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Archives for September 2017

You’ve Been Provided with Free Identity Theft Protection. Is it Taxable?

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Identity theft occurs when a person wrongfully obtains and uses another person’s personal information (such as name, social security number, bank account information, etc.) in a way that involves fraud or deception, usually for economic gain.  It has become the number one consumer complaint to the Federal Trade Commission for 15 consecutive years.

Businesses, government agencies, and other organizations make significant efforts to secure the personal information of customers and employees.  Even though significant effort is put forth to combat identity theft, criminals are becoming increasingly sophisticated.  A data breach can expose personal information to criminals causing harm to their victims.  In response to such breaches, organizations often provide credit reporting and monitoring services, identity theft insurance policies, identity restoration services, or other similar services to customers and employees whose information may have been breached.

When Identity Theft Protection Services are Tax-Free

The IRS has received questions regarding the taxability of identity protection services provided at no cost to customers and employees whose personal information may have been compromised.   The IRS issued an announcement that it will NOT assert that an individual whose personal information may have been compromised in a data breach must pay tax on the value of the identity protection services provided by the organization that experienced the data breach.

Additionally, the IRS will not assert that an employer providing identity protection services to an employee whose personal information may have been breached must include the value of identity protection services in the employee’s taxable compensation.

When Identity Theft Protection Services are Taxable

The IRS also states that this tax-free provision does NOT apply to cash received in lieu of identity protection services, or to identity protection services received for reasons other than as a result of a data breach, such as identity protection services received in connection with an employee’s compensation benefit package.  This announcement also does not apply to proceeds received under an identity theft insurance policy.

What if Identity Theft Protection Services are Provided before a Breach Occurs?

The IRS received comments stating that an increasing number of businesses are combating data breaches by providing identity theft protection services to employees and other individuals before a data breach occurs in order to help detect any occurrence of a breach in their information systems, and to minimize the impact of their operations.

Accordingly, the IRS will NOT assert that an individual must pay tax on the value of identity protection services provided by the individual’s employer or by another organization to which the individual provided personal information.  Similarly, employees will not have to include in taxable income the value of such services provided by their employers.

Again, this announcement does not apply cash received in lieu of identity protection services or proceeds received under an identity theft insurance policy.

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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.

Current Status of Tax Reform

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The President recently reaffirmed his desire for a 15% business tax rate that applies to all business entities (C corporations, S corporations, LLCs, etc).  However, most analysts do not believe that a 15% tax rate is possible with a $20 trillion national debt.  The House Republican plan called for a 25% tax rate.

Service Businesses May Not Benefit

According to a recent piece in the Wall Street Journal, Secretary Mnuchin stated that the lower 15% tax rate would NOT apply to service businesses such as accounting (boo!!!) or law firms.  The idea is to tax these services businesses at a rate between the lower business tax rate and the tax rate that applies to wages.  That new rate would apply to pass-through service businesses but with boundaries to prevent it from being used by services businesses where the pass-through income more closely resembles wages…sounds perfectly workable!

Principles of Tax Overhaul

The President outlined four principles as guiding his tax reform efforts:

  • A fair and simple tax Code
  • A tax Code that is competitive with other nations’ tax Codes
  • Tax relief for middle-class families
  • Repatriation of overseas profits (i.e., lowering the tax on profits corporations bring back to the U.S. from foreign corporations).

What to Expect Next

Outside of general principles, details are still unknown.  Republicans plan to release details of tax overhaul on September 25.  If a tax cut is passed, it is expected to take effect retroactively to January 1, 2017.

 

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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.

Rules for Deducting Rental Losses

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Rental losses may not be deductible because of the passive activity loss rules. The passive loss rules apply to activities in which taxpayers do not materially participate.  Taxpayers usually satisfy the material participation standard by being involved in a business for 500 hours per year (although there are several other ways of materially participating).  Passive losses can only be deducted against passive income.  Passive losses will also be allowed when the activity is disposed of in a taxable transaction (e.g., the activity is sold).  Congress created the passive loss rules in 1986 to curb tax shelter abuses.  Unfortunately, these rules also affect many legitimate activities.

Unfortunately, rental activities will be classified as passive activities even if the taxpayer materially participates in the rental.  Therefore, rental losses will not be deductible against other income until the rental activity is disposed of in a taxable transaction (e.g., the rental property is sold).

Fortunately, there are three ways rental losses may be deductible:

  • If the taxpayer actively participates in the rental activity, rental losses of up to $25,000 per year may be deductible
  • If the taxpayer meets the requirements to be classified as a real estate professional
  • If the activity is not treated as a rental by the tax law

Actively Participating in the Rental Activity

Taxpayers who actively participate in a rental activity can deduct up to $25,000 of rental losses per year.  Taxpayers actively participate in a rental activity through managerial functions such as deciding on rental terms, approving tenants, and approving capital expenditures.  Taxpayers must own at least 10% of the value of the rental activity to meet the active participation standard.  Finally, the $25,000 loss is reduced by 50% of the excess of the taxpayer’s adjusted gross income over $100,000.

