Lease, buy, trade....SELL

We get a lot of questions about vehicle deductions and there’s one thing that we really try to communicate to our clients when they are getting a new business vehicle.  And that one thing is: SELL YOUR OLD VEHICLE!

Your business vehicle gives rise to gains and losses when sold to third parties.  It works like this:

• The original purchase price is your beginning basis.
• You divide beginning basis into business & personal use based on business mileage (vs. personal mileage).
• Depreciation reduces your business basis.
• Depreciation comes from either the depreciation tables or the IRS mileage rates.
• When you sell or your corporation sells the business vehicle, you compare the net business sales proceeds with the adjusted business basis to find your gain or loss.

For tax planning purposes, you need to know if your vehicle would produce a gain or a loss on the sale.

Example.  Here’s how Bill Brown finds a $27,000 tax-loss deduction on his existing business vehicle.  Mr. Brown has been in business for 11 years, during which he:

• Converted his original personal vehicle into a business vehicle;
• Then traded in the converted automobile on a new business vehicle (car #2);
• Then traded in Car #2 on a replacement vehicle (Car #3); and
• Then traded in Car #3 for another replacement business vehicle (Car #4), which he is driving today.

During the 11 years Mr. Brown has been in business, he has owned four vehicles.  Furthermore, he used standard mileage rates to take deductions for the business use of his vehicle.  If Mr. Brown sells his mileage-rate-deducted business vehicle today, he realizes a deductible loss on the sale of $27,000.

The loss is the accumulations of 11 years of car activity during which Mr. Brown never cashed out, because he always traded in his old vehicle towards the purchase of his new one.  Trades are considered IRC Section 1031 tax free exchanges.  Unlike sales, where you cash out your ownership of the vehicle, trades defer the tax result to the next asset.  That’s how Mr. Brown unknowingly accumulated this big deduction.

To get a mental picture of how this one sale produces a huge deduction, consider this:  When Mr. Brown sells car #4, he is really selling four cars because the 1031 exchange rules pushed the old basis of each vehicle into the replacement vehicle’s cost-basis.

We’ve had clients with even bigger losses.  One fellow earned a tax loss in excess of $100,000 on the accumulated build up of 5 luxury automobiles over a number of years.

Examine your car buying habits for this possible tax windfall.  Have you been trading business vehicles?  If so, your loss could be a big one.  Is your current business vehicle really four cars for income tax reporting purposes?  Do this examination soon – to take the loss, you would have to sell your car to a third party before the year ends.

Best Tax Deduction for Employee Entertainment

Those infamous Holiday parties are on the horizon, so we thought we’d share these timely tax tips with you~!

Beware. Tax law requires two categories for your entertainment tax deductions.  Does your business chart of accounts contain two different accounts for entertainment? It probably should.  The two types of entertainment tax deductions are:

1.    50 percent deductible entertainment; and

2.    100 percent deductible entertainment

If you have staff training in your office and you take the staff to lunch, you have a 50 percent deductible entertainment. The 50 percent category is where your regular entertainment deductions go.  The 100 percent tax-deduction category is for entertainment that’s exempt from the 50 percent cut, such as the ever-popular employee Holiday party.  In this message, we will explain the following concepts:

1.    What it means to qualify an employee party for the 100 percent deduction;

2.    What types of employee entertainment qualify for this 100 percent deduction; and

3.    How tax law defines entertainment that’s primarily for the benefit of employees

Big Tax Deduction for Employee Entertainment

The IRS says that the following types of entertainment qualify for the 100 percent employee entertainment tax deduction:

1.    Holiday parties, annual picnics, and summer outings; and

2.    Maintaining a swimming pool, baseball diamond, bowling alley, or golf course.

The IRS uses the term “ordinarily” in describing the 100 percent entertainment above, and that makes it clear that more than the above is possible. Lawmakers stated that “expenses for recreational, social, or similar activities (including facilities therefore) primarily for the benefit of employees” qualify for the 100 percent deduction.

