Curcuru & Associates CPA, PLC | 248-538-5331

Expanded 1099 Requirements Finally Repealed

Share This:

 

On April 14, the President signed into law the Comprehensive 1099 Taxpayer Protection and Repayment of Exchange Subsidy Overpayments Act of 2011.  This law repealed both the expanded 1099 reporting requirements mandated by last year’s new health care law and also the 1099 reporting requirements imposed on taxpayers who receive rental income which was mandated by last year’s Small Business Jobs Act.

Last year’s health care law expanded the 1099 reporting requirements to include all payments from businesses totaling $600 or more in a year to a single recipient for purchases of property.  The term “property” had a broad meaning and would require businesses to issue SUBSTANTAIILY MORE 1099s.  This expanded 1099 requirement was going to become effective January 1, 2012 but is now repealed.

Last year’s Small Business Jobs Act added a new 1099 reporting requirement to people who rent out real estate.  The Jobs Act required landlords to issue 1099s to vendors who provided them with services if the amount paid to the vendor was at least $600.  Landlords would have started to issue 1099s to repair companies, utility companies, lawyers, accountants, etc.  This law was going to become effective this year (January 1, 2011), but is now repealed.

One provision that was NOT repealed was the increased penalties associated with not filing 1099s that are currently required by law and for filing 1099s with incorrect information.  The penalties have essentially doubled and range from $30 per incorrect/late 1099 to $100 per incorrect/late 1099.

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.

Any tax advice contained in the body of this post was not intended or written to be used, and cannot be used, by the recipient for the purpose of avoiding penalties that may be imposed under the Internal Revenue Code or applicable state or local tax law provisions. Any information contained in this post does not fall under the guidelines of IRS Circular 230.

Nightmare for People Who Rent Out Real Estate Starts This Year

Share This:

There has been quite a bit of chatter about the new 1099 reporting requirements for businesses beginning with expenses paid in  2012.  There has been much less chatter about the 1099 reporting requirement that became effective for payments made on or after January 1, 2011 (yes, this year) for taxpayers who have rental income from real property rentals.

The Small Business Jobs Act of 2010 requires taxpayers who lease out rental real estate to issue 1099s to persons and corporations to whom taxpayers make payments totaling $600 or more in a year.  Examples of  covered payments include repairs, premiums, property and equipment, payments to accountants >:-( , etc.

Bottom line–starting this year, if you rent real estate you have to start tracking exact amounts paid to each vendor, collect a Form W-9 to obtain the vendor’s EIN and address, issue that vendor a 1099 at year end, and send a copy of the 1099s you issued to IRS.

Certain taxpayers are exempt from this 1099 reporting requirements.  These exempt taxpayers include:

  • individuals who can show that reporting is a hardship (good luck with this one)
  • individuals who receive a minimal amount of rental income
  • certain military personnel
  • The IRS is expected to issue guidance on these exemptions.
Other 1099 reporting requirements
The 1099 reporting requirements for all businesses begin for payments over $600 per vendor made after December 31, 2011.  This will be a bookkeeping nightmare for business owners.  
Example:  You buy gas throughout the year at three gas stations.  Two of the gas stations are Marathons and one is a Sunoco.  You spend $500 at each location.  If the two Marathon locations are separate corporations, you do not have to issue any 1099s since the total payments to each corporation are under $500.  However, if the two Marathons happen to operate within the same corporation, you will have to issue a 1099 to the Marathon.  How will you know if the Marathons operate under the same corporation?  You’ll have to get a Form W-9 from each location to see if they operate under the same corporation.  In fact, you’ll pretty much have to get a Form W-9 for any business expense if it’s possible that you may spend more than $600 with that vendor.  

There is an exception for payments you make via credit card.  If you make a payment by credit card, you will not have to report that payment on a Form 1099.  The reason is because credit card companies will have to start reporting credit card receipts by businesses beginning January 1, 2011.  Since the credit card company is already reporting the revenue received by the vendor from its transaction(s) with you, you do not have to report the same transaction amount on a Form 1099.
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.

Any tax advice contained in the body of this post was not intended or written to be used, and cannot be used, by the recipient for the purpose of avoiding penalties that may be imposed under the Internal Revenue Code or applicable state or local tax law provisions. Any information contained in this post does not fall under the guidelines of IRS Circular 230.

Brand New 1st Year Expensing & FICA Tax Cut

Share This:

This post will explain a couple more of the changes in the Tax Relief, Unemployment Insurance Reauthorization, and Job Creation Act of 2010.  


In this post, I will focus on

  • 100% bonus depreciation for September 8, 2010 through December 31, 2011
  • 50% bonus depreciation for all of 2012
  • The reduction in the employee portion of FICA for Old Age, Survivors, and Disability Insurance
100% and 50% Bonus Depreciation

It seems like only a month ago when I posted the return of 50% bonus depreciation under the Small Business Jobs Act of 2010.  Actually, it was two months ago.  That post can be read here.  Bonus depreciation allows you to deduct the purchase price of certain assets much faster than if you had to follow the normal depreciation schedules. 

