Navigation

The Bottom Line

                                               SITE BLOG

 

Saturday
Jul142018

IRS wants exclusivity in Home Office Deductions


A recent Tax Court Case dealt with Home Office deductions of a small business tax payer.

The ruling is based on §280A(a); Disallowance of certain expenses in connection with business use of home, rental of vacations homes, etc.   “Except as otherwise provided in this section, in the case of a taxpayer who is an individual or a[n] S corporation, no deduction otherwise allowable under this chapter shall be allowed with respect to the use of a dwelling unit which is used by the taxpayer during the year as a residence.”

The taxpayer before the court operated a business in close proximity to the apartment he rented.  The apartment rent included the use of a garage.  The taxpayer stored business documents required by state law to be available for inspection at or near the business in the garage with business equipment and inventory. He did not store personal items of “note or value in the garage” with the inventory and business documents.  Further the business did not have a formal office or storage space in the business premises nor did he have space set aside in the apartment for an office.

The court stated the taxpayer did not fit within the exception of §280A(c)(2). The taxpayer did not sell products at retail or wholesale and the records where not inventory. This exception allows inventory or samples to be stored in a dwelling and the space used to be deductible. I call this the salesman’s exception as many salesmen carry samples and inventory to show and leave with customers and need storage for inventory or samples in their home as many do not have daily access to the storage of the companies they sell for.

And the taxpayer did not meet the exception granted by §280A(c)(1) as the garage was not used exclusively as the place of business.

The moral of this story is to be aware of when you meet the requirements to claim the home office deduction. If you use your home office as the:

  1. principle place of business for your business,
  2. a place of business where you meet clients, patients, or customers in meeting or dealing in the normal course of business or,

You may claim the home office deduction.

If your principle place of business is elsewhere you may only deduct the space allocated to storage of inventory or samples if you are involved in retail or wholesale. The taxpayer above made reasonable assumptions of what he could deduct as a business expense. It is business related, I can deduct it.  Tax law is not reasonable, It is a bag of compromises, manipulations, and feel good measures that often had no rhyme to it. If you are not sure, ask a tax preparer and save the time, money, and frustrations.

Thursday
May032018

2017 Tax Cut and Jobs Act Non-deductible Home Mortgage Interest

The Tax Cut and Jobs Act of 2017 is not wholly a tax cut or a jobs act. There are lower dollar limits on mortgages qualifying for home mortgage interest deduction. Starting in 2018 the limit is set at $750,000, down from $1 Million. This limit applies to the total of all debt secured by the home, many taxpayers will have the original acquisition mortgage and a home equity mortgage. If the total of the mortgages is greater than $750,000 a portion of the interest will be non-deductible. There is no word yet if existing loans that exceed the lower limit of $750,000 are grandfathered.  Or if the formula used under prior law to calculate the non -deductible interest for loans exceeding the limit will be applied. My guess is the formula will be applied without grandfathering in the loans that exceed the lower limit.

A second provision in the same area with large implications suspends the deduction of interest paid on non-acquisition mortgages for tax years 2018 to 2026 where the loan proceeds were not used to improve, expand, or add to the value of the home securing the loan. The same restrictions of the prior law still apply. The loan must not exceed the cost of the taxpayer’s main home or second home (a qualified residence), be secured by the home, were taken out before or after certain dates.

A client called asking about how the suspension of deductible interest would affect his small business by limiting his primary source of financing, his home. For many taxpayers their home is the only source of financing to start or expand a business. Other sources of financing; primarily retirement savings, either through loans from or withdrawals have limits on the amount barrowed and must be repaid within 5 years. Or penalties for early withdrawal and the tax on the deferred compensation is due in the year of the withdrawal reducing the funds available for business purposes or necessitating a larger withdrawal, penalty, and tax to have enough funds to finance the business.

In my opinion if the non-acquisition mortgage is for a legitimate business purposes the home owner/business owner will be able deduct the interest paid as a business expense. I have not yet read where this change limits the use of home equity for business purposes. Some IRS officials may interpret or expand the scope of the home improvement requirement to exclude business purposes with subsequent tax court cases determining if it does limit the deductibility of business use interest.