Here is how the full Tax Court treated a case that’s broader in scope than one involving a holiday party or summer picnic. During one year, American Business Service Corporation rented a powerboat 41 times at a cost of $1,000 a day for daylong recreational cruises for its employees and their guests. The company had about 100 employees, but the boat would accommodate only about 30 people at a time.

All employees, including owners, managers, and rank-and-file personnel, were eligible to take these cruises, but they had to sign up in advance on a first-come, first-served basis. The court allowed the full $41,000 deduction for the 41 cruises because the cruises:

1. were primarily for the employees,
2. did not discriminate in favor of the owners and highly compensated employees,
3. were documented as to who cruised and when, and
4. passed the “ordinary and necessary” business purpose test.

We recently read about an insurance agent who took his staff to Atlantic City, N.J., for an excursion. Obviously, this is not the traditional holiday party, but it qualifies for the 100 percent deduction.  Here are the facts in this case:

The owner of the Agency took his employees on an “incentive trip” to Atlantic City.  The “purpose” of the trip was for the employees to “learn, study and discuss future production”.  The owner admitted that most the time was spent having a good old time and consisted of a two night stay before returning to the office.

The owner has two choices for claiming a business deduction for these trips:

1. He could claim the trip as a business training trip, where you have to prove that the primary purpose of the trip is business; or
2. He could claim the trip as a recreational event primarily for the benefit of his employees.

His tax preparer suggested that he go with the recreational event for employees, because:

·         The owner admitted that they were not doing much work on this trip, and therefore it probably does not qualify as a business trip;

·         The recreational event provides a 100 percent write-off of the meals and beverages, whereas the business meeting only provides 50 percent; and

·         They don’t have to even think about work if you make the trip a recreational trip primarily for the benefit of the employees!

To deduct trips of this nature, you need proof that the cost of the trip was primarily for the benefit of:

• Employees other than owners;
• Employees who are officers or shareholders; or
• Highly compensated employees.

Example. You own a business and have seven employees, none of whom earns more than $110,000 a year.  The eight of you go to Atlantic City for two days of fun. You pick up the tab for transportation, meals, and lodging—that is, you pay for everything but the gambling. (Those who want to gamble have to fund that experience themselves.) You may deduct as employee recreational expenses the money you spend for transportation, meals, and lodging.

Also, as mentioned above, on this employee excursion, your payments for food and beverages do not suffer the 50 percent cut that applies to business meals.  You want to make it clear that this trip is for recreational, social, or similar activities primarily for the benefit of employees.

That’s what produces the 100 percent deduction and removes the need to have business meetings.

Not logical. You have to admit that being able to deduct 100 percent of the meal cost on the excursion when you can deduct only 50 percent for heavy-duty business meetings makes no sense. That’s true—it’s not logical—but that’s the way lawmakers put it together, so apply this rule to your benefit.

“Primary.”  The word “primary” in tax law means more than 50 percent. For examples, see Revenue Ruling 63-144, questions and answers 60 through 66. This means that your employee recreation has to benefit the rank-and-file more than it benefits the owner and highly compensated group. In this case, the agent has seven employees plus himself—eight people total on the excursion!  The Owner gets one-eighth of the benefit, far less than 50 percent; therefore, the trip with the employees to Atlantic City is of primary benefit to the employees, and that makes it deductible.  More on this later…

What About You?  What things do you do, or could you do, primarily for the benefit of your employees?

Thus, a cruise in the harbor with your two non-family-member employees is primarily for the benefit of the employees.  Let’s say you have a beach home. Suppose that, during the year, your employees use the beach home on more days than you use the beach home. Presto! With an ordinary business-use reason, which we discuss later, you have a beach-home deduction.

Who Are These Employees?

