Small Business Owners May Qualify for a Home-Office Deduction

Article Highlights:

  • Qualifications
  • Actual Expense Method
  • Simplified Method
  • Home Office Expenses for Renters vs. Homeowners
  • How Moving Affects the Home-Office Deduction
  • Other Issues
  • Gross Income Limitation

“Home office” is a type of tax deduction that applies to the business use of a home; the space itself may not actually be an office. One of the following must apply to be able to deduct home office expenses. The home office:

  • Must be the taxpayer’s main place of business. OR
  • Must be a place of business where the taxpayer meets patients, clients or customers. The taxpayer must meet these people in the normal course of business. OR
  • Must be in a separate structure that is not attached to the taxpayer’s home. The taxpayer must use this structure in connection with their business. OR
  • Must be a place where the taxpayer stores inventory or samples. This place must be the sole, fixed location of their business. OR
  • Under certain circumstances, must be where the taxpayer provides day-care services.

Generally, except when used to store inventory, an office area must be used on a regular and continuing basis and be exclusively restricted to the trade or business (i.e., no personal use).

Two Methods – There are actually two methods to determine the amount of a home-office deduction: the actual-expense method and the simplified method.

  • Actual-Expense Method – The actual-expense method prorates home expenses based on the portion of the home that qualifies as a home office, which is generally based on square footage. Aside from prorated expenses, 100% of directly related costs, such as painting and repair expenses specific to the office, can be deducted. Unlike the simplified method, the business is not limited to 300 square feet.
  • Simplified Method – The simplified method allows for a deduction equal to $5 per square foot of the home used for business, up to a maximum of 300 square feet, resulting in a maximum simplified deduction of $1,500. A taxpayer may elect to take the simplified method or the actual-expense method (also referred to as the regular method) on an annual basis. Thus, a taxpayer may freely switch between the two methods each year.

    Additional office expenses such as utilities, insurance, office maintenance, etc., are not allowed when the simplified method is used. Prorated rent or home interest and taxes are not either, although 100% of home interest and taxes are deductible if the taxpayer itemizes deductions.

    To determine the average square footage when using the simplified method, no more than 300 square feet for any month can ever be used, even if the taxpayer has multiple businesses for which he or she uses space in the home. If there are multiple businesses, a reasonable method to allocate between businesses is used. Zero is used for months when there was no business use or when the business was not operating for a full year. Don’t count any month when the business use was less than 15 days.

    Example: Sandra begins using 400 square feet of her home for business on July 20, 2019 and continues using the space as a home office through the end of the year. Her average monthly allowable square footage for 2019 is 125 square feet (300 x 5 months = 1,500/12 = 125).

Home Office Expenses – There are differences as to which prorated home expenses are deductible by renters and homeowners when computing the actual expense method, as illustrated in the table below.

Prorated Expense
Own
Rent
Mortgage Interest
X
Property Tax
X
Rent
X
Homeowner’s Insurance
X
Renter’s Insurance
X
Utilities
X
X
Depreciation
X
Home Maintenance
X
X

Note that the principal payments made on a home loan are not eligible expenses. Instead, homeowners claim a deduction for depreciation on the office portion of the home’s basis.

Rent vs. Own: What Happens If You Move or Sell the Home?

Rent – When you pay rent for your home and use part of it for business, move and then use space at the new location as a home office, for the year of the move, you’ll need to figure out the deduction separately for each home office based on the specific expenses and business use area of each home. If you don’t use space at your new living quarters for business purposes, then your home-office deduction for the year of the move will need to factor in just the expenses for the time you lived in the first home.

Own – On the other hand, if you own the home, sell it and had lived in it for two of the five years prior to the sale date, you can exclude up to $250,000 of gain ($500,000 for a married couple). However, you cannot exclude the part of any gain to the extent of depreciation you claimed for the home after May 6, 1997. For exclusion purposes, it makes a difference whether the home office was within the home itself or in a separate structure on the same property. If within the same structure, the exclusion will apply to the entire gain from the home (other than the depreciation component). If the office was within a separate structure, then the sale must be treated as two sales – one for the home and one for the office – and the gain from the office portion cannot be excluded.

Additional Issues That May Apply – As with everything tax, there are always special rules.

  • Multiple Businesses – If there are multiple businesses, only one method may be used for the year – either the regular or simplified.
  • Mixed-Use Property – A taxpayer who has a qualified business use of a home and a rental use of the same home cannot use the simplified method for the rental use.
  • Taxpayers Sharing a Home – Taxpayers sharing a home (for example, roommates or spouses, regardless of filing status), if otherwise eligible, may each use the simplified method but not for a qualified business use of the same portion of the home.

