Monthly Archives: October 2015
How Businesses Deduct the “Portion of Revenues Donated to Charity”
Some businesses advertise that they will donate a certain percentage of their revenues to a charity. The IRS recently issued guidance from its Chief Counsel that explains how these donations to various organizations are deducted.
In the Chief Counsel Advice (CCA), the business donated funds to organizations that were qualified charities and to organizations that were not qualified charities, but had a social mission included in their corporate bylaws.
Donations to Qualified Charities
An issue that the CCA addresses is whether the donations to qualified charities were deductible as charitable donations (IRC Section 170) or as ordinary and necessary business expenses (IRC Section 162).
The CCA resolves this issue by stating when the transfer to a qualifying charity is directly related to the taxpayer’s business and is made with a reasonable expectation of financial return commensurate with the amount transferred, the transfer is treated as a business expense and not as a charitable donation deduction.
The CCA held that the business appeared to have acted with the reasonable belief that, in establishing the charitable donation program, it would enhance and increase its business. As a result, the business’ donations to qualifying charities were deductible as ordinary business expenses.
This is beneficial to taxpayers for a couple reasons. The first is that, while ordinary business expenses must still be substantiated, charitable donations are subject to much stricter substantiation requirements.
The other reason that it is preferential for these expenses to qualify as business deductions is that charitable contributions are subject to percentage-of-income limitations. Pass through entities pass charitable donations through to their owners where the charitable donations are deducted as itemized deductions (generally limited to 50% of AGI). Ordinary businesses expenses are not subject to these limitations.
Donations to Nonqualified Charities
If the organization is not a qualifying charity then the donation is clearly not deductible as a charitable contribution. However, if the business has a reasonable expectation of commensurate financial return from the donations, then the donation will be deductible as an ordinary and necessary business expense.
There is an exception for donations to organizations that engage in lobbying. A business expense is not allowed for any amount paid in connection with influencing legislation or participation or intervention in any political campaign on behalf of (or in opposition to) any candidate for public office.
Merely donating money to an organization conducting lobbying activities is not an activity for purposes of supporting a lobbying communication. The CCA says that this phrase is intended to include more direct support such as research, planning, and coordination.
To see how this applies to you, give us a call at 248-538-5331.
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.
How to Exclude Foreign Earned Income from U.S. Tax
U.S. citizens and resident aliens are taxed on their worldwide income. This can lead to double taxation when a U.S. citizen or resident alien works abroad and incurs foreign income taxes. The foreign tax credit can reduce U.S. tax so that the double tax impact is lessened. Another available tax provision that lessens the double tax bite is the foreign earned income exclusion.
Background
IRC Sec. 911 provides U.S. citizens and resident aliens who work or have a business abroad to exclude a significant portion of their foreign earned income. For 2015, such individuals can exclude up to $100,800 of foreign earned income from their U.S. taxable income. Of course, they must still pay foreign income tax on this income, but the double taxation detriment has been greatly reduced.
Who Qualifies for the Foreign Earned Income Exclusion
To be eligible for the exclusion, an individual’s tax home must be in a foreign country. Generally, a tax home is the general area of the taxpayer’s main place of business or employment, regardless of where the family home is maintained.
There are two ways to establish a tax home in a foreign country:
- the bona fide residence test
- the physical presence test
The Bona Fide Residence Test
This test is based on the taxpayer’s intent in residing in a foreign country. The test is subjective and requires a taxpayer to satisfy the IRS that he/she has been a bona fide resident of a foreign country for an uninterrupted period of time that includes an entire year.
Factors the IRS will consider in determining the taxpayer’s intent to reside in the foreign country are:
- whether the taxpayer bought a home or entered into a long term lease in the foreign country
- the nature, extent, and reasons for temporary absences from the foreign home
- whether, and for how long, the taxpayer’s family has lived in the same foreign country
- whether the taxpayer has made a serious effort to become involved in the social life and culture of the foreign country
- whether the taxpayer maintains a home in the U.S., whether that home is rented out to others, and the taxpayer’s relationship to the renters
- whether the taxpayer has gone abroad with the intent to evade U.S. taxes
The Physical Presence Test
This test requires a taxpayer to be physically present in a foreign country for 330 full days during any 12 consecutive months. Unlike the bona fide residence test, the physical presence test is completely objective, requiring only the counting of qualifying days.