Technically, the law requires that the entertainment expenses be “primarily” for the benefit of employees other than a “tainted group.” The tainted group consists of:

1. a highly compensated employee (an employee who is paid more than $110,000 in 2011);
2. anyone, including yourself, who owns at least a 10 percent interest in your business (this is called a “10 percent owner”);
3. any member of the family of a 10 percent owner, i.e., brothers and sisters (including half brothers and half sisters); spouses; ancestors (parents, grandparents, etc.); and
4. lineal descendants (children, grandchildren, etc., including adoptees).

Primary Means More Than 50 Percent

In tax law, the term “primary” or “primarily” means “more than 50 percent.” For employee recreation, that means the non-tainted group of employees has to have more than 50 percent use of the entertainment facility, or in the case of a party, a majority of non-tainted employees must attend.

Documentation Tip. You can measure “primary” by days of use, time of use, number of employees, or any other reasonable method. Regardless of how you measure use, the key to your deductions is the records that prove the uses.

Business Purpose Requirement—Easy to Meet

When you think of business entertainment, you likely think of the terms “directly related” and “associated” entertainment. Smile. Those terms do not apply to employee entertainment!

But you still need to satisfy the overriding standard for business expense deductions, which is the “ordinary and necessary” business purpose test.  Fortunately, this test is pretty easy to pass.

Basically, an “ordinary and necessary” expense simply means an expense that is “appropriate and helpful” for your business. To meet the test, the expense does not have to happen often or be a recurring expense.

What’s your “ordinary and necessary” reason for partying with your employees?  Your reason might be as simple as improving employee morale and loyalty to your business. Or you might want to ensure that your business might offer more fun and better working conditions than the competition.

Documentation

You must document your 100 percent deductible employee entertainment expenses, just as you must document other entertainment.

Documentation Tip. When recording the expenses for an employee party, outing, or other type of entertainment, be sure to note your business reason for the entertainment.

• If it’s an annual event to improve employee morale and loyalty, write that down.
• If there’s a more specific reason, such as an office party to celebrate a fat new contract, write that down.

The point is, you need a reason and you need to write it down. The test is easy to meet, but like all deductions, you can’t nail it down without writing it down!

Documentation Tip. When we meet to begin the preparation of your returns, make sure to tell us that you have both regular (50 percent) and 100 percent deductible entertainment. Start with two categories for entertainment in your chart of accounts. If you give us your Quicken or QuickBooks files, the two separate accounts stand out. If you complete an organizer that has just one line for entertainment, make a note on the tax organizer you fill out for us at tax time.

When I grow up, I want to be in Tax!

We tax folks live in a strange, parallel universe.  When we find something amusing, we like to share.  Watch "When I Grow Up..."

http://blog.redmoonsolutions.com/kids-tell-all-they-want-to-be-in-tax

2012 IRS Inflation Adjustments and other tax news

November already?!?  Time for some tax news…


2012 Inflation-adjusted Amounts: To keep pace with inflation, the IRS modified dozens of tax benefits for 2012. For example, the (1) value of each personal and dependency exemption for most taxpayers will be $3,800 (up $100 from 2011); (2) standard deduction will be $11,900 for married couples filing a joint return (up $300), $5,950 for singles and married individuals filing separately (up $150), and $8,700 for heads of household (up $200); (3) tax-bracket thresholds will increase for each filing status; (4) basis exclusion from estate tax will be $5,120,000; (5) monthly exclusion amount for qualified parking will be $240; and (6) Section 179 limit (unless Congress increases it) will be $139,000 with a phase-out threshold of $560,000. The annual gift tax exclusion will remain unchanged at $13,000. Rev. Proc. 2011-52, 2011-45 IRB and News Release IR 2011-104
.
2012 Pension Plan Amounts: The IRS published cost-of-living adjustments to various pension plan and related amounts for 2012. For instance, the (1) benefit limit for defined benefit plans will increase from $195,000 to $200,000; (2) defined contribution plan limit will go up from $49,000 to $50,000; (3) compensation limit for determining benefits and contributions will increase from $245,000 to $250,000; (4) definition of a highly compensated employee will go from $110,000 to $115,000; and (5) elective deferral limit for employees who participate in 401(k), 403(b), and most 457 plans will go from $16,500 to $17,000. The following dollar limitations will stay the same—the $550 SEP contribution threshold, and the $11,500 SIMPLE elective deferral limitation. News Release IR-2011-103.


