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Archive for Business Expenses

Increase Your Tax Deductions—Switching from the IRS Mileage Rate to Actual Expenses

By Kim M. Larsen EA CTFS
Friday, February 27th, 2015

Do you feel like you’re not getting as much as you should from your business vehicle mileage deductions? For some business owners, gas and maintenance for a vehicle can be significant business expenses. If you’re not already using the actual expense method to calculate your mileage deduction, that may be your ticket to getting more from your vehicle expenses.

Usually, you’ll make a decision once regarding whether to use the IRS mileage rate for your deductions or to use the actual-expense method. If you choose the IRS mileage rate, you also lose out on MACRS depreciation.[1] However, you’re not locked into your choice forever. You have two different options for switching to claiming actual expenses.

Option 1: Amending Your Tax Return

If you realize fairly quickly that you’ve made the wrong decision in choosing to use the IRS mileage rate, you can act quickly and change your decision. That means you’ll have to file an amendment to your tax return before its original due date (if you filed extensions, the deadline includes the extensions).[2]

This option is fairly easy to enact. You’ll file the amendment, electing actual mileage expenses, Section 179 deductions, and MACRS depreciation. But, you have to act fast. This method essentially replaces the election on your original tax return.

Option 2: Straight-Line Depreciation

If you’ve already missed out on your chance to amend your return, you do have other options. You could still switch to the actual-expense method with MACRS depreciation, but you’ll have to get permission from the IRS commissioner . . . if you enjoy wasting time and money with the possibility of rejection.[3] Let’s be smart here; the commissioner is not a good option.

Instead, you can opt for straight-line depreciation for the remainder of your vehicle’s useful life.[4] This allows you to make the actual expense deductions. For calculating the straight-line depreciation, you’ll need the following information on your vehicle:[5]

  • Its Adjusted Basis—This is typically the original cost of the vehicle minus depreciation. When you use the IRS mileage rate, depreciation is included in it (22 cents per mile in 2014 and 24 cents per mile in 2015).[6] If you pay $30,000 for your car and drive it 5,000 miles for business (with no personal miles), you would calculate your depreciation at 5,000 miles x $0.22, which equals $1,100. Your adjusted basis is $28,900 ($30,000 – $1,100).
  • Its Estimated Remaining Useful Life—You don’t need to think too hard about this. It’s simply how long you expect to keep the vehicle.[7] We’ll call it 5 years for our example.
  • An Estimate of Its Salvage Value when the Useful Life Ends—To get a salvage value, you should use a respected pricing source, such as Kelly Blue Book. In our example, the value is what you estimate you could sell the vehicle for in 5 years (the remaining useful life). Let’s say this number is $4,000. Don’t forget to document where you get this number from!

Now, when you switch to actual mileage expenses, the IRS gives you a bonus on the salvage value if you plan to keep the vehicle for more than three years. Our example vehicle meets that requirement, which means you can reduce the salvage value by $3,000 (10 percent of the basis). If 10 percent of the basis exceeds the salvage value, that’s no problem. You’ll simply claim a salvage value of zero.

An Additional Consideration

When claiming actual expenses, you’ll have to pay attention to the luxury vehicle depreciation limits. These apply to passenger vehicles, and the limits differ between cars, vans, and trucks. You’ll need to find the amounts for the year you placed your vehicle in service.

For 2014 the limits for cars placed in service that year are:

The limits for vans and trucks are:

Note: These are amounts for used vehicles only. If your leased or purchased a new vehicle, use the tables in Rev. Proc. 2014-21 . Regardless of the type of vehicle or whether it is new or used, you must reduce the limit by your personal use. So, if you use your car for 80 percent business and 20 percent personal purposes, your first year limit is $2,528. If these limits affect your depreciation, you can simply claim the rest of the depreciation in a later year—you do not lose it.

Some vehicles are exempt from the luxury limits. Your truck, van, crossover, or SUV may be exempt if it 1) is classified as a truck by the Department of Transportation, and 2) has a gross vehicle weight rating over 6,000 pounds. Note that some passenger trucks are not classified as a “truck” by this definition.

If you don’t like the choice you made for your mileage deductions, you can fix it. If you catch it early, you’ll still get all the additional benefits that come with the actual-expense method (Section 179 expensing and bonus depreciation). However, if you make the switch later, you can still get some benefit from actual expense deductions with straight-line depreciation. What you need to know is that the choice to switch is available to you.

  1. Rev. Proc. 2010-51; IRC Section 168(f)(1) ↑
  2. Reg. Section 301.9100-2(d) ↑
  3. Rev. Proc. 2011-14, Appendix 6.02 ↑
  4. Rev. Proc. 2010-51 ↑
  5. IRS Pub. 534, Depreciating Property Placed in Service Before 1987, (Rev. Nov. 1995), p. 7 ↑
  6. Notice 2014-79; http://www.irs.gov/2014-Standard-Mileage-Rates-for-Business,-Medical-and-Moving-Announced ↑
  7. IRS Pub. 534, Depreciating Property Placed in Service Before 1987, (Rev. Nov. 1995), p. 7 ↑
Categories : Audits, Business Expenses, Cars, Trucks & SUVs, Depreciation, Listed Property, Tax Planning

Do You Own Multiple Businesses? Consider this Tax Advice for Passive Losses

By Kim M. Larsen EA CTFS
Friday, February 27th, 2015

Any time one of your businesses experiences a loss, you want to be able to claim those losses on your tax return. Unfortunately, the passive loss rules can stand in the way of these deductions, unless you plan ahead. In case you don’t already know the passive loss rules, here’s a breakdown of the requirements for deducting passive losses:

  1. You must participate materially in the business that has losses in order to deduct those losses (or if you group the business with another, you must actually participate in the group); or
  2. If you do not participate materially in the business, you must have other sources of passive income that you can deduct the losses against.

Grouping to Claim Passive Losses

Here’s a likely scenario. A medical doctor owns a medical practice, and she would like to open a physical therapy business, but she does not plan to actually work at the new business. Someone else will handle management of this business, and employees will provide the services. The doctor understands that the business will likely lose money for the first couple of years.

However, the doctor does not have any other source of passive income; her only other business is the medical practice in which she actively participates. Therefore, she has to figure out some other way to avoid passive loss rules and claim her deductions. Aside from deducting the losses from other passive income, she could also wait to deduct the losses in total when she gets rid of her entire interest in this passive business.[1] But, she doesn’t want to do that—she wants the deductions now because she doesn’t plan on selling this business for quite some time.

As you can see from the above points, one option for getting around passive loss rules is to form a group from the multiple businesses you own. So, in order to deduct those losses, she groups her new physical therapy business with her medical practice. “Wait a minute,” you may say. Even if she groups these two businesses together, doesn’t the physical therapy business still have only passive income?

It turns out that in order to meet the material participation requirements, you can group your business together to form suitable economic units.[2] That means the businesses and business activities within the grouping must make sense together based on these factors (quoted from IRS Publication 925):[3]

  1. The similarities and differences in the types of trades or businesses,
  2. The extent of common control,
  3. The extent of common ownership,
  4. The geographical location, and
  5. The interdependencies between or among activities.

Note that each business may conduct multiple sets of activities, and any entity structure may group its businesses or activities into one.[4] Even if you are the sole owner of three business that conduct four separate business activities, you can group all of these into one. Your material participation in the grouping then allows passive loss deductions for any of the business activities.

If you want to take advantage of such a common ownership grouping, you’ll need to make the election on your tax return and attach a disclosure statement.[5] Additionally, you’ll need to attach a statement with your tax return for any year that you add another activity to an existing group or regroup a grouping that was inappropriate. If you group inappropriately and don’t follow the requirements, you could end up losing your deductions because the activities will be treated separately.

