Timely Tax Tip: So Many Notices, so Little Time

Practically everyone is getting calls, emails and texts from clients who have IRS and/or state notices that need to be addressed – yesterday. Yup. That’s right. Often, you only about 1-3 days to respond. Why? Because our clients haven’t bothered to open up their mail and let us know about an impending deadline. Or worse. They did know and didn’t have the courtesy to forward the correspondence while we still have breathing space to respond (10-90 days). Now, they expect us to drop everything and help them – right now.

Which means, even tax practices that aren’t flush with clients are working year-round. Often, the busy-work comes from responding to the IRS and state notices. Sometimes, they are slam-dunk correspondence. Other times, there’s some real work involved. Why? Generally for one of two reasons:

1) We made a mistake and left something off the return – or didn’t understand where to report it, and now we have to straighten it out. These corrections should be done at no charge. After all, they are our own errors.

2) The client neglected to give us a document, or tell us about some income…and now we have sort out the issues. And we will probably have to help them deal with additional taxes, penalties and interest – and a way to pay all this. In particular, we are getting notices about Obamacare information missing from the tax returns. Our clients told us they didn’t get anything, right? Uh huh.

Too often, tax professionals tell me that they feel bad, or guilty in the second situation. Somehow, the fault must have been theirs. So they don’t charge a fee to help their clients resolve these issues.

Really? Truly? Why do you value yourself, your costly education, your continued training and years of skills so lightly? You really should be charging for these services. Learn more!

 

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Posted in Tax

Self-Employment Tax Developments

With the growth in sole proprietorship and partnership returns, self-employment tax continues to be a significant tax for individuals and their return preparers. The sharing economy has not only created more freelancers (contractors), but also more owners of short-term rentals who might be subject to self-employment tax. This article addresses developments of the past 18 months involving self-employment tax and reviews the rules as relevant in today’s sharing economy.

RECENT DEVELOPMENTS

Recent cases have generally centered around whether an individual’s activity constituted a trade or business subject to self-employment tax. Some cases focused on the nature of the receipts and application of the definition at IRC Section 1402 on “net earnings from self-employment tax.” In addition, the IRS issued regulations in May 2016 involving certain partnership arrangements. Summaries of this guidance follows.

Is it Self-Employment Income?

Case Study: Blogger’s Ad Revenue Subject to Self-Employment Tax: In 2012, Mr. Clark was a full-time video blogger. He had an agreement with Google to allow ads on his blog website. For 2012, ad revenue was just over $20,000 and Google issued Clark a 1099-MISC for this amount. Clark reported this as other income on his Form 1040. After an examination, the IRS imposed self-employment tax on Clark.

The Tax Court found that Clark was engaged in a trade or business as his intent was to make a profit. In addition, he worked six to eight hours per day seven days a week, making this a regular and continuous activity.

Clark’s argument that the revenue constituted royalty payments not subject to self-employment tax failed. The court noted that per Section 1402, “royalty payments received from a trade or business are subject to self-employment tax.”

Tax Shelter Activity Can Be Subject to Self-Employment Tax: Mr. Chai, an architect, became involved in tax shelter activity through a Harvard College classmate who married his cousin. Millions of dollars flowed through some of the more than 100 entities set up by the classmate. At issue was a $2 million payment to Chai in 2003. At one point, Chai was told the payment was a non-taxable return of capital (although he had not invested in the entity) but it was eventually reported on Form 1099 for consulting services. Chai did not report the income, arguing it was a return of capital from his investments.

Chai argued that he did not provide “any meaningful services” to the partnership. But the IRS argued that even if he delegated duties to others, the “risky nature and large receipts of the tax shelters provide ample justification for the high compensation relative to the low amount of personal effort involved.” Chai also indicated he signed a lot of documents. The IRS noted that whether Chai understood the transactions “does not eliminate the significance of the services he provided to Delta and the other tax shelters by signing the formation and organizational documents.” Also, Chai received large payments in the past (over $1 million) and had properly reported then as nonemployee income. The court also noted that the payment was not a gift because the payor expected work from Mr. Chai.

The court agreed with the IRS that the $2 million payment was income and subject to self-employment tax, finding that Chai’s “activities were continuous and regular.”

The court also upheld penalties against Chai. Chai’s argument that he relied on advice from his tax return preparer failed because he had not given all of the details of the transactions to his preparer.

Learn more about recent developments in Self-Employement Tax Law at: http://issuu.com/cpelink/docs/cpe_link_fall-winter_2016/12?e=16662403/38589379

 

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Posted in Tax

Tax Rules for Your Shared Economy Clients

The “new economy” really means new ways of doing business that involve digital and borderless transactions. That is, a business likely connects with clients via an Internet connection organized by software or an “app.” The location of the customer may not be important, particularly if the “product” is digital or services that can be provided electronically (online). Often, the costs to start generating revenues in the new economy are minimal. It might just involve signing up at a website as someone who can provide services (face-to-face or online) or offer to share (rent) property, such as a room in their home or their car. This part of the new economy is often referred to as the sharing economy or peer-to-peer networked economy where parties seeking to offer or use services or property are easily connected. Many aspects of the connection, such as payment and assessment, are completed on websites or apps that are simple to navigate.