The 2010 Tax Relief Act extends and expands additional first year depreciation to equal:
  • 100% of the cost of qualified property placed in service after September 8, 2010 and before January 1, 2012
    • Why such a specific date such as September 8?  Wonder what Congressperson/Senator has a constituent that bought a lot of assets on September 9…
  • 50% of the cost of qualified property placed in service after December 31, 2011 and before January 1, 2013.
Example:  ABC Corp bought $1 million of assets on October 1, 2010.  It can fully deduct the $1 million of asset purchases in 2010.  If it creates a net loss for the business, the loss can be carried back or carried forward.

Only assets that meet the following criteria are eligible for bonus depreciation:
  • It falls into one of the following categories:
    • property with a recovery period of 20 years or less
      • which includes most physical assets other than real estate
    • computer software (generally, off-the-shelf software)
    • qualified leasehold improvement property
  • ITS ORIGINAL USE BEGINS WITH THE TAXPAYER (I.E., IT IS PURCHASED NEW)
Qualified leasehold improvement property means any improvement to an interior portion of a nonresidential building if

  • such improvement is made pursuant to a lease by the lessee, sublessee, or lessor of such improved portion
  • such portion is to be occupied exclusively by the lessee or sublessee
  • such improvement is placed in service more than 3 years after the date the building was first placed in service

Qualified leasehold improvement property does NOT include:

  • an enlargement of a building
  • any elevator or escalator
  • any structural component benefiting a common area
  • the internal structural framework of the building

A lease between related persons (e.g., a lease between a taxpayer and his 80% owned business) does not qualify.


Bonus depreciation will not apply to qualified restaurant or qualified retail improvement property.

FICA Tax Cut

The Federal Insurance Contributions Act (FICA) imposes two taxes that total 7.65%.  The first is a 6.2% tax for Old Age, Survivors, and Disability Insurance (OASDI).  The second is a 1.45% tax for hospital insurance (Medicare).  Under old law, the employer and employee each paid a FICA tax rate of 7.65%.  Self employed people pay both the employer and employee portion of FICA and therefore pay self employment tax of 15.3% (7.65% times 2).  
For compensation received in 2011, the Act reduces the employee OASDI tax rate from 6.2% to 4.2%.  The total FICA taxes paid by employees will be 5.65% (4.2% OASDI plus 1.45% Medicare).  The employer portion of OASDI remains at 6.2%.  The employer continues to pay the current FICA rate of 7.65% on its employees’ wages (6.2% OASDI plus 1.45% Medicare).
The OASDI rate for self employment people is reduced from 12.4% to 10.4%.  The total self employment tax is therefore 13.3% for 2011 (10.4% OASDI plus 2.9% Medicare).  
Under old law, self employed people were able to deduct half of the self employment taxes paid.  The deductible half represented the employer portion of FICA.  Since the employer portion of OASDI is 6.2% and the employee portion is 4.2%, the deductible employer portion of total OASDI is now 59.6% (6.2% divided by total OASDI of 10.4%).  The deduction for the Medicare portion of self employment tax remains at 50%.
Example:  Joan has a proprietorship with $92,350 income subject to self employment tax.  The OASDI portion of self employment tax is $9,604.40 ($92,350 times OASDI tax rate of 10.4%.  The Medicare portion of self employment tax is $2,678.16 ($92,350 times Medicare tax rate of 2.9%).  Joan can deduct 59.6% percent of her OASDI tax of $9,604.40–which is a deduction of $5,724.22.  Joan can deduct 50% of her Medicare tax of $2,678.16–which is a deduction of $

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.

Any tax advice contained in the body of this post was not intended or written to be used, and cannot be used, by the recipient for the purpose of avoiding penalties that may be imposed under the Internal Revenue Code or applicable state or local tax law provisions. Any information contained in this post does not fall under the guidelines of IRS Circular 230.

Big Changes to the Estate Tax Law

Share This:

On December 17, the President signed into law the Tax Relief, Unemployment Insurance Reauthorization, and Job Creation Act of 2010.  This law prevented the increase in tax rates for all taxpayers, as well as create some new and interesting tax law changes for both individuals and businesses.  This post will focus on the radical changes to the estate tax.
Notable changes to the estate tax include:
  • A $5 million exemption ($10 million for spouses)
    • The estate tax exemption would have been $1 million in 2011
  • A 35% tax rate (down from 45% in 2009)
    • The estate tax rate would have maxed out at 55% in 2011
  • Estate tax exemption portability 
  • For 2010 the choice of either:
    • being subject to the estate tax and receiving a step up in basis
    • not being subject to the estate tax and following the carryover basis rules
A Very Brief History of the Estate Tax
Over the past ten years, Congress had phased the estate tax out of existence.  In 2009, the estate tax exemption amount was $3.5 million dollars and the estate tax rate was 45%.  In 2010, the estate tax was completely abolished; although the gift tax remained with an exemption of $1 million and a 35% tax rate.  When the estate tax is in effect, assets receive a “step up” in basis in the hands of the inheritors.  This means that the basis of assets equals the fair market value at the date of death, and the inheritors can then sell the assets tax free (if sold promptly after death).
Example:  John bought stock for $20,000 in 1960.  John died in 2009 while the value of the stock was $200,000.  John’s son Tim inherits the stock.  If there was no step up in basis, Tim would sell the stock for $200,000 and would have a gain of $180,000 ($200,000 sales price less $20,000 basis).  Since John died while the estate tax was in effect, the stock gets a step up in basis to $200,000. Tim can now sell the stock for $200,000 without a gain ($200,000 sales price less $200,000 basis).  Tim will have gain or loss if he sells the stock over or under $200,000.