Your disclosure statements should include the names, addresses, and employer identification numbers for each of the businesses being grouped together. Once you’ve made the election to group, you’re good to go with claiming deductions on an activity’s passive losses, so long as you meet the material participation requirements for the group. What that typically means is you have to participate in the combined businesses for at least 500 hours per year. Going back to our doctor, if she works at the medical practice for 1,968 hours in the course of a year and never does any work at the physical therapy business, she has met the 500-hour test for the entire group.

Not everyone has two business interests that make sense together as an economic unit. If you, like the doctor, are considering opening a second business, but your second business operates in a completely different way from the first, you may not be able to take advantage of grouping. When that’s the case, you should ask yourself, “Is it even worth it to start a business I cannot deduct losses for?” Remember, your tax deductions can make a big difference in your yearly profit.

Basically, you want to make sure the plans you make for your business ventures are the best choices for your bottom-line. Grouping elections are easy to make for the single-owner business, and the rules apply to real estate rentals, as well. So, if you have taxable income you’d like to offset, grouping may be a solution for your business.

  1. IRC Section 469 ↑
  2. Reg. Sections 1.469-4(a); 1.469-5T(a)(1) ↑
  3. Reg. Section 1.469-4(c)(2). ↑
  4. Passive Activity Loss Audit Technique Guide (ATG), Training 3149-115 (02-2005), Catalog Number 83479V, p. 4-2. ↑
  5. Rev. Proc. 2010-13 ↑
Categories : Audits, Business Expenses, Passive Income & Losses, Receipts, Records, Tax Planning

Own Two Cars? Claim Business Tax Deductions on Both!

By Kim M. Larsen EA CTFS
Sunday, February 22nd, 2015

If you use your car for business, you’re well aware by now that you can deduct your business mileage. If you have a tax-deductible home office, you can even deduct your commute to and from work each day. But, did you know that you might also be able to claim expenses for more than one vehicle? For business owners who fit the requirements, you can significantly increase your tax savings with deductions on both your vehicles.

Marriage Status Makes a Difference

It seems like married couples often get the most benefits when it comes to tax savings, but deducting business mileage for two vehicles is actually easier for the single folks. A single person who drives more than one car has a good chance of deducting expenses for both. The married person, on the other hand, will have a bit of a harder time justifying this deduction on their tax return. It can be done, though.

Here’s what you need to prove for the deduction if you’re married:

  1. You drive more miles than your spouse.
  2. Most of your miles are business miles.
  3. The two vehicles are of comparable value.

Figuring Out if You Qualify

So, either you’re a single person with two cars, or a married person who uses both vehicles for business miles. Either way, you’ll need to know four numbers regarding your vehicles and mileage. They are:

  1. How many business miles you drive,
  2. How many total miles you drive,
  3. The cost of each vehicle, and
  4. The estimated proceeds if you were to sell each of the vehicles.

These numbers should be pretty easy to produce. After all, you are keeping track of your business mileage already, right?

Get ready for some really easy math. It turns out the deductions work the same regardless of whether you’re married, single, a sole proprietor, or the owner of a corporation. No matter your circumstance, you can take those four numbers above and determine whether the two car deduction creates an advantage for you.

Tip: One thing that does make a difference is if you have the car on a lease. In the case of a lease, you must use IRS mileage rates and cannot use the formula below.

How to Do the Math

Let’s do an example. For this example, you own two cars: Yellow Car and Blue Car. Yellow Car cost you $23,000 and Blue Car cost you $21,000, so you know those numbers for the formula already.[1]

Say you used to drive only one of the cars for business purposes, and you drove a total of 28,000 miles. In this scenario, you drive Yellow Car 30,000 total miles and Blue Car 8,000 total miles, for a grand total of 38,000. That gives you 93.3 percent business use for Yellow Car and 0 percent business use for Blue Car.

Given this scenario, you are putting more miles on Yellow Car, so it will be worth less at the time of sale—$2,000. Blue Car could sell for $5,000. These numbers, of course, will be an educated guess. Now, you get your total tax deduction by calculating the net cost of your vehicle (purchase price minus sale price), and then multiplying by your business-use percentage. For the single-car scenario, your deduction equals $19,593.

Now, let’s see what happens if you start dividing your business mileage between two vehicles. Your 28,000 business miles are now divided between two cars—14,000 miles each. And, your total mileage is also divided between both vehicles—19,000 total miles each (the grand total remains the same, 38,000 miles). This means you are now driving both vehicles for business use 73.7 percent of the time.

Your estimated sales proceeds in this case are $3,500 for each vehicle, since they are being driven the same number of miles. Now what are the tax deductions for each car? Yellow Car: $19,500 (net cost, or basis minus proceeds) multiplied by 73.7 percent equals $14,372. Blue Car: $17,500 multiplied by 73.7 percent equals $12,898. This gives you a total tax deduction of $27,270.

You just added an extra $7,677 to your tax deduction! When you file your tax return, these deductions will be claimed (and adjusted) under depreciation, Section 179 expensing, and/or gain or loss on sales. These three elements equal the business percentage of the net cost of your vehicle. Before you decide to start using two cars for business, run the numbers through this easy formula, and see if it would save you money. Regardless of whether you claim these deductions using IRS mileage, actual expenses, or Section 179 expensing, the formula accurately determines whether claiming expenses for two vehicles is a better solution for you.

  1. If you traded in an older vehicle for one of these, you may want to use the adjusted basis rather than the original basis, or cost of the vehicle. ↑
Categories : Business Expenses, Cars, Trucks & SUVs, Receipts, Records, Section 179, Spouse, Tax Planning

Thinking about Buying a Business? Your Opportunities for Tax Deductions Have Already Begun!

By Kim M. Larsen EA CTFS
Friday, February 20th, 2015

Are you aware of business start-up deductions? If you’re not, you should find out right away! You don’t want to miss out on these tax-deductible activities that are only valid when you’re starting a new business. In fact, you don’t have to start your own business; you can get these tax benefits from simply buying a business. Fortunately, this article deals you in on the details.

It Pays to Plan

Before you even purchase your new business, you can start keeping track of your deductible expenses. That’s right, you are eligible for deductions related to merely thinking about your soon-to-be business. Here’s an example. Let’s say you invite a friend to dinner because she purchased her business only a few years ago, and you’d like to find out more about what goes into starting a newly purchased company. That dinner is deductible because you have a business purpose for the expense—you are seeking necessary information for your venture. These expenses are called “start-up expenses”.

Whether you create or buy a business, you will by necessity go through an investigatory phase. If you don’t do this, you may want to reconsider going into business for yourself! However, the rules about how deductions work are a little different in each situation, so we’ll stay focused on the process for purchasing an existing company.

Basically, you are going to incur expenses while you analyze your options and make a decision about what kind of (and then which) business to buy. That is the extent of the investigatory phase. After that, start-up expenses stop, and you begin tracking business expenses.

Here’s a breakdown of the steps and what expenses you may be looking at:

  • Investigating Possible Businesses—First of all, let’s make clear that when we say “buy a business”, we are talking about actually purchasing an active business, not buying corporate stock. If during this period, you spend $41,000 to analyze and review your options, you can begin writing off those expenses the day the escrow closes on your purchase. You get a $5,000 write-off on the first day, and $200 each month after for the 180 months.[1]
  • Identifying Your Prospective Business—In order to take advantage of the expenses for your investigatory phase, you must identify the business you plan to purchase. If after investigating the possibilities, you do not identify a target business, you will not be eligible for any deductions. At the point when you identify your target business, your investigative expenses stop. In the event that you identify a target business but do not end up buying it, you are still eligible for acquisition and facilitative costs, but not the investigative costs.
  • Buying the Business—Once you have identified the business and move forward with purchase, any additional expenses are considered capitalization rather than start-up costs. These are costs that you cannot benefit from until you later sell or leave your business. The IRS has what is called a “bright-line rule” regarding the date your research of possible businesses ends and acquisition activities begin.[2] It is either 1) the date of your letter of intent (or similar documentation), or 2) the date that a binding written contract is executed between you and the target business (unless board approval is required, in which case it’s the date terms are approved by the board or its authorized committee). The IRS will go with whichever of these two dates is earlier.[3]

Take a look at that last bit about the bright-line rule. That means that if you hire an accounting firm, for instance, to investigate your target company, the firm may continue to provide services to you after you submit a letter of intent. The accounting firm will make a financial analysis in the investigatory phase, but it also could review the target company’s books and records after that point. Only the services provided before submission of your letter of intent count as start-up costs.[4] The additional services are capital costs.