So, why did that pack of rascals called Congress make non-acquisition mortgage interest non-deductible when the proceeds of the loan do not improve the home or; in my opinion, serve a business purpose? Many taxpayers; and lenders are pushing this, use home equity loans to payoff personal debt, mainly credit card debt. Usually without the taxpayer changing their spending habits with the result the taxpayer is deeper in debt. Many of these mortgages have variable interest rates, banks can and have lowered HELOC barrowing limits overnight on a whim; basically it is an area where abuse exists.

Congress remembers the 2007-2008 meltdown and subsequent financial uncertainties, the pain of economic loss, and fear of financial collapse. Congress seeing the ticking time bomb of non-acquisition mortgage debt took a step to head off a repeat of the 2007-2008 financial crises. Too many taxpayers enjoying the hope of increased earnings are living beyond their means and using home equity to pay for it. Congress set the table for the 2007-2008’s woes, this time Congress is showing unusual wisdom.

 

Email link

The Tax Cut and Jobs Act of 2017 is not wholly a tax cut or a jobs act. There are lower dollar limits on mortgages qualifying for home mortgage interest deduction. Starting in 2018 the limit is set at $750,000, down from $1 Million. This limit applies to the total of all debt secured by the home, many taxpayers will have the original acquisition mortgage and a home equity mortgage. If the total of the mortgages is greater than $750,000 a portion of the interest will be non-deductible. There is no word yet if existing loans that exceed the lower limit of $750,000 are grandfathered.  Or if the formula used under prior law to calculate the non -deductible interest for loans exceeding the limit will be applied. My guess is the formula will be applied without grandfathering in the loans that exceed the lower limit.

A second provision in the same area with large implications suspends the deduction of interest paid on non-acquisition mortgages for tax years 2018 to 2026 where the loan proceeds were not used to improve, expand, or add to the value of the home securing the loan. The same restrictions of the prior law still apply. The loan must not exceed the cost of the taxpayer’s main home or second home (a qualified residence), be secured by the home, were taken out before or after certain dates.

A client called asking about how the suspension of deductible interest would affect his small business by limiting his primary source of financing, his home. For many taxpayers their home is the only source of financing to start or expand a business. Other sources of financing; primarily retirement savings, either through loans from or withdrawals have limits on the amount barrowed and must be repaid within 5 years. Or penalties for early withdrawal and the tax on the deferred compensation is due in the year of the withdrawal reducing the funds available for business purposes or necessitating a larger withdrawal, penalty, and tax to have enough funds to finance the business.

In my opinion if the non-acquisition mortgage is for a legitimate business purposes the home owner/business owner will be able deduct the interest paid as a business expense. I have not yet read where this change limits the use of home equity for business purposes. Some IRS officials may interpret or expand the scope of the home improvement requirement to exclude business purposes with subsequent tax court cases determining if it does limit the deductibility of business use interest.

So, why did that pack of rascals called Congress make non-acquisition mortgage interest non-deductible when the proceeds of the loan do not improve the home or; in my opinion, serve a business purpose? Many taxpayers; and lenders are pushing this, use home equity loans to payoff personal debt, mainly credit card debt. Usually without the taxpayer changing their spending habits with the result the taxpayer is deeper in debt. Many of these mortgages have variable interest rates, banks can and have lowered HELOC barrowing limits overnight on a whim; basically it is an area where abuse exists.

Congress remembers the 2007-2008 meltdown and subsequent financial uncertainties, the pain of economic loss, and fear of financial collapse. Congress seeing the ticking time bomb of non-acquisition mortgage debt took a step to head off a repeat of the 2007-2008 financial crises. Too many taxpayers enjoying the hope of increased earnings are living beyond their means and using home equity to pay for it. Congress set the table for the 2007-2008’s woes, this time Congress is showing unusual wisdom.

