In order to consistently treat the worker as an independent contractor the principal (employer) must have filed Form 1099 for the individual. The taxpayer could not show that it filed the required 1099s. The Court also found that the taxpayer did not have a reasonable basis for believing that the worker's correct status was that of an independent contractor. The Court held that the taxpayer was not entitled to Sec. 530 relief and was responsible for the penalties.
Tip of the DayLower taxes after retirement? . . . Many taxpayers try to defer as much income as possible with the anticipation of being in a lower tax rate on retirement. While that's generally true, tax professionals see many examples of taxpayers whose tax burden declines little, if any. Some taxpayers may even see an increase. The higher taxes can result from significant deferrals of business or investment income, large contributions to pension plans, etc. in preretirement years followed by required minimum distributions, the sale of a business, liquidations of a portfolio or rental properties, etc. on retirement. While the sale of investments generally produces favorably taxed long-term capital gains (which could now be taxed at 23.8%), pension distributions generally produce only ordinary income. And the death of a spouse will require a taxpayer to file as single unless he or she remarries. That can boost tax rates by 20% or more and other differences can increase the overall taxes even more. Don't automatically assume you'll be in a lower bracket. Work through the numbers with your tax advisor.
June 26, 2018
NewsNotice 2018-59 (IRB 2018-28) provides guidance to determine when construction has begun on energy property that is eligible for the Sec. 48 credit and provides two methods for taxpayers to establish the beginning of construction, a Continuity Requirement for both methods, rules for transferring energy property, and additional rules appicable to the beginning of construction requirement of Sec. 48. These changes reflect the changes made to the investment tax credit under the Bipartisan Budget Act of 2018 which retroactively extended the expiration date of the credit.
In another case (Jesse M. Loughman and Desa C. Loughman, T.C. Memo. 2018-85) involving an S corporation selling medical marijuana, the taxpayers argued that the application of Section 280E results in discriminatory treatment of S corporation owners of marijuana businesses in violation of subchapter S. They argued that the IRS's treatment of the taxpayers' wage income as an expense subject to Section 280E causes the same income to be taxed twice, once as wages, and a second time as S corporation income. They contend that this results in the disallowed officer wages attributable to trafficking being included in the corporation's earnings, which flowthrough to the taxpayers without any deduction for the wages. Petitioners contend that this treatment is contrary to the purpose and legislative intent of subchapter S. (E.g., after other expenses, but before the taxpayers' wages the corporation has $100,000 in earnings. The corporation deducts $40,000 in wages which the taxpayer/shareholders report on their personal return. They also report the $60,000 in net earnings from the passthrough of the net income. The IRS disallows the $40,000 of wage expense resulting in passthrough income of $100,000 rather than $60,000, but the taxpayer/shareholders still have $40,000 in wage income.) The taxpayers weren't disputing the reasonable wage requirement of the law, but that the reasonable wage requirement results in double taxation. The Court noted that the taxpayers were free to operate as any business entity, but chose to operate as an S corporation and that they were responsible for the tax consequences of their decision.
Tip of the DayInvoice can be critical for sales tax purposes . . . You ship a equipment to Madison Inc. in Nebraska, but the billing address is Madison's corporate office in New York. You're registered to do business in New York. You want to make sure the destination is on the invoice. If it's not New York may claim you should have collected New York sales tax on the sale. It might also try to source the sale to New York for the allocation of sales on your income tax return. Rules vary among the states so talk to your tax advisor. If you're the buyer make sure the item is shipped directly to its ultimate destination.
June 25, 2018
NewsYou're better off filing returns and extensions electronically. That way you'll get confirmation of filing on time. In Jones, Bell, Abbott, Fleming & Fitzgerald L.L.P. (U.S. District Court, C.D. California) the taxpayer's accounting firm detailed the procedures for handling the mail. The accountant did not use registered or certified mail and there was no there was no direct evidence of Plaintiff's timely mailing of its Form 7004 nor any corroboration. The accountant did not personally mail the form, instead stating only that he placed it in the office mail system. He does not say when he did this, and the clerk did not testify that he remembered depositing the Form 7004 in a United States Postal Service depository on April 18, 2016 (the deadline in 2016). As a result, the Court held Plaintiff has not demonstrated when the form was taken to a United States Postal Service depository on April 18, 2016 or processed by the United States Postal Service on April 18, 2016. The fact that the IRS did not receive the form until eight days after the deadline weighed against the Plaintiff. The IRS did not retain the postmarked envelope, which weighed against the IRS.
Tip of the DayJust in Time Inventory . . . Keeping your inventory as lean as possible is one way of increasing your cash flow and saving costs. But you may want to rethink that approach. A growing shortage of truck drivers potential delays in receiving goods from China could mean you'll have to stock more inventory than in the past.
Copyright 2018 by A/N Group, Inc. This publication is designed to provide accurate and authoritative information in regard to the subject matter covered. It is distributed with the understanding that the publisher is not engaged in rendering legal, accounting, or other professional service. If legal advice or other expert assistance is required, the services of a competent professional should be sought. The information is not necessarily a complete summary of all materials on the subject. Copyright is not claimed on material from U.S. Government sources.--ISSN 1089-1536