In most court cases, taxpayers lose vehicle expense deductions because they cannot present a credible business mileage log. The IRS code forbids deductions for vehicle expenses when taxpayers cannot prove the mileage and provide an adequate record.

 Failing to maintain such records could lead to far fewer deductions than the actual business mileage, potentially resulting in no vehicle deductions. In essence, having a mileage log is critical for both proprietors and corporate owner-employees.

Take the case of Jim and Martha Flake. During their IRS audit, they submitted reconstructed calendars, odometer readings, fuel receipts, credit card statements, and other documents. But they created the mileage after the fact, which contained math errors, thus failing to establish the mileage, time, and purpose of each vehicle use. 

The court examined the Flakes’ work and denied their vehicle deductions entirely. It allowed only what the IRS allowed.

The key takeaways from this case are:

• Maintain a mileage log to substantiate your business mileage.
• Stay updated on the basic principles of tax law.
• Operate your business with good books, checks, records, and receipts to verify income and expenses.
• There are APPs for your phone that can help with the mileage records.
• I recommend you have the vehicle serviced each year around the same time to verify the total mileage independently.

IRS Warns Of New Scam Involving Unclaimed Refunds IR-2023-123

Fraudsters are sending out cardboard envelopes from a delivery service asking people to send photos and bank account information so they can receive unclaimed tax refunds.

The envelope has a letter bearing the IRS masthead, claiming that the notice is “concerning your unclaimed refund.”

Five Things To Know About Employing Your Spouse

If you own your own business and operate as a proprietorship or partnership (wherein your spouse is not a partner), hiring your spouse to work as your employee is one of the smartest tax moves. 

But the tax savings may be a mirage if you don’t pay your spouse correctly. And the arrangement is subject to attack by the IRS if your spouse is not a bona fide employee.

Here are six things you should know before you hire your spouse that will maximize your savings and minimize the audit risk:

1. Pay benefits, not wages. The way to save on taxes is to pay your spouse using tax-free employee benefits, not taxable wages. Benefits such as health insurance are fully deductible by you as a business expense but not taxable income for your spouse. 

Also, if you pay your spouse only with tax-free fringe benefits, you need not pay payroll taxes, file employment tax returns, or file a W-2 for your spouse. 

2. Establish a medical reimbursement arrangement. The most valuable fringe benefit you can provide your spouse-employee is reimbursement for health insurance and uninsured medical expenses. You can accomplish this through a 105-HRA plan if your spouse is your sole employee or an Individual Coverage Health Reimbursement Arrangement (ICHRA) if you have multiple employees.
3. Provide benefits in addition to health coverage. You can provide your spouse with many other tax-free fringe benefits besides health insurance, including education related to your business, up to $50,000 of life insurance, and de minimis fringes such as gifts. 
4. Beware of Certain Tax-Free Benefits—Section 127 education plan.  The law prohibits Section 127 benefits to your spouse and dependents under the 5 percent ownership test.
5. Transportation benefits. If you and your spouse work in an outside office, you can provide him or her tax-free transportation benefits – just as you can for any rank-and-file employee. For 2023, you may pay up to $300 per month for parking near your business premises or for transit passes.  For 2024 and future years, the IRS will adjust this amount for inflation. NOTE: Due to the Tax Cuts and Jobs Act, you, the employer, do not deduct the tax-free transportation benefits to your employees. This law is due to expire after 2025.
6. Treat your spouse as a bona fide employee. For your arrangement to withstand IRS scrutiny, you must be able to prove that your spouse is your bona fide employee. You’ll have no problem if:

• You are the sole owner of your business.
• Your spouse works under your direction and control and keeps a timesheet.
• You regularly pay your spouse’s medical and other reimbursable expenses from your business checking account.
• Your spouse’s compensation is reasonable for the work performed.

Let’s Review The Kiddie Tax Rules

In brief, the kiddie tax was enacted by Congress to prevent parents from passing investment income to their children, who typically have a lower tax rate. Under the kiddie tax rules, a portion of a child’s net unearned income may be taxed at the parent’s marginal federal income tax rate. The kiddie tax applies to children up to age 24, assuming they meet specific criteria.

The kiddie tax can result in higher taxes on an affected child’s net unearned income than otherwise would apply. For example, if a child’s net unearned income exceeds the annual threshold of $2,500 for 2023 (increased from $2,300 in 2022), the portion of the income exceeding the threshold is subject to the kiddie tax. 

The kiddie tax does not apply if the child’s net unearned income for the year does not exceed the threshold for that year.