    As an example, a husband and wife, if otherwise eligible and regardless of filing status, may each use the simplified method for a qualified business use of the same home, for up to 300 square feet of different portions of the home.

  • Depreciation Rate When Switching Methods – When the simplified method is used and the taxpayer subsequently switches to the actual expense method, there are no special adjustments, and the depreciation is determined in the normal manner.

Final Notes – Even if you qualify for a home-office deduction, your deduction is limited to the business activity’s gross income, which for this purpose is defined as the activity’s gross income, reduced by the home expenses that would be deductible if there were no business use (e.g., mortgage interest, property taxes, certain casualty losses), and the business expenses unrelated to the home’s use. When using the actual expense method, the disallowed amount will be carried over to the next year subject to the same limitations. However, there’s no carryover when using the simplified method.

Business use of the home is deducted on a self-employed individual’s business schedule.

Does Your Tax ID Need to be Renewed?

Article Highlights:

  • Expiring ITINs
  • IRS Currently Accepting Renewal Applications
  • Family Renewal Options
  • How to Renew
  • Common Errors to Avoid

According to the Internal Revenue Service (IRS), just about 2 million Individual Taxpayer Identification Numbers (ITINs) are set to expire at the end of 2019.

ITINs are used by people who have tax filing or payment obligations under U.S. law but who are not eligible for a Social Security number. ITIN holders who have questions can visit the ITIN information page on the IRS website.

ITINs that have not been used on a federal tax return at least once in the last three consecutive years will expire Dec. 31, 2019. In addition, ITINs with middle digits 83, 84, 85, 86 or 87 that have not already been renewed will also expire at the end of the year. ITINs with middle digits of 70 through 82 expired in past years. Taxpayers with these ITIN numbers who haven’t already renewed their ITIN can renew at any time. Note: It is important to understand that ITINs with middle digits 83 through 87 will expire whether or not they were used for filing returns in the last three years.

IRS is currently accepting ITIN renewal applications – Taxpayers whose ITIN is expiring and who need to file a tax return in 2020 must submit a renewal application. Federal returns that are submitted in 2020 with an expired ITIN will be processed. However, exemptions and/or certain tax credits will be disallowed, and the taxpayers will be notified by mail advising them to renew their ITIN. Once the ITIN is renewed, any applicable exemptions and credits will be reinstated, and any applicable refunds issued. Therefore, renewing early will avoid these last-minute hassles and delays in receiving refunds.

Family renewal option – Taxpayers with an ITIN that has middle digits 83, 84, 85, 86 or 87, as well as all previously expired ITINs, have the option to renew ITINs for their entire family at the same time. Those who have received a renewal letter from the IRS can choose to renew the family’s ITINs together, even if family members have an ITIN with middle digits that have not been identified for expiration. Family members include the tax filer, spouse and any dependents claimed on the tax return.

How to renew an ITIN – To renew an ITIN, a taxpayer must complete a Form W-7 and submit all required documentation. Taxpayers submitting a Form W-7 to renew their ITIN are not required to attach a federal tax return. However, taxpayers must still note a reason for needing an ITIN on the Form W-7. See the Form W-7 instructions for detailed information. An application package can be submitted in one of three ways:

  1. By mail, along with original identification documents or copies certified by the agency that issued them, to the IRS address listed on the Form W-7 instructions. The IRS will review the identification documents and return them within 60 days.
  2. Work with Certified Acceptance Agents (CAAs) authorized by the IRS to help taxpayers apply for an ITIN. CAAs can authenticate all identification documents for primary and secondary taxpayers, verify that an ITIN application is correct before submitting it to the IRS for processing and authenticate the passports and birth certificates for dependents. This saves taxpayers from mailing original documents to the IRS.
  3. In advance, call and make an appointment at a designated IRS Taxpayer Assistance Center to have each applicant’s identity authenticated in person instead of mailing original identification documents to the IRS. Each family member applying for an ITIN or renewal must be present at the appointment and must have a completed Form W-7 and required identification documents. See the TAC ITIN authentication page on the IRS web site for more details.