Example:  Wilma owns a rental property.  She negotiates lease terms with potential tenants, approves tenants, and decides what improvements (repairs, carpeting, etc.) will be made to the property before leasing it out. Wilma’s adjusted gross income is $90,000.  Since Wilma decides on rental terms, approves tenants, and approves capital expenditures, she actively participates in the rental.  Her income is below the phaseout threshold so she can deduct up to $25,000 of rental losses.  

Real Estate Professionals

Real estate professionals may fully deduct rental losses.  A Taxpayer must meet the following three requirements to be classified as a real estate professional:

  • She must spend more than 750 hours per year in real property trades or businesses in which she materially participates (e.g., spends more than 500 hours in the activity) AND
  • She spends more than 50% of her time in real property trades or businesses in which she materially participates
  • She must materially participate in the rental activity for which she is trying to claim a loss

The term real property trade or business means any real property development, redevelopment, construction, reconstruction, acquisition, conversion, rental, operation, management, leasing, or brokerage trade or business.

Example:  Barney is a real estate broker.  He spends 1,000 hours per year working as a broker.  He also spends 1,000 hours per year managing an apartment building that he owns.  The apartment building will suffer a $100,000 rental loss this year.  These are Barney’s only activities.  Since Barney spends 2,000 hours per year on real estate businesses and 100% of his time is spent on real estate businesses, he is a real estate professional.  Since Barney spends more than 500 hours in the apartment building activity, he materially participates in the apartment building activity.  Barney meets the requirements of the real estate professional exception and may fully deduct the $100,000 loss.

Activities Not Treated as Rentals by the Taw Law

Rental activities of a very short duration or that require substantial services along with the rental property may be classified as business activities rather than rental activities.  This is due to the increased involvement of the taxpayer in such activities.  If a rental activity is classified as a business activity, taxpayers may be able to deduct losses if they materially participate.  Normally, rental losses are not deductible even if taxpayers materially participate (unless the active participation or real estate professional exceptions apply).

The following rental activities are treated as non-rental activities:

  • The property is rented by each customer for an average of seven days or less (e.g., hotel rooms or cars)
  • Significant personal services are provided, and each customer rents the property for an average of more than seven, but no more than 30 days (e.g., a dude ranch or resort).
  • Extraordinary personal services are provided, regardless of the average period of customer rental (e.g., nursing home).
  • The rental is incidental to the taxpayer’s nonrental activity, (e.g., the rental of a parking lot for a special event). If the gross rental income in those situations is less than 2% of the lesser of the property’s unadjusted basis or its fair market value, the rental of the property is considered incidental to a nonrental activity.
  • The property is made available by the taxpayer during defined business hours for nonexclusive use by various customers (e.g., a golf course that has both daily customers and customers who purchase long-term passes).

If the taxpayer conducts one of these activities, she will be able to deduct losses as long as she materially participates in the activity.

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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.

 

Leave-Based Donation Programs for Victims of Hurricane Harvey

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In response to the extreme need for charitable relief for victims of Hurricane Harvey, some employers are adopting leave-based donation programs.  Under these programs, employees can essentially donate their vacation and sick pay to charitable organizations.

The IRS recently issued a notice that cash payments an employer makes to a charitable organization in exchange for vacation, sick, or personal leave that its employees elect to forgo will NOT constitute income or wages of the employee if the payments are:

  • Made to charitable organizations for the relief of victims of Hurricane Harvey and Tropical Storm Harvey and
  • Paid to the charity before January 1, 2019

The IRS will not allow double dipping—employees won’t have to claim the donated vacation, sick, or personal leave time as income but they will also not be allowed a charitable donation for the amount donated.

The employer will take a business (and not a charitable deduction) for the amount of vacation, sick, or personal leave time donated.

People also need to be aware of scam artists that have created fraudulent charities.  The IRS cautions people wishing to make disaster-related charitable donations to avoid scam artists by following these tips:

  • Be sure to donate to recognized charities.
  • Be wary of charities with names that are similar to familiar or nationally known organizations. Some phony charities use names or websites that sound or look like those of respected, legitimate organizations. The IRS website at IRS.gov has a search feature, Exempt Organizations Select Check, through which people may find qualified charities; donations to these charities may be tax-deductible.
  • Don’t give out personal financial information — such as Social Security numbers or credit card and bank account numbers and passwords — to anyone who solicits a contribution. Scam artists may use this information to steal a donor’s identity and money.
  • Never give or send cash. For security and tax record purposes, contribute by check or credit card or another way that provides documentation of the donation.
  • Consult IRS Publication 526, Charitable Contributions, available on IRS.gov. This free booklet describes the tax rules that apply to making legitimate tax-deductible donations. Among other things, it also provides complete details on what records to keep.

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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.