In 2010, since there was no estate tax, there was no step up in basis.  The basis of assets in the hands of the inheritors would be equal to the lesser of market value or the original cost (plus improvements) of the assets.  However, even under the carryover basis rules, taxpayers could still step up the basis of assets up to $1.3 million (a surviving spouse could increase the basis of assets by an additional $3 million).
The New Estate Tax

Higher Exemption Amounts and Lower Tax Rate
The current exemption amount is $5 million per taxpayer, and $10 million for a married couple.  A flat tax rate of 35% applies to amounts over these exemptions.
Estate Tax Exemption Portability
This tax change is very substantial.  But first, some background info:  Each taxpayer has a $5 million exemption.  Taxpayers can transfer assets at their deaths to their spouses free of estate tax.  Under old law, transferring assets to a surviving spouse wasted the exemption of the first spouse to die.
Example:  John and Tina are married.  John has a $10 million estate.  Tina is destitute.  When John dies, Tina inherits all of John’s assets.  There is no estate tax because the surviving spouse inherited all the assets.  However, when Tina dies, her estate is $10 million.  Her estate tax exemption is $5 million, which makes her estate subject to estate tax of $1,750,000 ($10 million estate less $5 million exemption = $5 million estate subject to a tax rate of 35%).  Since John bequested all of his assets to his spouse, he never used his own estate tax exemption.

Exemption portability means that the surviving spouse can now utilize the unused estate tax exemption of her deceased spouse.  
Example:  Same as above, except now exemption portability applies.  Tina can still use her own $5 million tax exemption.  Under portability, she can now use her husband’s unused tax exemption of $5 million.  Since her total exemption of $10 million equals her assets at her death, she will have no estate tax.

To use the exemption portability, the first spouse to die must elect to use portability on his/her estate tax return.  An estate tax return must be filed by the first spouse to die to use portability even if the return is not otherwise required to be filed.
To Be (Subject to the Estate) or Not to Be (Subject to the Estate Tax)
For 2010 only, the choice is between:
  • being subject to the estate tax and receiving a step up in basis
  • not being subject to the estate tax and following the carryover basis rules (an election is required for this choice)
Why would someone want to be subject to the estate tax?  For most people it won’t make sense to be subject to the estate tax.  Even under the carryover basis rules, you can increase the basis of your assets up to $1.3 million (up to $3 million for spouses).  Therefore as long as you want to step  up the basis of your assets under $1.3 million or $3 million, it probably doesn’t make sense to be subject to the estate tax.  Where it does make sense is if you want to step up the basis of your assets over these amounts and won’t be subject to the estate tax (or would be subject to very little estate tax).
Example:  Jane has assets of $1.5 million.  Her basis in her assets is $500,000.  Since the potential step up in basis is the difference of $1 million between the market value and basis, and this amount is less than the maximum step up of $1.3 million, Jane can simply step up the basis of her assets by $1 million under the carry over basis rules.

Example 2:  Jane has assets of $4.5 million and a basis in those assets of $1 million.  Here, the potential step up is $3.5 million.  Under the carryover basis rules, the most that Jane could step up the basis of her assets is $1.3 million.  Under these circumstances it makes sense for Jane to be subject to the estate tax (which would be zero because her estate is under the exemption amount of $5 million), and receive a full step up in basis of $3.5 million.

If Jane has an estate over the exemption amount and would be subject to the estate tax, her advisor would have to do some number crunching to see if it is better to pay estate tax and receive a full basis step up, or avoid the estate tax and end up paying higher income taxes on gains from sales of assets that didn’t receive a basis step up.
Other items to take note:
  • The gift tax exemption is increased to $5 million (up from $1 million) and gift tax is at a 35% rate
  • The generation skipping tax (GST) exemption is $5 million.  
  • The GST tax rate in 2010 is 0%, then 35% in 2011 and 2012
  • There are extensions of filing deadlines for those who died before the enactment of these tax law changes
Oh, and by the way, all these tax rules change on January 1, 2013.  
Happy Holidays!
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.

Any tax advice contained in the body of this post was not intended or written to be used, and cannot be used, by the recipient for the purpose of avoiding penalties that may be imposed under the Internal Revenue Code or applicable state or local tax law provisions. Any information contained in this post does not fall under the guidelines of IRS Circular 230.

