Monthly Archives: September 2013
New Safe Harbor for Deducting Building Improvements
In an effort to make the tax code even more incomprehensible to people, this month the IRS issued over 200 pages of regulations to inform taxpayers when they can immediately deduct repair expenses or when they must depreciate the repairs over a number of years. The regulations address repairs to personal property and buildings. This post explains only building repairs.
Background
Usually, building repairs must be depreciated over a number of years if the repair is for a permanent improvement or betterment that increases the value of the property, restores its use or value, substantially prolongs its useful life, or adapts the property to a new or different use. If a repair falls into one of these categories, the repair must be depreciated over 39 years for commercial property and 27.5 years for residential rental property. However, even if the repair must be depreciated, the expense may be deducted faster under two rules:
- Qualified leasehold improvement property may be depreciated over 15 years
- The special $250,000 Section 179 deduction for certain real property
Fortunately, there are two safe harbors for building repairs under the regulations. If either of these safe harbors is met, the repairs can be immediately deducted.
Per-Building Safe Harbor for Small Taxpayers
Taxpayers with $10 million or less in average annual gross receipts over the past three years are able to immediately deduct improvements made to an eligible building property. An eligible building property has a cost of $1 million or less.
This new safe harbor applies only if the total amount paid during the year for repairs, maintenance, improvements, and similar activities performed on the eligible building does not exceed the LESSER of $10,000 or 2% of the building’s cost. If these expenses exceed the lesser of these two amounts, the safe harbor is not available for any amounts spent on repairs or improvements.
Example: Classy Real Estate LLC owns a commercial rental property. The property’s cost was $460,000. Classy spends $9,000 to upgrade most of the electrical system. Under the new safe harbor, Classy can immediately deduct up to the lesser of $10,000 or $9,200 (2% of the $460,000 cost) in repairs or improvements. Therefore, Classy can immediately deduct the full $9,000 cost of the electrical improvements.
Without the safe harbor, Classy would have to argue that the $9,000 was an ordinary repair that should be immediately deducted. It is possible that the repair would be classified as an improvement that would have to be depreciated over 39 years.
The $10,000 or 2% limit applies per building, so if, in the above example, Classy paid the same amount for electrical improvements to multiple buildings of the same price, it would be able to immediately deduct $9,000 per building.
Routine Maintenance Safe Harbor for Buildings
Expenses that fall under the routine maintenance safe harbor are immediately deductible. Routine maintenance includes the recurring activities that a taxpayer expects to perform as a result of using the property to keep the building structure or each building system (e.g., electrical, plumbing, HVAC, etc.) in its ordinarily efficient working condition.
Routine maintenance includes inspecting, cleaning, and testing of the building structure or each building system, and the replacement of worn or damaged parts with comparable replacement parts.
The activities are routine only if the taxpayer reasonably expects to perform the activities more than once during the 10 year period beginning when the building or building system is placed in service. Factors to be considered in determining whether maintenance is routine and whether the taxpayer’s expectation is reasonable include:
- The recurring nature of the activity
- Industry practice
- Manufacturers’ recommendations
- The taxpayer’s experience with similar property
Buzzkill Disclaimer: This post contains general tax information that may or may not apply in your specific tax situation. Please consult a tax professional before relying on any information contained in this post.
Avoid Underpayment Penalties with this Simple Tip
While individual tax returns are due April 15 each year, estimated tax payments must be made throughout the year. Business owners usually pay 
estimated taxes quarterly by filing Form 1040-ES with payment or by having taxes withheld from their payroll.
There is an advantage to having payroll tax withholding instead of paying estimated taxes quarterly. Income taxes withheld from wages are deemed to be paid evenly throughout the year, unless the taxpayer establishes the dates on which the withholdings were actually paid.
This advantage allows taxpayers to reduce or avoid estimated tax underpayment penalties by using three different strategies.
Increase Withholding at Year-end
If a taxpayer finds that she has substantially underpaid her estimated taxes late in the year, she may dramatically increase her payroll tax withholding near year end. The increased withholding at year end is deemed to be paid evenly throughout the year.
Example: Jenny’s business took off during 2013. In October, she discovers that her federal income tax liability will be roughly $10,000 for the year. She has made no income tax estimated payments and has had no withholding taxes paid. If Jenny makes a $10,000 estimated tax payment late in 2013, she will be subject to underpayment penalties because the $10,000 in estimated tax payments should have been made throughout the year.