Of course, the IRS never makes things easy, so there is an exception to the above bright-line rule. It wouldn’t be tax law if there weren’t, right? You see, some expenses are inherently facilitative, meaning they cannot be counted as investigatory expenses. What about the bright-line date, you may say. It doesn’t matter. Facilitative expenses are capital costs regardless of the date you incurred them. Here are some examples that are inherently facilitative to a purchase:[5]

  • Appraisal costs
  • The cost of a formal written evaluation of the transaction
  • The cost to have a purchase agreement prepared
  • Any costs necessary to obtain shareholder approval
  • Costs for negotiating the transaction
  • Costs for structuring the transaction
  • Any costs for conveying property, such as title registration or transfer taxes

When Corporations Are Involved

Things are always a little trickier when corporations are the entities making the transaction. You may find yourself in one or both of the following situations: you could be purchasing a corporation, and/or your corporation may be the buyer. Let’s look at a few scenarios.

  • You Only Buy Common Stock—If you take over a corporation through common stock, any investigatory expenses are not deductible. This is because you have gained an investment rather than an actual business or trade interest.[6]
  • You Buy Stock Plus Assets—If stock purchase is included in the process to fully take over a corporation, that is a different matter. When you acquire a business’s assets, even when stock is also exchanged, you are eligible for start-up deductions and amortization.
  • Your Corporation Is the Acquirer—Unlike the sole proprietor, who claims start-up expenses on the Schedule C, an S or C corporation will claim these expenses on the corporate tax return. Always keep in mind that your corporation is a separate entity from you. Do not pay any of the costs incurred by your corporation. If you do, make sure the corporation reimburses you. Doing otherwise will cause headaches with your taxes.
  • You Form the New Business as Corporation—When you do this, you incur organization expenses for setting up your company’s entity structure. This can include fees paid to incorporate, legal services required to set up the corporation, accounting services, and expenses related to organizational meetings for directors or stockholders. These costs are separate from investigatory costs and capitalization costs.[7] The good news is that they can be amortized just like start-up expenses. You claim up to $5,000 in the first year and amortize the remainder over 180 months.[8]

Now you know what to do as far as acquiring your business, but what if the business fails or is sold before you finish seeing the full benefits of amortization? No worries. For sole proprietors, you deduct the remaining (unamortized) costs as a business loss.[9] For corporations, both the unamortized start-up and organization costs are deducted on the corporation’s final tax return.[10]

Tax law is not written to slow down businesses, despite the fact that it can get complicated. On the contrary, legislators know that the opening of new businesses benefits the whole economy. That’s why your able to write-off expenses like the ones discussed here. Take advantage of it! The benefits are available so that you and your business can succeed.

  1. IRC Section 195(b). ↑
  2. TD 9107. ↑
  3. Reg. Section 1.263(a)-5(e). ↑
  4. Reg. Section 1.263(a)-5(e) ↑
  5. Reg. Section 1.263(a)-4(e)(2). ↑
  6. H. R. Rep. No. 1278, 96th Cong., 2d Sess. 3, 9-13 (1980). ↑
  7. Reg. Section 1.248-1(b)(2). ↑
  8. Reg. Section 1.248-1T(a). ↑
  9. IRC Section 195(b)(2). ↑
  10. Liquidating Co., 33 BTA 1173. ↑
Categories : Business Expenses, Entertainment, Receipts, Records, Start Up, Tax Planning, Travel

Deducting Business Education? Here’s What You Need to Know

By Kim M. Larsen EA CTFS
Wednesday, February 18th, 2015

Depending upon the field you’re in, business education can be a significant expense. Do you have to keep up with certain certifications? Do you need to learn a particular skill? Are you seeking more knowledge about running a business in general and gaining customers?

Lori Singleton-Clark attained an online MBA in order to increase her business knowledge. In one year of the program, she spent $14,787 on her business education, and that is the deduction she claimed on her tax return. Guess what? Ms. Singleton-Clark fought the IRS and won her deduction in court.[1] Even more encouraging is the fact that she did not hire an attorney and was able to represent herself sufficiently by having the right documentation.[2]

Why We Have Business Education Deductions

The government wants to help out people who are in business. It’s beneficial to the economy for the government to help businesses succeed. Because the government acknowledges the vast amount of information necessary to run a company, they give you tax breaks in order to get that knowledge and use it for the advantage of your business. Depending upon your industry, this knowledge could come in any number of forms, such as:

  • Learning to play golf
  • Learning to fly a plane
  • Learning about software
  • Finding out more about marketing
  • Obtaining writing skills
  • Obtaining negotiating skills
  • Obtaining selling skills

Education does not just mean taking classes. You may obtain your education at seminars or conventions.[3] Or, you may even hire a private coach.[4] As long as this education meets the requisites for deductible business education, you can save money on this necessity. So, how do you qualify?

Qualifying for the Deduction

The basic rule for qualifying for the deduction is pretty simple. In order to deduct the expense, the education obtained must either improve the skills you need in your business or maintain your current business skills, and it cannot train you for a new business.[5] Let’s break that rule down into some more specific guidelines:

  1. You must already be in the business the education pertains to.[6]
  2. In the business does not mean simply working in the field. To qualify, you must already have the basic, entry-level education required for the business—you cannot deduct minimum-requirement training.[7] However, if regulations change after you’ve entered the business, your expenses qualify if you need to get up-to-date with new requirements.
  3. The determination that you need the education can come either from yourself, from an employer, or from a change in legislation regarding your industry.[8]

Here are some examples of education costs that do not qualify:

  • Courses taken in the pursuit of a bachelor’s degree
  • A nurse taking courses to become a medical doctor
  • A legal assistant obtaining a law degree

But, these do qualify:

  • A dentist taking additional coursework to become an orthodontist[9]
  • A teacher seeking a Master’s or Ph.D. in their field[10]
  • A psychiatrist obtaining psychoanalyst training[11]

These latter three situations qualify for the deduction because each person is maintaining their current job (they are still a dentist, teacher, and psychiatrist) but increasing their skills.

Case Examples

Patrick O’Donnell did not get his deduction for the cost of attending law school. O’Donnell was a CPA who worked with lawyers regarding taxes. Although he already worked with lawyers and continued in the same position after receiving his law degree, he was not eligible for the deduction because it qualified him to eventually switch careers and become a lawyer if he chose. That is, a law degree is the bare minimum requirement for being a lawyer; thus, it is entry-level education for a particular field.[12] Bachelor’s degrees and medical degrees work the same way.[13] You will not be able to deduct any of these degrees.

An MBA degree, on the other hand, often is deductible. That’s because the majority of people who pursue the degree are already in business. Therefore, the degree contributes to knowledge in an area they are already involved in. Robert Beatty, for example, earned an MBA in order to improve his administrative, management, and interpersonal skills. He worked in management as an engineer, and the skills he obtained directly improved his business.[14] Beatty did get his deduction.

However, you may want to know a few tips about proving you are in the business for which you are receiving and deducting an MBA:

  • It’s best if you’ve been in the business for a few years before beginning the MBA. Trying to get one after only a few months in a new business could be harder to justify to the IRS.
  • If it’s possible, pursue your degree part time rather than full time. This allows you to continue working in your business while you obtain the degree.
  • If you decide to go the full-time route, you’d better plan your time efficiently. Quitting your business and doing nothing for a year before beginning the degree program may mean no deduction.