 

Friday
Sep082017

Do Hurricane Harvey Victims Deserve Less Federal Aid Because Texas is a Low-Tax State?

September 7, 2017

There are two kinds of thought-provoking op-eds: those that force readers to confront new ideas, and those that simply provoke the thought, “I wonder how that wound up in print?” Yesterday, tax attorneys and tax law professors Peter Barnes and H. David Rosenbloom served up the latter in a piece that is either an extremely contrarian take on disaster relief or a strained parable against means testing, welfare reform, and the “up-by-the-bootstraps” mentality.

After conceding that victims of Hurricane Harvey should receive federal aid as soon as possible, the professors contend that it should be structured primarily as federal loans, not aid – because Texas’s taxes are too low. Here’s their argument for structuring the bulk of federal aid as a loan, such as it is:

Here is why: Texas is avowedly a low-tax state. There is no personal income tax. There is no corporate income tax (although there is a surrogate tax on corporate receipts). There is no state-level tax on estates or inheritances. Texas ranks No. 46 out of the 50 states in state and local tax burden per capita, according to recent data from the Tax Foundation. It ranks 43rd in state tax revenue per capita.

Texas wants and needs federal help to rebuild from Harvey, and the federal government should provide significant financial aid. But it is grossly unfair for Texas to accept funds from all of America’s taxpayers to allow it to continue its exceptionally low-taxed ways. Unless Texas is willing to bear a reasonable share of the Harvey costs through increased state and local taxes, then the rest of the United States would just be giving Texas a handout. Better for the federal government to offer Texas a “hand-up” in the form of immediate cash support with the requirement that Texas generate tax revenue to repay that help.

Other states, like those impacted by Hurricane Sandy, are given a pass, because their residents already pay high taxes (“Compare that situation with New York and New Jersey’s in the wake of Hurricane Sandy: Those states (plus Connecticut) already pushed a significant state and local tax burden onto their residents.”). The piece then goes on to discuss how international aid is structured, referencing the debate, more commonly associated with IMF assistance, for whether a beneficiary jurisdiction should be required “to enact ‘good government’ policies, including changed tax laws” as a condition of aid.

The authors’ conclusion, buttressed by ability-to-pay arguments: “Although proud Texans often assert the state’s sovereignty, the truth is that Texas has no moral entitlement to federal aid to rebuild itself unless Texas is willing to shoulder a fair share of the cost. And that means increasing taxes on its residents to a level more commensurate with the burdens of residents in other states.”

Where to begin? A few thoughts, far from exhaustive, on this peculiar narrative:

  1. Texas is not a free rider, and Texans pay the same federal taxes as everyone else does. Even if Texans have greater fiscal capacity at the state level, they paid taxes to the entity that disburses federal disaster aid under the same rates and structures as the rest of the country.
  2. Tax rates and burdens are not an appropriate measure of disaster preparedness. One could argue—the authors hint at it—that perhaps Texas was less prepared because elected officials were unwilling to raise the revenue necessary to prepare for a storm of this magnitude. This is not, however, obviously true, and the authors don’t really make the case. Besides, high tax states are often woefully unprepared for hurricanes, too. Louisiana, which is said to be deserving of federal aid, clearly wasn’t ready for Hurricane Katrina. The states hit by Hurricane Sandy have decidedly high taxes, but didn’t allocate enough of that revenue to disaster preparedness either.
  3. Having lower state taxes isn’t an invitation to federal governmental discrimination. The crux of the authors’ argument seems to be that it’s somehow unfair that Texans pay less in state taxes than others do, and therefore if the federal government incurs an expense in Texas, it should treat it differently than it would an expense in any other state. This is not only punitive, but punitive on policy grounds utterly unrelated to the issue at hand.
  4. The federal government has no right to coerce states to have higher (or lower) tax burdens. Some people favor low-tax, low-service states; others gravitate toward high-tax, high-service states. It’s perfectly reasonable for someone to think that all states would be better off if they coalesced at a particular point on the spectrum, but it would be remarkable for the federal government to treat low-tax states as the functional equivalent of failed states at the international level, and to coerce policy changes by withholding federal aid. The federal government does have some authority under the Spending Clause to induce, but not coerce, state policy decisions that pertain to the aid in question, but the courts have never permitted such sweeping authority as recommended here.
  5. The “hand-up” vs. “handout” language of the op-ed makes little sense in this context. The argument appears designed to tweak certain views on welfare reform. Presumably, however, whether work requirements or other welfare reforms are or were a good idea, those favoring the “hand-up” approach believe that it is possible to induce lifestyle changes or facilitate opportunities that would reduce reliance on aid by enabling greater self-sufficiency. Is that the argument here? It could be, if the issue is how much states spend on disaster preparedness, but the authors only seem concerned with tax burdens, not how the revenue is spent. Even if Texas devoted a greater share of its existing budget to disaster preparedness and response, its low taxes overall would still mark it for disparate treatment under the authors’ approach.
  6. Without a clear linkage to state responsibilities on disaster preparedness and response, the federal government treating people differently based on divergent state political preferences is odious. The federal government has some authority to withhold funds from states that don’t comply with program mandates, or to incentivize behavior through certain aid programs. But conditioning hurricane relief not even on what Texas spends on disaster preparedness, but just on what its tax rates are is legally suspect, unseemly, and an unfortunate case of political point scoring in the wake of a terrible natural disaster.
Tuesday
May162017