However, if Jenny issues herself a paycheck at the end of the year with $10,000 income tax withholding, the $10,000 withholding is deemed to be have been paid $2,500 for each quarter throughout the year. Jenny will not be subject to underpayment penalties in this case.
Use Actual Dates Taxes Were Withheld
This strategy will help taxpayers whose withholding occurred only in the early part of the year (e.g., an employee who started a business during the year.)
Example: Jack had $75,000 in wages and $20,000 in tax withholding during the first six months of the year. He started a business mid-year and broke even for the rest of the year. If Jack does nothing, the $20,000 in withholding is deemed to have been paid $5,000 during each quarter. In this situation, Jack may have under-withheld taxes during the first two quarters. Here, Jack should allocate his tax withholdings to the first two quarters when they were paid. If Jack does this, he will not be subject to underpayment penalties for the first two quarters.
Withhold from IRA Distribution Followed by Qualifying Rollover (Effective, but Risky Strategy)
Sole proprietorships, members of LLCs, and partners in a partnership are not able to put themselves on payroll. However, if they are under-withheld and have funds in an IRA, they may use proceeds in their IRAs to reduce or avoid underpayment penalties IF THEY ALSO HAVE THE CASH FUNDS AVAILABLE TO REDEPOSIT THE WITHDRAWN IRA WITHIN THE 60 DAY TAX-FREE ROLLOVER PERIOD. If the funds aren’t redeposited within the 60 day period, the IRA distribution will be subject to tax and possibly a 10% early withdrawal penalty. Because of this, the strategy is risky.
A taxpayer may request an IRA distribution and have 100% of the amount withheld as taxes.
Example: Larry discovers on December 20 that he is underpaid on his estimated taxes by $10,000. While he has $10,000 in a savings account, if he uses these funds to make an estimated tax payment, he will be subject to an underpayment penalty because the payment is late in the year. Larry is a sole proprietor so paying tax withholding on payroll is not an option.
Larry does have $20,000 in an IRA. Larry can take a $10,000 distribution from his IRA and have 100% of the distribution applied to tax withholding. Here, the $10,000 withholding is deemed to have been paid evenly through the four quarters in the year. Finally, Larry uses the $10,000 in his savings account to redeposit funds back into an IRA within the 60 day rollover period.
If Larry did not redeposit the funds within 60 days, the $10,000 IRA distribution would be subject to income tax and could be subject to a 10% penalty ($1,000).
Buzzkill Disclaimer: This post contains general tax information that may or may not apply in your specific tax situation. Please consult a tax professional before relying on any information contained in this post.
Can’t Pay Your Tax Bill in Full? New Options are Available.
Many people have run into tax issues in the past few years due to the financial meltdown. The IRS has responded with a Fresh Start initiative to help taxpayers get caught up on their taxes. There are three main areas of relief available. These include more lenient standards for (1) installment agreements, (2) offers in compromise, and (3) lien withdrawal procedures.
This post will focus on the Fresh Start provisions for installment agreements.
When taxpayers are able to pay the full amount of their tax liabilities in full, but not immediately in a lump sum, taxpayers can set up an installment agreement with the IRS. An installment agreement allows the taxpayer to make payments over a period of time; however, interest and penalty continue to apply. Outside of the Fresh Start program, taxpayers usually must submit very, very detailed asset and income information to the IRS. The information provided on the financial disclosure provides a road map of your assets and income to the IRS for lien and levy purposes if the installment agreement is not approved.
The primary benefit of an installment agreement is that the IRS will not pursue more aggressive collection procedures (such as wage garnishment or bank account levy) while an installment agreement is in place.
The Streamlined Installment Agreement
The Fresh Start program allows a more streamlined installment agreement application process. These installment agreements generally do not require a financial statement described above, but a limited amount of financial information may still be required.
There are two categories of streamlined installment agreements based on the liability amount. There is one set of rules when the balance due is $25,000 or less and another set of rules when the balance due is between $25,001 and $50,000.
The criteria for the streamlined installment agreement with a balance due of $25,000 or less are:
- You owe $25,000 or less at the time the agreement is established. If you owe more than $25,000, you may pay down the liability before entering into the agreement to qualify.
- The debt must be fully paid within 72 months or prior to the 10 year collection statute expiration date
- You must be compliant with all filing and payment requirements (i.e., you must file all future tax returns on time with timely payment—or set up future installment agreements)
- It is available to individuals who owe any type of tax (income, Trust Fund Recovery Penalty, etc.)