2012 Social Security Wage Base: The social security wage base will increase from $106,800 in 2011 to $110,100 in 2012. As in prior years, there is no limit to the wages subject to the Medicare tax, so all covered wages are subject to the 1.45% tax. The FICA tax rate, which is the combined social security tax rate of 6.2% (4.2% on the employee portion in 2011) and the Medicare tax rate of 1.45%, is normally 7.65%, while the self-employment tax rate is normally 15.3% (13.3% in 2011). The threshold for coverage for domestic employees will be $1,800 in 2012.


Income Tax—Rental Home Losses: Taxpayer rented her home located in another state at various times throughout the years, but in recent years she was unable to find renters due to the property's location and economic factors. During the years under audit (two to three years following the year the property was last rented), taxpayer traveled to the state several times to visit family and would advertise the house for rent. The Tax Court held that the home was held for the production of income under IRC Sec. 212 , and the taxpayer met the active participation standard of IRC Sec. 469(i) enabling her deduct her substantiated rental expenses subject to the $25,000 limit. The court reasoned that the collapse of the real estate market might negate a finding in a future year that the property was held for the production of income, but for the years under audit a possibility of gain upon sale existed from the property's appreciation and taxpayer participated in significant management decisions. Hattie Bonds , TC Summ. Op. 2011-122 (Tax Ct.).


Income Tax—Home Office Deduction: Taxpayer operated a tax return preparation business out of his home and used one room regularly and exclusively as his office as required under IRC Sec. 280A(c) . He also built a bathroom for his clients' use that is across the hall from his office. In addition to home office deductions, the taxpayer deducted wages for administrative assistance provided by his two daughters who he compensated by paying their credit card bills. The Tax Court allowed a home office deduction for the area attributable to the bedroom, but not the hallway and the bathroom since the taxpayer's children and personal guests occasionally used the bathroom. The court also denied the wage deductions since there was no evidence to substantiate the amounts paid. Luis Bulas , TC Memo 2011-201 (Tax Ct.).


Hobby or Business: In this case (Mark Blackwell , TC Memo 2011-188 (Tax Ct.)), the Tax Court found that even though the taxpayers had substantial wealth and resources unrelated to their horse breeding activities, the recreational aspects were minimal, and their horse breeding business was carried on for profit under IRC Sec. 183 . The husband and wife taxpayers cautiously spent six or seven years learning about horse breeding and management before beginning their activities and proceeded after developing a comprehensive business plan. The Tax Court’s findings included these facts & circumstances:

·        Taxpayers performed essentially all of the horse maintenance,

·        consulted and hired expert trainers,

·        made adjustments in their business plan over time, and

·        kept good books and records.

Although the losses realized in the activity were substantial, the Tax Court was convinced that the taxpayers had the potential to earn a profit. Mark Blackwell , TC Memo 2011-188 (Tax Ct.).

Making a Federal Case out of it

Federal District Court Upholds IRS Summons Authority of Accounting Software File

Some CPAs and other tax professionals have taken the position that the IRS does NOT have the right or authority to request the entire accounting software file of a small business under examination.  In essence, IRS Agents are requesting a full, working back up file of the client’s QuickBooks or Peachtree accounting data.  As many proficient QuickBooks and Peachtree users know, the back up data contains detailed accounting transactions for multiple years and not just the year under examination. 

