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Making Loans Between Yourself and Your Corporation
Poorly documented loan transactions will almost certainly open up a can of worms
The financial lives of shareholders and their closely held corporations are often tightly intertwined. As a result, it’s not unusual for shareholders to make loans to their corporations and vice versa. Avoiding tax and other problems associated with such loans requires up-front planning.
Lending to your corporation
If your investment in a successful C corporation is entirely characterized as equity (i.e., stock), it will be difficult to withdraw any of your stake without some or all of the withdrawal being treated as a dividend. (This is normally not a problem with S corporations, because funds can generally be taken out tax-free to the extent of the withdrawing shareholder’s stock basis.) As you may have already learned the hard way, dividends from a C corporation are generally bad news because they are taxable to you, but your corporation cannot deduct the payments. The harshness of double taxation was softened somewhat when Congress lowered the maximum dividend tax rate to 15%. Nevertheless, a dividend paid to you by your corporation is palatable from a tax standpoint only when your personal income tax rate exceeds 30% and your corporation’s tax rate does not exceed 15%.
In contrast, when part of your investment is in the form of a shareholder loan to your C corporation, you gain the following tax advantages:
It’s quite common for a closely held C corporation to advance funds to a shareholder with little or no thought about the tax consequences. Although the transaction may be intended as a loan, documentation is often lacking. Once again, this opens the door for the IRS to claim that the payment to the shareholder was actually a disguised dividend rather than a loan. If the IRS is successful, double taxation will result. To avoid that, follow the earlier guidelines about loans from you to your corporation. The advice is equally relevant for loans going the other way.
Even if the transaction is clearly a loan, there can still be unfavorable tax consequences under the below-market interest rules when too little (or no) interest is charged. However, you need not worry about the below-market interest rules if the aggregate outstanding balance of loans from the corporation to you is $10,000 or less. If you qualify for this loophole, your corporation can charge very low interest or zero interest with no harm done.
You also need not worry about the below-market interest rules if your corporation charges an interest rate at least equal to the applicable federal rate (AFR), which is the minimum that can be charged without creating unwanted tax side-effects. (The IRS publishes AFRs monthly in the Internal Revenue Bulletin and at www.irs.org.) The relevant AFR for a particular loan is the one in effect for loans of that duration for the month the loan is made.
Once the AFR is determined, it continues to apply over the life of the loan, regardless of how interest rates may fluctuate during that time. An exception applies to demand loans, for which the AFR is re-determined annually by “blending” the monthly short-term AFRs for that year.
The AFRs are much lower than the rates charged by commercial lenders. However, as long as your corporation charges you at least the AFR, you won’t have to worry about any of the tax complications explained below. Your company will have taxable interest income equal to the stated interest rate, and you will have an equal amount of interest expense (which may or may not be deductible, depending on how the loan proceeds are used).
Imputed payments. When the below-market interest rules do apply – for example, because your corporation loans you over $10,000 at zero interest – the tax laws say you must calculate “imputed” or imaginary payments between you and the company. The imputed payments are calculated using the difference between the AFR interest rate and the interest rate, if any, actually charged. Basically, the corporation is treated as transferring imputed payments to you.
These payments are considered either taxable compensation (which is acceptable) or a taxable dividend (which is bad). Then, you are treated as transferring the imputed amount back to the corporation as interest (which you may or may not be able to deduct, depending on how you use the borrowed funds).
To avoid the dividend scenario, your corporation’s minutes should specify that any imputed payments from the corporation to you under the below-market interest rules are to be considered employee compensation. (This presumes that you are a bona fide employee and your total compensation is reasonable.) With this strategy, your corporation gets a compensation deduction for the imputed payment to you, thus offsetting the company’s imputed interest payment from you.
Conclusion
As you can see, there are plenty of things to think about when arranging a corporation-shareholder loan. With careful planning, the IRS can usually be kept at bay. On the other hand, poorly documented loan transactions will almost certainly open up a can of worms if either you or the corporation gets audited.
The financial lives of shareholders and their closely held corporations are often tightly intertwined. As a result, it’s not unusual for shareholders to make loans to their corporations and vice versa. Avoiding tax and other problems associated with such loans requires up-front planning.
Lending to your corporation
If your investment in a successful C corporation is entirely characterized as equity (i.e., stock), it will be difficult to withdraw any of your stake without some or all of the withdrawal being treated as a dividend. (This is normally not a problem with S corporations, because funds can generally be taken out tax-free to the extent of the withdrawing shareholder’s stock basis.) As you may have already learned the hard way, dividends from a C corporation are generally bad news because they are taxable to you, but your corporation cannot deduct the payments. The harshness of double taxation was softened somewhat when Congress lowered the maximum dividend tax rate to 15%. Nevertheless, a dividend paid to you by your corporation is palatable from a tax standpoint only when your personal income tax rate exceeds 30% and your corporation’s tax rate does not exceed 15%.
In contrast, when part of your investment is in the form of a shareholder loan to your C corporation, you gain the following tax advantages:
- You can collect the loan principal repayments tax-free. Thus, you can recover part of your investment in the corporation without triggering any taxes.
- The interest payments to you are deductible by your corporation. This allows you to withdraw additional cash corporation without double taxation. Furthermore, although you will pay income tax on this income, it isn’t subject to payroll taxes.
- The requirement to make debt payments can reduce your corporation’s exposure to accumulated earnings tax.
