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Archive for Records – Page 2

Maximize Your Tax Deductions on Business Repairs

By Kim M. Larsen EA CTFS
Monday, January 26th, 2015

When you own business properties, they will occasionally require repairs; that’s just a fact of business ownership. So, whether you need to make repairs on your place of business or your rental buildings, keep these simple truths in mind:

  • You can either increase your net worth with tax-favored repairs.
  • Or, you can decrease your net worth with tax-impaired improvements.

Now, which would you prefer?

Boosting Your Net Worth with the Right Fixes

The fixes that you can label as repairs are vastly more valuable to you than those labelled improvements. That means you need to know the difference between the two so you can a real monetary difference. Of course, it’s important to note that this only applies to an office or rental building that you own.

Fortunately, the IRS released a guide on this subject titled Capitalization v Repairs[1]. Without this guide, some tax deductions linger in an indeterminate gray area, which can be infuriating when it comes time for tax preparation. If you don’t know how the IRS classifies a particular fix, you lose control of your money. However, with the right planning, you can classify particular fixes as repairs and regain that financial control.

Here’s an example of how tax-favored repairs work:

  • Scenario 1: You put an entirely new roof on your office building. Uh-oh! Now you have to depreciate that roof over thirty-nine years, which means you have lost quite a bit of money up-front.
  • Scenario 2: Instead of completely replacing the roof on your building, you replace thirty-five percent of the roof one year, twenty-five percent of the roof a couple years later, fifteen percent of it a few years after that, and then twenty-five percent the following year. Each of those repairs can be deducted immediately, leaving you with a hefty financial advantage.

Defining a Repair

Do you see the difference in the above scenarios? Repairing is maintaining or mending. It is a fix that keeps a property running in its ordinary and efficient operating condition. A repair[2] does not 1) add to a property’s value, or 2) prolong the life of the property by an appreciable measure. You see, a repair ensures that you can continue using a property for the purpose you obtained it for, as opposed to increasing the value for a possible sale in the future[3]. An improvement, on the other hand, is a fix that 1) increases the property’s value[4], 2) prolongs its useful life substantially[5], or 3) modifies the property for a novel use[6].

Take a look at this actual situation to get an idea of how these definitions might play out (numbers are not in today’s dollars). A man purchased a four-unit apartment building (with one tenant residing) that was in poor repair for $30,000 and spent $6,247 for a contractor to fix it up. The contract work included removing tree limbs that were rubbing the roof; repairing water damage; repairing electrical wiring; cleaning the carpets, floors, and exterior; repairing the front porch; and, installing new cabinet doors and new countertops.

When the owner was audited, the IRS deemed the entire amount an improvement. The owner, however, disagreed, and the Tax Court allowed $5,000 worth of repair deductions[7]. The court only required the owner to capitalize $1,247 for the new cabinet doors and countertops.

Why did the court side with the building owner? First, the court noted that a tenant was living in the building. This meant the property was commercially active at the time of the fixes. If you’re repairing a rental property, having tenants in the building is beneficial to your claim of making repairs. Second, the $5,000 in repairs was not considered a large amount of money compared to the initial $30,000 spent to purchase the property. That is, the court could justify the expense as repairs rather than improvements to increase the property value.

Note: There is no defined amount of money that distinguishes a repair from an improvement. Two people could make the same fixes for the same amount of money and get differing tax results. That is why it is important for you to document the facts surrounding your repairs and present those facts when making a case with your tax preparer.

Tips on Making a Case for Repairs

By following a few best practices, you can make it easier on yourself to get the right tax deductions. A good way to get a favorable result for deductions on repairs is to get separate invoices for repairs and improvements[8]. This is especially important when you are carrying out a large renovation project. The IRS specifically states in its audit technique guide that repairs are not considered repairs when they are made as part of a general rehabilitation project[9]. So, keep those invoices separate! In fact, you’ll give yourself a lot fewer headaches if you just hire different contractors to do the repair work at different times from the improvements.

Here are some additional tips:

  • Always Document the Reasons for Your Repairs—Repairs, by their nature, are preceded by an event that indicates their need. For instance, you repair a water pipe because it begins to leak, or you repaint an exterior because the weather has faded it. Record these reasons as evidence of the need for repairs.
  • Fix Only Small Parts at a Time—This is pretty self-explanatory. When you replace something in its entirety (i.e., putting on a new roof, replacing an entire wall, installing new flooring), you are making an improvement[10]. When you focus on simply fixing a part of that roof, wall, or floor, you are making a repair[11].
  • Use Comparable Materials—If you want your claim for tax deductible repair work to be accepted, you should replace worn materials with those of similar, or even less expensive, quality[12]. If you’re using higher quality materials, the work may be considered an improvement[13].
  • Consider the Reason for the Repair—Another aspect to consider when making a case for fixes to be considered repairs for tax purposes is the condition of part being fixed up. A repair can only be made to something that is worn out, deteriorating, or broken[14]. If you’re not restoring or replacing a damaged part of the property, or if work expands to parts of the property that are not damaged, it becomes an improvement.

What’s the Main Concern?

Why is the IRS so particular about whether you are making repairs or improvements? They suspect you may buy a property to renovate, and then write off the renovation as repair costs. In its audit technique guide, the IRS distinguishes between money used to “put” or to “keep” the property in efficient operating condition[15]. Simply stated, if improvements need to be made in order to put the property in efficient operating order, then they are capital improvements. But, if they are only made in order to keep the property in efficient operating order, then they are repairs and are tax deductible.

This is not to say that you should not consider making improvements to your properties. Indeed, if you plan to sell, improvements may be exactly what you need. However, this article is a helpful guide for how to get the most out of your tax deductions when you are attempting to repair the buildings you still use. With proper documentation, you can designate whether the work you have done on your buildings is considered a repair or an improvement, and that means you have the power to take control of how much of your money goes to taxes.

  1. IRS Audit Technique Guide, Capitalization v Repairs, LB&I-4-0910-023. ↑
  2. Reg. Section 1.162-4. ↑
  3. Illinois Merchants Trust Co. v. Commr., 4 B.T.A. 103, 106 (1926), acq. ↑
  4. Reg. Section 1.263(a)-1(a)(1). ↑
  5. Reg. Section 1.263(a)-1(b). ↑
  6. Also see Reg. Section 1.263(a)-1(b). ↑
  7. Roger Verl Jacobson v Commr., TC Memo 1983-719. ↑
  8. E.g., Allen v Commr., 15 T.C.M. 464 (1956). ↑
  9. IRS Audit Technique Guide, Capitalization v Repairs, LB&I-4-0910-023. ↑
  10. Reg. Section 1.162-4; e.g., Ritter v Commr., 47-2 USTC Section 9378 (6th Cir. 1947) (new roof). ↑
  11. E.g., Kingsley v Commr., 11 B.T.A. 296 (1928) (patching roof), acq. ↑
  12. E.g., Illinois Merchants Trust Company v Commr., 4 B.T.A. 103 (1926). ↑
  13. E.g., Abbot Worsted Mills, Inc. v Cagne, 42-2 USTC ¶ 9694 (D. N.H. 1942). ↑
  14. Sanford Cotton Mills v Commr., 14 B.T.A. 1210 (1929) (portion of decayed floor replaced). ↑
  15. IRS Audit Technique Guide, Capitalization v Repairs, LB&I-4-0910-023. ↑
Categories : Business Expenses, Investments, Receipts, Records, Rental Properties, Tax Planning

You Can Make the Most of Tax Deductions on Employee Parties

By Kim M. Larsen EA CTFS
Monday, January 26th, 2015

If you’re going to throw an employee party, know that you are entitled to a tax deduction for this business expense. However, be careful in how you go about it. It turns out that there are two different kinds of deductions for business-related entertainment expenses—50 percent deductible or 100 percent deductible.