Tax Issues for Medical Marijuana :)

Share This:

In 2008, Michigan voters approved the legalization of medical marijuana  Medical marijuana clinics are opening and this creates new and interesting issues in how these clinics will be taxed.  This post will explain the following federal tax issues:

  • will deductions be allowed for expenses of medical marijuana clinics?
  • will medical marijuana clinics be allowed tax exempt status?

I’m going to have a little fun with this post, so please don’t be offended.  

Deducting Expenses Incurred in Illegal Activities.

Last year I wrote a light hearted post on deducting expenses in illegal activities.  View that post here

In 1969, Congress added language to the tax law that explicitly denied deductions for the following expenses:

  • Bribes and kickbacks. IRC §162(c)
  • Fines and penalties. IRC §162(f)
  • Punitive damages portions of criminal antitrust violations. IRC §162(g)

The legislative history of these provisions indicate that this list is all inclusive—thus, expenses of illegal activities are deductible against federal income tax unless Section 162 explicitly provides that the expenses are not deductible (as it does in the above list).

However, IRC §280E provides that no deduction or credit shall be allowed for any amount paid or incurred during the taxable year in carrying on any business if such business consists of trafficking in controlled substances (within the meaning of schedule I and II of the Controlled Substances Act) which is prohibits by Federal law OR the law of any State in which such trade or business is conducted.

While medical marijuana may be legal under Michigan law, it is still illegal under Federal law (Marijuana is on schedule I of the Controlled Substances Act and therefore is an illegal controlled substance).  Under Section 280E, business expenses will be disallowed when the substance is illegal under either Federal or state law.  Since medical marijuana is illegal under Federal law, business expenses will be disallowed even though medical marijuana is legal under Michigan law.

In 2007, the Tax Court confirmed the IRS’ position on the disallowance of business expenses under Section 280E for a not-for-profit California corporation selling medical marijuana legally under California law. 

Can a Medical Marijuana Clinic Achieve Tax Exempt Status?

The federal government does not allow Section 501(c) status to medical marijuana clinics due to public policy reasons.  Application of the public policy doctrine to the allowance of Section 501(c) status dates back to a series of court cases in the early 1970s related to non-profit status of racially discriminatory schools.  In Bob Jones University vs. U.S., the Supreme Court that “to warrant exemption under Section 501(c)(3), an institution must fall within a category specified in that section and must demonstrably serve and be in harmony with the public interest.” 

Since the position of the federal government is that medical marijuana violates public policy, it will not grant tax exempt status to medical marijuana clinics.

[youtube=http://www.youtube.com/watch?v=_L8DcjFOD1k&w=425&h=355]

Section 179 & Bonus Depreciation: A Love Story

Share This:

The recent Small Business Jobs Act of 2010 extended two provisions that help business owners deduct asset purchases faster.  The first provision allows 50% bonus depreciation on new assets purchased and placed in service during 2010 (this provision had expired December 31, 2009).  The second provision increases the Section 179 expense allowance to $500,000.  Section 179 is an election that can be made to immediately deduct the cost of certain assets.

What’s So Great about 50% Bonus Depreciation?

Bonus depreciation allows you to deduct the purchase price of certain assets much faster than if you had to follow the normal depreciation schedules.  Under bonus depreciation, you can immediately deduct 50% of the cost of eligible property.  The remaining purchase price is depreciated over the asset’s useful life.


Example:  You buy $100,000 of eligible property (defined below) during 2010.  The annual depreciation under regular depreciation and bonus depreciation (assuming it’s 5 year property) is shown in the following table:

Year
Regular Depreciation
Bonus Depreciation
1
$20,000
$60,000*
2
$32,000
$16,000
3
$19,200
$9,600
4
$14,400
$7,200
5
$14,400
$7,200
Total
$100,000
$100,000



* The $60,000 is composed of 50% bonus depreciation ($50,000) plus regular depreciation on the remaining purchase price of $50,000 ($10,000).


What is Eligible Property for Bonus Depreciation?
Eligible property includes:

  • tangible personal property with a recovery period of 20 years or less (which is pretty broad)
  • it is placed in service before January 1, 2011
    • certain long-period-production property and certain transportation property may be placed in service before January 1, 2012)
  • its ORIGINAL use must begin with the taxpayer (i.e., it is new and not used property)
Even though bonus depreciation only applies to new property, it may apply to reconditioned property.
Example:  John buys a $15,000 used machine and reconditions it for $10,000.  The $15,000 purchase price for the used equipment is not eligible for bonus depreciation, but the $10,000 for reconditioning is eligible for bonus depreciation.  

A safe harbor provides that property containing used parts is not treated as used if the cost of the used parts does not exceed 20% of its total cost.  In other words, for example, if a taxpayer buys a machine consisting of 80% new parts and 20% used parts is treated as having bought a new machine whose total cost is eligible for bonus depreciation.  
New property initially used by the taxpayer for personal use and then converted to business use meets the original use requirement.
Example:  Sara bought a new pickup truck that she used personally.  Later, she started a business and began using the pickup exclusively in her business.  The pickup is eligible for bonus depreciation as original use property because its use began with Sara, even though the original use was not business use.  The amount eligible for regular and bonus depreciation is the lower of market value or original purchase price when she starts to use the pickup in her business. 