There are four primary criteria for the application of the kiddie tax: including the child not filing a joint return for the year, at least one parent being alive at year’s end, the child’s net unearned income for the year exceeding the threshold for that year, and the child falling under specific age rules.

Despite these rules, there are several strategies to limit the kiddie tax’s impact on your child’s unearned income:

Exploit the unearned income threshold. Manage your child’s unearned income to ensure it remains below the annual threshold.

Pick suitable investments. You can reduce unearned income by selecting investments with minimal or no dividends, such as growth stocks or tax-efficient mutual funds.

Invest in Series EE U.S. Savings Bonds. The accumulated interest income from these bonds is tax-deferred until cashed in, meaning no kiddie tax applies if cashed in when the child is kiddie-tax-exempt.

Use a Section 529 College Savings Plan. Withdrawals from a Section 529 plan account are federal-income-tax-free, provided they’re used for qualifying education expenses.

Invest in life insurance products. Investment accounts included in life insurance products such as whole life and universal life policies allow tax-deferred accumulations and can be borrowed against the child’s college costs.

Generate earned income. The kiddie tax does not apply to children aged 18-23 if their earned income exceeds 50 percent of their support for the year.

The applicability of these strategies depends on your unique circumstances, and I would be delighted to discuss them in more detail to help you optimize your child’s financial situation. If this sounds good, please call me on my direct line at 702-878-3900.

Fishing Charter Was a Hobby, Not a Business

Taxpayers are generally allowed deductions for business and investment expenses under
IRC sections 162 and 212, even if the deductions exceed gross income from the activity.
However, under IRC section 183, deductions are allowed only to the extent of gross income derived from the activity if the activity is not engaged in for-profit.
Schedule C does not report Hobby income and deductions (Form 1040). Instead,
gross hobby income (less cost of goods sold) is reported on Schedule 1 of Form 1040. 

Expenses (up to the amount of gross income) are deductible as miscellaneous itemized
deductions on Schedule A, subject to the 2% AGI limitation. For tax years 2018 through 2025,
miscellaneous itemized deductions subject to the 2% AGI limitation are not deductible.
Thus, for tax years 2018 through 2025 (or for any other year when the standard deduction
exceeds itemized deductions), the taxpayer receives no benefit for hobby expenses, even
though gross hobby income is taxable.

To be a for-profit business, the expectation of a profit need not be reasonable. However,
the taxpayer must conduct the activity with the actual and honest objective of making a
profit.

The regulations provide a non-exhaustive list of nine factors to consider when determining
whether an activity is a for-profit business:
1) How the taxpayer carries on the activity.
2) The expertise of the taxpayer or the taxpayer’s advisers.
3) The time and effort expended by the taxpayer in carrying on the activity.
4) The expectation that assets used in the activity may appreciate.
5) The success of the taxpayer in carrying on other similar activities.
6) The taxpayer’s history of income or loss concerning the activity.
7) The amount of occasional profits, if any, earned.
8) The financial status of the taxpayer.
9) Whether elements of personal pleasure or recreation are involved.

Neither a single factor nor the existence of even a majority of the elements is controlling.
Instead, all the facts and circumstances should be evaluated.
In this case, the taxpayer was an avid fisherman and had been fishing in Alaska for more
than 30 years. After retiring in 2010 from two jobs (loading cargo and driving a city bus),
he decided to establish a fishing charter business. He acquired a boat designed to fish for halibut.

The bottom line to this story is that after considering the above nine factors, the court stated that while the taxpayer credibly testified about his time on his fishing charter activity and the obstacles he faced, he did not demonstrate that it was more than a retirement hobby. Considering the evidence, the court stated that although the taxpayer wanted his fishing charter activity to succeed and devoted time to it, he was not operating it as a for-profit business.  Consequently, he is entitled to deductions attributable to that activity only to the extent allowed by IRC Section 183. This meant that all losses taken in prior years were disallowed.

Income from a hobby business goes on Schedule 1, line 8 of Form 1040; deductions would go on other miscellaneous itemized deductions subject to the 2% of AGI limit. This section was eliminated under the Tax Cuts and Jobs Act until 2026. 

Early Withdrawals For 401(k)s and IRAs Can Avoid The Ten Percent Penalty.

The following are some exceptions to the 10% early withdrawal penalty taken before age 59 1/2:

1. Early withdrawals from IRAs and 401(k)s by disaster victims are penalty-free,

 up to $22,000 per disaster. The payout must generally be taken within 179 days of the date the disaster is declared.