Common errors to avoid – There are several common errors that can slow down ITIN renewal applications:

  • Mailing identification documentations without a Form W-7,
  • Missing information on the Form W-7, and
  • Insufficient supporting documentation, such as U.S. residency documentation or official documentation to support name changes.
  • The IRS no longer accepts passports that do not have a date of entry into the U.S. as a stand-alone identification document for dependents from a country other than Canada or Mexico, or dependents of U.S. military personnel overseas. A dependent’s passport must have a date of entry stamp, otherwise the following additional documents to prove U.S. residency are required:
o U.S. medical records for dependents under age 6,
o U.S. school records for dependents under age 18, and
o U.S. school records (if a student), rental statements, bank statements or utility bills listing the applicant’s name and U.S. address, if over age 18.

If you have questions or need assistance completing a renewal, please give us a call at 714-522-3337

Facing a Huge Gain from a Realty Sale?

If you are contemplating selling real estate property, there are a number of issues that could impact the taxes that you might owe, and there are steps you can take to minimize the gain, defer the gain, or spread it over a number of years. The first and possibly most important issue is adjusted basis. When computing the gain or loss from the sale of property, your gain or loss is measured from your adjusted basis in the property. Thus, your gain or loss would be the sales price minus the sales expenses and adjusted basis.

Adjusted Basis – So, what is adjusted basis? Determining adjusted basis can sometimes be complicated, but in a simplified overview, it is a dollar amount that starts with your acquisition value and is then adjusted up for improvements to the property, down for depreciation taken on the property, and down for any casualty losses claimed on the property. The acquisition value could be the price you paid for the property, the fair market value of an inheritance at the date of the decedent’s death, or, in the case of a gift, the donor’s adjusted basis at the time of making the gift.

As you can see, it is extremely important that you keep track of your basis, since it is a key factor in determining gain or loss upon the sale of the property. Failure to keep a record and substantiating documentation could cost you dearly in income tax.

Passive Loss Carryover – If the property was a rental and the rental operated at a loss, there is a chance that the losses were not fully deductible in the year(s) of the loss because of the passive loss limitation rules; in this case, you will have a passive loss carryover that can be used to offset the gain. In addition, current year passive losses and passive loss carryovers you may have from other properties can also be used to offset any gain from selling a rental property.

Next, you have to decide whether you want to take (i.e., report on your tax return) all the income in one year or whether to attempt to spread the income over a period of years with an installment sale (by carrying back a loan) or defer the income into a replacement property through a tax-deferred exchange.

Installment Sale – In an installment sale, the seller acts as the lender to the buyer. That can entail holding the first trust deed or taking back a second trust deed for only a portion of the loan amount. However, second trust deeds are as the name implies: They are second in line to be paid if the buyer defaults on the loan and thus are riskier. When set up as an installment sale, part of the gain is reported for each year that payments are received, generally as capital-gain income. In addition, the interest that the buyer pays the seller is taxable as ordinary income to the seller. Installment sales can be structured as short- or long-term loans, but remember, the buyer can always pay off the loan early or refinance. Either of these actions would make the balance of the profit from the sale taxable at that time.

Tax Deferred Exchange – Another option if the property is held for investment or used in a trade or business is to defer the gain down the road. This is accomplished by using the rules of IRS Code Section 1031, which allows the taxpayer to acquire like-kind property and defer the gain into the replacement property, which also must be used for business or be held for investment. However, the rules for like-kind exchanges are complicated, have strict timing issues, and require advance planning with a professional familiar with Section 1031 rules.

Net Investment Income Tax – Adding complications to the sale-planning issue is the surtax on net investment income. This 3.8% additional tax kicks in when a taxpayer’s modified adjusted gross income (MAGI) exceeds $200,000 ($250,000 for married joint filers and $125,000 for married individuals filing separately). Gain from the realty sale is included in the MAGI and could cause the MAGI threshold to be exceeded, resulting in this surtax applying to some or all of the realty gain. However, it may be minimized, or possibly eliminated, by using an installment sale and spreading the gain over a number of years or deferring down the road with a tax-deferred exchange.

Qualified Opportunity Fund (QOF) – Taxpayers who have a capital gain from selling or exchanging any property to an unrelated party may elect to defer that gain if it is reinvested in a QOF within 180 days of the sale or exchange. One exception is that the gain from the subsequent sale of the QOF cannot be deferred into another QOF. Only one election may be made with respect to a given sale or exchange. If the taxpayer reinvests less than the full amount of the gain in the QOF, the remainder is taxable in the sale year, as usual. Only the gain need be reinvested in a QOF, not the entire proceeds from the sale. This is in sharp contrast to a 1031 exchange where the entire proceeds must be reinvested to defer the gain.

