Author Archives: Madeline Wolberg

Tax-Saving Tips June 2019

THE WHALEN GROUP

Combine Home Sale with the 1031 Exchange

You don’t often get the opportunity to even consider making a tax-saving double play. But your personal residence combined with a desire for a rental property can provide just such an opportunity.

The tax-saving strategy is to combine the tax-avoidance advantage of the principal residence gain exclusion break with the tax-deferral advantage of a Section 1031 like-kind exchange. With proper planning, you can accomplish this tax-saving double play with full IRS approval.

The double play is available if you can arrange a property exchange that satisfies the requirements for both the principal residence gain exclusion break, and tax deferral under the Section 1031 like-kind exchange rules.

 

The kicker is that tax-deferred Section 1031 exchange treatment is allowed only when both the relinquished property (what you give up in the exchange) and the replacement property (what you acquire in the exchange) are used for business or investment purposes (think rental here).

Clarifying Example

Let’s say your principal residence—owned for many years by you and your spouse—is worth $3.3 million. You convert it into a rental property, rent it out for two years, and then exchange it for a small apartment building worth $3 million plus $300,000 of cash boot paid to you to equalize the values in the exchange.

Your basis in the former residence is only $400,000 at the time of the exchange. You realize a whopping $2.9 million gain on the exchange: proceeds of $3.3 million (apartment building worth $3 million plus $300,000 in cash) minus basis in the relinquished property of $400,000.

Now, let’s check on your tax bite. You can exclude $500,000 of the $2.9 million gain under the principal residence gain exclusion rules. So far, so good!

Because the relinquished property was investment property at the time of the exchange (due to the two-year rental period before the exchange), you can defer the remaining gain of $2.4 million under the Section 1031 like-kind exchange rules. Nice! No taxes on this deal.

Pay No Income Taxes Ever

If you hang on to the apartment building until you depart this planet, the deferred gain will be eliminated from federal income taxes thanks to the date-of-death basis step-up rule. Under the date-of-death rule, the tax code steps up the basis of the building to its fair market value as of the date of your death.

Example. You die. Your heirs inherit the building at its new stepped-up basis. They sell the building for its date-of-death fair market value. Presto, no income taxes.

Of course, you do need to consider estate taxes if your estate is greater than $11.4 million.

Know These Tax Rules If Your Average Rental Is Seven Days or Less

If you own a condominium, cottage, cabin, lake or beach home, ski lodge, or similar property that you rent for an “average” rental period of seven days or less for the year, you have a property with unique tax attributes.

Seven days example. Say you have a beach home and you rent it 15 times during the year, for a total of 85 days. Your average rental is 5.7 days. That’s an average of seven days or less for the year.

The right type of beach home or vacation cottage can produce great tax results when the average rental period is seven days or less. But it’s tricky because when the average rental period is seven days or less, the property is not a rental property as defined by the tax code. Instead, the property is a commercial hotel type property that you report on Schedule C of your tax return if you provide services in connection with the rentals, or

a weird in-limbo property that you report on Schedule E when you don’t provide services.

If the property shows a loss, you can deduct that loss on either Schedule C or Schedule E if you can prove that you materially participate. With the seven-days-or-less-average rental, you likely have only two ways to materially participate:

  1. The combined participation by you and your spouse constitutes substantially all the participation in the seven-days-or-less-average rental activity when you consider all the individuals who participated (including contractors).
  2. The combined hours of participation by you and your spouse in the seven-days-or-less-average rental activity are (a) more than 100 hours and (b) more hours than the participation of any other individual.

Example. Your seven-days-or-less beach rental produces a $20,000 tax loss for the year. On this rental, you spend 65 hours during the year. No other person works on the rental. You materially participate in this rental, and the $20,000 is deductible—period (regardless of its location on Schedule C or E).

If you have a profit on the rental, you likely have a Section 199A deduction when you report the rental on Schedule C as a business. Although not deemed a business by Schedule E reporting, the Schedule E rental could rise to the level of a business as defined for the Section 199A deduction.

Avoid This S Corporation Health Insurance Deduction Mistake

If you own more than 2 percent of an S corporation, you have to do three things to claim a deduction for your health insurance:

  1. You must get the cost of the insurance on the S corporation’s books.
  2. Your S corporation must include the health insurance premiums on your W-2 form.
  3. You must (if eligible) claim the health insurance deduction as an above-the-line deduction on Form 1040.

The three-step health-insurance procedure also applies under attribution rules (and this could be a surprise) to your spouse, children, grandchildren, and parents if they work for your S corporation, even if they don’t own a single share of S corporation stock directly.

You need to get this S corporation health-insurance thing right. Without the W-2 treatment, the S corporation does not get a tax deduction.

With the correct W-2 treatment, the more than 2 percent shareholder who finds the health insurance premiums on his or her W-2 can claim the self-employed health insurance deduction on Form 1040, provided he or she is not eligible for employer-subsidized health insurance through another job or a spouse’s job.

QBI Issue When Your S Corp Is a Partner in a Partnership

It’s common to consider making your S corporation (versus yourself) a partner in your partnership: it saves you self-employment taxes.

Does this affect your Section 199A deduction? It does.

Guaranteed payments are not qualified business income (QBI) for the Section 199A deduction. The non-QBI guaranteed payment rule applies whether the partner receives the payment as an individual or as pass-through income from an S corporation.

Your only options to claw back your Section 199A deduction with the S corporation as a partner are to reduce or eliminate the partnership’s guaranteed payments and then take the income pro rata based on ownership percentage, or to use a special allocation of partnership tax items.

Keep the S corporation self-employment tax savings in mind when considering your partnership activity. Often the self-employment tax savings can make the S-corporation-as-a-partner strategy well worth it.

Can the IRS Require Odometer Readings with the Mileage Rate?

Do you claim your business miles at the IRS optional rate? If so, imagine you are now being audited by the IRS for your business mileage. The IRS has requested odometer readings for your vehicle. You might wonder if the IRS can do this.

The answer is yes. The tax code says that you must substantiate your business vehicle deductions by adequate records or by sufficient evidence corroborating your own statement, including the time and place of the travel and the business purpose.

The standard mileage rate does not reduce the need for vehicle mileage records. In other words, the need for the records that prove business mileage does not change when you use the IRS standard mileage rate. They are the same mileage records you need with the actual expense method.

Here’s what the IRS, in its Internal Revenue Manual, tells its examiners to do when looking at business miles:

To verify total miles for the year, the taxpayer should provide repair receipts, inspection slips or any other records showing total mileage at the beginning of the year as well as at the end of the year.

The bottom line here is that the burden of proof is on you to prove your business mileage as required by the law. Thus, make sure that you retain odometer readings at or near the beginning and end of the year from oil changes, vehicle inspections, and repairs.

A GOVERNMENT SURPLUS – The US government ran a $160.3 billion surplus during the month of April 2019.  The surplus was the difference between $535.5 billion of tax receipts (the largest monthly amount collected in our nation’s history) and $375.2 billion of outlays (source: Treasury Department).

A GOVERNMENT DEFICIT– The Social Security Trust Fund paid out $853.5 billion in 2018, more than the $831.0 billion the fund produced in total income.  The 2018 deficit breaks a streak of 34 consecutive years (1984-2017) of “income exceeding cost.”  As recently as 2009, the annual surplus was $134 billion (source: OASI Trust Fund).

Required Minimum Distribution (RMD) – RMD’s can have a number of benefits for those that are 70 ½ years or older an have to take the distribution.  Some people are fortunate and would rather not have to take the mandatory distribution, however, let’s examine some uses that can benefit those who do not need the distributions to live on:

  1. IRA distribution direct to charities, if you make a distribution to a charity direct from your IRA (from custodian to the charity not to you) the distribution is NOT subject to tax and still counts toward your RMD up to $100,000 total per year. This type of distribution will not contribute to your modified adjusted gross income that may cause more of your social security to be taxed or force capital gains to be taxed at a higher rate as well as other MAGI negatives.
  2. Use the excess (after tax proceeds) to fund life insurance for a child or grandchild. There are multiple benefits that can be gathered from this; the life insurance gets an immediate multiple return on investment (cash investment vs. death benefit, chronic care benefit and long-term care benefit). Life insurance is a great way to fund education expense needs and is not limited to tuition only needs. EXAMPLE – When a grandchild is born make after tax distributions from your IRA to contribute to life insurance in the name of the parent.  The parent can use the excess cash build up to fund the educational needs of the grandchild and if willing continue funding for retirement benefits for the themselves.
  3. Estimated tax may be reduced or avoided entirely by withholding on the RMD up to the full amount of the distribution if necessary. You can direct the custodian to withhold any percentage up to the entire amount of distribution, therefore, avoiding having to make quarterly estimated tax payments.
  4. If you have grandchildren that are working this summer you may want to contribute to a ROTH IRA for them. The contribution limit for 2019 is $6,000 maximum to a ROTH IRA not to exceed their earnings.  Remember ROTH IRA do not get an income tax deduction, however, they grow tax deferred and at age 59 ½ or older they can withdraw both principal and earnings tax free. PLANNING NOTE:  For first time home buyers they can even withdraw up to $10,000 of earnings tax free, therefore they could use principal and up to $10,000 of earnings tax free. Before age 59 ½ they can withdraw principal (contributions) not earnings out tax free at anytime for any purpose.  This is a great way to start a liquid fund for emergencies or a great jump on retirement building for their young portfolios.
  5. Expect congressional changes in this area – A bill has recently been introduced in the upper chamber that would incrementally hike the age for taking RMDs to age 72 in 2023 and to age 75 by 2030.

“The difference between death and taxes is death doesn’t get worst every time Congress meets.” – Will Rogers

Point of Interest – As of 3/31/2019, there were 6.2 million unemployed Americans and 7.5 million job openings. Back on 7/31/2009, there were 14.6 million unemployed Americans and 2.1 million job openings (source: Department of Labor).  Looks like in this robust economy the focus needs to be on training and education so the available jobs may be filled by qualified individuals.

IRS Issued IRR-2018-211 on November 1, 2018. that increases the contribution limits for ROTH IRAs, and traditional IRAs it increased from $5,500 to $6,000 for under age 50 and add an additional $1,000 age 50 or older.  For 401(k), 403(b), most 457 plans and government’s Thrift Saving Plans.  The contribution  increased from $18,500 to $19,000 and you get to add another $6,000 if age 50 or older. The above IRS Notice also sets new limits on Defined Benefit Plans and Defined Contribution Plans. Remember there are phase outs based upon MAGI (modified adjusted gross income) for IRAs and ROTH IRAs those limits have been increased.

                                            UNDER AGE 50                                                     AGE 50 OR OLDER

ROTH IRA                             $6,000                                                                        $7,000

TRADITIONAL IRA               $6,000                                                                        $7,000

401(K), 403(b)                    $19,000                                                                      $25,000

457 & Govt Thrift               $19,000                                                                     $25,000

IMPORTANT ELECTIONS TO CONSIDER – IRS Elections can save time and/or increase current deductions:

  1. SAFE HARBOR TO EXPENSE ASSETS – You can elect the de minimis safe harbor to expense assets costing $2,500 or less ($5,000 with applicable financial statements).

The safe Harbor election eliminates the burden of tracking those small dollars cost assets, depreciating and/or Section 179 expensing them in your tax returns and book of account, and then making sure to remove them from your books when you remove the assets from your business.

You must make the election on your tax return every year you want to use the safe harbor.  To make the election, you must attach a statement to your federal return and file that tax return by the due date (including extensions).

Election should state:  “Taxpayer hereby elects under Reg. Section 1.263(a)-1(f) de minimis safe harbor expensing of up to $ 2,500.”

  1. ELECTION TO DEDUCT BUSINESS START-UP COST – Expenses incurred prior to starting a new business are not But a taxpayer can elect to deduct up to $5,000 of startup expenses in the year in which the trade or business begins.  Specifically, the taxpayer is allowed a deduction for the tax year in which the active trade or business begins in an amount equal to the lesser of:
  2. The amount of startup expenditures for the active trade or business; or
  3. $5,000, reduced (but not below zero) by the amount by which the start-up expenditures exceed $50,000.

The remainder of startup expenditures are deductible over an 180- month period beginning with the month in which the active trade or business begins.

The IRS deem that you made the election, to amortize your start-up expenses for the taxable year the business began.  In other words, if you do nothing, you have made the election.

  1. ELECTION TO CAPITALIZE CARRYING COST OF VACANT LOT AND UNPRODUCTIVE LAND – If you own a vacant lot or unproduction land, the first step that’s needed is to determine whether you will or will not get a tax deduction for the interest, property taxes, and other carrying cost (cutting grass, removals of debris, insurance,  ) If you can get a deduction then take it, however, if it is not currently deductible then capitalizing those cost will reduce the gain on the sale of the property later.

The election to capitalize is a formal election, and you need to make it for every year you want to capitalize one or more of the cost of the vacant lot or unproductive land.  The election to capitalize is an annual election that you should consider every year, and when you capitalize, you need to file the election for that year

Election should state: “Taxpayer hereby elects under Code Section 266 and IRS Regulation 1.266-1(b)(1)(i) to capitalize, rather than deduct, property taxes on the (address of property).”

REMEMBER:  If you are considering any of the above tax planning issues seek additional help for complete details by calling 702-878-3900 there is no charge for consultation.

Respectfully,

Al Whalen, EA, ATA, CFP®

e-mail:   al@whalengroup.com

Web Site:  www.whalengroup.com

 

 

Tax Tips May 2019

Good news. The Tax Cuts and Jobs Act (TCJA) did not harm the backdoor Roth strategy.

As you likely know, the Roth IRA is a terrific way to grow your wealth with a minimum tax downside because you pay the taxes up front and then, with the proper holding period, pay no taxes after that.

But if you earn too much, you’re completely barred from contributing to a Roth IRA unless you can use the backdoor Roth technique, which involves making a nondeductible contribution to a traditional IRA and then rolling that money into a Roth.

The backdoor Roth strategy has been around for a good nine years, and it has experienced no trouble that we are aware of, so we think it’s a good strategy. We also like the recent notations in the legislative history and the comments from the IRS spokesperson that show approval of the strategy.

Keep in mind that with some planning, you can avoid any taxes on the rollover. For example, if you have an existing traditional IRA, you can move those monies to your qualified plan to avoid having the backdoor strategy trigger some taxes. And if you have no traditional IRA, the nondeductible contribution to the traditional IRA and the subsequent rollover to the Roth IRA triggers no taxes.

New IRS FAQs on Section 199A

On April 11, likely after you filed your tax return, the IRS updated its Section 199A frequently asked questions (FAQs) by increasing the number of questions and answers from 12 to 33. The IRS often publishes FAQs on its website to help educate you on various tax law provisions. Section 199A is no different: the IRS has been updating its FAQ website with additional questions and answers on the new qualified business income (QBI) tax deduction.

We noted three of the FAQs that help fill in some holes in the final Section 199A regulations but will cause problems for many taxpayers. In fact, there will be taxpayers who will need to file amended tax returns because of the FAQs.

FAQ 29: QBI Subtractions for Partnerships

In this FAQ on partnerships, the IRS hints at the following:

  • Unreimbursed partnership expenses and business interest expenses reduce QBI in some, if not all, circumstances.
  • Traditional IRA contributions based on self-employment income don’t reduce QBI (since the IRS didn’t include them), while SEP, SIMPLE, and qualified plan deductions do reduce QBI.

FAQ 32: QBI in Final vs. Proposed Regulations

In FAQ 32, the IRS clearly states that the definition of QBI is the same in both the proposed and the final regulations. Since the definition was clarified in the final regulations, this was a surprise to many.

And what this means is that you reduce QBI by the self-employed health insurance deduction, the one-half of self-employment tax deduction, and the qualified retirement plan deductions.

FAQ 33 Has to Be Wrong

FAQ 33 states that an S corporation shareholder who owns more than 2 percent may have to reduce QBI at both the entity (S corporation) and the shareholder (1040 tax return) levels.

We don’t agree with the double subtraction indicated in IRS FAQ 33, for three reasons:

  1. The final regulations state that you reduce QBI “to the extent that the individual’s gross income from the trade or business is taken into account in calculating the allowable deduction.” Unlike the proprietorship, the S corporation reduces its business income by reimbursing or paying for the health insurance that it puts on the more than 2 percent shareholder’s W-2.
  2. Under Notice 2008-1, the self-employed health insurance deduction for the 2 percent S corporation shareholder requires that you include the insurance cost as shareholder wages. The wages reduce QBI.
  3. And income from the trade or business of being an employee is not QBI.

Website Is Not an Authority

If you don’t like the positions taken on the IRS’s FAQ website, then there’s one silver lining: FAQs don’t constitute an authority for tax return positions.

TCJA Allows Bonus Depreciation on Purchase of Leased Vehicle

Before the Tax Cuts and Jobs Act (TCJA), your purchase of the vehicle you were leasing did not qualify for either Section 179 expensing or bonus depreciation. But times have changed.

The TCJA made two changes that mean 100 percent bonus depreciation is available on the vehicle you lease and then purchase, regardless of whether you purchase it during the lease term or at the end of the lease. The two technical reasons you can do this are as follows:

  1. During the lease, you had no depreciable interest.
  2. Bonus depreciation is now available on used property.

Technically, the two changes work like this:

  • While you were leasing the vehicle, you had no depreciable interest in the vehicle. The lessor depreciated the vehicle. You, the lessee, paid rent.
  • Your purchase of the vehicle that you were leasing is the purchase of a vehicle that you had NOT used under the bonus depreciation law, because you did not have a depreciable interest in it at any time.

Example. You pay $32,000 for a pickup truck that you have been leasing for business purposes. The pickup truck has a gross vehicle weight rating of 6,531 pounds, and your mileage log proves 90 percent business use. You may use bonus depreciation to deduct the $28,800 business cost of the pickup ($32,000 x 90 percent).

Note the difference: As with prior law, with Section 179 expensing, you get no additional deductions. But with bonus depreciation, you can expense your entire business cost.

How to Handle Multiple Rental Activities and the 199A Deduction

There’s a lot of confusion out there around your rental activity and Section 199A. Your Section 199A considerations multiply when you have multiple rental activities. Here’s what you need to consider:

  • Are your rental activities multiple trades or businesses, or one trade or business?
  • Can you aggregate the rentals for Section 199A purposes? Do you want to?
  • How does the Section 199A rental safe harbor impact your Section 199A deduction if you use it?

Whether your rental activities are each a trade or business, or they constitute one trade or business, is inherently based on the facts of your particular situation. The IRS also believes that multiple trades or businesses will generally not exist within an entity unless it can use different methods of accounting for each trade or business under the Section 466 regulations. These regulations explain that you can’t consider a trade or business separate and distinct unless you keep a complete and separable set of books and records for that trade or business.

This determination is an important factor for you if any one rental activity (taken individually) doesn’t rise to the level of a trade or business, but all the rental activities (viewed collectively) do rise to the level of a trade or business. One of the factors the IRS looks to when determining whether a rental activity is a trade or business is the number of properties rented.

Aggregation

The Section 199A regulations allow you to aggregate multiple trades or businesses such that you treat the aggregated group as one trade or business for determining your Section 199A deduction. This is an important consideration if one or more of your rental businesses have insufficient wages or unadjusted basis in assets (UBIA) to get the maximum Section 199A deduction for that property.

The final regulations tell us you can aggregate, in most circumstances, provided that the rental activities share centralized administrative functions, such as accounting, legal, and human resources functions. The big wrinkle is the type of rental business: you generally can’t aggregate residential rental businesses and commercial rental businesses with each other because they aren’t the same type of property.

Rental Safe Harbor

Along with the final regulations, the IRS gave you an optional safe harbor to deem your rental activities as qualifying for the Section 199A deduction. The safe harbor isn’t the best strategy because most rentals qualify as a trade or business anyway.

Deduct Your Costs of Sponsoring Sports Teams

Have you wondered what it takes to deduct the costs of sponsoring a sports team? What if you play on the team? Could you pay for the team travel expenses?

Revenue Ruling 70-393 states that the monies spent to outfit and support a sports team are similar to monies spent on other methods of advertising; accordingly, you may deduct them as business expenses for federal income tax purposes.

In the Strong case, Strong Construction Co. Inc. advertised its business primarily through either word of mouth or athletic sponsorships. As part of the athletic sponsorships, the corporation paid for the uniforms, logo design, hats, T-shirts, sweatpants, coats, bags, and pants for all players on its sponsored teams (broomball, softball, wrestling, etc.). The court ruled that the expenses were ordinary and necessary business expenses and that Strong could deduct them as advertising or promotion.