1. Terminal illness and permanent disability of account owner.
2. Some beneficiaries of deceased owners.
3. Substantially equal payments from IRA or 401(k). The distribution must continue for five years or until the recipient reaches age 59 1/2, whichever is longer.
4. IRS levy on retirement funds.
5. People having a baby or adopting can take up to $5,000 starting in 2024.
6. Starting in 2024, up to $24,000 can be taken penalty-free by domestic abuse victims.
7. First-time home buyers can only take out up to $10,000 penalty-free from IRA accounts. However, you can transfer from 401(k) to IRA and then withdraw to get the same treatment. As a first-time home buyer, IRS considers not owning a home for the prior two years as qualifying. This is a once-in-a-lifetime event.
8. Higher education cost of college tuition, computers, books, and room and board for students enrolled at least half-time. As in number 8 above, this is for IRA owners.
9. The unemployed can sometimes use IRA funds to buy health insurance without penalty.
10. Early 401(k) withdrawals escape penalties in the year they turn age 55 or later—age 50 for public safety officers.
11. Qualified Domestic Relationship Order (QDRO) transfers from your 401(k) to your ex-spouse to avoid the penalty in a divorce situation. This exception does not apply to an IRA.
12. To the extent you itemize deductions for medical expenses, the portion deductible above 7.5% of AGI can be withdrawn penalty-free.

Senate Report Confirms Data Leakage from Tax Software 

A Senate investigation report says that significant tax preparation software companies have been sending sensitive personal information to tech companies like Meta and Google, possibly violating taxpayer privacy laws. 

The report details the results of an investigation led by Sen. Elizabeth Warren, D-Massachusetts, launched in response to reports late last year that several prominent tax prep solutions providers were leaking data to third parties. The Senate report backs up this assertion, naming three companies — H&R Block, TaxAct, and TaxSlayer — as having shared the private information of millions of taxpayers by using tracking tools that connect to third parties. According to Accounting Today Magazine.

I Want To Talk About The Required Minimum Distribution (RMD) On Inherited IRAs

“….In this world, nothing can be said to be certain but death and taxes” (Ben Franklin, 1789). Now I want to talk about taxes after death.

The IRS proposed regulations are extensive and 275 pages in length. I will reduce much of it to a few paragraphs:

Before the proposed regulations under the Secure Act issued on February 23, 2022, answering the question about how to handle the RMD on an inherited IRA or 401(k) plan was simple. If you are a designated beneficiary of an inherited IRA or 401(k) plan, whether or not the IRA owner has reached their RMD age, you have ten years to withdraw the retirement funds.

That answer has changed under the Secure Act. If the deceased IRA owner has reached their RMD age, the designated beneficiary must take their first distribution in the year of the IRA owner’s death if the deceased owner did not receive their RMD that year. The distribution amount would be based on the IRA owner’s age used in the Uniformed Lifetime Table published by the IRS (or the divisor they should have used reduced by one each of the remaining years). In other words, they would continue taking distributions as if you were the deceased owner. They must continue the distribution rate using the table rate every year at a minimum and ultimately distribute the funds by the end of the tenth year. So, if they continue the RDM requirement for nine years, the account balance must be distributed by the end of the tenth year. This is very different from just having ten years to withdraw the funds.

The rules for RMDs differ by type of beneficiary:

Eligible Designated Beneficiary any of the five following categories:

1. Surviving Spouse has a rollover ability or can keep the inherited option of the spouse if under 59 1/2 years of age and avoid a 10% penalty on early withdrawal
2. Minor child less than 21 years of age (has until age 31)
3. A disabled individual (can use their single life table) and stretch the distributions
4. A chronically ill individual (can use the greater of the owner or their life)
5. Any other individual that is not more than ten years younger than the deceased account owner (can use the greater of the owner or their life)

Designated Beneficiary any person not included in the above category of an eligible designated beneficiary. A designated beneficiary is a living person. Non-person entities are not considered designated beneficiaries, even if named on a retirement account. Non-person entities would be; estates and non-qualifying trusts.

Note:  A grandchild is a designated beneficiary, not an eligible designated beneficiary.

Ten Year And Five Year Rule

For Eligible Designated Benefices and Designated Beneficiaries inheriting IRAs and 401(k)s before the account owner reached RMD age requirements, the ten-year rule applies. Just distribute the funds by December 31st of the tenth year (dies anytime in 2023, then by December 31, 2033). 