Section 179 and You

Under Section 179, a taxpayer can elect to deduct as an expense in the year of purchase up to a specified amount of the cost of new or used tangible personal property.  The remainder of the purchase cost is depreciated over the asset’s useful life.  For tax years beginning in 2010 and 2011, the dollar limitation on the expense deduction is $500,000.  The amount was $250,000 for 2010 before the law change.  The Section 179 expense allowance is reduced dollar for dollar when the cost of property placed in service for the year exceeds $2 million.
Example:  ABC Corp buys machinery and equipment for $2.1 million.  Since the property placed in service exceeds the limit by $100,000, the allowable Section 179 expense is reduced by $100,000 to $400,000.  

The Section 179 expense is limited to taxable income from any of the taxpayer’s trades or businesses.  If the taxpayer operates under an S corporation or LLC, Section 179 is also subject to the taxable income of the S corporation or LLC.  However, when determining the taxable income of an S corporation or LLC, shareholder wages (for an S corporation) or guaranteed payments (for an LLC) are added back to the business’ taxable income.  Section 179 disallowed because of the taxable income limitation can be carried forward indefinitely.  
Example:  S Corp has $100,000 of taxable income before Section 179 expense.  If S Corp buys $150,000 of equipment, its Section 179 expense is limited to its taxable income of $100,000.

Example 2:  Same as above example except that the $100,000 taxable income is after a $60,000 deduction for shareholder wages.  Since shareholder wages are added back to taxable income for Section 179 purposes, the adjusted taxable income is $160,000 and the S corp can claim the full $150,000 Section 179 deduction.

Example 3:  NEW SET OF FACTS:  Joan operates as a proprietorship and files a Schedule C (Profit or Loss from Business).  She has $2,000 of taxable income from the business and bought $5,000 of equipment.  Her husband has wages of $50,000.  Even though her proprietorship only has $2,000 of taxable income, she can claim the full $5,000 Section 179 expense because her husband’s $50,000 wages count as taxable income from a trade or business for Section 179 purposes.  

If a business can immediately deduct 100% of the purchase price under Section 179 up to $500,000, when would 50% bonus depreciation ever be advantageous?  Bonus depreciation would be advantageous if the taxable income limitation prevents the taxpayer from using the full Section 179 deduction.  Bonus depreciation is also helpful if the taxpayer has already used the full $500,000 Section 179 for the year and has bought additional assets for which it can claim bonus depreciation. Bonus depreciation can also be used to create a loss in the business which can be carried back to prior years to obtain an immediate refund.  Section 179 is limited to taxable income for the year and thus cannot be used to create a business loss that can be carried back. 


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.


Any tax advice contained in the body of this post was not intended or written to be used, and cannot be used, by the recipient for the purpose of avoiding penalties that may be imposed under the Internal Revenue Code or applicable state or local tax law provisions. Any information contained in this post does not fall under the guidelines of IRS Circular 230.

President Obama Signs a New Tax Law…New Blog Post

Share This:

On September 27 (yesterday) the President signed into law the Small Business Jobs Act of 2010.  There is some good news in this latest tax law change.  This post will provide a brief overview of the new law, and future blog posts will elaborate on each of the topics in this post.

Section 179 Deduction Increased for 2010 and 2011

The Section 179 deduction is a first-year deduction allowed for purchases of most tangible personal property.  The amount of the annual deduction for 2010 and 2011 is increased to $500,000 from $250,000.  There is a phaseout based on the amount of property you buy in a year.  The Section 179 deduction is phased out by one dollar for each dollar of tangible property purchases over $2 million ($800,000 under prior law). 

Up to $250,000 of Qualified Real Property is Eligible for Section 179 in 2010 and 2011

Under prior law, Section 179 was allowed only for tangible personal property.  For any tax year beginning in 2010 or 2011, a taxpayer can treat up to $250,000 of qualified real property as Section 179 property.

What is qualified real property?  It is:

  • qualified leasehold improvement property
  • qualified restaurant property
  • qualified retail improvement property

Clear?  Don’t worry-I’ll have a post on this topic in the very near future.

50% Bonus Depreciation is Back-But Just for 2010

50% bonus depreciation expired in 2009, but has been extended to 2010 under the new law.  Under bonus depreciation, you can immediately deduct 50% of the purchase price of qualifying property in the year of purchase.  Qualifying property includes most machinery, equipment or other tangible personal property, most computer software, and certain leasehold improvements.

Deduction for Start Up Expenses is Increased to $10,000

When taxpayers incur otherwise deductible expenses (such as payroll for training, advertising, or supplies) before a business opens, such expenses are usually deducted over 15 years.  Under prior law, up to $5,000 of such “start up” expenses could be deducted in the first year of business and the remainder deducted over the normal 15 years.  Under the new law, up to $10,000 of start up expenses can be deducted in the first year of business, and the remainder is deducted over 15 years. 