How the Exclusion is Calculated
The foreign earned income exclusion is computed on a daily basis. The total number of qualifying days under the bona fide residence test or the physical presence test are divided by the total number of days during the year.
This exclusion is limited to the amount of earned income in foreign countries. This requires taxpayers to allocate their work days or earned income between foreign qualifying work days and other work days (e.g., U.S. work days).
Example: Grover, a U.S. citizen, is a bona fide resident of Freedonia from May 1, 2013 through November 30, 2015 and has a salaried position in Freedonia during this period. Before and after this period, Grover has U.S. salary income.
Grover earns $90,000 in 2013 and $110,000 in 2014. These amounts are earned equally throughout the year.
The maximum foreign earned income exclusion in 2013 was $97,600 and was $99,200 in 2014.
For 2013, Grover’s maximum foreign earned income exclusion is $65,512 ($97,600 maximum foreign income exclusion times 245 days in Freedonia divided by 365 days in the year). For 2014, Grover’s maximum foreign earned income exclusion is $99,200 ($99,200 maximum foreign income exclusion times 365 days in Freedonia divided by 365 days in the year).
Grover’s actual foreign earned income exclusion is limited by his actual foreign earned income, which must be apportioned between foreign earned income and other income (e.g., U.S. income).
Assume there are 240 work days during the year. In 2013, Grover worked 161 work days in Freedonia and in 2014, Grover worked all 240 work days in Freedonia.
For 2013, Grover’s foreign earned income exclusion is the lesser of $65,512 or $65,473 ($97,600 salary times 161 work days in Freedonia divided by 240 work days during the year).
For 2014, Grover’s foreign earned income exclusion is the lesser of $99,200 or $110,000 ($110,000 salary times 240 work days in Freedonia divided by 240 work days during the year).
If Grover’s salary was not earned equally throughout the year, it would be more appropriate to apportion his salary based on where it was earned rather than on the number of days worked in each country.
A related income exclusion is for employer paid housing costs for a taxpayer in a foreign country. This is a topic for a future post.
To see how this applies to you, give us a call at 248-538-5331.
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.
Out-of-State Companies Will Start Collecting Sales Tax from Michigan Residents
If you’ve made a very recent purchase from Amazon.com or another out-of-state company and were surprised that you were charged sales tax, this post will explain what has happened.
Background
The U.S. Supreme Court ruled over 20 years ago that a state could not force an out-of-state company to collect sales tax from the state’s residents if the company does not have a physical presence in the state. A company generally has a physical presence in the state if it has an office, employees, equipment, delivery trucks, etc. in the state.
What is Affiliate Nexus?
In 2014, the Michigan legislature passed a law that requires out-of-state sellers to collect sales tax from Michigan residents if the out-of-state seller has Michigan residents acting as solicitors. The solicitors do not have to be employees of the company. Basically, Michigan considers the out-of-state company to have physical presence in the state based on the presence of non-employee solicitors who are Michigan residents. This is referred to as affiliate nexus and similar laws have been passed in other states.
Amazon.com, among other companies, have affiliate programs where residents (individuals and business entities) can place links to the companies’ products on their own websites. The company would then pay a commission to the resident if a purchase is made from a purchaser who clicked through that resident’s website to the company’s.
Under the new law that became effective October 1, an out-of-state company is presumed to be engaged in the business of retail sales in Michigan if the seller has entered into an agreement with one or more Michigan residents under which the resident refers potential purchasers (by an internet link, by in-person oral presentation, etc.) to the seller for a commission or other consideration based on completed sales.
Which Out-of-State Companies are Affected?
The out-of-state company is exempt from this new law if it only has minimal sales in the state. The provision will apply if:
• Gross receipts from all referred sales to purchasers in Michigan are greater than $10,000 during the immediately preceding 12 months AND
• Gross receipts from all sales to purchasers in Michigan exceed $50,000 during the immediately preceding 12 months
Example: Internet.com sells products via the internet across the country. It has an affiliate program in Michigan. It has no other connection or presence in Michigan. The affiliate program generates $5,000 in sales over the past 12 months. Internet.com’s total sales in Michigan are $100,000. Internet.com is not subject to the new law because it has less than $10,000 in sales from the affiliate program.
Example 2: Same facts as above except that Internet.com has $10,001 in affiliate program sales and $50,001 in total Michigan sales over the past twelve months. Internet.com is now presumed to be in the business of retail sales in Michigan and is required to collect Michigan sales tax from Michigan residents because it surpasses both thresholds.
How Out-of-State Companies Rebut the Presumption
A company meeting the above requirements is presumed to be engaged in making retail sales in Michigan. The presumption can be rebutted by demonstrating that the residents with whom the seller has an agreement did not engage in any solicitation or other activity that is significantly associated with the seller’s ability to establish or maintain a market in Michigan.
The Michigan Department of Treasury issued proposed guidance on what type of evidence will rebut the presumption.
This evidence includes:
Contract Conditions: the agreement between the seller and the resident provides that the resident is prohibited from engaging in any solicitation activities in Michigan on behalf of the seller.
Proof of Compliance: Each resident representative provides to the seller a signed statement stating that the resident has not engaged in any prohibited solicitation or other activities in Michigan on behalf of the seller.
Merely hiring an advertising company or agent in Michigan will not subject the seller to this new law unless the advertising company or agent is compensated with a commission or other consideration based on completed sales.
Two Final Notes…
First, even if this law was not passed. Amazon.com is expanding its office in Detroit and will have a physical presence in the state that would require it to collect sales tax from Michigan residents anyway.
Second, Michigan residents were already required to report purchases from out-of-state companies and pay use tax on these purchases on their Michigan income tax returns.
To see how this applies to you, give us a call at 248-538-5331.
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.
Choice of Business Entity for the Professional
Professionals who are starting their own firms run into significant tax and legal issues in setting up their new businesses. These range from choosing the correct form of legal entity to taking advantage of tax planning opportunities. This post will describe some of the legal entities available and how the choice will impact professionals.
Making the Choice of Entity Decision
Forming a corporation or LLC is a common method of limiting the professional’s liability. However, forming one of these entities will not protect a professional’s personal assets from liability for his or her own malpractice. These entities will; however, protect the professional from the malpractice of the company’s employees in most circumstances. These entities will also shield the professional from contractual liabilities (assuming the liabilities are not personally guaranteed).
The Single Member LLC (SMLLC): For tax purposes, the SMLLC is ignored and is treated as a sole proprietorship. The
professional will report the income and expenses from the LLC on her personal tax return on Schedule C. The SMLLC can elect to be treated as a corporation. Despite being disregarded for tax purposes, the SMLLC is not disregarded for liability protection purposes.
Multimember LLCs: Much like the SMLLC, the multimember LLC is ignored for federal tax purposes and is treated as a partnership. The income and expenses of the LLC will be reported on Form 1065. The multimember LLC can also elect to be treated as a corporation. An advantage of forming a multimember LLC is that partnership taxation is more flexible than corporation taxation and allows special allocations of income and deductions. This is relevant to professionals because income can be allocated to members based on member performance and/or differences in capital contributions.
C Corporations: Setting up one or more professionals as shareholder-employees of a C corporation will typically maximize the availability of tax-advantaged fringe benefits for the ownership group. However, C corporations are subject to double taxation. Most corporations are subject to graduated tax rates that range from 15% to 35%. If the C corporation is classified as a professional corporation, it will be subject to a flat 35% income tax rate. This 35% rate applies to professionals because they are believed to be in a high personal tax bracket and the tax rules prevents them from sheltering income in a corporation that is in a lower tax bracket.