Daniel Allemeier, Jr. is another example of someone who pursued the MBA and won his deduction.[15] He was a well-respected salesperson and trainer for a dental products company, and after being with the organization for three years, he chose to get an MBA. Shortly after enrolling in the degree program, Mr. Allemeier’s employer promoted him to marketing manager. The employer’s policy stated that it would not reimburse employees for education, so Allemeier chose to pay for his MBA himself while continuing to work full time. Although his employer did not require this education, the CEO of the company did encourage it in Allemeier’s case.

Do you see why Mr. Allemeier was able to defend his deduction?

  • He had been in the same business for several years;
  • His degree did not qualify him specifically for any other profession;
  • The MBA coursework improved the skills he currently used in his position; and
  • The MBA was not a requirement for his promotion, even if it may have helped in that regard.

In another court case, Deputy District Attorney Edward Kosmal defended his deduction for Spanish lessons. He won because he worked in a community with many Spanish speakers, and this education helped him to better perform his job.[16]

Kenneth Knudtson was even able to deduct the cost of flying lessons.[17] He successfully proved an ordinary and necessary business expense for both the cost of his plane and the lessons because he used this transportation method to visit customers and suppliers for his automobile windshield wiper motor rebuilding company. The companies he visited were spread over a wide area, and this made flying himself a reasonable choice for his business practice, considering how important it was for him to maintain close working contact with his suppliers.

What’s important to note is that it’s the circumstances that determine whether you get your deduction, not the particular courses you take. Ronald Beckley was an FBI special agent who had a pilot’s license before joining the FBI. He was sent on multiple missions as a pilot, but he was unable to take some missions because he lacked an instrument rating. Beckley took the courses he needed to perform his job better, but he also took several other courses that certified him as a commercial pilot and flight instructor. When his case went to court, Beckley was able to deduct the expense for the instrument rating, but not the expense for the other courses.[18] Those courses did not contribute to skills for his current position, and they qualified him to work in another field—as a commercial pilot.

Here’s a funny example. David Kohen failed a different part of the requirements. He had obtained his law degree, and rather than entering the profession, he chose to wait and pursue postgraduate courses in tax law. Unfortunately for Mr. Kohen, both the IRS and the court denied his deduction because he had never actually practiced law, and therefore was not in the business and did not have skills to “improve” or “maintain”.[19] That’s right—the postgrad in tax law could not justify and defend his tax deductions!

As mentioned, it’s best to be established in your business for several years before pursuing additional formal education. If you take the leap to leave your job while obtaining this education, you only have a chance at winning your deduction if you can prove that your absence was temporary. Unfortunately, the IRS and the courts disagree on the definition of “temporary absence”.

Robert Picknally benefited from this difference when he won his business education expense deduction.[20] After working for 10 years, he left for 3 in order to get a PhD. However, he was not able to get a job afterwards. In this situation, the IRS states the leave was not temporary because it lasted longer than one year (the IRS safe harbor limit). The courts, on the other hand, allow longer than a year if you can prove that you intend to stay in the same business after your temporary absence. Whether Picknally was actually able to find work in the same field did not matter, and the IRS even filed an acquiescence stating that the one-year-safe-harbor rule could be overridden when certain facts and circumstances make it appropriate.

Filing the Return

When you file your tax return, how you claim the deduction depends upon what kind of entity structure your business runs under. Here are a few possible scenarios:

  • Independent Contractor or Sole Proprietor—If you’re an individual business owner or freelancer, you use Schedule C of Form 1040 in order to claim your expenses. You’ll just put the business education deduction on this form with your other business expenses, and it will reduce your state income taxes, federal income taxes, and self-employment taxes.
  • S or C Corporation—When you operate as a corporation, things get a little trickier because you are considered an employee of your corporation. Because of this, you actually have two options for making the deduction. Either you can make the deduction as an individual, unreimbursed by your company for the business expense, or the corporation can make the deduction after reimbursing you for your employee business expense.

You do not want to take this first option, and here’s why: employees get the shaft when it comes to deducting business expenses. First, this option relegates your education costs to the miscellaneous itemized deductions category, meaning they are reduced by 2 percent of adjusted gross income.[21] Second, if you do not itemize deductions, you lose any benefit. And third, employee business expenses could trigger the alternative minimum tax (AMT), where they are disallowed.

The best choice for the owner of a corporation is to have the corporation take the deduction, after reimbursing you in a timely and appropriate manner. Your corporation gets a deduction, you get the cash (from your company), and you have no taxable income on this.[22] Perfect!

Now, here’s how you protect this perfect situation from the IRS. When your corporation deducts employee business expenses, it has the burden of proof on your behalf. So, your company should set up an accountable plan for providing reimbursements on these expenses. The accountable plan requires the employee to prove they complied with the rules of the plan before receiving reimbursement. It’s easy to do and could be something as simple as filling out and signing an expense report that states the employee met the qualification requirements for deductible education. You’ll also need the receipts. Providing this proof to your corporation builds protection both for you and your business entity.

Armed with this information, you’ll be able to choose educational options that benefit your business and are tax-deductible. But, you don’t really need to put up a fight—the government wants you to gain education. Typically, more educated individuals earn more money, and the government knows it shares in your financial growth. Education really is a smart investment, both for tax-savings and future success.

  1. Lori A. Singleton-Clarke v Commr., TC Summary Opinion 2009-182. ↑
  2. “Nurse Outduels IRS over M.B.A. Tuition,” by Laura Saunders, The Wall Street Journal, January 9, 2010 ↑
  3. Coughlin v Commr., 203 F.2d 307 (2d Cir. 1953); 260 F.2d 80 (9th Cir. 1958). ↑
  4. Walter G. Lage v Commr., 52 TC. 130 (1969). ↑
  5. Reg. Section 1.162-5. ↑
  6. Reisinger v Commr., 71 TC. 568 (1979). ↑
  7. Reg. Section 1.162-5(a)(2). ↑
  8. IRC Section 67(b). ↑
  9. Rev. Ruling 74-78. ↑
  10. Rev. Ruling 68-580. ↑
  11. Reg. Section 1.162-5(b)(3)(ii). ↑
  12. Patrick L. O’Donnell v Commr., 62 TC. 781 (1994), affirmed 519 F.2d 1406 (7th Cir., 1975). ↑
  13. Thomas J. Cangelosi v Commr, TC Memo 1977-264. ↑
  14. Robert C. Beatty v Commr., TC Memo 1980-196. ↑
  15. Daniel R. Allemeier, Jr. v. Commissioner, TC Memo 2005-207 ↑
  16. Edward J. Kosmal v Commr., TC Memo 1979-490, affirmed per curiam, 82-1 USTC ¶9255 (9th Cir., 1982). ↑
  17. Kenneth L. Knudtson v Commr., TC Memo 1980-455. ↑
  18. Ronald J. Beckley v United States, 490 F.Supp. 123 (S.D. Ga. 1980). ↑
  19. David M. Kohen v Commr., TC Memo 1982-625 ↑
  20. Robert Picknally v Commr., TC Memo 1977-321, Acq. AOD 1978-60. ↑
  21. IRC Section 67(b). ↑
  22. Rev. Ruling 76-71. ↑
Categories : Business Expenses, College, Education, Tax Planning

How You Can Deduct Your S Corporation Board Meeting with Your Spouse

By Kim M. Larsen EA CTFS
Wednesday, February 18th, 2015

When it comes time to deduct business expenses on a tax return, most corporation include expenses for board meetings. After all, that’s undeniably a business expense, right? Well, sometimes it’s not so clear, like when the only two board members are a wife and husband. If you and your spouse jointly hold stock in your S corporation, how do you prove your right to a deduction? Can you go to a restaurant or take a business trip and still deduct the meeting?