Health Insurance Costs for Self and Family are Deductible for Self Employment Tax for 2010

A self employed person can deduct the amount paid during the year for health insurance for herself, her spouse, her dependents, and effective March 30, 2010 for any child under age 27 as of the end of the year.  Under old law, the health insurance expense was not deductible against self employment income (which is taxed at a 15.3% FICA rate). 

For 2010 only, the health insurance expenses are also deductible against self employment income. 

Tax Treatment of Cell Phones is Simplified

Under old law, cell phones were considered listed property which required substantial recordkeeping that no one complied with.  There were some news stories earlier in the year that reported that the IRS would require 25% of the cost of employer-paid cell phones to be treated as compensation to employees to estimate their personal use of cell phones.  This never took effect.

Beginning in 2010, cell phones are no longer considered listed property.  To support a deduction for cell phones, the employer need only substantiate their cost, in much the same way as the employer supports the deduction for other types of business equipment.

Retirement Plan Distributions May Be Rolled Over to a Roth 401k

Under old law, rollovers to a designated Roth account (such as a Roth 401k) could only have been made from another designated Roth account.  Under new law, a distribution from an applicable retirement plan (401k, 403b, 475) that maintains a qualified Roth contribution program, a distribution from the portion of the plan that is not a designated Roth account may be rolled over to the designated Roth account portion of the plan. 

The rollover is not tax free.  The taxpayer must pay tax based on the market value of the distributed assets.  A 10% penalty will apply if any of the roll over funds are withdrawn within five years of the rollover. 

If there is a rollover in 2010, the income can be recognized over 2011 and 2012.  However, if there is a distribution of the rollover funds in 2010 or 2011, some of the income deferred to 2011 or 2012 will be recognized earlier.

So, that’s an overview of the brand new tax law.  I’ll be posting more often in the next couple weeks to expand on the above topics. 

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.

Any tax advice contained in the body of this post was not intended or written to be used, and cannot be used, by the recipient for the purpose of avoiding penalties that may be imposed under the Internal Revenue Code or applicable state or local tax law provisions. Any information contained in this post does not fall under the guidelines of IRS Circular 230.

Disallowed Losses: Pain in the S Corporation

Share This:

There are certain rules that may prevent you from deducting losses from your business.  The concern of the IRS is that business owners are taking loss deductions when they are not suffering an actual economic loss.  One way to limit taxpayers’ losses to the amount of economic loss they actually incur is through basis limitations.  This post will focus on the basis rules applicable to S corporations.

What is Basis?

While basis is a critical concept in tax law, it is not defined in the Internal Revenue Code or in Treasury regulations.  Basis is basically your investment in a business (i.e., the amount you “put into” the business).  To generate basis, you have to incur some type of actual economic outlay.  You cannot deduct losses in excess of your basis in the business.  Any distributions that exceed your basis in the S corporation are taxed as capital gains.  Basis is therefore advantageous and should generally be maximized.

Determining the Initial Basis in an S Corporation.

A shareholder’s initial basis in an S corporation depends on how the shares are acquired.

If Shares are Acquired by: Then Basis is:
outright purchase from an existing shareholder the initial cost of those shares
forming and capitalizing the S corporation equal to cash plus the original cost (not current market value) of assets contributed plus gain recognized on the transfer (if any)
gift equal to the basis in the hands of the donor (generally)
inheritance equal to the fair market value of the shares on the date of death (if the estate tax is in effect)
holding stock on the date the corporation makes an S corporation election the shareholder’s original basis in the stock
providing services to the corporation equal to the fair market value of the stock (the shareholder has compensation income for the services provided in exchange for the stock)

Shareholders generate basis in an S corporation by loans they make DIRECTLY to the S corporation.  It is VERY important to note that only direct loans to the business create basis—bank loans and other third party loans to the business do NOT generate basis.

Example:  Joan invests $5,000 from her savings accounts in her newly formed S corporation.  The S corporation borrows $20,000 from a bank to pay business expenses.  Joan has a basis in her S corporation of $5,000 for her cash contribution.  She can deduct losses up to her $5,000 basis.  The $20,000 bank loan to the S corporation does not increase Joan’s basis. 

Example 2:  Same facts as in the above example.  The S corporation has lost all of the $25,000 invested in it.  How much can Joan deduct as a loss on her tax return?  Only $5,000—her basis in the S corporation.  The $20,000 bank loan does not create basis.

Even if the shareholders personally guarantee bank loans and other third party loans to S corporations, they still do not receive basis for such loans.

A solution is to have the bank make the loan directly to the shareholder and then the shareholder will make a loan to the S corporation.

Example:  Now assume that Joan personally borrows $20,000 from a bank then loans it to the S corporation.  Joan now has a basis of $25,000 in the S corporation ($5,000 cash contributed plus $20,000 in direct shareholder loans).  Now that Joan’s basis is $25,000, she can deduct the full loss of $25,000.

If a business is going to have significant bank or third party debt, the business may be better off being organized as an LLC.  LLC members can receive basis for their shares of the LLC’s third party debt.

Any losses disallowed under the basis limitation are carried forward into future years and can be deducted if the shareholder’s basis in the S corporation increases.

How Shareholder Basis is Increased and Decreased

In addition to increasing basis by contributing cash, property, and making direct loans to the S corporation; each shareholder’s basis is adjusted each year by pass-through items of income, loss, and deduction, and by distributions to the shareholder.  Adjustments are generally made to stock basis in the following order.

  • increased by pass-through income and gain items;
  • decreased by distributions; and
  • decreased for pass-through items of loss or deduction.

Example:  Tina has a $5,000 basis in her S corp stock.  The S corp has current year revenues of $100,000, deductions of $50,000, and Tina received distributions during the year of $60,000.

Her basis and allowed losses are:

Initial Basis                   $5,000

Income Items             $100,000 (revenues)

Basis                         $105,000

Distributions              ($70,000)

Remaining Basis         $35,000

Allowed Losses          ($35,000) (limited to remaining basis)

Disallowed Losses      $ 15,000 (which are carried forward)

Example 2:  Same as above except that S corp only has $50,000 of revenues for the year:

Initial Basis                  $5,000

Income Items              $50,000 (revenues)

Basis                          $55,000

Distributions              ($70,000)

Excess Distributions    $15,000 (since distribution exceed basis,

                                              the shareholder has a capital

                                              gain in the amount of the excess

                                              distribution – $15,000)

Basis                            $0 (reduced to $0 by distributions)

Disallowed Losses         $50,000 (which are carried forward)

Wasn’t this fun.  The basis rules tend to trip up taxpayers when there’s a significant amount of third party debt for which the taxpayer does not receive basis.

If you have any questions on how these rules apply to you, please feel free to contact me with questions.

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.

Any tax advice contained in the body of this post was not intended or written to be used, and cannot be used, by the recipient for the purpose of avoiding penalties that may be imposed under the Internal Revenue Code or applicable state or local tax law provisions. Any information contained in this post does not fall under the guidelines of IRS Circular 230.

Claiming Children and Other People You Support as Dependents

Share This:

Most people claim their minor children as dependents.  The rules for claiming minor dependents is fairly straight forward.  Where the dependent deduction rules become much more complicated is where you try to claim other people as dependents.  For example, claiming an elderly parent, a niece of nephew that lives with you, an adult child, etc.

There are two categories of dependents that are deductible:

  • Qualifying Child
  • Qualifying Relative

Qualifying Child

A qualifying child is a person who:

  • is the taxpayer’s child or sibling, or a descendent of the taxpayer’s child or sibling (which includes grandchildren and nieces and nephews)
  • is 18 years old or younger (or 23 or younger if the child is a full time student)
  • lives with the taxpayer for more than half the year
    • a child who is away at school is deemed to live with the taxpayer
  • does not provide more than half of his own support

If the person you’re trying to claim as a dependent does not meet the requirements of a qualifying child, it’s possible you may claim the person as your dependent under the qualifying relative rule.

Qualifying Relative

A qualifying relative is a person:

  • who either
    • is the taxpayer’s
      • child or descendent (i.e., grandchild, great-grandchild, etc.)
      • parent or ancestor (i.e., grandparent, great-grandparent, etc.)
      • sibling, aunt, uncle, niece, nephew, cousin, or in-law
    • lives with the taxpayer for the full year
      • need not be a relative
  • whose gross income for the year is less than the personal exemption for the year ($3,650 for 2010)
  • who receives more than half of his/her support from the taxpayer
  • who is not a qualifying child of the taxpayer

The qualifying relative requirement is the traditional test for claiming dependents and may be familiar to you.  The qualifying child requirement was created a few years back to set a common definition of a qualifying child for claiming a dependency deduction, a child tax credit, a child care credit, and the earned income tax credit.  Before the adoption of the qualifying child requirement, each credit/deduction had its own definition of a qualifying child.

Let’s run through some examples…

Example:  John and Joan have three children.  They provide more than half of the support for each child.  Emily is 15 years old and has a part time job that pays $4,000 per year.  Tina is 20 years old and is a full time student who lives on campus.  Jimmy is 22 years old, is not a student, earns $10,000 per year, and lives in an apartment with a buddy.

They may claim a dependent exemption for Emily because she is a qualifying child.  She is the taxpayers’ child, she is 18 years old or younger, she lives with them for more than half the year, and she has not provided more than half of her support.  Note that Emily makes $4,000 which is more than the exemption amount of $3,650 for 2010.  This does not prevent her from being a qualifying child because there is no gross income test for a qualifying child—the main thing is that she does not provide more than half of her own support.

Tina is a qualifying child—she is the taxpayers’ child.  Although she is over age 18, she is a full time college student under age 23.  Tina is deemed to live with her parents because she is away at school.  Tina does not provide more than half of her support.

Jimmy is not a qualifying child because he does not live with his parents for more than half of the year.  Jimmy is also not a qualifying child because he is over age 18 and is not a full time college student.  Even though his parents provide more than half his support, his living situation prevents his parents from claiming him as a dependent.

While Jimmy does not meet the requirement of a qualifying child, he should be tested under the requirements for a qualifying relative.  Jimmy is not a qualifying relative because his gross income for the year ($10,000) is more than the personal exemption amount for the year ($3,650)

Example:  Lisa has an elderly mother who lives in a nursing home.  Mother’s only income is Social Security.  Lisa is paying the cost of the nursing home, which means Lisa pays for more than half of her mother’s support. 

Mother does not qualify as a qualifying child because Mother is not LIsa’s child or sibling, is over age 18, and does not live with Lisa for more than half the year. 

Mother does qualify as a qualifying relative because Mother:

  • is Lisa’s parent
    • Mother does not have to live with Lisa because Mother is Lisa’s parent
  • has gross income under the personal exemption amount
    • only the taxable portion of Social Security is counted as gross income under this test
  • receives more than half of her support from Lisa
    • while nontaxable Social Security does not count as income under the gross income test, Mother’s support provided by Social Security does count toward the support Mother provides for herself
    • the amount Lisa pays for the nursing home provides more than half of Mother’s support
  • is not a qualifying child of Lisa

Lisa may claim Mother as a dependent.

Example:  John’s best friend, Henry, was severely injured in a skiing accident.  Henry is out of work.  John let Henry move in with him on January 1.  John provides more than half of Henry’s support.  There is no familial relationship between John and Henry.

Henry is John’s qualifying relative because Henry:

  • lives with John for the full year
    • remember—there either has to be a familial relationship or the dependent has to live with the taxpayer for the year
  • has no gross income and therefore has gross income under the personal exemption amount
  • receives more than half of his support from John
  • is not a qualifying child of John

John may claim Henry as a dependent.

There you have it.  A fairly in depth review of dependency deductions for children and other people.  If you have any questions on how these rules apply to you, feel free to comment below or email me your question.

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.

Any tax advice contained in the body of this post was not intended or written to be used, and cannot be used, by the recipient for the purpose of avoiding penalties that may be imposed under the Internal Revenue Code or applicable state or local tax law provisions. Any information contained in this post does not fall under the guidelines of IRS Circular 230.

Self Employment Tax on All Profit from Professional S Corps?

Share This:

There Will Be Blood
(not literally of course, but it’s going to cheese off a lot a people who are already over-burdened by the tax code.)

Congress is looking to restore some fiscal restraint.  It could do so by reigning in spending, but let’s be practical—they’re going to raise taxes.  Congress is trying to drink your milkshake.See full size image

The American Jobs and Closing Tax Loopholes Act of 2010 (which is currently working its way through Congress) has a provision that subjects all profit in a professional S corporation to self employment tax of 15.3%.  Examples of professional services include accounting, legal, architectural, consulting, engineering, etc.

Here’s the kicker—the tax applies only to professional S corps that are based principally on the reputation and skill of three or fewer employees.  So the business can have more than three employees and still be subject to the full self employment tax, as long as three or fewer employees are the firm’s principal asset.  Thus, each year the business must assess (through valuation?) whether the principal asset of the firm is three or fewer key employees.


Example:  Timmy and Jimmy have a law firm that is a professional corporation.  They have filed an S corporation election and are therefore taxed as an S corporation.  The corporation has $200,000 in profit before officer salaries.  Timmy and Jimmy each take a $60,000 salary, so the remaining profit is $80,000.  Under current law, Timmy and Jimmy pay their share of FICA taxes of $4,590 ($60,000 * 7.65%) and the corporation matches their FICA contributions of $4,590 each.  This is the rough equivalent of each owner paying self employment tax of 15.3% (7.65% * 2).  The remaining profit of $80,000 is exempt from self employment tax (assuming Timmy and Jimmy are paid a reasonable salary).


Under the new law, the $80,000 remaining profit is also subject to self employment tax of $12,240 ($80,000 * 15.3%). 


What if the corporation hires a receptionist and a couple paralegals so it has more than three employees?  The result will not change because the principal asset of the firm is based on two employees—Timmy and Jimmy.


THIS LAW HAS NOT YET PASSED.  IT IS VERY UNPOPULAR, BUT WHEN HAS THAT STOPPED CONGRESS?

The IRS already has power to challenge unreasonably low compensation of S corporation owners, can reclassify profit distributions as wages, and collect FICA taxes on them. 

If passed, this new law will dramatically increase the tax burden on small businesses by increasing their taxes and imposing the new requirement to perform a quasi-valuation each year to determine if three or fewer employees are the business’ principal asset.  This will harm their ability to grow their businesses and create new jobs. 

I’m Finished (spoiler alert)…

[youtube=http://www.youtube.com/watch?v=I1PYp-fsZOA&w=425&h=355]

Get Our Posts by Email



Created by Webfish.