To avoid double taxation and/or the 35% tax rate, taxable income of the C corporation is typically zeroed out by paying compensation, fringe benefits, and bonuses to shareholder-employees. However, if compensation is unreasonably high, the IRS can reclassify the compensation as non-deductible dividends and subject to corporate income to the 35% tax rate.
A disadvantage of C corporations is that losses of the C corporation are not allowed to offset the income of the shareholders. This is a distinct disadvantage to using a C corporation as opposed to an S corporation or LLC where the business’ losses are available to offset income on the owners’ personal returns.
S Corporations: S corporations avoid the double taxation and 35% flat tax rate problems of the C corporation. However, strict qualification rules must be met for a corporation to qualify as an S corporation. The rule requiring pro rata profit, loss, and distribution allocations among the shareholders may not work with many professional businesses which have special allocations among their owners.
The S corporation does have a critical advantage over LLCs. The profit of an S corporation is not subject to self-employment tax, which is a 15.3% tax. However, the shareholders must receive a reasonable salary from the S corporation, otherwise the IRS may reclassify distributions of profit from the S corporation as salary and charge self-employment tax on the distributions.
To see how this applies to you, give us a call at 248-538-5331.
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.
When Sales Tax Applies to Delivery and Installation Charges
Michigan has a 6% sales tax on gross proceeds from sales of tangible personal property. For periods after September 1, 2004, the sales tax act was amended to provide that gross proceeds includes delivery and/or installation charges in certain instances. New guidance from the State was recently issued to help determine when delivery and installation charges are subject to sales tax.
The law provides that gross proceeds include the following:
• Delivery charges incurred before the transfer of ownership of tangible personal property from seller to buyer and
• Installation charges incurred before the transfer of ownership of
tangible personal property from seller to buyer
The Factors the State of Michigan Considers when Determining if Delivery/Installation Charges Are Subject to Sales Tax
The Michigan Department of Treasury will consider all facts and circumstances to determine if delivery or installation charges are subject to tax. Such factors to be considered include:
• Whether the customer has the option to either pick up the property or have the property delivered
• Whether the delivery or installation charge is separately negotiated and contracted for on a competitive basis
• Whether the property and delivery or installation charges are separately invoiced
• Whether the taxpayer’s books and records separately identify the transactions used to determine the tax on the retail sale
• Whether delivery or installation service records (separated from the main business) indicate a profit
• The time at which risk of loss and title transfer from seller to buyer
What if a Single Delivery Charge Applies to Taxable and Exempt Sales?
Delivery charges on exempt property (e.g., sales for resale) are not subject to sales tax. However, when there is a single delivery charge on a sale containing both taxable and exempt property, the delivery charge is apportioned between the taxable and exempt sale. Sales tax will apply to the portion allocated to the taxable sale. This allocation can be based on either relative sales price or relative weight of each property.
The choice of allocation method is in the seller’s discretion.
Example: XYZ Corp purchases inventory and supplies from Seller, Inc. Inventory is exempt property and the supplies are taxable. XYZ pays $80 for inventory and $20 for supplies. The inventory weighs 50 pounds and the supplies also weigh 50 pounds. The delivery charge is $20. Based on price, the taxable delivery charge is 80% of $20 or $16. The sales tax is $0.96. If based on weight, half of the delivery charge is taxable ($10). The sales tax is $0.60.
Examples of Sales Tax on Delivery Charges
Example: ABC sells appliances. When a customer purchases property from ABC, she may either arrange for her own delivery or ABC, at additional cost, will provide delivery.
Scenario 1: if the customer chooses ABC for delivery, a separate contract is entered into by the customer and ABC after the sale which passed all rights of title to the customer. Because the delivery charge is incurred after the transfer of ownership, the delivery charge is not taxable.
Scenario 2: if the customer chooses ABC for delivery, no separate contract is entered and the delivery charges are itemized as “Shipping & Handling” on the same invoice as the appliance. Under the terms of the sale, risk of loss remain with ABC until delivery. The customer pays the entire invoice at the time of purchase. Because the delivery charge is incurred before the transfer of risk of loss, it is taxable.
To see how this applies to you, give us a call at 248-538-5331.
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.