- It is available to closed-down businesses, including any type of business entity and any type of tax (income, payroll, etc.)
- Businesses currently operating can only enter into streamlined installment agreements for income taxes only (i.e., it is not available to payroll taxes or other types of tax).
The criteria for the streamlined installment agreement with a balance due of $25,001 to $50,000 are:
- You owe $25,001 to $50,000 at the time the agreement is established. If you owe more than $50,000 , you may pay down the liability before entering into the agreement to qualify.
- The debt must be fully paid within 72 months or prior to the 10 year collection statute expiration date
- You must be compliant with all filing and payment requirements (i.e., you must file all future tax returns on time with timely payment—or set up future installment agreements)
- It is available to individuals who owe any type of tax (income, Trust Fund Recovery Penalty, etc.)
- It is available only to sole proprietors (i.e., no corporations or partnerships) that are out of business for any type of tax owed (income, payroll, etc).
- You must enroll in a Direct Debit Installment Agreement
- A limited amount of financial information may be required to be disclosed to the IRS
The In-Business Trust Fund Express Installment Agreement
Small businesses that currently have employees can qualify for an In-Business Trust Fund Express Installment Agreement. These agreements generally do not require a financial statement.
The criteria include:
- Your owe $25,000 or less at the time the agreement is established. If you owe more than $25,000, you may pay down the liability before entering into the agreement to qualify.
- The debt must be fully paid within 24 months or prior to the end of the 10 year Collection Statute Expiration Date
- You must enroll in a Direct Debit Installment Agreement if the amount you owe is between $10,000 and $25,000
- You must be compliant with all filing and payment requirements
Buzzkill Disclaimer: This post contains general tax information that may or may not apply in your specific tax situation. Please consult a tax professional before relying on any information contained in this post.
Is Your Worker an Employee or Independent Contractor?
Workers generally fall into one of two classes: independent contractors and employees. The process of determining whether a worker is an 
independent contractor or employee is known as worker classification. A business must withhold taxes on employee wages, pay payroll taxes, provide workers’ compensation, provide employee benefits, and observe employee rights during employment. A business does not have these duties when dealing with an independent contractor.
Businesses usually prefer to treat a worker as an independent contractor to avoid these duties. However, for a business to genuinely classify a worker as an independent contractor, the relationship between the business and the worker must be consistent with independent contractor status. If a business has a right to control its workers’ performance with respect to both methods and results, an employment relationship exists and the employer must withhold taxes, pay payroll taxes, and meet other employer responsibilities.
The IRS has listed 20 factors it considers important in determining whether a sufficient degree of control exists to classify a worker as an employee. The 20 factors develop an overall sense of the relationship between the worker and the business. No one factor is controlling.
The 20 factors are as follows:
- Instructions: A worker who is required to comply with the business’ instructions about how, when, and where the work is to be done is ordinarily an employee. If a business tells the worker what has to be done, but leaves it up to the worker to determine how, when, and where; the worker may qualify as an independent contractor.
- Training: Providing training to a worker indicates employee status
- Integration: If the worker’s services are the same service the business provides, the worker is usually an employee. Example: a plumber who provides services for a plumbing company will usually be an employee. A plumber who provides services to a law firm will usually be an independent contractor.
- Services Personally Rendered: If the services must be provided personally by the worker, employee status is usually required
- Hiring/Supervising/Paying Assistants: If the business hires, supervises, and pays assistants of the worker, the worker is usually an employee.
- Continuing Relationship: A continuing relationship between the business and the worker indicates an employee relationship
- Set Hours of Work: The establishment of set hours of work indicates employee status
- Full Time Required: If the worker must devote substantially full time to the business, employee status is usually required
- Doing Work on Employer’s Premises: If the work is done on the employer’s premises, this indicates control over the worker’s work, and employee status.
- Order or Sequence Set: If a worker must perform services in the order or sequence set by the business, that factor shows the worker is not free to follow the worker’s own pattern of work. Employee status is usually required
- Oral or Written Reports: A requirement that the worker submit reports to the business indicates an employee relationship
- Payment by Hour/Week/Month: Regular pay days indicates employee status
- Payment of Business and/or Traveling Expenses: If the business pays for the worker’s business or travel expenses, it usually indicates an employee relationship
- Furnishing of Tools and Materials: If the business provides the worker with tools and materials, it usually indicates an employee relationship
- Significant Investment: If the worker invests in facilities or equipment that are used by the worker in providing services, an independent contractor relationship usually exists
- Realization of Profit or Loss: A worker who can realize a profit or loss is generally an independent contractor.