Home Sale Exclusion – If the real estate is your home (primary residence), there are special rules. Generally, if you own and occupy the home in two out of the five years prior to the sale, you will be able to exclude a substantial portion of your gain. The tax-deferred exchange rules do not apply to personal-residence sales. The amount of the home exclusion can be as much $250,000 ($500,000 for married couples filing jointly). There are even special rules that allow a reduced exclusion under certain special circumstances.

As you can see, the result of selling real estate property can include a number of tax issues, and minimizing current taxes requires some careful planning. Please give this office a call for assistance in planning your real estate transactions.

Americans Losing Trillions Claiming Social Security at the Wrong Time

Most retirees should wait longer to access their benefits, researchers find. Some should claim them sooner.

Almost all American retirees claim Social Security at the wrong time, a newreport estimates, which means they will miss out on a collective $3.4 trillion in benefits before they die.

While they can tap their benefits as early as age 62, retirees could boost the size of their checks for every year they wait until age 70, when the maximum benefit accrues. The advantage in waiting is substantial: A person eligible for a $725 monthly check at 62 could get a $1,280 check if they wait to start at age 70.

United Income, a money management firm that provides financial advice to retirees, teamed up with former Social Security officials to simulate retiree decisions on when to claim benefits, along with factors that include income, wealth, taxes, health status and longevity. Their analysis, published Friday, found that 96% of retirees choose the wrong year to tap Social Security.

“People are pretty much doing the opposite of what they should be doing,” said Matt Fellowes, founder and chief executive officer of United Income and co-author of the paper.

When to take Social Security is a key decision for America’s elderly, for whom the program has become a critical safety net. About half of older Americans get most of their income from the program.

Unlike investments and other sources of retirement income, Social Security benefits are guaranteed to keep up with inflation and last for life. That’s important when half of all 65-year-old American women can expect to live past age 86, according to Social Security estimates. The average life expectancy for U.S. men who are currently 65 is age 84.

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Looking Ahead to 2019 Taxes

You have your 2018 tax return filed, or perhaps on extension, and now it is time to look forward to the changes that will impact your 2019 return when you file it in 2020.

Keeping up with the constantly changing tax laws can help you get the most benefit out of the laws and minimize your taxes. Many tax parameters, such as the standard deduction, contributions to retirement plans, and tax rates, are annually inflation adjusted, while some tax changes are delayed and take effect in future years. On top of all that, we have Congress considering the retroactive extension of some tax provisions that expired after 2017 as well as proposing new tax legislation.

The inflation adjustments shown are not the only items adjusted for inflation. For a full list, see IRS Revenue Procedure 2018-57.

At any rate, here are some changes that might affect your 2019 return:

  1. Solar Credit – Although the solar credit remains at 30% for 2019, as a reminder, the credit rate will drop to 26% in 2020. This means that for each $1,000 spent on qualified solar property, the credit will be $40 less in 2020 than if the expense were paid and the credit was claimed in 2019. However, this is a non-refundable credit, meaning it can only offset your tax liability, but the unused credit can carry over to a future tax year as long as the credit is allowed; it is currently scheduled to end after 2021. So, be cautious of overzealous salespeople trying to talk you into an expenditure for which you may not get the full credit.
  2. Plug-In Electric Vehicle Credit – Although the credit amounts have not changed, the credit begins to phase-out for each manufacturer after it produces its 200,000th qualifying vehicle. For example, the very popular Tesla vehicle did qualify for the full credit in 2018. However, Tesla has entered the phase-out stage, and for 2019, the credit is only $3,750 for purchases in the first 6 months of the year, then drops to $1,875 for vehicles bought through the rest of 2019, and is zero for post-2019 purchases. If you are contemplating buying a plug-in electric vehicle, check the IRS websitefor the current credit by manufacturer.
  3. Penalty for Not Being Insured – The Affordable Care Act required individuals to have health insurance and imposed a “shared responsibility payment” – really a penalty – for those who didn’t comply. The penalty could have been as much as $2,085 for most families. That penalty will no longer apply in 2019 or the foreseeable future.
  4. Medical Deductions Further Restricted – Unreimbursed medical expenses are allowed as an itemized deduction to the extent they exceed a percentage of a taxpayer’s adjusted gross income (AGI). As part the Affordable Care Act, Congress increased that percentage from 7.5% to 10%. That increase was temporarily rescinded in the most recent tax form. However, starting with the 2019 returns and for the foreseeable years, the AGI medical floor will be 10% of AGI. This is where the “bunching” strategy may benefit your ability to deduct medical expenses.This means paying as much of your medical expenses as possible in a single year so that the total will exceed the AGI floor and your overall itemized deductions will exceed the standard deduction.