When tracking entertainment deductions, it’s best to keep these two types separate from the beginning. That means keeping two separate accounts for them. So, what is the difference?

50 Percent Deductible Entertainment

Most expenses for entertaining employees or other business contacts will fall into the 50 percent deductible category. You can consider this your usual account for these types of expenses. Here’s an example. Let’s say you take a team out to lunch following a training session. The lunch tab falls into the 50 percent deductible classification.

The Employee Party and 100 Percent Deductible Entertainment

Unlike business lunches, other expenses are exempt from that 50 percent cut, meaning they are 100 percent deductible[1]. The primary example of this is the employee party. When an entertainment expense is chiefly for the benefit of your employees, it may qualify as 100 percent deductible entertainment. Read on to determine whether your party qualifies:

  • Which Activities Qualify—According to the IRS, qualifying activities include holiday parties, annual picnics, and summer group outings. You can also deduct the cost of maintenance for employee benefit, such as keeping up a golf course, swimming pool, bowling alley, or baseball diamond. The important thing to remember about this is that in order to qualify, the IRS must deem that these expenses are primarily for the benefit of your employees[2].
  • What the Law States about Benefit—How do you know if your use of time or facilities meets the definition of employee benefit? A sample case may make the term clearer. During one year, American Business Service Corporation rented a powerboat at a rate of $1,000 per day on forty-one separate days. The boat was used for single-day recreational cruises both for employees and their guests. Any employee was eligible to sign up in advance, and the choices were made on a first-come, first-served basis. The court’s decision indicated that the full $41,000 was deductible. Here’s why[3]:
  1. The cruises were primarily for employees.
  2. The decision on who participated did not favor owners or other highly-compensated employees over other employees.
  3. Documentation was kept that recorded who participated and when.
  4. And, the activities sufficed for the “ordinary and necessary” business purpose test.

How Does This Fit into Your Business?

For tax law purposes, the term “primarily” means greater than 50 percent[4]. So, if you take two employees (who are not your family members) on a recreational cruise, then that activity is more than 50 percent for the benefit of employees because employees make up two-thirds of the group.

This definition does not only apply to numbers of people participating. For instance, if you own a vacation home, and you allow your employees to use it more days out of the year than you do, your vacation home now qualifies for an entertainment deduction! You simply make clear that the home was used for an ordinary business-use reason.

Normally, recreational expenses are not something we think of in terms of business expenditures. Unlike, for instance, traveling for a conference, your employee entertainment[5] does not need to fit any definitions for being directly related to business. The terms for employee entertainment are a bit looser. You simply need to pass the “ordinary and necessary” business purpose test[6]. All this means is the expense should be appropriate to and helpful for your business[7]. Keeping your employees motivated and making your business a competitive employer are perfectly sound reasons for providing employee entertainment.

Exceptions to Watch Out For

You must keep in mind that these activities and facilities must primarily benefit employees. Given this stipulation, you need to understand that certain individuals are considered a part of “tainted groups”. Tainted groups[8] include highly compensated employees (those who earned more than $115,000 in 2014[9]), any person who owns 10 percent interest or more in your business (called a 10 percent owner), or any family member of a 10 percent owner[10]. This includes siblings (full and half), ancestors, spouses, and descendants (biological and adopted).

Obviously, you as the business owner are a member of the tainted group. This does not mean you can’t party with the employees; it just means you have to make sure the partying is mostly for the employees, and watch out for the greater than 50 percent rule. Participants should be more than 50 percent from outside the tainted group for your activity or facilities use to qualify.

Keeping Records

Important: Make sure you document the facility usage or activity attendance[11]. You can use any reasonable measurement, such as the number of days of use, the number of times used, or the number of employees participating. The most important aspect of these measurements is that your records prove the uses.

Here are a couple of tips for making sure your documentation meets IRS standards:

  • Always note the business reason for any entertainment expenditures, whether it’s an annual morale-booster or a celebration for a newly acquired contract. Write this down and keep it with your other account documentation.
  • Let the person who prepares your taxes know that you have two separate categories of entertainment expenses, 50 percent deductible and 100 percent deductible. You can make the whole process easier by keeping separate accountings of each from the outset.

With this advice, you’ll keep your employees pleased and your accounts squared away without much difficulty. Don’t be afraid to join in the fun yourself! Tax-deductible employee entertainment is fairly simple to keep straight as a business expense when you understand what qualifies as 100 percent deductible.

  1. Reg. Section 1.274-2(f)(2)(v). ↑
  2. IRC Sections 274(n)(2); 274(e)(4). ↑
  3. American Business Service Corp. v. Commr., 93 TC 449. ↑
  4. For example, see Rev. Rul. 63-144, Questions and Answers 60 through 66. ↑
  5. Reg. Section 1.274-2(f)(2)(v). ↑
  6. IRC Section 162(a). ↑
  7. E.g., Capital Video Corporation v Commr., 90 AFTR 2d 2002-7429 (CA1) November 27, 2002. ↑
  8. IRC Section 274(e). ↑
  9. http://www.irs.gov/Retirement-Plans/Plan-Participant,-Employee/Definitions ↑
  10. IRC Sections 274(e)(4); 267(c)(4). ↑
  11. Reg. Section 1.274-5T(a)(2), referring to items in IRC Section 274(e), which includes employee entertainment expenses. ↑
Categories : Business Expenses, Employees, Entertainment, Receipts, Records, Tax Planning

How to Make Your Proprietorship a Corporation

By Kim M. Larsen EA CTFS
Monday, January 26th, 2015

As a business owner, converting your sole proprietorship to a corporation can have tax advantages. When you’re ready to incorporate your business, the first thing you’ll need to do is prepare and file your corporate documents[1]. You probably already guessed that paperwork needed to be filed, but hold on there—your business is not a corporation yet. Filing the required documents is not the only step in the process.

Transferring Assets

Filing incorporation documents creates an empty corporation. Your business, however, continues operating as it always has, as a sole proprietorship. For your business to fill that empty corporate shell, you have to move your assets over to the corporation in exchange for stock. Basically, when you are incorporating your business, it becomes its own entity rather than an extension of you. Here’s a tip: You don’t have to transfer all of the assets to the corporation. You can keep some under your name. In fact, it would be wise to consult your tax adviser about which assets are better kept in your name.

In the case that you maintain control of your corporation, the exchange of assets for stock is tax-free[2]. How do you know if you control your corporation? For tax law purposes, “control” means that directly following the exchange, you own at least 80 percent of the combined voting power over all the stock and you own at least 80 percent of each of the stock classes without voting rights[3]. This rule of the tax-free exchange always applies, regardless of when you form the corporation.

Be aware: Your family’s stock (including that of your spouse) does not count toward your 80 percent ownership. If, for example, after the exchange you own 70 percent and your spouse owns 30 percent, you do not meet the control criteria. That means you lose the tax-free exchange. Luckily, there are ways around this problem. Your spouse can join you on the transfer, such that both of you are contributing property for the stock. By making the exchange together, you qualify for tax-free status as a group[4].