If the deceased account owner has reached RMD year with a designated beneficiary, then 

The designated beneficiary would continue having the required minimum distributions calculated using the designated beneficiaries life expectancy (IRS Single Lifetime Table) for the next nine years and distribute the balance in the tenth year. For the year of distribution, you find the divisor and reduce that number by one each of the next nine years.

The five-year rule applies for non-designated beneficiaries inheriting IRAs and 401(k)s before the account owner reaches RMD requirements. Just distribute the funds before  December 31st of the fifth year.

However, if the non-designated beneficiary (say an estate) inherits the IRA and the deceased account owner has reached RMD required age and has taken this distribution in that year, how is it treated? 

In the above example, the Five-Year Rule will not apply. The estate beneficiary uses the deceased owner’s age at the year of death and then goes to the IRS Single Lifetime Table. Assume the owner that died was age 77 in the year 2022. That table says the applicable denominator (the number you divide the account balance by) is 13.3 for age 77. For 2023, you reduce the number 13.3 by 1 = 12.3, the number you divide the year-end account balance by in 2023. For 2024, again reduce by 1 (12.3 – 1= 11.3), divide by 11.3, and continue until the denominator reaches 1.0 or less, requiring the balance to be distributed. In the above example, it could take 13 years to distribute the retirement funds if desired.

NOTE:  At this point, we should ask, “Why make this so complex?” I have been practicing tax preparation for 48 years, and it is not the first time I have thought this way.

  Albert Einstein: “The hardest thing in the world to understand is the income tax.”

Eligible Designated Beneficiary Rules For RMD Owner

An eligible designated beneficiary receives a better payout arrangement than a designated beneficiary.

Under the Secure Act, an Eligible Designated Beneficiary has two options if the owner has not reached RMD year:

Option 1. The ten-year rule applies, giving you up to ten years to withdraw funds in any preferred order. 

Minors reach the age of maturity at the age of 21. They would have until age 31 to complete the withdrawal process.

Option 2. Life expectancy payment rule. The options allow the beneficiary to use the Single Lifetime Table. The eligible designated beneficiary (with certain exceptions) receives stretch payments during their lifetime. Upon death, the (successor) beneficiary can take advantage of the ten-year rule that starts after the death of the eligible designated beneficiary.

RMD Requirements Deferred By One Year

IRS has changed the RMD rules for those non-spouse beneficiaries who inherit 401(k) and IRA funds and those who turn 72 in 2023.

In Notice 2022-53, the IRS stipulated that the RMD rules for defined contribution plan balances (including IRAs) inherited from a beneficiary who passed away after their required beginning date-as outlined in the proposed regulations under the Secure Act- would not take effect until 2023.  However, with the release of Notice 2023-54, the IRS has delayed the implementation of these rules by at least one year, meaning they will not be applicable until 2024 at the earliest.

Many individuals had understood that, irrespective of whether the original account owner had reached the required beginning date, inheritors of accounts simply needed to withdraw the entire balance by the end of the tenth year following the year of the account holder’s death. This misunderstanding led the IRS to issue Notice 2022-53, which provided relief from penalties for those who did not interpret the law as the IRS did in the proposed regulations.

You will not be penalized if you inherited an IRA from someone who turned 72 in 2023 and has not started taking distributions yet.

The QSEHRA Health Plan

If you’re a small employer (fewer than 50 employees), you should consider the Qualified Small Employer Health Reimbursement Arrangement (QSEHRA) as a good way to help your employees with their medical expenses.

If the QSEHRA is indeed your plan of choice, then you have three good reasons to get that QSEHRA plan in place on or before October 2, 2023: First, this avoids penalties. Second, your employees will have the time to select health insurance. Third, your plan will be in place on January 1, 2024, when needed.

One attractive aspect of the QSEHRA is that it can reimburse individually purchased insurance without subjecting you to the $100-a-day per-employee penalty that generally applies to the employer reimbursing employees for individually purchased insurance. The second and 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 any employee group health or a flexible spending arrangement. 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 the following:

• 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 2023 limits are $5,850 for self-only coverage and $11,800 for family coverage. For part-year coverage, you prorate the limit to reflect the number of months the QSEHRA covers the individual.

Home Office Deduction For The Corporate Owner

If you operate your business as a corporation and are an employee of the corporation, would you like to deduct an office in your home? Then the following must be necessary to get the deduction:

1. You use the office in your home for the convenience of your employer-corporation
2. You pass the tax code rules for deducting a home office, and 
3. Your corporation must reimburse the home-office deduction to you as an employee business expense.

The Convenience of Employer To qualify as a tax-deductible expense, your use of your home office must be for the convenience of your employer (your corporation).

Office In The Home Is The Only Office If your corporation has no office outside your office in your home, your home office is obviously for the convenience of your employer corporation. In this case, you don’t need any special documentation as to the need for the office.

To deduct the office, the corporation reimburses you for its expenses and claims the deduction as office space on the corporate tax return.

You must provide the corporation with proof of your expenses and that you used the home office regularly and exclusively for the corporate business.

Key point.  If the office in your home is the only office of the corporation, it is a tax-law-defined principal office.

More Than One Office When you have more than one office-say, an office in your home and a  downtown office – you want the IRS to consider the office in your home a tax-law-defined “principal office.”  Why?

Because the principal office in the home turns the vehicle mileage from your home to your downtown office into business use, it eliminates commuting mileage.

Creating The Principal Office If you have both an office in your home and a downtown office, you need to meet all of the following rules to make the office in your home a principal office:

1. Use the office in your home for your corporate administrative or management activities.
2. Have no other fixed place, such as the downtown office, where you conduct substantial administrative or management activities.
3. Use the office in the home exclusively and regularly as a place of business.
4. Use the office in the home for the convenience of your employer corporation.

Convenience Of Employer Neither the law nor the IRS has given guidance on what is an office in the home for the employer’s convenience.  One recent court case states: “A home office is not for the convenience if it is maintained for the employee’s personal convenience, comfort, or economic benefit.”

Here’s another rule to know.  It’s from the legislative history of the convenience test: 

In the case of an employee, whether an employee chose not to use suitable space made available by the employer for administrative activities is relevant to determining whether the present-law “convenience of the employer” test is satisfied. JCS-23-97, Joint Committee on Taxation

Documentation Is Key. Once you establish that you meet the basic rules of administrative, regular, and exclusive use, you must document how and why you meet the convenience-of-the-employer test.

Once you have that figured out, have the corporation write you a letter requiring you to do your administrative or management activities at home for the corporation’s convenience.

For example, your corporation might require that your administrative or management work be carried out at home:

1. To protect the confidentiality of the payroll and accounting records.
2. To ensure that your work at the office focuses on sales (patient care, production).
3. Because the office has inadequate space to accommodate the payable records, invoices, receipts, and so; or
4.  To facilitate uninterrupted attention to business plans and budgets.
5. Your business requires you to work after hours and on weekends, but the landlord eliminates air conditioning and heating once business hours are over.
6. Although the neighborhood is perfectly safe during the day, it is not safe after hours, as evidenced by crime in the area (which you can prove).
7. You have drugs in the office. Accordingly, your corporation has a policy that no person should be in the office alone.
8. Generate more work output. With a home office, an owner-employee can work at home anytime without being restricted to office hours. Facilitate international calls and business or east coast versus west coast timetables.
9. Cost efficiency. Having the office in the home may facilitate less physical office space and save rental costs if the employee is also the owner.
10. Business continuity. If an emergency, disaster, or situation makes the downtown office inaccessible or unsafe (such as a pandemic, natural disaster, etc.), having a home office allows work to continue uninterrupted.
11. Reduced commuting time. Allowing the owner-employees to work from home, the corporation reduces the time and stress involved in commuting, which enhances productivity.
12. Health reasons. A home office could be necessary, depending on the individual’s health condition.
13. Childcare or eldercare responsibilities.  For owner-employees with significant childcare or eldercare responsibilities, having a home office allows them to work more hours and meet personal responsibilities.

This list is not exhaustive, but it should help trigger some viable reasons for your administration or management at home.

The critical factor is that a home office must be used for the employer’s convenience, not the employee’s. 

Finally

It is summertime, and it is getting hotter. Remember to stay hydrated when outside. Now is a perfect time to have a semiannual business review to see exactly where you are on the business deductions available to you and your estimated tax liabilities. Retirement planning and business planning are an ongoing process.  It is also an excellent time to review or complete your estate planning. Schedule your appointment with Nancy at 702-878-3900.

Respectfully,

Al Whalen, EA, ATA, CFP®

Sources:

  Bradford Tax Institute

  Accountants Daily Insights

  National Association of Tax Professionals (NATP)

  Tax Pro Journal

  CPA Practice Advisor

  Accounting Today

  The Tax Book

  CPA Trendlines

  Practitioner’s Guide to the IRA Distribution Rules under The Secure Act by

  Seymour Goldberg, CPA, MBA (Taxation) JD

  NCPE Foundation

  Nancy Eade, Proof Reader, Whalen Financial