Nevertheless, the position of NOT providing that data file must now be carefully weighed against a recent Florida Federal District Court case which upheld the IRS’s right to summon the accounting software file of a small business under examination.  A link to the court’s finding is provided here.

http://www.aicpa.org/InterestAreas/Tax/Resources/IRSPracticeProcedure/DownloadableDocuments/Federal_District_Court_Case.pdf

Many CPAs have sought the advice of the tax practice section of the American Institute of CPAs (“AICPA”) to see if they should resist cooperating with an Agent when requests for QuickBooks data files are made. The AICPA’s official position is “clearly each IRS examination stands on its own based on the specific facts and circumstances of that audit and tax professionals should carefully consider the risks of not cooperating with the Service.”  Yawn.  Well, that doesn’t help much.

At Franty & Company, we have encountered this dangerous request countless times and have been able to avoid providing a full back up copy of the client’s QuickBooks or Peachtree data file by giving the Agent an Excel file containing all of the same information that could be pulled from QuickBooks or Peachtree. Essentially, we have exported the accounting data into user-friendly spreadsheets and provided that information to the agents in lieu of a full QuickBooks or Peachtree back up file. True, the Excel files only contain data for the year under examination but we believe that the information provided complies in all material respects with the Agent’s request. 

The results?  Well, so far, so good.  Our Excel file switch has satisfied the examiners and we’ve never had to provide a full QuickBooks or Peachtree back up file to any Agent.  However, with IRS making a Federal Court case out of this, our solution to the problem may come with an expiration date.  

We wish the taxpayer’s CPA in this Florida case had done what we do so that the courts wouldn't have gotten involved.  Give them the information in an electronic format and then keep your mouth shut.  Now that there's a federal precedent, an Agent familiar with this court ruling may not be satisfied with Excel files.  Let’s hope that’s not the case.

We’ll keep you posted so feel free to enjoy the coming weekend and the rest of your summer!

IRS Increases Mileage Rate to 55.5 Cents per Mile, effective 7/1/2011

IR-2011-69, June 23, 2011

WASHINGTON — The Internal Revenue Service today announced an increase in the optional standard mileage rates for the final six months of 2011. Taxpayers may use the optional standard rates to calculate the deductible costs of operating an automobile for business and other purposes.
The rate will increase to 55.5 cents a mile for all business miles driven from July 1, 2011, through Dec. 31, 2011. This is an increase of 4.5 cents from the 51 cent rate in effect for the first six months of 2011, as set forth in Revenue Procedure 2010-51.  In recognition of recent gasoline price increases, the IRS made this special adjustment for the final months of 2011. The IRS normally updates the mileage rates once a year in the fall for the next calendar year.

"This year's increased gas prices are having a major impact on individual Americans. The IRS is adjusting the standard mileage rates to better reflect the recent increase in gas prices," said IRS Commissioner Doug Shulman. "We are taking this step so the reimbursement rate will be fair to taxpayers."

While gasoline is a significant factor in the mileage figure, other items enter into the calculation of mileage rates, such as depreciation and insurance and other fixed and variable costs.

The optional business standard mileage rate is used to compute the deductible costs of operating an automobile for business use in lieu of tracking actual costs. This rate is also used as a benchmark by the federal government and many businesses to reimburse their employees for mileage.

The new six-month rate for computing deductible medical or moving expenses will also increase by 4.5 cents to 23.5 cents a mile, up from 19 cents for the first six months of 2011. The rate for providing services for charitable organizations is set by statute, not the IRS, and remains at 14 cents a mile.

The new rates are contained in Announcement 2011-40 on the optional standard mileage rates.

Taxpayers always have the option of calculating the actual costs of using their vehicle rather than using the standard mileage rates.

Mileage Rate Changes

Purpose	Rates 1/1 through 6/30/11	Rates 7/1 through 12/31/11
Business	51	55.5
Medical/Moving	19	23.5
Charitable	14	14

http://www.irs.gov/newsroom/article/0,,id=240903,00.html

IRS getting bigger on health care reform responsibilities

Hi Folks,

Hope you had a memorable Memorial Day weekend.  I was in NYC and got to personally say "thank you for your service" to several sailors & marines that were on leave & taking in the scene at Time Square!