    Example: Your child is having orthodontic work done, which will cost a total of $12,000, and the dentist offers a payment plan. If you pay in installments, you will spread the payments out over several years and may not exceed the medical AGI floor in any given year. However, by paying all at once, you will exceed the floor and get a medical deduction. 

  5. New Alimony Rules – For divorces and separation agreements entered into after 2018, the alimony paid is not deductible, and the alimony received is not taxable. In addition, the alimony recipient can no longer make an IRA contribution based on the alimony received.It is important to understand that this treatment of alimony only applies to alimony payments paid under agreements entered into after 2018 or under prior agreements modified after 2018 that include this new provision. For agreements entered into before 2019 that haven’t been modified, the old rules continue to apply: the alimony paid is deductible, and the alimony received is included in income. Also, an IRA deduction can be made based upon the taxable alimony received.
  6. Standard Deduction – The standard deduction, which is inflation adjusted annually, is used by taxpayers who do not have enough deductions to itemize. For 2019, the standard deductions have increased as follows:• Single: $12,200 (up from $12,000 in 2018)
    • Married filing jointly: $24,400 (up from $24,000 in 2018)
    • Married filing separately: $12,200 (up from $12,000 in 2018)
    • Head of household: $18,350 (up from $18,000 in 2018)

    Individuals who are blind and/or age 65 or over are allowed standard deduction add-ons. These add-ons are for the taxpayer and spouse but not for dependents. The add-on amounts are $1,300 for those filing jointly (unchanged from 2018) and $1,650 for all others (up from $1,600 in 2018).

  7. Increased Retirement Contributions – All IRA and retirement contributions are subject to inflation adjustment, meaning the allowable amounts may be increased each year. This gives you the opportunity to increase your retirement savings in 2019.• Simplified Employee Pension (SEP) Plans – The maximum amount for 2019 is $56,000 (up from $55,000 in 2018).

    • Individual Retirement Accounts (IRAs) – For both traditional and Roth IRAs, the maximum contribution has been increased to $6,000 (up from $5,500 in 2018). This is the first change to IRAs since 2013. The additional amount taxpayers age 50 and over can contribute remains unchanged at $1,000.

     401(k) Plans – The maximum employee contribution has been increased to $19,000 (up from $18,500 last year). The additional amount for taxpayers who’ve reached age 50 remains unchanged at $6,000.

    • Simple Plans – The maximum elective contribution is $13,000 (up from $12,500 in 2018). The additional amount for taxpayers age 50 and older remains unchanged at $3,000.

    • Health Savings Accounts (HSAs) – Although meant to be a way for individuals covered by a high-deductible health plan to save money for future medical expenses, these plans can also be used as a supplemental retirement plan. Contributions are deductible, earnings accumulate tax-free, and if distributions are used for qualified medical expenses, they are tax-free. However, when used as a supplemental retirement plan, the distributions would be taxable. The following are the contribution limits for 2019:

    o Self-only coverage: $3,500 (up from $3,450 last year)
    o Family coverage: $7,000 (up from $6,900)
  8. Federal Tax Brackets – The tax brackets were inflation adjusted (by approximately 2% over the 2018 brackets), meaning more of your income is taxed at a lower bracket in 2019 than it was in 2018. As an example, here are the brackets for 2019 for taxpayers using the single filing status:• 10%: $9,700 or less
     12%: More than $9,700 but not more than $39,475
    • 22%: More than $39,475 but not more than $84,200
     24%: More than $84,200 but not more than $160,725
    • 32%: More than $160,725 but not more than $204,100
    • 35%: More than $204,100 but not more than $510,300
     37%: Applies to taxable incomes of more than $510,300

    These are the brackets for married taxpayers filing jointly:

    • 10%: $19,400 or less
     12%: More than $19,400 but not more than $78,950
    • 22%: More than $78,950 but not more than $168,400
    • 24%: More than $168,400 but not more than $321,450
    • 32%: More than $321,450 but not more than $408,200
     35%: More than $408,200 but not more than $612,350
    • 37%: Applies to taxable incomes of more than $612,350

    For other filing statuses, see Revenue Procedure 2018-57.