Considerations When Doing Business with Your Corporation

Since your corporation is a separate entity from you, you have effectively created a new person for tax purposes. This means that you and the corporation do not share assets, and you cannot use each other’s assets without certain consequences. After all, you can’t just use your neighbor’s assets without compensating the person, right?

Here are some scenarios you’ll want to consider:

  • Using Corporate Assets—What if you would like to use your corporation’s assets? You simply have to arrange the use like you would with any other unrelated business acquaintance. You can treat your borrowing of corporate assets like any of the following situations:
  • Compensation,
  • A fringe benefit,
  • A purchase,
  • A lease,
  • A dividend, or
  • Any other economic arrangement business people might enter into.

You should be aware that because you control these arrangements between you and the corporation, the IRS will keep a close eye on the terms you arrange. If the IRS thinks you are mishandling such an arrangement or interchanging your assets with the corporation’s assets, it has the authority to reallocate your deductions, income, and assets in the manner it approves[5].

Usually, these reallocations will not be to your benefit. So, you need to protect yourself when dealing with your new corporation. That means documenting all your transactions and using fair market value terms to the best of your ability.

  • Contributing Debt—When you incorporate your company, it’s not only assets that you can transfer to the corporation. You can also transfer your business debt, such as mortgages and outstanding loans[6]. For tax purposes, this poses no problem; however, your creditors may have a different opinion.

For an asset tied to debt, such as an office building, you will probably need approval from the creditor before transferring the asset to your corporation. It’s not a big deal if you don’t get approval, though. You can always make arrangement with your corporation to compensate you for the use of assets still in your name (e.g., by paying rent to you).

  • Dual-Purpose Assets—Even after careful doling out of assets, you will probably still have some items that you use for both business and personal uses. Your car is an example of these. In such cases, you will have to make your own reasonable decisions based on how the assets are used. The best strategy is to talk to your tax adviser about your options for dual-purpose assets.

When determining how to classify these dual-purpose assets, you may want to consider liability. Incorporating your business does a wonderful job of protecting your personal assets. This is because business creditors are then limited to dealing with the corporation’s assets.

  • Handling Third Parties—When you transfer assets, some of those may have third parties involved. Any permits, licenses, or bank accounts, for instance, will need to be changed and put into the name of the corporation. They cannot remain under your name. It may cost money to make these changes, but by doing so, you avoid the cost of contract penalties and additional taxes. These costs are just part of changing your business over to a corporation.

This article gives you a good overview of how to handle incorporating your sole proprietorship. Now you know what to be thinking about (and documenting!) when it’s time to make the change. Good luck in your endeavors, and be sure to check with your accountant when it comes down to the nitty-gritty!

  1. The necessary documents and process for filing vary between states. ↑
  2. IRC Sections 351(a); 361(a). ↑
  3. IRC Section 368(c). ↑
  4. See Burr Oaks Corp., 43 TC 635, 651 (1965), aff’d, 365 F2d 24 (7th Cir. 1966), cert. denied, 385 US 1007 (1967). ↑
  5. IRC Sections 482; 7701(o). ↑
  6. IRC Section 357(a), (c). However, in some instances, you may recognize gain. ↑
Categories : Corporations, Depreciation, Receipts, Records, Tax Planning

How to Protect Your New Business Investment and Deduct It from Income Taxes

By Kim M. Larsen EA CTFS
Monday, January 26th, 2015

Buying a business is an exciting time. You’re sure to feel the promise of new success; however, don’t let that rush of adrenaline get the best of you. When you invest in a business, remember to keep your head in order to protect your investment.

How You Buy

You have two primary options for buying a business. The simplest way is to just buy all of the company’s stock. If you’re interested in a corporation, all you have to do is purchase 100% of the current owner’s stock. Presto! You now own the corporation.

The other option is to purchase the company’s assets, which can be more complicated. If the business you’re interested in is a sole proprietorship or a single-member LLC (that is taxed as a proprietorship), then stocks are not an option; you will buy assets[1]. However, you can also buy assets when purchasing a corporation. Hint: See the tips below for why you may want to do this.

The big advantage to an asset purchase is that the money you invest increases the basis of the individual assets. What this means for you is that you can depreciate them and eventually recover the investment cost. Any premium you pay that’s in excess of the assets’ value can also be deducted[2].

Your Purchase Affects Your Taxes

One thing to keep in mind is that you usually have multiple options for purchasing. And, each decision you make regarding your business will affect your taxes. So, make sure you understand these two things:

  • Making an Asset Purchase—If you purchase a corporation through stocks, your investment money goes towards basis in the stock. This means you don’t own the company’s assets; the corporation does. However, this is not the best situation for you because you cannot depreciate the stock. The only tax benefit you will get from stock is when you sell it. Furthermore, the corporation’s assets will already have a depreciation schedule.
  • Making Use of Your Depreciation—What you can do instead, to help recover the cost of your investment, is make a hybrid purchase[3]. However, a hybrid purchase is a complicated process, and you will need your tax advisor and an attorney to assist you along the way. Basically, a corporation you already own, or a corporation you form, buys the stock of an S corporation[4]. The difference is you will then treat the purchase like an asset purchase for tax purposes. You will set up the basis of the assets, as normal.

After purchasing the S corporation’s stock, you’ll have to sign an IRS Form 8023[5]. Just keep in mind that all stockholders will need to sign the form[6]. This includes those of the buyer, the seller, and (if you live in a state with community property laws) the stockholders’ spouses.

Issues When Purchasing Stocks

A primary concern when purchasing stocks is protecting yourself from liability, both future and past. If you go the stock purchase route, you could be liable for any problems caused by the previous owner. That’s right—you just bought the history of the company. That means any past grievances brought up by employees and any product issues brought up by consumers can be stacked up against you, and the victims have a right to sue you.

To avoid these situations, make sure you address them in your stock purchase contract. The seller should agree to pay all past debts and taxes. Also, make sure the seller includes language to indemnify you from lawsuits that arise from the time period of previous ownership. Of course, this does not stop people from suing you. They still can. What the contract ensures is that you can then get the previous owner to pay any costs incurred under this liability.

Things to Consider When Purchasing Assets

When you purchase assets, it means you are buying each bit of the company separately. You buy the name, the property, the inventory, etc. During this process, you may have to deal with third parties, which can be a headache. Third party transactions can also end up costing you additional money. Make sure you’re away of the details, including whether you will have to substitute your name on future documents, before signing the final contract.

On a positive note, asset purchase differs from buying stock in that you are free from past liabilities of the business. You buy the business’s parts, not the entity itself. The benefit of this is that any issues arising from past ownership stay with the previous owner; they are not your responsibility. Just play it smart; antifraud laws can protect creditors. You may be at risk for accepting liability in the following cases[7]:

  • You specifically agree to take on past liabilities;
  • The sale is made as a “de facto” merger;
  • Your official status is a “continuation” of the previous owner’s business;
  • The purpose of the sale is to evade liability;
  • The product you manufacture is the same as the seller did.

If one of these situations applies, be sure to made release of liabilities a part of the contract. Just as with a stock purchase, the seller should agree to indemnify you from lawsuits and pay accumulated debts.

Understanding the Seller’s Incentives

Of course, your business purchase is not going to be beneficial only to you. If that were the case, the seller would not go through with the deal. The best transactions are those that are mutually beneficial. So, what exactly is the seller looking for?

Capital Gain

Sellers are looking to make capital gains rather than ordinary gains (those from the operation of the business). The capital gains are taxed at a lower rate, which means the seller benefits when the sale can be classified as such[8]. With a sale of assets, the seller ends up with a mix of gains from income and capital (including losses).

This doesn’t mean a seller won’t negotiate with you on the type of sale, but they will probably raise the price to cover their losses. One situation in which the seller’s return may be negatively affected is the hybrid corporation sale method. If you find yourself in the position of seller, you should check with your attorney and your tax advisor about what tax rates will apply (especially if you face a gains tax from previously operating as a C corporation[9]).

Remember that with the new Obamacare tax (3.8 percent on net investment income), your stock and asset sales will be taxed. If you operate as a C corporation, you cannot avoid this. As an S corporation, you may be able to reduce this tax in the case that the income was active rather than passive[10].

Protection from Future Liability

Just as you want to protect yourself from past liability, the seller wants to be protected from future liability at the hands of your ownership. For this reason, the stock purchase is usually the preferred method for a seller. It means you have taken over responsibility for the company as an entity.

Whether buying or selling, consider the benefits of each purchase type. Gaining an understanding of the options helps to protect your investments and protect you from undue liability. Remember, always have a professional look over the contracts with you.

  1. See Rev. Rul. 99-5, Situation 1 for LLCs. ↑
  2. The amount is generally considered a goodwill amount, which you amortize over 15 years. IRC Section 197(a); (d)(1). ↑
  3. IRC Section 338(h)(10). PLR 200649015. Also see Reg. Section 1.338(h)(10)-1(c)(2). ↑
  4. Reg. Section 1.338(h)(10)-1(c)(1); (d). ↑
  5. Form 8023, Elections Under Section 338 for Corporations Making Qualified Stock Purchases, Rev. February 2006. ↑
  6. Reg. Section 1.338(h)(10)-1(c)(3). ↑
  7. CCA 200847001; Dayton v Peck, Stow and Wilcox Co., 739 F.2d 690, 692 (1st Cir. 1989). ↑
  8. Reg. Section 1.338(h)(10)-1(d). ↑
  9. See this article on built-in gains. ↑
  10. Prop. Reg. Section 1.1411-7(a)(1). ↑
Categories : Business Expenses, Capital Gains, Receipts, Records, Start Up, Tax Planning

What the Statute of Limitations Means for Your Tax Records

By Kim M. Larsen EA CTFS
Monday, January 26th, 2015

When you went into business, chances are you weren’t imagining grand evenings filled with paperwork. Maybe you thought tax records were a thing you would think about once a year and have your accountant deal with. But, the truth is, as you progress in business, you come to realize that record-keeping for your taxes needs regular maintenance. In fact, even after you breathe a sigh of relief once that return has been double-checked and sent off to the IRS, you may need to make a change to the document.

That’s where the statute of limitations comes in. It refers to the periods of time during which both you and the IRS may make changes to your tax return (not just audits). Those time frames are clearly delineated in IRS publications[1].

Here they are:

  • No limit if you did not file a return
  • No limit if you filed a fraudulent return
  • Three years after filing if you filed on time (or with extensions), you did not understate your income by 25 percent or greater, and you did not file fraudulently
  • Six years after filing if you filed on time (or with extensions) but you understated your income by greater than 25 percent
  • If you filed an amended return or already made changes to the original return (like a quick refund claim), either three years after filing or two years after paying the tax
  • Seven years from filing for a claim filed for a bad-debt deduction or loss from worthless securities

Keeping Appropriate Records

Aside from letting you know how long you have to make changes to a return, the statute of limitations also lets you know how long the IRS has to audit your return. If an audit occurs, you are going to need all of your tax records to prove your deductions. What does this mean for your record keeping habits? Hang on to those records until any chance of audit has passed.

The following are a few guidelines for making sure you hold on to the appropriate records long enough:

  • Employment Tax Records—If you have employees, you need to save your employment tax records for four years after whichever date comes later, the date payroll taxes were paid or the date they were due. An easy way to do this is simply to keep six separate drawers in your filing cabinet for each tax year. Every year, discard the sixth drawer when it’s statute of limitations expires.
  • Records for Assets—You have certain assets that are pertinent to your tax return for as long as they remain in the depreciable category. Examples of such assets include your office building, computers, desks, and even your car. If you are depreciating those assets, they will be on your tax return. Otherwise, if you are using Section 179 to expense the assets, you may be able to recapture the depreciable class life.

For example, let’s say you purchased a desk for $1,500 and depreciate it over the seven year Modified Accelerated Cost Recovery System (MACRS) life, which takes eight years. You’ll still have to prove depreciation in the eighth year. So, you need the record of the original purchase in the eighth year and through the eleventh year to meet the three year statute of limitations (the time during which this purchase is subject to auditing). The example works the same if you used Section 179. Any assets with more than a one year class life should be kept in a separate, permanent file so they don’t get tossed out with files whose statutes of limitations have expired.

Record Keeping Tips

As mentioned in the section on employment tax records, you can simplify your file system by devoting separate drawers for each tax year. In those drawers, you’ll put any information on assets, income, and other information applicable to your return. The first drawer will be where you put all documents as you acquire them throughout the year. The next drawer is last year’s tax documents. The drawer after that contains documents from three years ago, and so on until you reach the year at which your statute of limitations expires.

In order to use this method, it’s important that you file your taxes on time or file an extension so you know for sure your specific time frames. At the end of each year, the last drawer gets dumped and you move the other drawers down, starting a new drawer for the current year. It’s really simple once you put the system in place. Record-keeping may seem tedious, but remember, it shows you where your business has been and where it’s going, like a runner trying to improve their time. You can’t improve the numbers if you don’t know what they are.

  1. IRS Pub. 583, Starting a Business and Keeping Records (Rev. December 2011), Dated Feb. 17, 2012, p 12. ↑
Categories : Audits, Business Expenses, Capital Gains, Payroll, Receipts, Records, Tax Planning

Understanding Travel Deductions for Educational Seminars

By Kim M. Larsen EA CTFS
Monday, January 26th, 2015

If you’re considering going out of town for an educational seminar, you may want to ask yourself a few questions to determine whether the expense is justified[1]. First, is the trip primarily for the purpose of continuing education? If so, how many hours of each day there will actually be spent in educated-related activities? If not, then is the trip part of a vacation or leisure trip?

To deduct your travel for a business-related education seminar or event, you have to show that obtaining business education is the primary reason behind your travel[2]. Not only that, you must also keep in mind that for tax law purposes, the term “travel” refers only to trips that take you out of town long enough to require a stop for sleep[3].

Is the Trip Business or Personal?

Of course, sometimes you combine business and personal time on a trip out-of-town. It would be silly not to take advantage of new sights if you have the opportunity. But, what do you do about deducting expenses in these situations? It’s actually not that difficult.

If your trip otherwise qualifies as a tax deductible business trip, and you take, for example, a three-hour hike through the mountains while you’re there, you can just handle any hiking costs as personal expenses. This does not cancel the validity of your business trip[4]. All you need to do is document which expenditures went towards business events and which were for personal activities.

Matters aren’t much more difficult for personal travel that includes business. If you take a vacation or other personal trip and end up spending a day working on business matters, you treat the travel expenses and the majority of the trip as personal for tax purposes[5]. Then, you keep track of any expenses for the business day and note them as business expenditures. Note: This does not mean you can deduct food and lodging for a day of your vacation because you took a one-hour conference call. But, if you spend a full seven hours of one day trying to work out business issues during your vacation, then you can count that day as business.

If your trip is fairly evenly mixed between business education and personal activities, it may be more difficult to determine whether travel and lodging expenses are deductible. IRS regulations state that the important thing is to weigh the relative amount of time spent to each in order to determine the primary purpose of the trip (in particular, you can look at regulation 1.162-5(e)(1)). Now, look at that last sentence. You will see that time is the determining factor, not importance of the educational activities. The division of time is what the IRS will consider.

Another example may help to clear up how this works. In revenue ruling 84-55, a taxpayer took a trip for educational classes sponsored by his alumni association. The educational meetings only lasted about two hours per day, and the rest of the time he spent with his family. The IRS ruled the trip a family vacation. However, he was allowed to deduct expenses for the cost of the classes. Nothing of the hotel stays, meals, or back and forth travel was allowed to be deducted.

Other cases have been ruled in much the same way (see Holswade[6]). You should understand that if the number of hours spent on business education is minimal, the trip will be considered personal. In this case, you will likely only be able to deduct the costs of the educational course itself. It is only when more than half the day is spent on business that you can consider it so[7].

Time is easy to measure. When you’re going on a mixed-purpose trip, be sure to track your time consistently. This is the only way you have an argument for deducting expenses for lodging, meals, and travel.

How to Document Your Trip

Be aware that the IRS is not going to just take your word for it that you spent more than half your time conducting business. You may be asked to provide documentary evidence of your business activities during the trip. In that case, each of the following items is useful:

  • Receipts—Obviously, you will file all the receipts from your trip. This shows both the business-related expenses and how you paid for them. Tax law absolutely requires that you save receipts and document the business reason for each day (e.g., attending a specific seminar) if expenses exceed $75. Be sure to note what each receipt is for—breakfast, gas, etc.
  • Brochures—Most education seminars will provide an event brochure. Hang on to this, and put it in a folder with other information regarding your travel. This is especially useful if the brochure outlines how the seminar is useful for your business purposes and has a clear outline of benefits.
  • Notes—You may not remember every detail of your outing. This is where taking timely notes comes in handy. Once you are back from your trip, or even better, during the trip, take time to note which activities you took part in for business and how long they lasted. You can also jot notes down on your brochure if it’s not clear how the seminar benefits your business.
  • Travel Log—What format you use for your log does not matter. What is important is that you have somewhere (a notebook, calendar, or app) that allows you to your activities during your stay. This should include all events that you attend, contacts you meet, and how you otherwise spend your time. You can find several good software applications for this.
  • Summary of Benefits—If you haven’t noted this in any other journal, you may want to outline the benefits you received from the seminar after the trip ends. This allows you to state clearly what you got from the trip and how you will apply it to your business. This works as a supportive document that explains why the travel was business related.

With the proper documentation, you should be able to prove that your trip is eligible for business tax deductions. Just remember the half-day rule and to keep thorough records. A business trip does not have to be “all business,” so relax—figuring out eligible expenses is not all that difficult.

  1. Rev. Rul. 84-55. ↑
  2. Reg. Section 1.162-5(e)(1). ↑
  3. Rev. Rul. 75-168; U.S. v Homer O.Correll (1967, S Ct) 389 US 299; IRS Pub. 463 Travel, Entertainment, Gift, and Car Expenses (2005), p. 3. ↑
  4. Reg. Section 1.162-5(e)(1). ↑
  5. Ibid. ↑
  6. Holswade v Commr., 82 T.C. 686 (1984). ↑
  7. Reg. Section 1.274-4(d)(2)((iii). ↑
Categories : Business Expenses, Education, Receipts, Records, Tax Planning, Travel

Are You a “Dealer” or “Investor” for Tax Purposes?

By Kim M. Larsen EA CTFS
Monday, January 26th, 2015

Tax law is forever classifying people and making structures that either create benefits or disadvantages on your tax return. Part of getting the most from your return is about understanding the definitions of the IRS. Two that seem very similar, but have distinctly different consequences on your taxes, are real estate dealer and real estate investor.

What’s the Downside of Each?

We’ll start by discussing the disadvantages. That’s right—there is no golden choice when trying to figure out if you classify as a dealer or an investor. In either case, there will be some disadvantages.

As a real estate dealer:

  • Your profits are taxed at both the ordinary income rates (up to 35 percent) AND the self-employment rates (up to 14.13 percent).[1]
  • You may not depreciate property that you are holding with the intention of selling.
  • You may not use the tax-favored installment method to report dispositions of your property.
  • And, you may not use the Section 1031 exchange to defer taxes on properties you hold as a dealer.

As a real estate investor:

  • You are subject to the net capital losses limit of $3,000 (applied after gains are offset against losses).
  • You must treat selling expenses as a reduction in sales proceeds, which means those expenses produce benefits at the capital-gains tax rates only.

Admittedly, the dealer gets the lesser deal when it comes to disadvantages. The investor does get to depreciate property, is allowed to sell using the tax-favored installment method, and may choose to use a Section 1031 exchange, thereby deferring taxes on a disposition.

What about the Up Side?

Every coin has a heads and a tails. And, it’s the same with tax designations. Both dealers and investors gain some advantages from their respective positions.

Advantages for real estate dealers include:

  • You are treated as a business and may treat most expenses as ordinary business deductions (advertising, commissions, legal fees, real estate sales, etc.).
  • Your property sale losses are not limited capital loss cap of $3,000 that limits investor properties.
  • Your losses are deducted as ordinary losses.
  • You get to deduct the entire loss (either immediately or using the net operating loss rules to deduct it over time—these rules allow you to carry back your losses up to five years and forward up to twenty years).

Advantages for real estate investors include:

  • Your sales profits are taxed at 15 percent or less, a tax-favored capital gains rate.
  • You are not subject to the self-employment tax.

Practical Application

So, what does all this mean for you and your business? Let’s run through some example numbers. For the example, we’ll say you have a $90,000 profit from a property sale. Based on the tax rates mentioned above, your taxes as a dealer could be as high as $36,370.[2] Your taxes as an investor might be as high as $13, 500.

You can clearly see that having your properties qualify as investment sales generates a considerable tax savings—potentially $22,870!

However, depending upon your business structure and activities, it may not be possible to define all of your property sales as investment sales. No problem. The IRS has no qualms with an individual taxpayer acting as part dealer and part investor. You read that right; you can balance the pros and cons of each situation. It’s simply a matter of taking each property on a case-by-case basis.[3]

Not so fast. You may think the IRS is giving you some kind of free gift by allowing this pick and choose method, but it’s not quite as unstructured as all that. You will be required to make a clear distinction in your record books. You didn’t think the IRS was going to let you off without documentation, did you? And, this means you must decide before-hand which route you’re going with each property sale. You cannot simply go back over your sales at tax time and assign designations. You will have to establish what your intent was with the sale—dealer sale or investment sale.

Tips on Documentation

Good documentation of your purpose and activities helps you to establish your case with the IRS. You should determine, and make note of, your intent for the property throughout the process:

  • When you purchase the property;
  • During your ownership; and
  • At the time you sell it.

If you keep records throughout the process (not just at the time of sale) it gives your case credibility. It’s important to keep in mind, however, that if your return is challenged in court, they will likely examine the sale when they rule on whether you acted as a real estate dealer or real estate investor on a particular property.[4] None of this means that your purpose may not change between the time you buy a property and sell it, but at least you will be prepared to understand and plan for such a scenario.

The All Important Point-of-Sale

Important: The point-of-sale is the most critical part of the process in determining your investor or dealer status. It’s often the deciding factor in IRS decisions. Although a single piece of real estate can have features of both dealer and investor property, it can only be treated as one or the other. Take a look at the characteristics of each from a tax standpoint.

  • Real Estate Dealer—First off, dealer property is held with the intention of being to customers in the ordinary fashion of business or trade.[5] If you buy and sell many properties throughout the year, you are likely a dealer regarding those properties.[6] Unfortunately, the IRS has not established any set number for determining dealer status, so it’s all about making your case. In fact, number is only one factor, and in previous rulings:
  1. A company earned dealer status with only one sale because it had already agreed on sale to a third party prior to purchasing the property itself;[7]
  2. A taxpayer, Mr. Goldberg, did not earn dealer status even with 90 home sales in a year.[8] In his case, the homes were built for rentals and used as such prior to the time of sale.

However, in the majority of cases, more sales equal dealer properties. In addition to the influence of the number of properties sold, real estate that you subdivide also has an increased chance of achieving dealer status,[9] except under Section 1237.[10] Removing a lien can also make a property more salable under the ordinary processes of business[11] (recall that dealer property is sold in the ordinary course of business).

Several other traits indicate a dealer business transaction over investment actions. They include active marketing and sales activities,[12] property held for a short period of time (indicating the intention to turn over the property for profit),[13] generally making your living as a dealer,[14] regularly buying and selling real estate for your own account,[15] and buying property with the proceeds from another property.[16]

  • Real Estate Investor—In contrast to dealer property, investor property is held with the intention of producing rental income[17] or appreciating in value. This means that investor properties are typically held for longer periods of time[18] and are not often sold, unlike the quick turnover of a dealer property.[19] Other situations in which a court may rule your property is an investor property include acquiring the real estate by inheritance,[20] dissolution of a trust,[21] or a mortgage foreclosure.[22] It’s even possible for you to make improvements to such property prior to selling it and still retain investor status.[23] [24] Just don’t put the proceeds into more real estate or subdivide the property[25] if you want to maintain that status.

If you don’t make clear in your documentation which type of property sale you are making, the IRS will make the decision based on their interpretation, and that is not the best situation for you! So, look at those characteristics above again. Since you’re going to know at the outset what your purpose is with each property, you can make sure to include as many of the appropriate features as possible well before the sale.

  1. The usual self-employment tax rate times the Schedule SE adjustment. ↑
  2. Assuming the real estate profits were your only income. ↑
  3. Tollis v Commr., T.C. Memo 1993-63. ↑
  4. Sanders v U.S., 740 F2d 886. ↑
  5. IRC Section 1221(a)(1). ↑
  6. Sanders v U.S., 740 F2d 886; Suburban Realty Co. v U.S., 615 F2d 171. ↑
  7. S & H, Inc., v Commr., 78 T.C. 234. ↑
  8. S & H, Inc., v Commr., 78 T.C. 234. ↑
  9. Revenue Ruling 57-565 ↑
  10. IRC Section 1237. ↑
  11. Miller v Commr., T.C. Memo 1962-198. ↑
  12. Hancock v Commr., T.C. Memo 1999-336. ↑
  13. Stanley, Inc. v Schuster, aff’d per curiam 421 F2d 1360, 70-1 USTC paragraph 9276 (6th Cir.), cert den 400 US 822 (1970); 295 F. Supp. 812 (S.D. Ohio 1969). ↑
  14. Suburban Realty Co. v U.S., 615 F2d 171. ↑
  15. Armstrong v Commr., 41 T.C.M. 524, T.C. Memo 1980-548. ↑
  16. Mathews v Commr., 315 F2d 101. ↑
  17. Planned Communities, Inc., v Commr., 41 T.C.M. 552. ↑
  18. Nash v Commr., 60 T.C. 503, acq. 1974-2 CB 3. ↑
  19. Rymer v Commr., T.C. Memo 1986-534. ↑
  20. Estate of Mundy v Commr., 36 T.C. 703. ↑
  21. U.S. v Rosbrook, 318 F2d 316, 63-2 USTC paragraph 9500 (9th Cir. 1963). ↑
  22. Cebrian v U.S., 181 F Supp 412, 420 (Ct Cl 1960). ↑
  23. Yunker v Commr., 256 F2d 130, 1 AFTR2d 1559 (6th Cir. 1958). ↑
  24. Metz v Commr., 14 T.C.M. 1166. ↑
  25. U.S. v Winthrop, 417 F2d 905, 69-2 USTC paragraph 9686 (5th Cir. 1969). ↑
Categories : Audits, Business Expenses, Capital Gains, Depreciation, Exchanges, Investments, Land, Leases, Passive Income & Losses, Receipts, Records, Rental Properties, Self-employment Tax, Tax Planning

You Can Deduct Clothing and Laundry Expenses—Legally!

By Kim M. Larsen EA CTFS
Monday, January 26th, 2015

Most of us don’t wear the same thing we wear on the weekend or out to dinner at night as office apparel. Since you’re likely spending extra money to have appropriate clothing to wear to work, it makes sense that you can count it as a business expense. In fact, the IRS allows tax deductions both for the purchase of work clothes and their laundering—as long as you follow the rules.

What Clothing Qualifies

You could be spending several hundred dollars per year on work clothes, plus more for dry cleaning or other laundry expenses. Of course, the IRS isn’t just going to let you buy whatever fancy duds you want and write it off. So, check if your clothes fit into one of these categories before determining whether you qualify:

  • The clothing has a business logo or is a uniform, scrubs for example;
  • You frequently wash or dry-clean your work clothes at your expense; or
  • You are required to wear protective gear or protective equipment for work.

If you already fit one of these requirements, then make sure you’re using this strategy to save on taxes. If not, maybe you should look into purchasing qualifying clothing items. The savings could really add up—even just for the laundry expenses. Not only that, but you’ll extend the life of your non-work clothes by not needing to wash them as often.

Sounds too easy, right? Well, there is a little more to it than that. If you know anything about the IRS, you know that they like to have proof. Here are the rules for making sure the cost of your clothing and its maintenance is deductible:

  1. The clothes are either required or essential for the work you do.
  2. The clothes are either protective or distinctive.
  3. They are not appropriate for wearing outside of work as everyday clothing.

You must provide evidence for all three of these criteria in order to get the deduction[1]. You may need to get a little creative with some of these requirements, but as long as you provide reasonable proof, you can make this deduction work for any type of business. Basically, the IRS wants to see that you are not gaining any personal benefit from the clothing. Let’s take a look at how to meet these criteria.

Required or Essential Clothing

As a business owner, this is a pretty easy requirement to meet. After all, you make the rules on work attire for your company, and that includes what you and your employees wear. No employees? Don’t worry about it. You can still qualify and meet this criterion as a sole proprietor who works alone[2]. In fact, case law offers a few examples of how individuals have qualified:

  • A dairy salesman who was self-employed decided to wear a uniform on his routes—green trousers, shirt, and hat, all stitched with the name of his company, “Mortrud Dairy”. His deduction was approved by the court[3].
  • A professional violinist was required to wear formal wear, including sequined gowns, for performances with the Los Angeles Chamber Orchestra and Long Beach Symphony. The court approved her clothing deductions, noting that the clothes were “quite formal” and not “adaptable for general and personal wear.”[4]

Protective or Distinctive Clothing

Fortunately, for this requirement you only need to prove one or the other, that your clothing is either protective or distinctive. Protective items include equipment, such as safety gloves, hard hats, or painter’s smocks. Distinctive is a fairly simple case to make. Examples of distinctive attire would be items with a company name or logo, or uniforms that affiliate you with a particular profession, such as scrubs for medical professionals.

So, combine this with the first requirement, and you’ve got a pretty easy solution. Put your logo on the clothing and make it a rule that employees must wear it. When you do these two things, the clothing becomes a work uniform.

If you’re uncertain of whether your apparel counts, look at these two case examples:

  • A carpenter attempted to deduct his shoes and work overalls; however, the court ruled that the items were not deductible. The white overalls did not contain a logo and were ordinary work clothes that could be worn outside of work (they did not meet the “distinctive” requirement). The shoes were also deemed ordinary, as opposed to protective shoes[5].
  • In another case, a salesman was able to deduct some, but not all, of his clothing. His employer required a tailor-made cap, jacket, and shirt with the company logo on all three. These items were deemed deductible by the court. However, his socks, shoes, raincoat, and overshoes were not deductible since they were not specifically part of a uniform[6].

In the case of armed services employees, military uniforms meet these requirements and are eligible for deduction. The established requirement for military personnel is that you have to be full-time active duty and not allowed to wear the clothes during off hours[7].

Not Appropriate for Usual Wear

As you’ve probably guessed, this is the hardest requirement to prove. It’s somewhat subjective since you must determine whether the average person would want to wear these clothes outside of the workplace. You have a better chance of proving this requirement to the IRS if the clothes veer further towards unusual or distinct from everyday wear.

Tip: Do not wear your work clothes outside of work activities if you plan to make a clothing deduction. No matter how distinctive they are from ordinary clothes, you will not win the deduction if you wear the clothes for non-work purposes. Of course, it’s okay to wear them while commuting.

Let’s start with an example of a case in which the individual did not meet this requirement:

  • A saleswoman for a high-end clothing store was required to buy the store’s clothes and wear them at work. Although she claimed she only wore them to work and nowhere else, the court denied her deductions because the clothes were suitable for wearing every day[8].
  • In another case, a dental office manager had her deductions approved for both the cost of purchasing and laundering her uniforms, which were not considered ordinary clothing[9].
  • A physician was also able to deduct his purchase and laundry costs for scrubs. He was expected to wear them while at the hospital where he worked, and they were not appropriate as ordinary clothes[10].

On Employee Uniforms

Here’s some good news for employers. After wrapping your head around all these stipulations for deducted clothing expenses, you’ll be happy to know that when you purchase uniforms for your employees, these are always deductible expenses[11]. You have no need to worry about any of the above criteria.

Your employees, however, should still be concerned about the three criteria above, and here’s why. If the uniforms meet all the criteria, your employees get to treat the clothes as a tax-free fringe benefit as part of their working conditions[12]. If, on the other hand, the above rules are not met, then your employees will have to treat the apparel as taxable compensation[13].

So, is it worth the expense for you to purchase clothing specifically for your work? It really depends on your situation. If you’ll be spending a significant amount on the maintenance of such clothing (i.e. dry-cleaning or laundry expenses), it may make up for the expense of buying work-only clothes. And, if you’re already wearing clothes devoted exclusively to your business, then make sure you meet the three rules and get the deductions you’re qualified for. You know what they say; dress for success—and deductions!

  1. IRS Publication 529, Miscellaneous Deductions (2013), dated November 13, 2013, ps. 7-8. See also Tyler v Commr., TC Memo 1982-160. ↑
  2. Mortrud v Commr., 44 TC 208. (Self-employed business owner could deduct the cost of his uniform.) ↑
  3. Mortrud v Commr., 44 TC 208. ↑
  4. Katia v Popov, TC Memo 1998-374. ↑
  5. Jim McNamee, 12 TCM 1131. ↑
  6. Marshall J. Hammons, 12 TCM 1318. ↑
  7. IRS Publication 529, Miscellaneous Deductions (2013), dated November 13, 2013, p. 8. ↑
  8. Barry D. Pevsner v Commr., 628 F.2d 467 (CA5). ↑
  9. Floyd Gilbert Bickel II, TC Memo 1966-202. ↑
  10. Lynn Crawford, TC Memo 1993-192. ↑
  11. IRC Section 162; Rev. Rul. 72-110. ↑
  12. IRC Section 132(d). Section 1.132-5(a)(1)(v) ↑
  13. Rev. Rul. 80-322. ↑
Categories : Business Expenses, Receipts, Records, Tax Planning

Why Running a Corporation Increases Your Cell Phone Tax Deductions

By Kim M. Larsen EA CTFS
Sunday, January 25th, 2015

It’s no secret that how you run your company—as a proprietorship, an LLC, or a corporation—affects your tax deductions. In many cases, corporations get the biggest advantages, and that is the case with business cell phone expenses. This article will give you advice for getting the most out of your corporate advantage on cell phone deductions, as well as the requirements for other business owners.

History of Cell Phone Deductions

Did your corporation pay for, or reimburse you for, a business-purpose phone? If so, your corporation gets to deduct both the cell phone’s cost and its usage charges. Does that sound like a good deal? Well, it is—because sole proprietors and single-owner LLCs do not have this advantage! (Keep in mind, however, that partnerships and LLCs run as partnerships are eligible for the same deductions as corporations in this scenario.)

Why are corporations the only entities to cash in on this situation? It goes back to the listed property rules. These tax rules were applied to cell phones all the way back in 1989, and although listed property creates several hoops for taxpayers to jump through, the one that applied to cell phones was the requirement to log both business and personal use. You may be familiar with this requirement in the form of your business vehicle’s mileage log.

But, that’s just where the situation started. In 2010, cell phones were removed from the listed property category. Legislators realized that they simply do not fit in this group. The removal was accomplished through the Small Business Jobs Acts[1].

Corporate Advantage

So, why are some small business owners still getting the shaft? First off, the newer act did not address how to tax personal cell phone use. Then, in 2011, the IRS laid down cell phone guidelines. And, they address cell phone use for employees. As the owner of a corporation, you are considered an owner-employee because your corporation is a fully separate entity from you—not so for the owner of a proprietorship or LLC.

Here’s what the IRS decided[2]:

  • No records need to be kept regarding personal vs. business use of employees’ cell phones, and employer-provided cell phones will not be taxed for personal use.
  • To qualify for this tax advantage, the reason for providing an employee with a cell phone must be mainly for “noncompensatory business purposes”. That means one of the following (or a similar situation) must apply:
  1. The phone allows the employer to contact the employee regarding work-related emergencies at any time;
  2. The employee is required to speak with clients when away from the office; or
  3. The employee is required to talk to clients in other time zones, which may fall outside regular workday hours.

For a corporate owner-employee, it should be fairly easy to meet at least one of those requirements. In fact, your company doesn’t even need to purchase a cell phone for you. You can use your personal cell phone and have the corporation reimburse you or provide a cash allowance for phone usage[3]. That means no logging usage for you (or your corporation), and you still get the deduction! That’s right. As long as you pay a fixed monthly fee (not pay as you go), then your corporation can reimburse you for the entire amount—even if you use the phone for personal calls, too.

What about Other Business Owners?

Because of the differences in business structure, sole proprietors and LLC owners are not considered owner-employees. That means these hassle-free tax breaks apply to your employees and not to you. However, you can still deduct your monthly business-related cell phone costs. You’ll just have to calculate the amount for personal use. Your business-related cell phone use will be deducted like any other business expense, and you depreciate your cell phone’s cost.

Basically, you still benefit from cell phones no longer counting as listed property, but you do have to log usage. So, if you tally up the usage hours for the year, and 80 percent of those were business-related hours, then you can monthly fee and depreciation deductions are for 80 percent of the total.

Important: You will need to document those calls to prove the 80 percent business use. But, don’t droop your head! You can do this easily by simply taking a pen to your phone bill and marking which calls were business and which were personal[4]. Here’s another bit of good news: you don’t need to pour over every phone bill for the entire year. The IRS allows you to take a sample, three months for instance, and apply it to the year if you make about the same number of business calls each month[5]. Or, just save yourself some time and get two phone numbers for your cell.

For employees: Be aware that cell phones given as an incentive or morale booster are counted as taxable income[6].

A Note on Independent Contractors

If you are an independent contractor, you get tax-free, tax-favored employee status for your cell phone, as long as your cell phone is reimbursed by or given to you by an employer. That employer can be a broker, customer, client, etc.[7] In all other circumstances (your phone usage is not reimbursed), you are considered a proprietorship and must prove your usage for deductions.

With all its distinctions for various groups and categories, tax laws will always end up providing an advantage to one group or another. In the case of cell phones (and many other fringe benefits) corporations and their owner-employees get the edge on tax deductions. Whatever type of company you run, make sure you know the rules so you can get the most from your tax return.

  1. P.L. 111-240: IRC Section 2043. ↑
  2. IRS Notice 2011-72; See also IRS Publication 15-B, Employer’s Tax Guide to Fringe Benefits (for use in 2012; updated Dec. 7, 2011), p. 12. ↑
  3. IRS Memorandum for All Field Examination Operations, Sept. 14, 2011. ↑
  4. Umit Tarakci, T.C. Memo. 2000-358. ↑
  5. Reg. Section 1.274-5T(c)(3)(ii)(C), Example 1. ↑
  6. IRS Notice 2011-72; see also IRS Publication 15-B, Employer’s Tax Guide to Fringe Benefits (for use in 2012; updated Dec. 7, 2011), p. 12. ↑
  7. IRS Regulation 1.132-1(b)(2)(iv). ↑
Categories : Business Expenses, Listed Property, Receipts, Records, Tax Planning

Legal Tax Benefits for Your Small Business at Year’s End

By Kim M. Larsen EA CTFS
Saturday, January 24th, 2015

Many people see the IRS as an entity that only seeks to take away their hard-earned cash. But, think of it this way. In a game of basketball, is the other team just going to let you win? No, but most teams will play fair, meaning you have an opportunity to score, just as they do. It’s the same with the IRS. Of course the IRS is going be aggressive in making sure you pay what you owe; however, it also expects you to play just as hard by making sure you receive the money owed to you.

5 Smart Tax Moves

The amount of potential savings is going to vary depending upon your company’s cash flow and its need for supplies and equipment. By playing the game correctly, you could save your business thousands in taxes. What you need is a smart strategy that can be implemented easily and safely, so check out these 5 tips for immediate savings:

  1. Stop Billing at the End of the Year—If your business operation is based on the calendar year, simply don’t send out invoices in November and December. Wait, instead, to request payment for those services at the beginning of January. With no invoice, insurance companies or customers are unlikely to send payment, which means less taxable income on your return. By waiting to bill, you’ve postponed those taxes.
  1. Purchase Office Equipment—After much anxious waiting from taxpayers in 2014, the IRS raised Section 179 expensing back to $500,000, as it had been in previous years. Unfortunately, the smaller $25,000 cap has been reinstated for 2015[1]. However, the limit in 2014 was not raised until nearly the end of the year, so pay attention towards the end of the year to see if the limit is raised again. If so, it will pay to go forward with equipment purchases rather than waiting.
  1. Pay Expenses in Advance—You have the IRS tax-deduction safe harbors to thank for this advantage. According to IRS Regulation 1.263(a)-4(f), cash-basis taxpayers can deduct qualifying expenses up to twelve months in advance[2]. Here’s an example of how it works. Let’s say you pay $2,000 per month in office space rent. To immediately get a $24,000 deduction, on December 31st you just send a check for the entire payment for the next twelve months.

What happens is you get the deduction in the year you paid the money (not the year the money is due). Your landlord, however, does not have to report the payment until the following year since it was not received by mail until January. To prove that you mailed the check in the current tax year (and remember, the IRS always requires proof!), you can send the check certified or by registered mail so that you get a dated receipt.

Tip: Make sure your landlord understands what you are doing. You don’t want this strategy derailed because the landlord thinks it’s an error and your check is returned. Also, don’t send payment too early. Your landlord will not be happy to receive the check before January 1st and have to claim the full amount on the current tax return.

Remember, you can pay expenses for the upcoming tax year in advance, but no further out than that. That means you could not pay two years, or even eighteen months, of expenses in advance. Qualifying expenses for cash-basis taxpayers include office and machinery rent payments, business and malpractice insurance premiums, lease payments for business vehicles, and others.

  1. Pay with Credit Cards—For sole proprietors, expenses are deductible as of the day they are charged to their card. This method allows for immediate deductions of office supplies and other business necessities, and it has the advantage of proof in the form of your credit card statement. For those who own a corporation, this advice works in the same way as long as you have a credit card under your corporation’s name. However, if the card is in your personal name, the expenses are not eligible for deduction until you submit your expense report and the company reimburses you, so plan accordingly.
  1. Don’t Worry that You’re Taking Too Many Deductions—As long as you’re following the rules, you have no reason to hold back on your deductions. A great basketball player doesn’t hold back for fear of scoring too many shots. It is possible that your business deductions exceed your business income. When this happens, it’s called a “net operating loss” (NOL)[3].

Fortunately for you, in the case of NOL tax law allows you to claim refunds from as far back as the previous two tax years[4]. So, you may actually get back money you previously paid in taxes! Not only that, but if you still have unused losses after going back two years, you can carry those losses forward for up to twenty years[5]. That’s an astounding twenty-two year window during which you can benefit from the deductions made in one year, and it works that way no matter how you run your business (proprietorship, corporation, or other methods)[6].

Now that you understand just how much of an effect your deductions can have on your lasting tax benefits, you know to make those deductions count. Don’t avoid deductions for fear of a tax loss. Just because you have an NOL on your return does not mean your business is not thriving and successful. More deductions mean less regular tax paid and less AMT tax paid. So, keep documenting those deductions!

  1. IRC Section 179(b)(1)(B). ↑
  2. IRS Reg. 1.263(a)-4(f). ↑
  3. IRC Section 172(d). ↑
  4. IRC Section 172(b)(1)(A)(i). ↑
  5. IRC Section 172(b)(1)(A)(ii). ↑
  6. IRC Sections 172; 642(d); 512(b)(6). ↑
Categories : Business Expenses, Receipts, Records, Tax Planning
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