As the health care reform law enacted in March 2010 is being implemented, the Internal Revenue Service’s role is only going to get bigger

• the tax credit for small firms that provide employee health coverage,
• having employers list the value of medical insurance on W-2 forms for employees,
• the 10% excise tax on indoor tanning salons (the "Snooki" tax) and
• nondiscrimination rules for health plans.

Congress did remove one unpopular item – forcing businesses to prepare & file 1099 forms for any individual or business to whom they had paid $600 or more for goods or services.  The expansion of 1099 reporting was very unpopular and the repeal was only signed into law a few short months back.  Even though that was a potential bonanza of new revenue for our firm, we were pretty happy about that one being repealed!

Congressional opponents of the 2010 health care law won’t be able to repeal or “defund” it before 2013.  There aren’t enough votes in the Senate to repeal and the president has indicated that he would veto any such legislation. The opposition’s best hope for repealing “Obamacare” rests in the Supreme Court, which will determine the law’s constitutionality. Because a final decision isn’t likely until mid-2012, IRS will keep working on the rules so taxpayers will have guidance if the law is upheld.  Which ever way the Supreme Court goes will make for interesting politics as we head into next year’s presidential election.

One of the provisions IRS has to prepare for includes the refundable income tax credit to help low-income earners afford health coverage. The credit will be available for households with income up to 400% of federal poverty levels (currently, about $43,300 for an individual and about $88,200 for a family of four). IRS will have a lot of work to do to define exactly how household income is determined (total income, taxable income, AGI, etc.), so stay tuned for that.

Beginning in 2013 (after the next election -- what an unbelievable coincidence), IRS will begin collecting a special 3.8% Medicare surtax on unearned income of high-earners (defined as single taxpayers with adjusted gross incomes (“AGI”) over $200,000 and married taxpayers with AGI over $250,000).  The surtax is levied on the lesser of the taxpayer’s net investment income or the excess of AGI over the thresholds. Unearned income includes interest, royalties, dividends, capital gains, annuities and passive rental income, but not tax-free interest and retirement plan payouts. IRS is charged with making rules to clarify in which cases rents are treated as unearned income.

There has been some mis-information circulating about the 3.8% Medicare surtax on gains attributable to the sale of a principal residence.  The surtax would only apply if your GAIN (not proceeds, but gain) exceeded $500,000 (married taxpayers) or $250,000 (single taxpayers).  Note that there would be a 3.8% surtax liability on any gain from the sale of a second home, vacation home, rental property or other investment if the taxpayer’s income exceeded the applicable AGI limits.

IRS has also been charged with determining how to collect penalty taxes on individuals who remain uninsured after 2013. In 2014, the tax will be the greater of $95 or 1% of income above the filing threshold (the income amount below which an individual is not required to file a tax return) but not more than $285. Special rules will be required to apportion the penalty among uninsured people in a household. While $285 doesn’t sound too onerous, note that the fines increase sharply after 2014.  Reporting of insurance coverage to the IRS also will be required so they can determine which individuals owe the penalty tax for not having coverage (Big Brother really is watching).

An excise tax will be assessed on businesses with 50 or more full-time employees and no health plan. As of 2014, the tax is due if one or more employees get the insurance tax credit.  IRS regulations will have to spell out how to compute the number of full-time workers, since the excise tax is based on that figure.  The number of part-time workers will complicate the calculation.  We don’t see this a being a huge deal to our client base as most firms that large are providing health benefits to their employees.

And further down the road we’ll see an excise tax on high-value (“Cadillac”) health plans.  Starting in 2018, insurance companies and self-insurers owe a 40% excise tax on the value of plans in excess of $10,200 for individual coverage and $27,500 for family coverage. Higher thresholds apply to policies for retirees over age 55 and folks in high risk jobs, such as first responders. IRS is busily preparing for the enforcement of this now.

That’s it for now!  Carpe Diem~!.  So far, the IRS has issued rules on: