THE WHALEN GROUP
Tax-Saving Tips
June 24, 2022
Alert: A Massive New FinCEN Filing Requirement Is Coming
Do you own a corporation, limited liability company (LLC), limited partnership, limited liability partnership, limited liability limited partnership, or business trust?
Or are you planning to form one of these entities?
If so, be alert. There’s a new federal filing requirement coming.
Back in 2021, Congress passed a new law called the Corporate Transparency Act (CTA) that requires corporations, LLCs, and other business entities to provide information about their owners to the Department of the Treasury’s Financial Crimes Enforcement Network (FinCEN), which is a unit separate from the IRS.
The CTA is part of a government crackdown on corruption, money laundering, terrorist financing, tax fraud, and other illicit activity. It targets the use of anonymous shell companies that facilitate the flow and sheltering of illicit money in the United States.
Businesses subject to the law will have to file a “beneficial owner report” with FinCEN, including each beneficial owner’s full legal name, date of birth, and residential street address, as well as an identifying number from a legal document such as a driver’s license or passport. FinCEN will include the information in a database for use by law enforcement, national security and intelligence agencies, and federal regulators that enforce anti-money-laundering laws. The database will not be publicly accessible.
Violations of the CTA can result in a $500-a-day penalty (up to $10,000) and up to two years’ imprisonment.
The CTA did not take effect immediately. Rather, Congress gave the FinCEN time to write regulations governing how the CTA should be applied and to give businesses a heads-up about the new law. FinCEN has now issued its proposed regulations, and they take a fairly hard line on how the law will be applied.
Here are four things the new regulations make clear:
1. The filing requirement may begin soon. The CTA goes into effect when the proposed regulations become final, which is expected to occur sometime in mid-to-late 2022. As soon as it goes into effect:
- new corporations, LLCs, and other entities will have to comply with the filing requirement within 14 days of being formed, and
- existing entities will have one year to comply.
2. Millions of small businesses are affected. The reporting requirements will apply to almost every small business that is not a sole proprietorship or general partnership, including corporations, LLCs, limited liability partnerships, limited liability limited partnerships, business trusts, and most limited partnerships—over 30 million in all.
Larger companies with more than 20 full-time employees and $5 million in gross receipts are exempt.
3. There will be many beneficial owners. The proposed regulations make it clear that a company can have multiple beneficial owners, and it may not always be easy to identify them all. There are two broad categories of beneficial owners:
- any individual who owns 25 percent or more of the company, and
- any individual who, directly or indirectly, exercises substantial control over the company.
4. Law and accounting firms are not exempt. Neither the CTA nor the proposed regulations contain any exemption for legal or accounting firms, except for the relatively few public accounting firms registered under Section 102 of the Sarbanes-Oxley Act of 2002. Thus, any law or accounting firm that is a professional corporation or an LLC will have to file a beneficial owner report unless it has more than 20 employees and $5 million in annual income.
Deduct a Cruise to Mexico
You may not have thought of this, but taking a cruise ship to Mexico for a business meeting is acceptable as a deductible form of transportation.
Because Mexico is in the tax law–defined North American area, the law says that you need no stronger business reason to deduct your trip to Mexico than you need to deduct a trip to Chicago, Illinois, or Scottsdale, Arizona.
Less-than-one-week rule. If your trip is outside the 50 states but inside the North American area and if the trip is for seven or fewer days (excluding the day of departure), then the law allows you to deduct the entire cost of travel to and from this business destination. Mexico fits this location rule.
Cruise ship transportation. The law authorizes any type of transportation to and from your travel destination, so long as it is not lavish or extravagant. The cruise ship cost is not a lavish or extravagant expense, as the law precludes this possibility by placing luxury water limits on this type of travel.
The daily luxury water limit is twice the highest federal per diem rate allowable at the time of your travel.
Example. Say you are going to travel by cruise ship in September 2022. The $433 maximum federal per diem rate for September 2022 comes from Nantucket, Massachusetts. Your daily luxury water limit is $866 (2 x $433).
Thus, for you and your spouse, two business travelers, the daily limit is $1,732. On a six-night cruise, that’s a cruise-ship cost ceiling of $10,392. If you spend $12,000, your deduction is limited to $10,392. If you spend $8,000, you deduct $8,000.
Are Self-Directed IRAs for Real Estate a Good Idea?
The stock market is tanking while real estate continues to skyrocket.
If your retirement savings have taken a hit, you may be wondering if this is the time to invest in real estate through your IRA, Roth IRA, or SEP-IRA.
You can’t invest in real estate with a traditional IRA or Roth IRA (or SEP-IRA) you establish with a bank, brokerage, or trust company. These types of IRA custodians typically limit you to a narrow range of investments, such as publicly traded stocks, bonds, mutual funds, ETFs, and CDs.
But you can invest in real estate if you establish a self-directed IRA with a custodian that allows self-directed investments. There are dozens of such IRA custodians.
Real estate is the single most popular investment in self-directed IRAs. The self-directed IRA can be used for all types of real estate investments: multi-family rental properties, single-family homes, commercial rentals, raw land, farmland, international real estate, tax lien certificates, trust deeds and mortgage notes, and private placements.
Investing in real estate through a self-directed IRA is one way to diversify your retirement holdings. There are also some tax advantages.
And there are several disadvantages and complications you should carefully consider:
First, you need to understand that owning real estate in a self-directed IRA is not like owning it any other way because you and your self-directed IRA must be totally separate—self-dealing is not allowed.
You, the self-directed IRA owner, should not benefit from your self-directed IRA other than through distributions from the self-directed IRA. And your self-directed IRA itself should not benefit from you other than through contributions you make to the account.
In practical terms, this means you, your relatives, and certain other “disqualified persons” cannot do business with your self-directed IRA. For example, you can’t:
- sell a property you personally own to your self-directed IRA
- purchase or lease property from your self-directed IRA
- personally guarantee loans taken out by your self-directed IRA to purchase property
- receive rental income from a rental property held in a self-directed IRA, or
- repair or improve any self-directed IRA property
If you do any of these things, your self-directed IRA could lose its tax-deferred status. If that happens, you then pay taxes on the value of all the property the IRA owns.
When your self-directed IRA owns real estate, you also don’t benefit from real estate tax deductions such as depreciation and the 20 percent qualified business income (QBI) deduction.
It may not be pleasant to think about, but upon your death, there is no step-up in basis for real estate held in the self-directed IRA. Instead, your beneficiaries pay tax at ordinary rates on any money or property distributed from a traditional self-directed IRA. This eliminates one of the most valuable tax benefits for real estate owners.
Don’t get the idea that self-directed IRAs are all bad. None of the income from property held in a self-directed IRA is taxable to you personally. Likewise, if you sell property in a self-directed IRA, you need to pay no personal tax on any profit. You pay tax only when you withdraw money from a traditional IRA.
With a self-directed Roth IRA, you pay no tax at all on withdrawals after age 59 1/2, provided your IRA held the property for at least five years.
But you need to balance these benefits with all the potential drawbacks.
It is getting increasingly popular for individuals to use self-directed IRAs to invest in alternative investments—that is, investments in things other than stocks, bonds, CDs and the like.
The single most popular alternative investment for self-directed IRAs is real estate.
With real estate values continuing to climb, you may be thinking about establishing your own self-directed IRA to purchase a residential rental property, commercial property, or other real estate investments.
But before you do so, you should be aware of some potential downsides of using self-directed IRAs for real estate. These aren’t necessarily dealbreakers, but they can be big obstacles.
Debt Financing
First, it is more difficult to get debt financing for real estate held in a self-directed IRA:
You, the self-directed IRA owner, are not allowed to lend any money to your self-directed IRA. Your close relatives are also barred from making loans. Nor can you personally guarantee a loan taken out by your self-directed IRA.
Instead, your self-directed IRA must obtain a non-recourse loan. With a non-recourse loan, the lender’s sole recourse in the event of default is to foreclose on the property. Such loans are more difficult to obtain than regular loans. Typically, the lenders that make these loans require your self-directed IRA to furnish a 30 percent to 50 percent down payment.
Unrelated Business Income Tax
If you obtain such debt financing, your self-directed IRA could become subject to the unrelated business income tax. This is a tax imposed on tax-exempt entities, including IRAs, that earn money from businesses unrelated to their tax-exempt purposes.
The unrelated business income tax is based on the percentage of the property that is debt-financed. For example, if your self-directed IRA buys a rental property worth $500,000 with $250,000 of non-recourse financing, 50 percent of the rental income from the property is subject to the unrelated business income tax.
The unrelated business income tax most often poses a problem when your self-directed IRA sells debt-financed real property. It pays the unrelated business income tax on any profit at capital gains rates. If the property has substantially increased in value, the tax could be large.
Key point. Your self-directed IRA can avoid paying the tax if the debt on the property is paid off more than 12 months before the sale.
RMDs
Finally, if you’re at or near 72 years of age, you need to consider how holding real estate in a traditional IRA will impact the requirement that you take annual required minimum distributions (RMDs). (No RMDs are required for Roth IRAs.).
Once you hit the RMD age, you must distribute a percentage of your IRA’s value to yourself each year, based on your life expectancy, or face an enormous 50 percent penalty.
If all or most of the assets in your traditional IRA consist of real estate, the property may not generate enough cash to pay your RMD. This is not an unsolvable problem, but it is a problem.
The IRS Wants to Know about Your Crypto
Cryptocurrency such as bitcoin is all the rage these days. Crypto is not legal money. It is property, similar to gold. Like gold, its use can result in taxable income.
The IRS is concerned that you and millions of Americans are using crypto without paying tax on the earnings. To clarify that it expects you and other taxpayers to report crypto earnings, the IRS added the following question about cryptocurrency to the top of Form 1040:
At any time during 2021, did you receive, sell, exchange, or otherwise dispose of any financial interest in any virtual currency?
You must answer this question under penalty of perjury, even if you have never heard of bitcoin and don’t know what cryptocurrency is. You can’t leave the field blank.
Unfortunately, this is something of a trick question. It is so broadly worded; that you’d think any transaction involving digital currency requires a “yes” answer. But that is not the case.
IRS guidance makes clear that it is interested only in virtual currency transactions that result in taxable income (or loss) that must be reported on a taxpayer’s return.
Thus, for example, if you simply purchased bitcoin during the year and held on to it, you should answer “no” to the crypto question. The same goes if you received crypto as a gift, or transferred crypto from one wallet to another.
You should answer “yes” to the crypto question if you purchased or sold goods or services with crypto, received new crypto through mining or staking activities, exchanged crypto for dollars or another crypto, or got new crypto from a hard fork. All these activities result in taxable income (or loss).
What should you do if you answered the crypto question wrong?
If you answered the crypto question “yes” when you should have answered “no,” you don’t have to do anything. There is no need to amend your tax return.
On the other hand, if you answered “no” when it should have been “yes” and you did not report your taxable virtual currency transactions, you need to file an amended or superseding return. If you fail to do so, you may get a letter from the IRS advising you to file an amended return and pay any taxes due. The IRS began sending out such letters in 2019.
A Better Way To Handle Business Milage
We absolutely, positively don’t like commuting mileage. You should dislike it, too. It’s personal. It’s not deductible. But with knowledge, it’s avoidable:
Let’s eliminate commuting and make those trips from your home to your office deductible.
The law gives you two ways to eliminate commuting from your home to your outside-the-home office:
- Make a temporary business stop on the way to the office.
- Establish a home office that qualifies as a principal office.
Temporary Business Stop
The temporary business stop strategy is designed for the home that contains no home office. In this case, the stop turns a commute from your home to the office into a deductible business trip.
Example 1. Sam, a property and casualty insurance agent, does not claim a home-office deduction. He has to photograph a property before the insurance company will issue the policy. Sam’s trip from his home to the property and from the property to his downtown office produces business miles.
Example 2. Sam, the guy from Example 1, drives from his home to his downtown office. That’s a non-deductible commute.
Caution. If your only office is in your home and that office does not qualify as a principal office, then the IRS labels your trip from your home to a business stop as the “first stop,” and that trip is a non-deductible commute.
Example 3. You have an office inside your home that does not qualify as a principal office, and you have no office outside the home. You drive 17 miles to a business stop and then return home. Because your only office is inside the home and it does not qualify as a principal office, your 34-mile round trip is a personal non-deductible commute under the IRS’s first and last stop rule.
Home-Office Solution
If you have both a downtown office and a principal office inside your home, you have no commuting mileage from your home to your downtown office. You don’t need to work in your home before you leave for the office. You simply need an office in the home that qualifies under the law as a principal office.
Example 4. You have an administrative office in your home that qualifies as a principal office. You drive 11 miles from your home to your downtown office, work all day in your downtown office, and then drive the 11 miles from your downtown office back home. This 22-mile round trip to and from your downtown office is deductible as business mileage.
Do You Have 1099-NEC contractors that Should Be Employees?
You have read horror stories about how the IRS audits business owners and deems their 1099 independent contractors W-2 employees—and then assesses tens (or hundreds) of thousands of dollars in back payroll taxes, interest, and penalties.
Are you one of those horror stories?
Okay, let’s say you are one of them. You know that you are an IRS target because you have workers who really should be employees, but you treat them as independent contractors. And you are afraid that if you change now, the IRS will see that change, audit your prior years, and charge big bucks for your mistake.
What should you do? Keep the workers as independent contractors and hope the IRS doesn’t catch on? Or amend your past returns to show the misclassified workers as employees?
Depending on how many workers you have misclassified, and the number of years involved, that amendment process could cost prohibitive.
The Pennies-on-the-Dollar Come-Clean Program
The come-clean program, which should have you paying just pennies on the dollar, is the IRS Voluntary Classification Settlement Program (VCSP) for business owners who want to change their worker classification on a going-forward basis.
Not everybody qualifies for the VCSP. To be eligible to participate in the VCSP, you must meet the following requirements:
- Reporting consistency. You must have timely filed the previous three years’ federal tax returns for your workers (that is, 1099s) consistent with your treatment of the workers as independent contractors.
- Not currently under audit. You cannot currently be under employment tax audit by the IRS, under worker classification audit by the Department of Labor, or by any state government agency.
Benefits of the VCSP Settlement Agreement
If you decide to participate in the VCSP, you must agree to treat the class or classes of workers covered by the agreement as employees for future tax periods. In exchange, you will receive the following most-favorable benefits:
- Reduced employment tax liability. You pay only 10 percent of the employment tax liability that would have been due on compensation paid to the workers for the most recent tax year. (Pennies on the dollar for one year—about 3.3 percent of what that likely would have been for the past three years.)
- No interest or penalties. You will not be liable for any interest and penalties. (Okay, knock that 3.3 percent down to something like 0.93 percent.)
- Audit protection for misclassifications in prior years. You will not be subject to an employment tax audit for prior years with respect to the workers covered by the VCSP. (Priceless.)
If you have misclassified workers, there is very little downside to participating in the VCSP—except, of course, that you will have to treat the workers covered by the VCSP agreement as employees on a going-forward basis.
IRS Announces Increase in Standard Mileage Rates
“R-2022-124, June 9, 2022
WASHINGTON — The Internal Revenue Service today announced an increase in the optional standard mileage rate for the final 6 months of 2022. Taxpayers may use the optional standard mileage rates to calculate the deductible costs of operating an automobile for business and certain other purposes.
For the final 6 months of 2022, the standard mileage rate for business travel will be 62.5 cents per mile, up 4 cents from the rate effective at the start of the year. The new rate for deductible medical or moving expenses (available for active-duty members of the military) will be 22 cents for the remainder of 2022, up 4 cents from the rate effective at the start of 2022. These new rates become effective July 1, 2022.
In recognition of recent gasoline price increases, the IRS made this special adjustment for the final months of 2022. The IRS normally updates the mileage rates once a year in the fall for the next calendar year. For travel from January 1 through June 30, 2022, taxpayers should use the rates set forth in Notice 2022-03.
“The IRS is adjusting the standard mileage rates to better reflect the recent increase in fuel prices,” said IRS Commissioner Chuck Rettig. “We are aware a number of unusual factors have come into play involving fuel costs, and we are taking this special step to help taxpayers, businesses, and others who use this rate.”
While fuel costs are a significant factor in the mileage figure, other items enter into the calculation of mileage rates, such as depreciation and insurance, and other fixed and variable costs.
The optional business standard mileage rate is used to compute the deductible costs of operating an automobile for business use in lieu of tracking actual costs. This rate is also used as a benchmark by the federal government and many businesses to reimburse their employees for mileage.
Taxpayers always have the option of calculating the actual costs of using their vehicle rather than using the standard mileage rates.
The 14 cents per mile rate for charitable organizations remains unchanged as it is set by statute.”
|
Midyear increases in the optional mileage rates are rare, the last time the IRS made such an increase was in 2011. |
||
| Purpose |
Rates 1/1 through 6/30/2022 |
Rates 7/1 through 12/31/2022 |
| Business |
58.5 |
62.5 |
| Medical/Moving |
18 |
22 |
| Charitable |
14 |
14 |
When the average price per gallon is over $5.00 this may not feel like a fare adjustment, but that is $62.50 for every 100 miles driven after June 30th, 2022.
If you have questions about this letter or any advice given and would like to discuss items further just contact me at 702-878-3900.
Until the July Tax Tips Letter has a comfortable summer.
Respectfully,
Al Whalen EA, ATA, CFP®
Phone: 702-878-3900
FAX: 702-878-7200
al@whalengroup.com
www.whalengroup.com