Some of the companies creating shared economy opportunities have grown rapidly, such as Airbnb and Uber. There are in fact though, numerous “sharing economy” operations beyond these two. The low barriers to entry, and desire by many to generate income (or at least cash flow), makes it highly probable that at least one of your clients is generating income from sharing or freelancing. It is also likely that your client needs assistance with the recordkeeping and income tax consequences of this cash-generating activity. Planning on how to optimize the treatment of deductions and any losses may also be needed. In addition, freelancing also leads to self-employment tax and perhaps local business license taxes. Home-sharing often also involves local transient occupancy tax (TOT), business license tax and perhaps other local taxes. Some short-term rentals may be subject to self-employment tax.

The continued growth in the sharing economy makes this a practice area that can’t be ignored.

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Depreciation of Assets Acquired as a Gift

Special rules apply to property acquired as a gift. The determination of the basis for depreciation purposes and the amount of deductible loss on the eventual sale of the asset are treated differently for property received as a gift.

The first step in determining the depreciation deduction allowable for property received as a gift is to determine the donor’s adjusted basis, the FMV of the property at the time of the gift, and any gift tax paid by the donor on the gift.

The donor’s adjusted basis plus a portion of the gift tax paid by the donor is used by the taxpayer to establish their depreciable basis in the gift. However, unlike a related party transaction, the taxpayer does not “step into the shoes” of the donor. Instead, the taxpayer starts the depreciation recovery period as of the date of the gift, using the applicable convention and method.

Example: Grandpa decided it was time to abandon his summer home and move permanently to Florida. On April 30, 2015, he gave his house to his niece, Peggy. The FMV of the property at that time was $250,000. Grandpa’s basis in the home was $200,000. He filed Form 709, U.S. Gift (and Generation-Skipping Transfer) Tax Return, but did not owe any gift tax.

Peggy decides to use the house as rental property. On her 2015 return, she reports the acquisition date as April 30, 2015, and a beginning basis of $200,000. Residential real estate is depreciated over 27.5 years using the mid-month convention and the straight-line method.

For gifts received after 1976, a portion of the gift tax that was paid on the gift is added to the basis. This is calculated by multiplying the gift tax by a fraction. The numerator of the fraction is the net increase in value of the gift, and the denominator is the amount of the gift. The net increase in value of the gift is the FMV of the gift less the donor’s adjusted basis. The amount of the gift is its value for gift tax purposes after reduction for any annual exclusion and marital or charitable deduction that applies.

For an update on depreciation and other tax law changes affecting tax year 2015, get your tax updates today!

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Tax Issues of High-Income Clients

High-income clients face a number of complex tax-planning issues. Recent changes in tax law implemented by the Affordable Care Act (ACA) and ATRA have greatly increased the potential tax liability of this group of taxpayers.

Provisions important to high-income taxpayers include the following.

INCOME TAX MARGINAL RATE – ATRA permanently lowered the marginal tax rates for many middle-income taxpayers. However, it permanently increased the highest marginal tax rate for high-income earners from 35% to 39.6%. This increase affects single taxpayers with 2015 taxable incomes greater than $413,200 and married filing jointly (MFJ) taxpayers with taxable incomes greater than $464,850.

ADDITIONAL MEDICARE TAX – Beginning January 1, 2013, the ACA implemented an additional Medicare tax of 0.9% for taxpayers whose wages, compensation, and self-employment (SE) income exceeds threshold amounts. Thresholds for 2015 are $200,000 for single taxpayers and $250,000 for married filing jointly (MFJ) taxpayers. The additional Medicare tax applies to the following income categories.

  • Wages and other compensation subject to Medicare
  • Compensation subject to the Railroad Retirement Tax Act (RRTA)
  • SE net income (an SE net loss is not considered for purposes of this tax)
  • Taxable wages not paid in cash, such as noncash fringe benefits
  • Tips

CAPITAL GAINS TAX – ATRA permanently set the tax rate for long-term capital gains (assets held for more than one year) at 15% for many middle-income taxpayers. In addition, it eliminated a long-term capital gains tax for taxpayers in the two lowest income brackets. However, ATRA raised the long-term capital gains rate from 15% to 20% for taxpayers with ordinary income taxed at the highest marginal rate. 2015 rate is $413,200 for Single taxpayers and $464,850 for MFJ taxpayers.

PERSONAL EXEMPTION PHASEOUT – In 2015, taxpayers are granted a personal exemption of $4,000 for themselves and for each of their dependents. However, this exemption is reduced by 2% for each $2,500 (or part of $2,500) that AGI exceeds a certain threshold and is eliminated entirely at higher income levels. The phaseout begins at $258,250 for single filers and at $309,900 for MFJ filers.

ITEMIZED DEDUCTION LIMITATION – As with the personal exemption, certain itemized deductions are limited once a taxpayer reaches a certain income threshold. This limitation, sometimes called the Pease limitation, was permanently reinstated for tax years after 2012. The Pease limitation is triggered when AGI exceeds the threshold amounts for 2015 of $258,250 for single filers and $309,900 for MFJ filers.