    Note: These are step functions, so for example, the first $9,700 of taxable income is taxed at 10%, the next $29,775 ($39,475 − $9,700) is taxed at 12%, and so forth.

For further information or to request a 2019 tax planning appointment, please give our office a call at 562-404-7996.

Would a Mid-year Tax Checkup Benefit You?

If you are inclined to procrastinate until the end of the year or, even worse, until tax-filing season to worry about your taxes, you may be missing out on opportunities to reduce your tax and avoid certain penalties. The following are some events that can affect your tax return; you may need to take steps to mitigate their impact and avoid unpleasant surprises after it is too late to address them.

  • Did you get married, get divorced, or become widowed?
  • Did you change jobs or has your spouse started working?
  • Did you have a substantial increase or decrease in income?
  • Did you have a substantial gain from the sale of stocks or bonds?
  • Are you considering an investment in a Qualified Opportunity Fund to defer tax on capital gains?
  • Did you buy or sell a rental?
  • Did you start, acquire, or sell a business?
  • Did you buy or sell a home?
  • Did you retire this year?
  • Are you on track to withdraw the required amount from your IRA (age 70.5 or older)?
  • Are you taking advantage of the IRA-to-charity transfers (age 70.5 or older)?
  • Did you refinance your home or take out a second home mortgage this year?
  • Were you the beneficiary of an inheritance this year?
  • Did you welcome a new child into your family? Time to consider a tax-advantaged educational savings plan!
  • Are you taking full advantage of retirement savings plans?
  • Have you made any significant equipment purchases for your business?
  • Are you planning to purchase a new business vehicle and dispose of the old one?
  • Are your cash and non-cash charitable contributions adequately documented?
  • If your expenses eligible for itemizing are less than the standard deduction, have you considered bunching charitable contributions so you can itemize this year and then use the standard deduction next year?
  • Did you, or are you planning to, make energy-efficiency improvements to your main home or install a solar system for your main or second home this year?
  • Are you paying college tuition for yourself, your spouse or dependent(s)?
  • Are you keeping up with your estimated tax payments or do they need adjusting?
  • Did you purchase your health insurance through a government insurance marketplace and qualify for an insurance premium subsidy? If your income subsequently increased, you may need to be prepared to repay some portion of the subsidy.
  • Do you have substantial investment income or gains from the sale of investment assets? If so, you may be hit with the 3.8% surtax on net investment income and need to adjust your advance tax payments.
  • Did you make any unplanned withdrawals from an IRA or pension plan?
  • If you are a business owner, do you need to change how the business is organized to take full advantage of the 20% of qualified business income deduction?
  • If you are an employee that incurs job-related expenses that aren’t deductible for years 2018 through 2025, have you arranged with your employer to participate in an accountable reimbursement plan for these expenses?
  • Have you stayed abreast of every new tax law change?

If you anticipate or have already encountered any of the above events or conditions, it may be appropriate to schedule a mid-year tax checkup and consult with this office—preferably before any of the events listed, and definitely before the end of the year.

Hobby or Business? It Makes a Difference for Taxes – Now More than Ever

Taxpayers are often confused by the differences in tax treatment between businesses that are entered into for profit and those that are not, commonly referred to as hobbies. Recent tax law changes have added to the confusion. The differences are:

Businesses Entered Into for Profit – For businesses entered into for profit, the profits are taxable, and losses are generally deductible against other income. The income and expenses are commonly reported on a Schedule C, and the profit or loss—after subtracting expenses from the business income—is carried over to the taxpayer’s 1040 tax return. (An exception to deducting the business loss may apply if the activity is considered a “passive” activity, but most Schedule C proprietors actively participate in their business, so the details of the passive loss rules aren’t included in this article.)

Hobbies – Hobbies, on the other hand, are not entered into for profit, and the government currently does not permit a taxpayer to deduct their hobby expenses but does require the income from the activity to be declared. (Prior to the changes included in the Tax Cuts and Jobs Act of 2017, hobbyists were allowed to deduct expenses up to the amount of their hobby income as a miscellaneous itemized deduction on Schedule A. Being able to take this deduction is suspended for years 2018 through 2025.) Thus, hobby income is reported on Schedule 1 of their 1040 and no expenses are deductible.

So, what distinguishes a business from a hobby? The IRS provides nine factors to consider when making the judgment. No single factor is decisive, but all must be considered together in determining whether an activity is for profit. The nine factors are:

(1) Is the activity carried out in a businesslike manner? Maintenance of complete and accurate records for the activity is a definite plus for a taxpayer, as is a business plan that formally lays out the taxpayer’s goals and describes how the taxpayer realistically expects to meet those expectations.

(2) How much time and effort does the taxpayer spend on the activity? The IRS looks favorably at substantial amounts of time spent on the activity, especially if the activity has no great recreational aspects. Full-time work in another activity is not always a detriment if a taxpayer can show that the activity is regular; time spent by a qualified person hired by the taxpayer can also count in the taxpayer’s favor.

(3) Does the taxpayer depend on the activity as a source of income? This test is easiest to meet when a taxpayer has little income or capital from other sources (i.e., the taxpayer could not afford to have this operation fail).

(4) Are losses from the activity the result of sources beyond the taxpayer’s control? Losses from unforeseen circumstances like drought, disease, and fire are legitimate reasons for not making a profit. The extent of the losses during the start-up phase of a business also needs to be looked at in the context of the kind of activity involved.

(5) Has the taxpayer changed business methods in an attempt to improve profitability? The taxpayer’s efforts to turn the activity into a profit-making venture should be documented.

(6) What is the taxpayer’s expertise in the field? Extensive study of this field’s accepted business, economic, and scientific practices by the taxpayer before entering into the activity is a good sign that profit intent exists.

(7) What success has the taxpayer had in similar operations? Documentation on how the taxpayer turned a similar operation into a profit-making venture in the past is helpful.

(8) What is the possibility of profit? Even though losses might be shown for several years, the taxpayer should try to show that there is realistic hope of a good profit.

(9) Will there be a possibility of profit from asset appreciation? Although profit may not be derived from an activity’s current operations, asset appreciation could mean that the activity will realize a large profit when the assets are disposed of in the future. However, the appreciation argument may mean nothing without the taxpayer’s positive action to make the activity profitable in the present.

There is a presumption that a taxpayer has a profit motive if an activity shows a profit for any three or more years within a period of five consecutive years. However, the period is two out of seven consecutive years if the activity involves breeding, training, showing, or racing horses.

All of this may seem pretty complicated, so please call thif you have any questions or need additional details for your particular circumstances.

MIDYEAR 2019 TAX PLANNING LETTER

Dear Clients and Friends,

For better or worse, the past tax season provides you a clear picture of how the updated tax code impacts your situation. Now it’s time to use this insight to ensure you’re in the best position to effectively minimize your 2019 tax obligations.

Consider the actions you can take today that will make a difference to next year’s tax bill. Have you adjusted your withholdings or boosted your retirement plan contributions? Are you saving the right records for the deductions you want to take? If you own a business, have you made any equipment purchases or updated your employee benefits? Address these questions now while there’s still time to adjust your money-saving strategies for maximum results.

Call today to set up a midyear review so you can make the most of your tax-cutting efforts. And as always, feel free to share this newsletter with friends and associates who are interested in cutting their tax bills for 2019 and beyond.

Letter Highlights

Plan now and pay less later – Procrastination is easy, especially when it comes to summertime tax planning. But waiting to implement strategies to reduce your 2019 tax obligations could cost you money. CONTINUE READING HERE

Add your business tax planning to your summer to-do list – A midyear tax review of your business can pay off in big ways. CONTINUE READING HERE

Fund retirement or your child’s education? Should you prioritize your own future over your child’s education? This is an emotionally charged question that leads many parents to fund college at the expense of their own retirement. However, with proper planning, you may be able to fund your retirement and still offer financial support for college. CONTINUE READING HERE

Read the complete letter here: http://www.planningtips.com/Planning_Tips.asp?Co_ID=42935&Tip_ID=4422

New Twists on Tax Scams

On June 5, 2019, The IRS released and article urging taxpayers to be on the lookout for a spring surge of evolving phishing emails and telephone scams. 

The IRS is seeing signs of two new variations of tax-related scams. One involves Social Security numbers related to tax issues and another threatens people with a tax bill from a fictional government agency. Here are some details:

  • The SSN hustle. The latest twist includes scammers claiming to be able to suspend or cancel the victim’s Social Security number. In this variation, the Social Security cancellation threat scam is similar to and often associated with the IRS impersonation scam. It is yet another attempt by con artists to frighten people into returning ‘robocall’ voicemails. Scammers may mention overdue taxes in addition to threatening to cancel the person’s SSN.
  • Fake tax agency. This scheme involves the mailing of a letter threatening an IRS lien or levy. The lien or levy is based on bogus delinquent taxes owed to a non-existent agency, “Bureau of Tax Enforcement.” There is no such agency. The lien notification scam also likely references the IRS to confuse potential victims into thinking the letter is from a legitimate organization.