- Working for More than One Business at a Time: If the worker provides services for multiple businesses, independent contractor status usually exists
- Making Service Available to the General Public: If the worker makes services available to the general public, the worker is usually an independent contractor.
- Right to Discharge: The right to fire a worker is a factor indicating that the worker is an employee. This is a weak argument for employee status in my opinion, but this is the view of the IRS.
- Right to Terminate: If the worker has the right to end his or her relationship with the business, the worker is generally an independent contractor. Again, this is a weak argument for employee status in my opinion, but this is the view of the IRS.
The IRS has developed Form SS-8 to help businesses classify their workers. The form can be submitted to the IRS for a ruling on how a worker should be classified. I DO NOT RECOMMEND FILING THIS FORM WITH THE IRS. I DO RECOMMEND REVIEWING THE FORM TO SEE IF YOU ARE PROPERLY CLASSIFYING EMPLOYEES SO YOU CAN MAKE ADJUSTMENTS, IF NECESSARY, TO YOUR WORKER CLASSIFICATION PROCEDURES.
Buzzkill Disclaimer: This post contains general tax information that may or may not apply in your specific tax situation. Please consult a tax professional before relying on any information contained in this post.
ALERT: Small Businesses Must Send Out Obamacare Notices by Oct. 1.
An employer covered by the Fair Labor Standards Act must provide each of its employees (part-time and full-time) with a notice informing the 
employees of their right to enroll in health insurance coverage through a state insurance marketplace (exchange).
Employers who have at least 1 employee engaged in commerce and who have gross annual sales of $500,000 or more are covered by the Fair Labor Standards Act. So many employers are subject to this requirement.
The written notice must:
- Inform the employee of the existence of a state insurance marketplace;
- Include a description of the services provided by the marketplace;
- Explain how the employee may contact the marketplace to request assistance
- State that if the employer plan’s share of the total allowed costs of benefits provided under the plan is less than 60% of the total allowed costs or the employee’s premiums for self-only coverage exceed 9.5% of the employee’s household income, the employee may be eligible for a premium assistance credit and a cost-sharing-reduction subsidy if the employee purchases a qualified health plan in the individual market through the exchange
- State that if the employee purchases a qualified health plan in the individual market through the exchange, the employee may lose any employer contribution to any health benefits plan offered by the employer and that all or a portion of the contribution may be excludable from income for U.S. tax purposes.
The Department of Labor has two model forms employers can use to give to their employees. If you already provide health coverage for your employees, use this model form. If you do not provide health coverage for your employees, use this model form.
Employers must distribute the notice to all employees regardless of whether the employee is part-time or full-time or if the employer does or does not provide health insurance coverage to the employee.
For all employees who are employed before October 1, 2013, the notice must be provided by October 1, 2013. For employees hired on or after October 1, 2013, the notice must be provided at the time of hiring; however, through 2014, a notice provided within 14 days of an employee’s start date will be considered provided at the time of hiring.
The notice must be provided by first class mail or electronically under certain circumstances.
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Buzzkill Disclaimer: This post contains general tax information that may or may not apply in your specific tax situation. Please consult a tax professional before relying on any information contained in this post.
New IRS Rule on Tips Frustrates Restaurants
Beginning in 2014, the IRS is changing the way restaurants treat service charges they add to customers’ bills. A service charge is usually a
required tip amount that restaurants add to the bill of large parties. For example, a restaurant may add a 18% required tip to a bill of a party of 10 or more people.
Restaurants are currently treating service charges as tips and not as wages. By doing this, they are leaving it up to the employee to report the service charges as income (i.e., some of these service charges may go unreported by employees). Restaurants are also claiming the tip tax credit on the amount of FICA taxes they are paying on service charges. The tip tax credit can be a substantial tax benefit for restaurants.
The IRS issued new guidance in 2012 that is taking effect January 1, 2014 that will require restaurants to treat service charges as wages, and not as tips. By doing this, restaurants will be required to track the service charges paid to employees (and not rely on the employee reporting the service charges as tips). Restaurants will also have to withhold taxes from the service charges.
Additionally, treating the service charges as wages will affect the hourly wage earned by employees. Finally, since the service charges are classified as wages, the FICA taxes paid on service charges will no longer qualify for the tip tax credit.
There is a way to avoid service charge treatment. To be classified as a tip, and not as a service charge:
- the payment must be made free from compulsion
- the customer must have the unrestricted right to determine the amount
- the payment should not be the subject of negotiation or dictated by employer policy; AND
- generally, the customer has the right to determine who receives the payment.