In the Bower case, James Bower sponsored the Lafayette Bower Housing Hustlers basketball team, and he was both an assistant coach and a player. As the Hustlers’ sponsor, Bower paid for the team’s travel, lodging, food, promotions, AAU fees, tournament fees, gym rental, and uniforms. The court noted that Bower’s sponsorship increased his commodity brokerage commissions and generated additional clients; accordingly, the court ruled that Bower’s sponsorship expenses were deductible business expenses.

WHERE DO WE GET OUR REVENUE?

Sources of Tax Revenue in the United States, 2017

Individual Income Taxes         38.63%

Social Insurance Taxes            23.05%

Consumption Taxes                 15.85%

Property Taxes                         15.40%

Corporate Taxes                         7.07%

Source: Tax Foundation

Social Security Issue.   The estimated Social Security shortfall today (i.e., a present value number) between the future taxes anticipated being collected and the future benefits expected to be paid out over the next 75 years is 13.9 trillion.  The entire $13.9 trillion deficit could be eliminated by an immediate 2.7 percentage point increase in combined Social Security payroll tax rate (from 12.4% to 15.1%) or an immediate 17% reduction in benefits that are paid out to current and future beneficiaries (source: Social Security Trustees).

Medicare Issue.  Per a 4/22/19 report, the trust fund supporting Medicare Part A (hospital insurance) is projected to be depleted by 2026.  The long-term (75 year) present value shortfall in the trust fund could be corrected by an immediate 0.91 percentage point increase in combined Medicare payroll taxes (from its current 2.9% to 3.81%) or an immediate 19% reduction in Medicare expenditures (source: Medicare Trustees 2019 Report).

Dollars In, Dollars Out.  At the end of 2018, Medicare was covering 59.9 million Americans (18% of our population).  The program was cash positive in 2018, taking in $756 billion of income (including $10 billion of interest income) while paying out $741 billion in benefits (source: Medicare)

Note:  When politicians espouse “Medicare for all”, you should ask the question, How are you going to pay for it?

Politics defined, Poly from the Latin meaning “many” and “ticks” are “blood sucking parasites”

WHO PAYS WHAT BY PERCENTAGE?

Summary of the Latest Federal Tax Data, 2018 Update.  The top 50 percent of all taxpayers pay 97 percent of all individual income taxes.  The bottom 50 percent pay the other 3 percent.   Makes you wonder about all those folks who claim the wealthy aren’t paying their fair share.

The Top 1 Percent’s Tax Rates Over Time.  In the 1950s, when the top marginal income tax rate reached 92%, the top 1 percent of taxpayers paid an effective rate of only 16.9%.  As top marginal rates have fallen and tax loop holes have closed, the tax burden on the “rich” has risen.  In 2016 the top 1 percent of income earners (those with AGI over $481,000) paid  37.3% of all income tax.

The Progressive Tax System.  Our current income tax system started in 1913 with a progressive tax on income, meaning the more you make the higher your tax bracket and the more by percentage you pay. The following is the 1913 Tax Schedule:

1 percent on amount over $20,000 and not exceeding $50,000

2 percent on amount over $50,000 and not exceeding $75,000

3  percent on amount over $75,000 and not exceeding $100,000

4 percent on amount over $100,000 an not exceeding $250,000

5 percent on amount  over $250,000 and not exceeding $500,000

6 percent on amount over $500,000

$1,000,000 of taxable income then and now:

1913 single or married tax liability $50,050

2018 single tax liability $345,690

2018 married filing jointly $309,379

Inflation adjusted (3 percent average)  the above minimum $20,000 before tax began would be $445,593 today.  To be included in the top 1 percent of income earners your adjusted gross income had to be $481,000 or more in 2016.

Quotable:  “What is the difference between a taxidermist and a tax collector?  The taxidermist takes only your skin.”—Mark Twain

IRS ON ISSUES.

IRS has announced that they are extending a nationwide survey of consumer tipping practices in businesses where tipping is prevalent, such as casinos, restaurants, hotels, hair salons and taxis. The IRS first announced the project in 2015 and is now extending it.  Look for audits in this area in the future.

IRS announces the backup withholding requirements for 2019 at 25%.  Backup withholding is the percentage IRS requires payors to withhold when the payor does not have a valid social security or employer identification number on file.

IRS creates passenger automobile depreciation safe harbor  Rev Proc 2019-13, 2019-9 IRB; IR 2019-14, 2/13/2019.  Code Sec. 280F(a) imposes dollar limitations on the depreciation deduction for the year the taxpayer places the passenger automobile in service and for each succeeding year. Code Sec 168(k) for which the 100% additional first year depreciation deduction is allowable. Code Sec 168(k) (2)(F)(i) increases the first year depreciation by $8,000.

What does this mean?  If you place in service a passenger automobile after September 27, 2017 you are allowed with this safe harbor rule to deduct:

$18,000 for the placed in service year;

$16,000 for the second tax year;

$9,600 for the third tax year; and

$5,760 for each succeeding year.

The Rev Proc. Gives examples on how the Safe Harbors Rule Works in the Procedure, year 2 the adjusted basis is multiplied by 32%, year 3 adjusted basis is multiplied by 19.2% and so on, the above amounts are the maximum amount that can be deducted.

Effective date.  The Revenue Procedure is effective on Feb. 13, 2019.

Quotable: “This is too difficult for a mathematician, it takes a philosopher.”– Albert Einstein, on his tax return.

REMEMBER;  My monthly Tax Tips Letters are available at the Web Site, www.whalengroup.com under” WG Blog” also review the quarterly News Letters under “News Letters”.  Invite a friend or business  to be added to the news letters e-mail list through the Web Site.

Enjoy the beginning of summer.

Respectfully,

Al Whalen, EA, ATA, CFP®

Drive Time Increases Odds of Deducting Rental Property Losses

THE WHALEN GROUP
Tax-Saving Tips
October 2018

Drive Time Increases Odds of Deducting Rental Property Losses
Your rental properties provide tax shelter when you can deduct your losses against your other income. One step to deducting the losses is to pass the tax code’s 750-hour test. And one step to finding the hours you need to pass the time test may be your drive times.

Trzeciak Case

Mariam Trzeciak owned, managed, and rented 14 single-family homes in and near Columbus, Ohio. She and her husband, Marc, on their joint tax returns claimed rental property losses of $126,376 and $151,884 in the two years that were subject to this IRS audit.

The IRS revenue agent assigned to examine the Trzeciaks’ returns disallowed the losses as passive losses, claiming that Mariam did not qualify as a real estate professional because she could not count her drive time from her home near Dayton to Columbus, where the properties were.

It took Mariam’s CPA, who prepared her returns and assisted with the audit, and then her lawyers almost three years to surface the home-office deduction as the savior. Once it surfaced, the IRS allowed the drive time, and that allowed Mariam to deduct her rental property losses of $126,376 for year 1 and $151,884 for year 2.

Leland Case

In Leland, Clarence McDonald Leland traveled 13 to 16 hours from Mississippi to Texas and back several times each year to perform necessary work on his 1,276-acre farm in Turkey, Texas.

The court noted that the IRS did not object to the inclusion of the travel time in determining Clarence’s participation in the farm. And the court went on to say: “The facts of this case establish that petitioner’s [Clarence’s] travel time was integral to the operation of the farming activity rather than incidental.”

Leyh Case

The Leyh case involved Richard Leyh and Ellen O’Neill. Ellen owned 12 rental properties in Austin, Texas, about 26 to 30 miles from her home at a ranch in Dipping Springs, Texas.

Ellen and Richard deducted a $69,531 loss from their rental operations. The IRS said no because Ellen, without inclusion of her drive time, failed the 750-hour test to establish herself as a real estate professional.

The sole question that the court had to address was whether Ellen could include her drive time from her home to the rentals as rental property time. Interestingly, she failed to include her travel time in her well-kept log of time and had to reconstruct that travel time for the court.

The court ruled that her reconstruction of the travel time to and from the properties was adequate and ruled that she and Richard could deduct her $69,531 in rental losses on their joint tax return.

What You Should Do

Take the steps necessary to make your rental property drive time count as material participation time. The first step is to keep an accurate log of the time that you spend on your rentals (yes, we know this is a pain—but suffer a little and just do it).

Audit-Proof Your Time Spent on Rental Properties
If you claim status as a tax law–defined real estate professional who can deduct his or her rental property losses, your time record for the year must prove that you spent

1. more than one-half of your personal service time in real property trades or businesses in which you materially participate, and
2. more than 750 hours of your personal and investor services time in real property trades or businesses in which you materially participate.

If you are married, either you or your spouse must individually qualify as a real estate professional. If one spouse qualifies, both spouses qualify.

Achieving real estate professional status is the first of two steps. You face one additional hurdle. To deduct tax losses on a rental, you also must prove that you materially participated in the rental activity. If you are married, you and your spouse may count your joint efforts toward passing the material participation tests. Most of the tests for material participation are based on hours worked.

What Does This Mean to You?

In simple terms: keep a time log. In an audit of your real estate activity, the IRS tells its examiner:

Request and closely examine the taxpayer’s documentation regarding time. The taxpayer is required under Reg. Section 1.469-5T(f)(4) to provide proof of services performed and [of] the hours attributable to those services.

If you don’t have what the IRS wants, your odds of winning your rental property tax loss deductions are slim, if that. And don’t think you can create this log after the fact. Most everyone who spends the considerable time it takes to jump through the hoops to create an after-the-fact log of hours using the IRS spreadsheets loses the deductions.

Changes to Net Operating Losses After Tax Reform
Tax reform made many good changes in the tax law for the small-business owner. But the changes to the net operating loss (NOL) deduction rules are not in the good-changes category. They are designed to hurt you and put money in the IRS’s pocket.

Now, if you have a bad year in your business, the new NOL rules are designed to stop you from using your business loss to find some immediate cash. The new (let’s call them bad-for-you) rules certainly differ from the prior beneficial rules.

Old NOL Rules

You have an NOL when your business deductions exceed your business income in a taxable year. Before tax reform, you could carry back the NOL to prior tax years and get refunds of taxes paid in those prior years.

Alternatively, you could have elected to waive the NOL carryback and instead carry forward the NOL to offset some or all of your taxable income in future tax years.

New NOL Rules

Tax reform made two key changes to the NOL rules:

1. You can no longer carry back the NOL (except for certain qualified farming losses).
2. Your NOL carryforward can offset only up to 80 percent of your taxable income in a tax year.

The changes put more money in the IRS’s pocket by

• ®delaying your ability to get tax benefits from future NOL carryforwards.

We are bringing the NOL rules to your attention in case you need to do some planning with us. We likely have some strategies that can help you realize some immediate benefits from your business loss.

Take Money Out of Your IRA at Any Age Penalty-Free
You probably think you can’t take money out of your IRAs before age 59 1/2 unless you meet a narrow exception to the unpleasant 10 percent penalty on early distributions. But that’s not true. We have a variety of planning opportunities here.

For example, you don’t pay taxes or the 10 percent penalty on amounts you withdraw that you previously contributed or converted to the Roth IRA. These amounts are your “basis” in the Roth IRA. (Remember, you funded your Roth IRA with after-tax money!)

The law says Roth distributions come out in the following order:

• regular contributions,
• rollover contributions, and finally
• earnings.

Example. Jane opened her Roth IRA in 2002. She contributed $30,000 over the life of the Roth IRA. Today, the account is worth $50,000. Jane can withdraw up to $30,000 tax-free and penalty-free regardless of her age.

If you made nondeductible contributions to a traditional IRA, then you have “basis” in all your traditional IRAs. With basis, you have some planning opportunities with your business’s qualified plans, such as your 401(k).

And then, on a totally different front, there’s a little-known escape from the 10 percent penalty, called the substantially equal periodic payment exception. It allows you to create a stream of penalty-free traditional IRA distributions starting at any age for any reason.

You have to continue the substantially equal periodic payments for at least five years or until you reach age 59 1/2, whichever is later. As you can see from the above, you can touch your IRA accounts before age 59 1/2 without a special reason.

Respectfully,

Al Whalen, EA, ATA, CFP®

New IRS 199A Regulations Benefit Out-of-Favor Service Businesses

THE WHALEN GROUP
Tax-Saving Tips
September 2018

New IRS 199A Regulations Benefit Out-of-Favor Service Businesses
If you operate an out-of-favor business (known in the law as a “specified service trade or business”) and your taxable income is more than $207,500 (single) or $415,000 (married, filing jointly), your Section 199A deduction is easy to compute. It’s zero.

This out-of-favor specified service trade or business group includes any trade or business

• involving the performance of services in the fields of health, law, consulting, athletics, financial services, and brokerage services; or
• where the principal asset of such trade or business is the reputation or skill of one or more of its employees or owners; or
• that involves the performance of services that consist of investing and investment management trading or dealing in securities, partnership interests, or commodities. For this purpose, a security and a commodity have the meanings provided in the rules for the mark-to-market accounting method for dealers in securities [Internal Revenue Code Sections 475(c)(2) and 475(e)(2), respectively].

If you were not in one of the named groups above, you likely worried about being in a reputation or skill out-of-favor specified service business. If you were worried, you joined a large group of worried businesses, because many businesses depend on reputation and/or skill for success.

For example, the National Association of Realtors believed real estate agents fell into this out-of-favor category.

But don’t worry, be happy. The IRS has come to the rescue by regulating the draconian reputation and/or skill provision down to almost nothing. The reputation and/or skill out-of-favor specified service business includes you if you

• receive fees, compensation, or other income for endorsing products or services;
• license or receive fees, compensation, or other income for the use of your image, likeness, name, signature, voice, trademark, or any other symbols associated with your identity; or
• receive fees, compensation, or other income for appearing at an event or on radio, television, or another media format.

Example. Harry is a well-known chef and the sole owner of multiple restaurants, each of which is a single-member LLC—disregarded tax entities that are taxed as proprietorships. Due to Harry’s skill and reputation as a chef, he receives an endorsement fee of $500,000 for the use of his name on a line of cooking utensils and cookware.

Results. Harry’s restaurant business is not an out-of-favor business, but his endorsement fee is an out-of-favor specified service business.

If you have questions about how the law will treat your business income for the new Section 199A 20 percent tax deduction, please give us a call, and we’ll examine your situation.

Does Your Rental Qualify for a 199A Deduction?
The IRS, in its new proposed Section 199A regulations, defines when a rental property qualifies for the 20 percent tax deduction under new tax code Section 199A.

One part of the good news on this clarification is that it does not require that we learn any new regulations or rules. Existing rules govern. The existing rules require that you know when your rental is a tax law–defined rental business and when it is not. For the new 20 percent tax deduction under Section 199A, you want rentals that the tax law deems businesses.

You may find the idea of a rental property as a business strange because you report the rental on Schedule E of your Form 1040. But you will be happy to know that Schedule E rentals are often businesses for purposes of not only the Section 199A tax deduction but also additional tax code sections, giving you even juicier tax benefits.

Under the proposed regulations, you have two ways for the IRS to treat your rental activity as a business for the Section 199A deduction:

1. The rental property qualifies as a trade or business under tax code Section 162.
2. You rent the property to a “commonly controlled” trade or business.

Your rental qualifying as a Section 162 trade or business gets you other important tax benefits:

• Tax-favored Section 1231 treatment
• Business use of an office in your home (and, if it’s treated as a principal office, related business deductions for traveling to and from your rental properties)
• Business (versus investment) treatment of meetings, seminars, and conventions

If your rental activity doesn’t qualify as a Section 162 trade or business, it will qualify for the 20 percent Section 199A tax deduction if you rent it to a commonly controlled trade or business.

How to Find Your Section 199A Deduction with Multiple Businesses
If at all possible, you want to qualify for the 20 percent tax deduction offered by new tax code Section 199A to proprietorships, partnerships, and S corporations (pass-through entities).

Basic Rules—Below the Threshold

If your taxable income is equal to or below the threshold of $315,000 (married, filing jointly) or $157,500 (single), follow the three steps below to determine your Section 199A tax deduction with multiple businesses or activities.

Step 1. Determine your qualified business income 20 percent deduction amount for each trade or business separately.

Step 2. Add together the amounts from Step 1, and also add 20 percent of

• real estate investment trust (REIT) dividends and
• qualified publicly traded partnership income.

This is your “combined qualified business income amount.”

Step 3. Your Section 199A deduction is the lesser of

• your combined qualified business income amount or
• 20 percent of your taxable income (after subtracting net capital gains).

Above the Threshold—Aggregation Not Elected

If you do not elect aggregation and you have taxable income above $207,500 (or $415,000 on a joint return), you apply the following additions to the above rules:

• If you have an out-of-favor specified service business, its qualified business income amount is $0 because you are above the taxable income threshold.
• For your in-favor businesses, you apply the wage and qualified property limitation on a business-by-business basis to determine your qualified business income amount.

The wage and property limitations work like this: for each business, you find the lesser of

1. 20 percent of the qualified business income for that business, or
2. the greater of (a) 50 percent of the W-2 wages with respect to that business or (b) the sum of 25 percent of W-2 wages with respect to that business plus 2.5 percent of the unadjusted basis immediately after acquisition of qualified property with respect to that business.

If You Are in the Phase-In/Phase-Out Zone
If you have taxable income between $157,500 and $207,500 (or $315,000 and $415,000 joint), then apply the phase-in protocol.

If You Have Losses
If one of your businesses has negative qualified business income (a loss) in a tax year, then you allocate that negative qualified business income pro rata to the other businesses with positive qualified business income. You allocate the loss only. You do not allocate wages and property amounts from the business with the loss to the other trades or businesses.

If your overall qualified business income for the tax year is negative, your Section 199A deduction is zero for the year. In this situation, you carry forward the negative amount to the next tax year.

Aggregation of Businesses—Qualification
The Section 199A regulations allow you to aggregate businesses so that you have only one Section 199A calculation using the combined qualified business income, wage, and qualified property amounts.

To aggregate businesses for Section 199A purposes, you must show that

• you or a group of people, directly or indirectly, owns 50 percent or more of each business for a majority of the taxable year;
• you report all items attributable to each business on returns with the same taxable year, not considering short taxable years;
• none of the businesses to be aggregated is an out-of-favor, specified service business; and
• your businesses satisfy at least two of the following three factors based on the facts and circumstances:
1. The businesses provide products and services that are the same or are customarily offered together.
2. The businesses share facilities or share significant centralized business elements, such as personnel, accounting, legal, manufacturing, purchasing, human resources, or information technology resources.
3. The businesses operate in coordination with or in reliance upon one or more of the businesses in the aggregated group (for example, supply chain interdependencies).

Help Employees Cover Medical Expenses with a QSEHRA
If you are a small employer (fewer than 50 employees), you should consider the qualified small-employer health reimbursement account (QSEHRA) as a good way to help your employees with their medical expenses.

If the QSEHRA is indeed going to be your plan of choice, then you have three good reasons to get that QSEHRA plan in place on or before October 2, 2018. First, this avoids penalties. Second, your employees will have the time they need to select health insurance. Third, you will have your plan in place on January 1, 2019, when you need it.

One very attractive aspect of the QSEHRA is that it can reimburse individually purchased insurance without your suffering the $100-a-day per-employee penalty. The second and perhaps most attractive aspect of the QSEHRA is that you know your costs per employee. The costs are fixed—by you.

Eligible employer. To be an eligible employer, you must have fewer than 50 eligible employees and not offer group health or a flexible spending arrangement to any employee. For the QSEHRA, group health includes excepted benefit plans such as vision and dental, so don’t offer them either.

Eligible employees. All employees are eligible employees, but the QSEHRA may exclude

• employees who have not completed 90 days of service with you,
• employees who have not attained age 25 before the beginning of the plan year,
• part-time or seasonal employees,
• employees covered by a collective bargaining agreement if health benefits were the subject of good-faith bargaining, and
• employees who are non-resident aliens with no earned income from sources within the United States.

Dollar limits. Tax law indexes the dollar limits for inflation. The 2018 limits are $5,050 for self-only coverage and $10,250 for family coverage. For part-year coverage, you prorate the limit to reflect the number of months the QSEHRA covers the individual.

THE ACCOUNTABLE PLAN
If your corporation wishes to reimburse business expenses to employees then the use of The Accountable Plan allows the company to deduct expenses that will no longer be deductible to the employee and benefits both the employer and employee, a win, win situation. I have attached a sample accountable plan document provided by “Bradford Tax Institute”

Respectfully,

Al Whalen, EA, ATA, CFP®