Form 8959 Additional Medicare Tax

Several clients have asked me this year, “What is this tax from Form 8959 on my 1040.” And I spend several minutes on the phone or writing a letter to the client explaining the form, the tax, and how it is calculated. The tax is Additional Medicare Tax authorized under the American Care Act (ObamaCare) and is assessed on all income subject to Medicare tax; wages, tips, self-employment income, basically all earned income. Passive income (interest and dividends) is not subject to this tax. Non-cash wages; i.e. fringe benefits, are subject to this tax. Example, taxpayers who receive the use of a vehicle for work and are taxed on the personal use of the vehicle (reported on their W-2). The personal use is subject to this tax if total gross income exceeds the threshold.

An individual is liable for Additional Medicare Tax when the individual’s wages, compensation, or self-employment income (together with that of his or her spouse if filing a joint return) exceed the threshold amount for the individual’s filing status:

Filing Status

Threshold

Married Filing Jointly (MFJ)

$250,000

Married Filing Separately (MFS)

  125,000

Single

  200,000

Head of Household(with qualifying person)

  200,000

Qualifying Widow(er) with dependent child

  200,000

 

There are no exceptions for resident aliens or U.S. Citizens living abroad, they are subject to the tax even if over sea’s income is excluded from income tax.

Employers must withhold the tax from wages when an individual in their employ has earned income in excess of $200,000 in a calendar year without considering the individuals filing status or wages paid by another employer. And individuals who are self-employed or are employed by two or more employers and whose wages will not exceed the threshold from anyone employer but in total will exceed the threshold; should make estimated tax payments for the Additional Medicare Tax. The threshold amount for this purpose is $200,000. However the taxpayer cannot request the employer withhold additional funds specifically for this tax. But the employee may request additional withholding for income taxes which will be available on Form 1040 to apply to the tax there.

The additional tax is included in the total Medicare tax withheld from the employee’s wages for reporting purposes and is included in the Medicare number of Box 6 on the W-2.

The tax rate is 0.9% (.009) on income in excess of the threshold so for a couple filing MFJ with gross taxable income of $300,000 the tax 0.9% of $50,000 or $450.00. An individual filing single with gross income of $300,000 the tax is $900.

Calculating the tax is a three step process:

1.)    Calculate Additional Medicare Tax on any wages in excess of the applicable threshold for the filing status, without regard to whether any tax was withheld.

2.)    Reduce the applicable threshold for the filing status by the total amount of Medicare wages received, but not below zero.

3.)    Calculate Additional Medicare Tax on any self-employment income in excess of the reduced threshold.