These provisions that affect high-income taxpayers present numerous planning opportunities for tax practitioners. Don’t miss out.  Get your 2015-2016 Tax Updates today!

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Tax Avoidance vs. Tax Evasion

In addition to preparing tax returns, practitioners may provide additional related services, such as tax planning. Practitioners who engage in tax planning and provide tax advice must keep these rules in mind.

Tax Planning - Tax planning to reduce tax liability is a legitimate goal. However, if the planning includes an element of fraud, deceit, or concealment, it becomes tax evasion. Practitioners who engage in tax planning should keep the following references in mind.

• IRC §7201 relating to tax evasion
• IRC §7206 relating to false returns, concealment, and other prohibited conduct
• Requirements for written advice under Circular 230, §10.37

Tax Evasion - IRC §7201 states that any person who willfully attempts to evade any tax imposed by the Code (including evasion of tax payments assessed under the Code) is subject to felony conviction. Upon conviction, IRC §7201 provides a fine of up to $100,000 ($500,000 for a corporation), or five years’ imprisonment, or both (along with the costs of prosecution). Moreover, under the same Code section, a fine of up to $250,000 may be imposed for tax evasion.

Read more (including some specific examples of tax avoidance vs tax evasion).

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Recent Tax Bills Passed in the House

Since January 2015, several bills have been passed by the House, including ones to make permanent a few of the 50-plus provisions that expired at the end of 2014. Described below is a sampling.

Permanent, higher Sec. 179 expensing: America’s Small Business Tax Relief Act of 2015, H.R. 636, passed on Feb. 13. This bill makes permanent the $500,000 expensing and $2 million threshold amounts for expensing business property, also indexing them for inflation. Software and qualified real property, as well as air conditioners and heaters, would now be Sec. 179 property, and taxpayers can revoke a Sec. 179 election without IRS consent.

Permanent sales tax deduction: State and Local Sales Tax Deduction Fairness Act of 2015, H.R. 622, passed on April 16 (272–152). This bill makes permanent the option to claim an itemized deduction for sales tax rather than state income tax, which has existed in temporary form since 2004.

Permanent research tax credit: American Research and Competitiveness Act of 2015, H.R. 880, passed on May 20 (274–145). H.R. 880 makes the credit permanent and increases the rate for the simplified credit from 14% to 20%. The traditional credit with the 1984–1988 base years would be terminated. This bill also allows small businesses (gross receipts of $50 million or less on average over a three-year period) to use the credit against either regular tax or alternative minimum tax.

Read the full article

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Estate and Succession Planning: More Important Than Ever

After enactment of the American Taxpayer Relief Act of 2012, many clients and their advisors quickly concluded that “estate planning” was no longer important. This was primarily due to the effectively permanent large Federal estate and gift tax exemption level of $5 million-plus per person. This exemption, which is adjusted for inflation annually, this year is at $5.43 million – effectively eliminating Federal estate tax concern for over 99% of U.S. families! Yet estate and succession planning is more important than ever – for both tax and non-tax reasons.

First of all, 19 States still have an estate or inheritance tax of some type, and some of these jurisdictions have much lower exemption levels than does the Federal estate tax. So tax practitioners must know their State law for clients before eliminating estate tax from the planning agenda. In addition, many Wills and trusts are quite out-of-date, especially if not updated the past few years, and the changes in family situations, increase or decrease in net worth and other factors call for updating of the estate and succession plan.

Read the full article at cpelink.com/estate-and-succession-planning

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Marijuana’s Tax Paradox

These days, over half the country (32 states + DC) has some level of pot legalization, whether for medical or recreational use or both. Despite the way our founding fathers established states’ rights, when the federal government’s laws conflict with state laws – the Internal Revenue Code will follow federal law for U.S. income tax purposes.

The good news is, buried in the spending bill last December (Public Law No: 113-235), Congress included a provision to end federal drug enforcement raids on medical marijuana establishments. In effect, it legalized medical marijuana on a federal level.

This is an interesting opportunity for accountants and tax professionals to cater to a readily-identifiable niche market that can afford our fees…

Read the full article at http://www.cpelink.com/Marijuanas-tax-paradox

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Maximize the Social Security Income Election for your Clients

The clients of Accountants, Tax Professionals, and Financial Advisors increasingly ask for guidance on how to best take their Social Security income election. This issue has become very important to baby boomers for many reasons. Pre-retirees and early retirees are now living longer than previous generations. Also, there has been a shift away from defined benefit plans (i.e. pension plans) to self-retirement funding. Financial market forces, such as low interest bearing accounts, real estate devaluation, and a flat stock market for the past 10 years, also make the Social Security income election much more important.

The Social Security income election decision may be one of the most important financial decisions your clients make in their lifetime. Singles, and especially couples, can miss opportunities to collect hundreds of thousands of dollars of additional income over their lifetimes when they make poor Social Security income election decisions. By applying little-known, yet creative claiming strategies, your clients may be rewarded with significant additional lifetime retirement income.

Read more for three important strategies

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