Proving Your Business Purpose

When your board meeting consists of just your spouse and yourself, you have to be careful that the IRS has sufficient evidence documenting the business activities of the meeting. How do they know the event was a board meeting, and not just a pleasant lunch date? Husbands and wives have been conducting business together since before the birth of US tax law. You can study precedent cases to find out how the IRS is likely to view your situation.

Unfortunately, not many cases exist regarding this particular scenario, so you have to look at similar situations regarding deductible business expenses. In the case of Ben Heineman, the IRS questioned him for building an office at his vacation property, costing $1.4 million in today’s dollars (the office was built in 1969). Heineman stated that he could perform certain work (such as making business plans) better with his family and away from the distractions of the Chicago offices. Not exactly the same situation as a board meeting, but the same requirements for determining whether an expense is business or personal.

Heineman was the president and CEO of Northwest Industries, Inc., which had its principal offices in Chicago, IL. Not wanting to spend his summers in Chicago, he built the office at his vacation home in a resort area, Sister Bay, Wisconsin. During the period of the year when Mr. Heineman used this office (from about August until Labor Day), he worked at least 5 hours per day, six to seven days per week. He used this time to perform duties essential to the Chicago offices, including long-term business planning.

In the end, the courts ruled in favor of Mr. Heineman, stating it didn’t matter if it would have been less expensive for him to get a second office in Chicago. He had a necessary and ordinary business reason for the trip—he could concentrate better on his work at that location. Therefore, he was entitled to his deduction.

What the Heineman Case Means for You

Why is this case important for your board meeting scenario? The only deductions that Mr. Heineman claimed were depreciation on his office building and maintenance expenses for it. He did not claim traveling expenses for the trip between Chicago and Wisconsin. However, he did travel—to his vacation property. According to tax law travel regulations, you are able to deduct business expenses incurred on a trip that is otherwise personal, and that is why Mr. Heineman was able to deduct his second office expenses.

The same travel regulations would apply to you if you take your spouses-only board meeting to an out-of-town location. So, what you need to show the IRS (with accepted documentation) is:

  1. Business was the primary purpose of the trip, and
  2. Business actually took place during the trip.

All you have to do to establish business as the trip’s primary purpose is to ensure that you conduct business on more days than you partake in personal activities. Fulfilling the requirement that the trip was necessary for business is tougher. How do you show that it was necessary to go out of town? Again, look at Heineman. You could have some very good reasons for going out of town to conduct business: get away from ringing phones, find peace and quiet to concentrate, or not to be distracted by email or employees.

As for proving that you conducted business, you simply keep records of evidence that you did work. These could include:

  • Documents generated on this trip (such as a business plan)
  • A recording of business conversations that took place
  • Evidence that you were in a business setting
  • A print log showing you physically printed business documents to be discussed and reviewed

The out-of-town board meeting can be a bit of hassle to document, so if you’re banking on the deductions making the cost of the trip worthwhile, you’d better make sure you plan efficiently and can back up your claim to the business purpose of the trip. The funny thing, however, is that an in-town board of directors meeting for a wife and husband is even more difficult to prove.

You see, tax law specifies that you cannot deduct personal, family, or living expenses. That means deducting a meal at a restaurant as a business expense is going to be awfully difficult to justify to the IRS, particularly when no one else is participating other than you and your spouse. You’ll see why with an example of a couple who was not allowed to deduct their board meeting expenses.

Mr. and Mrs. Duquette were the sole board members of Norman E. Duquette, Inc. and attempted to deduct expensive meals at two separate restaurants on January 1 and February 1. At the meals, they discussed items such as approval of payment for trips and determining whether to move the business to Naples, Florida. Unfortunately for the Duquettes, the court decided that the couple had no evidence that the issues required significant discussion.

The Duquettes had no employees, and the couple both lived and worked together. The court found no proof that could justify a husband and wife having an expensive dinner in this situation, when they could have just as easily had the discussions elsewhere without the expense. Here is the IRS’s standard stance on the matter (from the Internal Revenue Manual): “Board meetings between husband and wife are not ordinary and necessary business expenses, but personal entertainment expenses, and are therefore not deductible” (Treas. Reg. Section 1.162).[1]

The takeaway from this is that fine dining expenses are not deductible as a wife-and-husband board meeting under official IRS policy. That does not necessarily mean you cannot deduct such expenses, but you’d better be prepared to have a rock-solid justification for it (i.e. a well-documented business reason). Unlike the Heineman case, the Duquette case does not set a precedent (and neither does the IRS audit manual).

Applying the Cases to Your Situation

If your spouse-only board meeting needs to be away from home, either in-town or out, you need to be able to answer the question “Why?” Heineman had something concrete to show the IRS and the court—a business plan that he developed because he was able to concentrate and focus better at the second office. The Duquettes, in contrast, failed to produce any evidence of work effort during the meetings.

To take advantage of deductions for a spouses-only board meeting for your S corporation, you should be confident that you have at least a 50-50 shot at your reasons being accepted, and whoever prepares your taxes has to back up that assertion. Your tax preparer is at risk of severe penalties for filing a return that doesn’t have a justifiable 50-50 chance. When using this strategy, show the Heineman case to whoever prepares your taxes. But, remember that you are highly unlikely to be able to deduct the in-town, husband-and-wife meeting at a restaurant.

Still want to conduct a meeting during a meal? If it’s an issue that requires a third party, such as your attorney, then go ahead! It’s only when spouses dine together exclusively that the deduction becomes difficult. But, when the two of you are meeting to discuss business matters with someone else who is necessary to the discussion, it makes sense that you must find a location to meet (just be sure to document the business purpose!).

  1. Internal Revenue Manual 4.10.10, Paragraph 9707. ↑
Categories : Business Expenses, Corporations, Entertainment, Tax Planning, Travel

Hire Your Kid and Get a Tax Break

By Kim M. Larsen EA CTFS
Tuesday, February 17th, 2015

Do you want to find out a better way to teach your child about money than just giving an allowance? If you own your own business, you can pay your kid in a way that benefits both you and the child when it comes time for taxes. You see, it’s possible to get a deduction by hiring your child to work in your company, and your kid could get the money without paying any taxes! Compare that to paying taxes first (without the deduction) and then paying an allowance out of after-tax dollars.

A Precedent Case

Sally Wilson hired her 13-year-old to work in her proprietorship, and she paid the child $5,700. For doing so, she got back $2,600 from state and federal governments. If Wilson’s business functioned as a corporation, she still could have gotten back $644. This extra money comes from hiring-your-child tax breaks.

Additionally, Ms. Wilson’s child paid zero taxes. That’s because the child can take the standard deduction (instead of itemizing property taxes, mortgage interest, charitable donations, etc.). In 2009, the standard deduction was $5,700 (the total amount of the child’s income). The standard deduction is $6,200 for 2014 and $6,300 for 2015.

Why You Should Hire Your Child

Hiring your child is a great way to teach them about finances, as well as what it takes to work and earn money. Aside from that, your own child can make a terrific employee because you already know and trust them.

There’s an added benefit to this tactic if you plan to help your child pay for college. Legally, your child can put money into an IRA (traditional or Roth) to grow tax-free, and because your child is employed by a parent, they can take out that money penalty free to use for college. This is a big advantage for you and your child.

Considering the $6,200 standard deduction for 2014, let’s look at what would happen if your kid earned $11,200. Zero taxes are paid for the $6,200, and if your child puts the additional $5,000 in a traditional IRA, then zero tax dollars are paid for the entire earnings! That’s right—your kid could nearly double their income and still not pay a single penny in taxes.

The benefits are still impressive even when you pay your child even more throughout the course of the year. Let’s use Ms. Wilson’s example again. If she had paid her child $19,050, she would have received total benefits from state and federal deductions equaling $8,763 (saving 7 percent in state income tax, 14 percent in self-employment tax, and 25 percent in federal income tax). She would keep that money. The child has taxable income only on what’s left after the standard and IRA deductions. The tax would have equaled $1,035, and the child would have kept $18,015 (including what is in the IRA).