Both display classic signs of being scams. The IRS and its Security Summit partners – the state tax agencies and the tax industry – remind everyone to stay alert to scams that use the IRS or reference taxes, especially in late spring and early summer as tax bills and refunds arrive.

As a reminder the IRS will never: 

  • Call to demand immediate payment using a specific payment method such as a prepaid debit card, gift card or wire transfer. The IRS does not use these methods for tax payments. Generally, the IRS will first mail a bill to any taxpayer who owes taxes. All tax payments should only be made payable to the U.S. Treasury and checks should never be made payable to third parties.
  • Threaten to immediately bring in local police or other law-enforcement groups to have the taxpayer arrested for not paying.
  • Demand that taxes be paid without giving the taxpayer the opportunity to question or appeal the amount owed.
  • Ask for credit or debit card numbers over the phone.

Report the caller ID and/or callback number to the IRS by sending it to [email protected] (Subject: IRS Phone Scam)

June Estimated Tax Payments Are Around The Corner

June 15th falls on the weekend this year, so the due date for the second installment of estimated taxes is the next business day, June 17, which is just around the corner. So, it is time to determine if your estimated tax payment should be lowered if you overestimated your income for 2019 or increased if you underestimated it.

Unlike employees, a self-employed individual must estimate his or her net earnings for the year and pay taxes on a quarterly basis according to that estimate. Failure to do so will result in interest penalties.

The self-employed are not the only ones who are subject to estimated tax requirements, which also apply to anyone who has income that is not subject to withholding taxes and even to those whose taxes are not sufficiently withheld. Thus, if you have income from stock sales, property sales, investments, alimony, partnerships, S-corporations, inherited pension plans, or other sources that are not subject to withholding, you may also be required to pay either estimated taxes or an underpayment penalty. Others subject to making estimated payments are individuals who must pay special taxes such as the 3.8% tax on net investment income or the employment tax on household employees.

Although these payments are called “quarterly” estimates, the periods they cover do not usually coincide with a calendar quarter.

Quarter
Period Covered
Months
Due Date*
First January through March 3 April 15
Second April and May 2 June 15
Third June through August 3 September 15
Fourth September through December 4 January 15

 

 *If the due date falls on a Saturday, Sunday, or holiday, the payment is due on the next business day.

An underestimate penalty won’t apply if the tax due on a return (after withholding and refundable credits) is less than $1,000; this is the “de minimis amount due” exception. When the tax due is $1,000 or more, underpayment penalties are assessed.

These underpayment penalties are determined on a quarterly basis, so an underpayment in an earlier quarter cannot be made up for in a later quarter; however, an over payment in an earlier quarter is applied to the following quarter.

The amount of an estimated payment is determined by estimating one fourth of the taxpayer’s tax for the entire year; the projected tax is paid in four installments. When the income is seasonal, sporadic, or the result of a windfall, the IRS provides a special form, and the underpayment penalty is based on actual income for the period.

For individuals who do not want to take the time to estimate their quarterly taxes but who still want to avoid the underpayment penalty, Uncle Sam also provides safe-harbor estimates.

However, even these can be tricky. Generally, a taxpayer can avoid an underpayment penalty if his or her withholding and estimated payments are equal to or greater than:

  • 90% of the current year’s tax liability or
  • 100% of the prior year’s tax liability.

However, these safe harbors do not apply if the prior year’s adjusted gross income is over $150,000, in which case, the safe harbors are:

  • 90% of the current year’s tax liability or
  • 110% of the prior year’s tax liability.

Sometimes, individuals who have withholding on some (but not all) of their sources of income will increase that withholding to compensate for the additional income that comes from sources that have no withholding. Although this may work, withholding adjustments are not as precise as quarterly payments and should be used with caution. Similarly, when the safe harbor method based on the prior year’s tax liability is used, and the taxpayer has some withholding and also makes estimated tax payments, it’s important to monitor the current year’s withholding to be sure that the combined withholding and estimated installment prepayments will meet the safe harbor target amount.

We can assist you in estimating payments, adjusting withholding, and setting up safe-harbor payments. Please call for assistance at 562-404-7996 for more information.