An example is a single filer (C), has $130,000 in wages and $145,000 in self-employment income. C’s wages are not in excess of the $200,000 threshold for single filers, so C is not liable for Additional Medicare Tax on these wages. Before calculating the Additional Medicare Tax on self-employment income, the $200,000 threshold for single filers is reduced by C’s $130,000 in wages, resulting in a reduced self-employment income threshold of $70,000. C is liable to pay Additional Medicare Tax on $75,000 of self-employment income ($145,000 in self-employment income minus the reduced threshold of $70,000).

The method is the same for other filing statuses with the threshold increasing or decreasing depending on the filing status as shown in the above table.

The additional tax withheld is included in box 6 of the W-2; Medicare tax withheld and is added to the income tax withholding amount from box 2 of the W-2 when reported on Form 1040. The tax is calculated again using total income on Form 8959. The tax amount is shown on Form 1040 under the Taxes section increasing the filer’s tax liability and the tax paid through withholding paying the tax.

I end with this is a tax intended to fund Medicare services and ObamaCare with a tax on high income filers and is a separate tax on previously taxed income; essentially double taxation of income. A rare occurrence in American taxation as it has been policy to avoid double taxation. Will this tax be rescinded under the changes proposed by the Trump administration has yet to be seen? Typically taxes once enacted stay even when the purpose they were enacted for have long since past.

Monday
Apr242017

§1231 Loss and Basis



 

Types of Tax Property

This tax year I encountered a different treatment of property under the IRC. A partnership a client was invested in chose to cease operations and dissolve to stop the losses. Receiving the K-1 his share of the loss was under IRC §1231. Under the IRC property is defined and named by code sections addressing the tax treatment of property; §1245, 1250, and 1231 to name a few of the code sections. The code section dealing with business property is §1231 and it has a few quirks when capital gains and losses come into play.

Identifying §1231 Property

Normally depreciable property and real estate are not capital assets. But depreciable personal property and real property used in a trade or business and held for more than one year which is not inventory or held for sale to customers or intangible property is capital property under §1231 and includes:

  • ·         Trade or business property held for more than one year and  compulsorily or involuntarily converted;
  • ·         Capital assets held for longer than one year in connection with a trade or business or a transaction entered into for profit and compulsorily or involuntarily converted;
  • ·         An unharvested crop on land used in a trade or business and held for more than one year, if the crop and land are sold, exchanged, or involuntarily converted at the same time to the same person;
  • ·         Certain livestock but not poultry; and
  • ·        

Gain Loss Treatment

Generally when §1231 gains exceed §1231 losses for a taxable year, all of the §1231 gains and losses are treated as long-term capital gains and losses. When §1231 gains do not exceed §1231 losses for a taxable year the gains and losses are not treated as gains and losses from sales and exchanges of capital assets. Or, §1231 losses exceed §1231 gains all of the §1231 losses and gains are treated as ordinary income and losses. Transactions where §1231 property is sold, exchanged, or involuntarily exchanged are reported on Form 4797. Unlike capital asset exchanges are not netted against each other but are reported as individual transactions.

Recapture

When §1231 property is subject to depreciation recapture, only the §1231 gain that exceeds the amounts recaptured and taxed at ordinary income tax rates. Gains or losses disallowed by other rules is not taken into account in determining §1231 gains and losses.

Recapture of Net §1231 Losses

A taxpayer with net §1231 gains that exceed losses for the year must recapture past net §1231 losses by treating the current year’s net §1231 gain as ordinary income to the extent of unrecaptured net §1231 losses for the five previous tax years on a first in, first out basis; i.e. starting with the oldest §1231 loss, the next oldest until the current year gain or prior year losses are used up.

Compulsory or Involuntary Conversion

The capital gain and ordinary loss rules of §1231 apply to gains and losses from the compulsory or involuntary conversion of §1231 property unless the non-recognition rules for involuntary conversions apply.

Summary

When dealing with business property or non-equity (stocks, bonds) be aware of the nature of the property and keep track of your prior losses and depreciation.  These can influence or eliminate a capital gain or at least reduce it.