Example: Euro Restaurant automatically adds an 18% gratuity to bills of parties of 10 or more. On the bill, the tip line is automatically filled in with an amount equal to 18% of the food and beverage charge. Euro Restaurant distributes the service charge to its wait staff and bussers. The service charge will be treated as wages because: the payment was made under compulsion because it was required, the customer did not have the right to determine the amount, the payment was dictated by employer policy, and the customer did not have the right to determine who would receive the tip.
A technique some restaurants are using to avoid the service charge treatment is to suggest (and not require) tip amounts.
Example: Asia Restaurant does not require a service charge to bills of large parties, but they do suggest either a 15%, 18%, or 20% tip amount. The tip amount at each percentage level is listed on the bill. Customers are free to use any of the suggested tips, tip based on their own rate, or not tip at all. Under these circumstances, any amount the customers fill in the tip line will be treated as tips and not as wages. This is because: the payment was not made under compulsion—the restaurant only suggested a tip amount. The customer was free to determine what amount would be tipped. The payment was not dictated by restaurant policy.
It is expected that most restaurants who charge a required service charge will stop doing so and instead only suggest tip amounts.
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Benefit from the Home Sale Exclusion Even if the 2 Year Rule Is Not Met
People are usually aware that they can sell their home and treat up to $500,000 of the gain as tax-free. The requirements for this tax benefit are:
- The taxpayer must have owned the home for at least 2 of the past five years
- The taxpayer must have used (lived in) the home for at least 2 of the past five years
- The taxpayer must not have claimed an exclusion on a prior residence within two years of the sale of the current primary residence.
If the taxpayer fails to meet any of the above requirements, the taxpayer may still be able to exclude a portion of the gain if the primary reason for selling the principal residence was:
- A change in place of employment;
- Health; or
- Unforeseen circumstances
Each of these three exceptions have safe harbors that, if met, qualify the taxpayer for the partial gain exclusion. Even if a safe harbor is not met, the taxpayer may still qualify for the partial gain exclusion if they can prove that one of the above three exceptions was the primary reason for a premature home sale.
Change in Place of Employment
The change in place of employment test is met if the primary reason for the sale is a change in location of employment of a qualified individual. A qualified individual is the taxpayer, the taxpayer’s spouse, a co-owner of the property, or a person whose principal place of abode is in the same household of the taxpayer.
Under the safe harbor, the primary reason for the sale is deemed to be a change in employment if:
- The change in place of employment occurs while the taxpayer owns and is using the property as a principal residence AND
- The individual’s new place of employment is at least 50 miles farther from the residence sold than was the former place of employment, or, if there was no former place of employment, the distance between the individual’s new place of employment and the residence sold is at least 50 miles.
Health Reasons
The health reason test is met if the primary reason for the sale is to obtain, provide, or facilitate the diagnosis, cure, mitigation, or treatment of a disease, illness, or injury to a qualified individual. A qualified individual is the same as for the change of employment test and also includes any of those individual’s dependents and descendants of the taxpayer’s grandparents (i.e., parents, aunts, uncles, siblings, cousins, etc.)
Under the safe harbor, a change in residence recommended by a physician qualifies as a health reason.
Unforeseen Circumstances
An unforeseen circumstance is the occurrence of an event that the taxpayer does not anticipate before purchasing an occupying the residence. Under a safe harbor, the primary reason is deemed to be unforeseen circumstances if any of the following events occur during the period the taxpayer owns and uses the property as a principal residence:
- the involuntary conversion of the property (e.g,. foreclosure or destruction due to fire, flood, or earthquake)
- natural or man-made disasters or acts of terrorism
- any of the following in the case of a qualified individual (under the change in employment test)
- death
- cessation of employment and the individual is eligible for unemployment compensation
- change in employment or self-employment and the taxpayer is unable to pay housing costs and basic living expenses
- divorce or legal separation under a decree of divorce or separate maintenance
- multiple births resulting from the same pregnancy
- an event the IRS determines to be from unforeseen circumstances. Examples include:
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- probation’s officer’s recommendation to move to avoid harassment from neighbors
- criminal activity in the neighborhood
- the need for a larger home to facilitate an adoption
- unexpected excessive noise
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Buzzkill Disclaimer: This post contains general tax information that may or may not apply in your specific tax situation. Please consult a tax professional before relying on any information contained in this post.