You may be wondering, “What about the payroll taxes?” Well, if your business is a sole proprietorship (or partnership owned only by the parents of a child), then payments to a child under 18 are not subject to Social Security or Medicare taxes.[1] Additionally, no unemployment taxes have to be paid by such an entity while the employed child is under 21.[2]

Other Considerations

Perhaps you’ve heard of the kiddie tax, which puts a limit on how much income an underage child can bring home without paying taxes. Don’t worry—it doesn’t apply to this situation. The kiddie tax applies only to net unearned income.[3]

As for age restrictions regarding hiring your child, tax law has none. In fact, in one case that the IRS acquiesced to, a couple hired all three of their children to work at their mobile home park operation.[4] The youngest was 7. What the IRS does care about is that you are paying the children fair wages for services rendered. In this case, it noted that compensation paid to children is only deductible if the amount is reasonable and paid for actual services rendered, and parents may deduct amounts paid to their minor children.[5] That means you’ll have to have documentation proving the wages were fair.

Of course, the IRS will be keeping a closer eye on you to make sure that the child actually is an employee and performing services for the business.[6][7] One way to provide documentation of this is to keep a timesheet for your child’s earned wages. And, here’s an extra tip: don’t try to deduct food and lodging expenses for your child employee. Parents are legally liable for the support and maintenance of their minor children.[8]

Maybe the IRS doesn’t mind, but what about child labor laws? For the most part, parents employing their own children are exempt from child labor laws. According to the Fair Labor Standard Act, parents can have their children under age 16 work for any number hours at any time of day in a business owned solely by the parents.[9] The Department of Labor, however, does have prohibitions about employing children in hazardous jobs.[10] Check their website for a list .

What About Corporations?

The rules for corporations differ, of course. As you saw in the numbers above, if Ms. Wilson had been the owner of a corporation, she would have gotten significantly less in tax benefits. That’s because a corporation is not the mother or father of a child. As a corporation, your business will have to pay unemployment taxes, and the corporation and your child will be responsible for Social Security and Medicare taxes.

If you’re going into business and already have children, you may want to consider the different outcomes of hiring your child when choosing an entity structure. When choosing, keep in mind that hiring your under-18 child for a proprietorship or partnership definitely pays off. But, hiring your under-18 child for an S corporation or C corporation may or may not. It’s important that you run the numbers in those situations.

Ensuring Against Audit

As with any tax strategy, the key to winning your child employee deductions with the IRS is to provide adequate documentation. Here are some tips for providing enough proof:

  • Have an Employer ID—Even if your child is your only employee, you need to get an employer ID number in order to make the employer-employee relationship legitimate. You can do this online or call the IRS at 1-800-826-4933.
  • Track Work with a Time Sheet—Having your child fill out a time sheet is a great way to keep proof of the time they worked and the wages they earned. In one case, Vernon E. Martens hired his four children, but failed to require time sheets and lost out on 80 percent of his deductions.[11]
  • Have Support for Your Pay Scale—If you want to pay your child more than minimum wage, you’ll need documentation supporting the wage. One way to do this is to determine how much it would cost if you hired someone outside the family, and adjust for variables such as skill level and whether it takes your child longer to complete the task than it might take someone else. However, if you’re just paying minimum wage, there’s no need to document your reasoning.
  • Always Use Payroll Checks—Checks maintain a clear trail from your business account to your kid’s checking or savings account. There’s no question left about the amount paid or whether it was paid by the business. When you hire your child, the money you pay is theirs, and you must be able to show that the pay went to a separate account, not one of your own. Also, be sure to check the payment if you use a payroll service; they may mistakenly take out Medicare and FICA, which is unnecessary for a minor.
  • Fill Out Payroll Forms (Both State and Federal)—These are the documents you have to fill out to set up your child as an official employee of your business and properly prove the child’s earnings and any taxes due. The federal forms include IRS Form W-4, IRS Form W-2, IRS Form 941, and IRS Form 940. Even though your minor is exempt from withholding for FICA, Medicare, and unemployment taxes, you’ll still need to turn in those forms. You can find all the forms at the IRS Forms and Instructions page.

Now that you’ve learned all the advantages of hiring your child as an employee for your proprietorship or partnership, it’s time to teach your child the value of money. You’re giving your kid a wonderful opportunity to begin investing early. As mentioned above, your kid can even save up for college with an IRA, which stretches the tax savings even further.

  1. IRC Section 3121(b)(3)(A); Reg. Section 31.3121(b)(3)-1. ↑
  2. IRC Section 3306(c)(5). ↑
  3. IRC Section 1(g). ↑
  4. Eller v Commr., 77 TC 934; Acq. 1984-2 CB 1. ↑
  5. AOD 1985-004. ↑
  6. Gerald W. Jordan v Commr., T.C. Memo. 1991-50. ↑
  7. Denman v Commr., 48 T.C. 439, 450 (196). ↑
  8. Rev. Rul. 73-393. ↑
  9. http://www.dol.gov/elaws/esa/flsa/cl/exemptions.asp ↑
  10. http://www.dol.gov/elaws/esa/flsa/docs/haznonag.asp ↑
  11. Vernon E. Martens v Commr., No. 90-3104, May 91 (4th Cir.). ↑
Categories : Business Expenses, Employ Your Kids, Employees, Payroll, Tax Planning

Why You May Want to Consider Antiques as Business Assets

By Kim M. Larsen EA CTFS
Tuesday, February 17th, 2015

It’s already well-known that antiques can make a wonderful personal asset for collectors. If you know how to choose the right pieces, you can see a nice return on investment from quality antiques. But, have you ever thought of doing the same with your business? Let’s put it this way, if you could choose between two desks for your office, both for the same price, do you go with the regular desk or the antique?

In many cases, the antique could be a better choice. Thanks to newer tax laws, antiques are now assets under Section 179, just like any other standard business equipment. That means you’ll get the same business tax deductions regardless of which desk you choose. So, why opt for the antique? For the same reason you might buy an antique for a personal collection. A regular desk will likely depreciate over the years, but the antique is a money-maker, likely to increase in value. The final difference could be thousands of extra dollars for your business.

Antiques as Smart Choices

Let’s put together an example so you can see just how the numbers work. Both desks cost $5,000 to purchase. In 10 years, the antique desk would be worth $15,000 and the regular desk would be worth $500. For the sake of this example, we’ll say you’re in the 35% income tax bracket and 15% capital gain bracket when you sell the piece of furniture. Here’s what your federal taxes would be on the antique:

  • 15% of the $10,000 in capital gain equals $1,500
  • 35% of the $5,000 in depreciation recapture equals $1,750

That means you’ll keep $11,750 after taxes from the sale of your antique desk. Compare that to only $325 from the sale of the regular desk ($500 from the sale minus 35% in recapture taxes). You can see how choosing antiques for multiple items in your office can quickly increase your business’s gains!

What kind of items could be purchased as antiques?

  • Conference tables
  • Desks
  • Rugs
  • Business car
  • Cabinets
  • Clocks
  • Paperweights
  • Bookcases
  • Coatracks
  • Umbrella stands
  • Chairs

Think of the possibilities! Any antique that functions just as well as a new purchase is a great investment. It could increase in value, and thus increase your net worth. Just don’t try to buy an antique computer!

Many business owners don’t even consider antiques when purchasing equipment. But, why not? When you choose antiques, you usually get a quality piece of furniture that looks beautiful in your office. They still count as depreciable Section 179 assets. And, they could increase in value. Even if a particular antique choice doesn’t increase its value significantly, you’ve lost nothing (as long as you pay reasonable prices).

Cases Regarding Antiques as Business Assets

Several previous court cases have held up the ability to count antiques as business assets. In particular, Liddle[1] and Simon[2] allowed these two professional musicians to depreciate antique and collector violins as business assets. These musicians used the violins in their role with the Philadelphia Orchestra.

The instruments involved in the case were already 300 years old when purchased. They were bought for $30,000 and had increased in value to $60,000 in less than 10 years when the musicians had depreciated them to zero. Regarding this case, the court noted that the Economic Recovery Tax Act of 1981 (ERTA) had changed the rules for depreciation. Prior to ERTA, antiques could not be depreciated in a business, no matter how often they were used for business purposes.

The cases went through the Tax Court, the Second Circuit Court of Appeals, and the Third Circuit Court of Appeals. Thanks to the decisions made in these courts, the musicians (and you) may now depreciate antiques and count them as a Section 179 expense. ERTA set the path for this by changing the useful-life rules to statutory depreciation periods. So, what does all this mean for you? It means you qualify for tax-favored expensing and depreciation when:

  • During the normal course of business, you actually use the antiques (they are not decorative).
  • The antiques are subject to the same wear and tear that any other business asset would be.

Interestingly, the IRS did not agree with the decisions of the courts in the cases of Liddle and Simon. In 1996, they formally issued a non-acquiescence and stated that in the seven other circuits they would go after taxpayers who tried to depreciated antiques.[3] However, to date they have never done this.

The circuit for the above cases covers the areas of Vermont, Connecticut, New York, New Jersey, Pennsylvania, Delaware, and the Virgin Islands. This means that if you work in one of those areas, the IRS cannot attack your antique depreciation because the courts have already made their decisions regarding that circuit.

Further, it is unlikely that the IRS will actually go after you for business antique depreciation no matter where you live. That’s because courts can order the IRS to pay attorney’s fees for bringing a case that is “not substantially justified.” Per IRS Publication 556, that means:[4]

  • The IRS didn’t follow its own published guidance, such as announcements, private letter rulings, revenue rulings, and regulations.
  • The IRS has taken on substantially similar cases in another circuit’s courts of appeal and lost.

Therefore, even if you live outside the Second and Third Circuits, you are unlikely to be hassled by the IRS about depreciation of antiques. Bringing a similar case in other circuits could obligate the IRS to pay attorney fees, and the IRS has not tried since the time of these cases.

When Preparing Your Taxes

Just remember to follow certain rules established during Liddle and Simon. Artwork does not count as a depreciable business asset, as found in the Noyce case.[5] Any antique furniture or equipment you plan to depreciate on your taxes must be physically used as a part of your business and subjected to the wear and tear of ordinary office equipment.

It turns out you actually get a better deal on taxes than the antique dealer who sells you the piece. A dealer gets to deduct the antique’s cost as a cost of sale, but he pays both self-employment taxes and regular income taxes on the profit. A business owner, on the other hand, deducts the cost at the time of purchase with Section 179 expensing rather than having to wait for the sale. Also, because the item is counted as a business asset, when you do sell it the amount of profit that exceeds the purchase price is a Section 1231 gain, which is a tax-favored capital gain as long as you used the antique in your business for more than one year (assuming you have no offset from Section 1231 losses).

All of this sounds pretty good so far, right? Well, here’s some even better news. If you’re kicking yourself for having antiques that you have not deducted in your business because you weren’t aware of the rules, you can claim those benefits on this year’s tax return. You just claim the depreciation retroactively with a Form 3115.

For business antiques you buy this year, you can expense up to $125,000 of qualifying purchases. You get immediate deductions for this. Down the road, when you sell the items, you’ll get tax-favored capital gains benefits on the amount of appreciation. All in all, you come out way ahead, even with the price of recapture taxes on the depreciation. After all, a regular piece of office equipment is worth much less when you’re ready to sell it. It’s clear that antiques are a good financial choice when you need to select furniture or equipment for practical use in your business.

  1. Brian P. Liddle v Commr., No. 94 7733, 76 AFTR2d &95 5327, 3d Cir, September 8, 1995, aff’g 103 T.C. 285, 94 TNT 165 8 (1994). ↑
  2. Richard L. Simon v Commr., No. 94 4237; 76 AFTR2d &95 5496; 95 2, 2nd Cir., October 13, 1995, aff’g 103 T.C. 247, 94 TNT 165 7(1994). ↑
  3. AOD 1996 009, July 15, 1996. ↑
  4. IRS Pub. 556, Examination of Returns, Appeal Rights, and Claims for Refund (Rev. August 2005), p. 10. ↑
  5. Noyce v Commr, 97 T.C. 689. ↑
Categories : Antiques, Business Expenses, Depreciation, Investments, Section 179, Tax Planning

Did You Know Your Car Can Accelerate Your Tax Savings?

By Kim M. Larsen EA CTFS
Sunday, February 8th, 2015

Would you like thousands, or even tens of thousands, more dollars in tax deductions every year? Of course you would! To boost your deductions, you can count on your vehicle to be a deduction generator if you use it to drive from one business location to another. The only thing you have to do is keep the right records in order to prove your business mileage. Your tax records, like your car, require regular maintenance in order to function properly.

The Documentation You Need

We can look at the court case of salesman, Marcus Crawford, for an example of what a difference minor deviances in documentation can make.[1] Crawford spent much of the work day driving to meet customers. He tried to defend is vehicle deductions in an amount greater than $20,000 by providing 1) destination notes on his daily calendar, and 2) saved gas receipts. Although this sounds like decent record keeping, the IRS rejected this documentation and Crawford got none of the deductions. Zero.

Unfortunately for Mr. Crawford, the IRS is pretty strict about documentation for vehicle deductions. Here’s what you actually need in order to qualify:[2]

  1. A mileage log
  2. Receipts that support your mileage log

Crawford’s proof didn’t work because it failed to document the true number of miles spent driving to each location and how the location was related to his business activities. A proper log divides mileage into the appropriate categories:

  • Personal mileage
  • Commuting mileage
  • Business mileage
  • Investment mileage
  • Rental property business mileage

Here’s a hypothetical example:

Note that rental property mileage should be calculated separately from other business mileage. This is so you can determine Section 179 expensing for your vehicle. Additionally, you see that the miles marked for the trip to the grocery store are zero. Why? It’s because the stop was located on the way between two other stops, so it does not generate any additional mileage.[3] Although the grocery trip is a personal stop, you would have had to drive the same distance from one office to the other whether you stopped for groceries or not.

In some cases, it may be more convenient to group the mileage together for multiple stops. This is perfectly fine as long as you document it that way. For example, a real estate professional may make a note indicating multiple stops to show the same client six different properties. These six stops can go together on one line of your mileage log.

Simplifying Your Record-Keeping by Sampling

Writing down every single stop you make every day for the entire year sounds fun, right? Not so much. If tracking your mileage is starting to sound like too much work to even be worth it, keep reading. Per the IRS, you are allowed to track your mileage for only part of the year, and then use that sample to calculate your total business mileage for the rest of the year. You have two options:[4]

  1. Keep a mileage log one week out of every month, or
  2. Keep a mileage log for three consecutive months.

By using the second option, you can log your mileage for one three-month period and then forget about it for the rest of the year. This is the better way to go because the one week a month method increases your risk of missing a month, and when that happens, the IRS no longer accepts your records. It does not accept “almost” with mileage logs.

There is one little catch. If you use the three consecutive months method, those months must be representative of your driving habits for the entire year. For those of you who work in a business with noticeable seasonal fluctuations in your business mileage, you’d better stick to the one week a month strategy.

Supporting Your Log

Okay, so you’ve logged your mileage and labeled its category for either three consecutive months, or one week out of each month for the year. You’re all set, right? Not so fast. The IRS isn’t so trusting that it will just accept the records you’ve individually recorded. So, you’ll have to back up your mileage sheets with evidence from other sources that match your records.

Some documents the IRS may request during an audit include:[5]

  • Inspection slips, repair receipts, and any other records that record your vehicle’s total mileage
  • A copy of your calendar or appointment book that indicates your business activities for the year
  • A copy of your mileage log

Each of these proofs will be cross-referenced with each other to ensure that everything matches up. That means if your gas receipt shows you were in Henderson, NV on a day your mileage log shows you staying in Riverside, CA, you’ve set off a red flag that may cancel your deductions.

What If You Don’t Keep Paper Records

Certainly many business people are switching over to digital record keeping. If you prefer to track mileage on an app, that’s no problem. However, it may be a good idea to keep paper print-outs as backup until you’re certain the app’s records meet the requirements of the IRS. Always keep some kind of backup of your digital records. You never know when a glitch, virus, or hacker may delete all your records, or render your app inactive.

Tracking your vehicle mileage isn’t too difficult once you set up a system for yourself. Remember, you only have to do it for part of the year. The IRS mileage rate for deductions is $0.56 per mile, so with the right documentation, you can claim thousands in deductions just by going about your normal work routine.

  1. Marcus O. Crawford, TC Memo 2014-156. ↑
  2. IRS Publication 463, Travel, Entertainment, Gift, and Car Expenses (2013), Dated Jan. 14, 2014, p. 25-27. ↑
  3. Reg. Section 1.274-5T(c)(6)(i)(C). ↑
  4. Reg. Section 1.274-5T(c)(3)(ii)(A). ↑
  5. Internal Revenue Manual Exhibit 4.13.7-20 — Examination Documentation Requirements Paragraphs – Cont. 6 [09-01-2006]. ↑
Categories : Business Expenses, Cars, Trucks & SUVs, Depreciation, Listed Property, Receipts, Records, Tax Planning

Is a Home Office Worth Having? It is If You Want to Save on Taxes for Your S Corporation!

By Kim M. Larsen EA CTFS
Sunday, February 8th, 2015

Operating your single-owner business as an S corporation has a variety of tax advantages. One way to ensure your tax advantages is to have your company reimburse you for the costs of keeping a home office. This tax savings strategy enables you to:

  • Convert the mileage from your commute into business mileage, thus increasing your vehicle deductions;
  • Consider a portion of your home expenses to be business expenses; and
  • Avoid home office audit risks on your tax return.

And, here’s even more good news when you employ this strategy—you never pay back those tax savings, even when you sell your house. Of course, in order to reap these benefits, you will have to make sure you follow the proper procedures (including documentation) regarding the office in your home. Many of these apply even if you operate your business under an entity structure other than S corporation.

Getting Reimbursed for Your Office

By tax law, S corporation owners are able to make deductions on home office expenses, and there’s more than one way you can go about doing so. However, the best way is to have your corporation reimburse you for the employee-business expenses you incur from having an office at your home.[1]

Let’s just look at the basics for a moment. When you create an office in your home, you have switched a portion of your house to business use from personal use. So, on your taxes, part of your home is considered a business asset. If, as an example, you used 1/3 of your house for office space, then 1/3 would be a business asset and 2/3 would be a personal asset.

Office Location Makes a Difference

Did you know that where you locate the office in your home can make a big difference on your tax savings? In fact, in the right location, your office is eligible for a $250,000/$500,000 home profit exclusion from taxes. This exclusion applies when you eventually sell your home. That’s right—how you locate your office now can affect tax savings at the time of sale. Specifically, you get a break on taxes for up to $250,000 (filing singly) or $500,000 (filing jointly) of profits on the sale of your personal residence.[2]

What does the business portion of your home have to do with this? Well, you generally have two possible scenarios:[3]

  1. The office is inside the walls of your home. If this is the case, you’re in a good position because the home sale profit exclusion applies to both the business and personal portions of your residence. The only exception to this is depreciation recapture (which will be further explained).
  2. The office is outside the walls of your home. An example of this would be an office located in a detached garage, guest house, or some other separate structure. In this situation, you’ll need to do a little more planning in order to get the best possible result. The tax exclusion will only apply to the residential part of your property. The sale of the business part will generate taxable business gains, as well as recapture on depreciation. However, as you’ll see discussed below, you can use a Section 1031 exchange to get out of those taxes.

Anytime you sell a house, you have a recapture tax for the depreciation you claimed. Regardless of the location of your home office, the home sale profit exclusion does not get rid of the recapture.[4] Before you start to feel gloomy about this, know that depreciation still gives you an advantage, even with the recapture tax, and here’s why:

  • You defer this payment until the year of sale, and
  • It’s possible for your depreciation deduction to be greater than (up to 36.9 percent rates) your recapture tax rate (up to 25 percent).[5]

Of course, it would be even better to just get rid of that recapture tax all together, wouldn’t it? Well, you can.

Making a 1031 Exchange

For any business gain you have left that is not covered by the profit exclusion you can make a like-kind, Section 1031 exchange. In fact, the IRS has provided guidance specifically on how to combine the home sale profit exclusion with the 1031 exchange for selling a house with an office.[6] Section 1031 will not dispose of your tax. What it does instead is defers it. But, here’s the really nifty bit, you can keep on making 1031 exchanges with every home sale and deferring that payment for the rest of your life. Then, the home goes up to fair market value and your taxable gains disappear.

The most important thing you need to know about making the 1031 exchange is that you must hire a professional intermediary to handle the monetary exchange. Don’t worry—you’ll spend less on an intermediary than what you would have paid in taxes, and a professional will ensure that you go through the process correctly.

Here’s how Section 1031 works when your office is inside your home (this example comes from the IRS):[7]

  1. You bought your home for $210,000 and split it into 1/3 business use and 2/3 personal use.
  2. Because you split the basis between business and personal, you have a business use basis of $70,000 and a personal use basis of $140,000.
  3. With a $30,000 depreciation for your office, that leaves a business use basis of $40,000 (reduced from $70,000).
  4. When you sell your home, it will split into a business portion and a personal portion. So, if you sell the house for $360,000, then you have sale prices of $120,000 for the business part and $240,000 for the personal part.
  5. You qualify for the full $250,000 Section 121 exclusion (single filing).
  6. Determine the gain on both parts of the home. In this example it’s $80,000 for business ($120,000 – $40,000) and $100,000 for personal ($240,000 – $140,000).
  7. Apply the profit exclusion to both parts (personal first). Don’t include recapture. Applying the $250,000 exclusion to your $100,000 personal gain gives you zero taxable gains, and you are left with $150,000 of profit exclusion. This remainder is applied to the business portion, except for your $30,000 of depreciation recapture.
  8. Finally, you defer the $30,000 using a Section 1031 exchange to acquire a new house with a new home office and watch the taxes disappear!

And, what about when your office is in a structure outside of the main residence? The example above changes a little bit. Here’s how it all works out:

  1. Determine the gain on both parts of the home. This is done in exactly the same way as it’s calculated in steps 1-6 above.
  2. Apply the profit exclusion to both parts of your residence. This step, however, is different from above. In this case, the exclusion does not apply to the business portion, which is located outside the walls of your home. You still get $0 in personal gain, but business gains will come to $50,000 capital gains and $30,000 depreciation recapture (determined by the $80,000 in business gains calculated above).
  3. Here’s the good news. You can still use a 1031 exchange to defer both the $50,000 in capital gains and the $30,000 in depreciation recapture.

It’s pretty clear that converting part of your home into an office for your S corporation makes good financial sense. If you don’t have an appropriate space inside your home, you can make an office in a detached structure. The math works out a bit differently, but you can still save big on taxes when you plan correctly.

  1. Reg. Section 1.62-2(d)(1). ↑
  2. IRC Section 121. ↑
  3. Reg. Sections 1.121-1(e)(1) and 1.121-1(e)(4) example 5. ↑
  4. IRC Section 121(d)(6). ↑
  5. IRC Section 1(h)(1)(E). ↑
  6. Rev. Proc. 2005-14. ↑
  7. Example 3 from Rev. Proc. 2005-14. ↑
Categories : Business Expenses, Home Office, Tax Planning
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