- You should receive a written promissory note from the corporation stating that the company is making an unconditional promise to repay on demand a specified sum at a fixed maturity date or in installments on specified dates. Preferably, the interest rate should be at least equal to the applicable federal rate or AFR (more on that later).
- Your corporation should not be “thinly capitalized.” If it is, the IRS may try to recharacterize purported corporate debt as disguised equity, which would put you back into the double-taxed dividend scenario. Thin capitalization is a potential problem whenever the corporation’s ratio of debt to equity is considered excessive for the industry. It’s difficult to generalize about when a corporation will cross the thin capitalization line. However, you should address the issue whenever any new debt will cause the debt-to-equity ratio to exceed about 3:1.
- At the time the loan is made, the corporation’s financial condition should indicate it is capable of repaying the loan according to the terms of the promissory note, and adequate collateral should exist.
- The corporate minutes should reflect that taking on the debt was authorized by corporate officers and should include a summary of the loan terms (interest rate, repayment schedule, collateral, etc.).
- Your corporation’s financial statements and your personal financial records should reflect a loan between you and the corporation. The same goes for any financial statements given to lenders or issued to third parties for regulatory or credit rating purposes.
- Avoid convertible debt instruments; debt that can be converted into stock has historically been looked upon less favorably by the IRS than debt with no conversion feature.
- Perhaps most important of all, the interest and principal payments should be made on time. If the corporation misses scheduled payments, the promissory note should be amended to reschedule them. When payment deadlines go by with “no comment” from the lender and no collection activity against the borrower, the IRS can make a much stronger case that the purported debt was actually disguised equity.
It’s quite common for a closely held C corporation to advance funds to a shareholder with little or no thought about the tax consequences. Although the transaction may be intended as a loan, documentation is often lacking. Once again, this opens the door for the IRS to claim that the payment to the shareholder was actually a disguised dividend rather than a loan. If the IRS is successful, double taxation will result. To avoid that, follow the earlier guidelines about loans from you to your corporation. The advice is equally relevant for loans going the other way.
Even if the transaction is clearly a loan, there can still be unfavorable tax consequences under the below-market interest rules when too little (or no) interest is charged. However, you need not worry about the below-market interest rules if the aggregate outstanding balance of loans from the corporation to you is $10,000 or less. If you qualify for this loophole, your corporation can charge very low interest or zero interest with no harm done.
You also need not worry about the below-market interest rules if your corporation charges an interest rate at least equal to the applicable federal rate (AFR), which is the minimum that can be charged without creating unwanted tax side-effects. (The IRS publishes AFRs monthly in the Internal Revenue Bulletin and at www.irs.org.) The relevant AFR for a particular loan is the one in effect for loans of that duration for the month the loan is made.
Once the AFR is determined, it continues to apply over the life of the loan, regardless of how interest rates may fluctuate during that time. An exception applies to demand loans, for which the AFR is re-determined annually by “blending” the monthly short-term AFRs for that year.
The AFRs are much lower than the rates charged by commercial lenders. However, as long as your corporation charges you at least the AFR, you won’t have to worry about any of the tax complications explained below. Your company will have taxable interest income equal to the stated interest rate, and you will have an equal amount of interest expense (which may or may not be deductible, depending on how the loan proceeds are used).
Imputed payments. When the below-market interest rules do apply – for example, because your corporation loans you over $10,000 at zero interest – the tax laws say you must calculate “imputed” or imaginary payments between you and the company. The imputed payments are calculated using the difference between the AFR interest rate and the interest rate, if any, actually charged. Basically, the corporation is treated as transferring imputed payments to you.
These payments are considered either taxable compensation (which is acceptable) or a taxable dividend (which is bad). Then, you are treated as transferring the imputed amount back to the corporation as interest (which you may or may not be able to deduct, depending on how you use the borrowed funds).
To avoid the dividend scenario, your corporation’s minutes should specify that any imputed payments from the corporation to you under the below-market interest rules are to be considered employee compensation. (This presumes that you are a bona fide employee and your total compensation is reasonable.) With this strategy, your corporation gets a compensation deduction for the imputed payment to you, thus offsetting the company’s imputed interest payment from you.
Conclusion
As you can see, there are plenty of things to think about when arranging a corporation-shareholder loan. With careful planning, the IRS can usually be kept at bay. On the other hand, poorly documented loan transactions will almost certainly open up a can of worms if either you or the corporation gets audited.
Former Credit Suisse Employees Indicted for Role in Hiding Billions for U.S. Customers
Three former Credit Suisse employees and the founder of a Swiss trust company have been charged in the U.S. District Court for the Eastern District of Virginia July 21 with conspiring with other Swiss bankers to defraud the United States by assisting U.S. customers in hiding $3 billion in Swiss accounts, the Justice Department and Internal Revenue Service announced.
The superseding indictment issued July 21 named as defendants Markus Walder, former head of North America Offshore Banking with Credit Suisse; Susanne D. Ruegg Meier, a former manager with the bank; and Andreas Bachmann, a former banker with a Credit Suisse subsidiary. Additionally, Josef Dorig, the founder of a Swiss trust company, was also charged.
Four other defendants—Marco Parenti Adami, Emanuel Agustino, Michele Bergantino, and Roger Schaerer, were charged in a February indictment for their roles in the conspiracy, DOJ said. The bankers engaged in illegal cross-border banking that was designed to assist U.S. customers in evading their income taxes by opening and maintaining secret bank accounts with Credit Suisse or with other Swiss banks, DOJ said. As of 2008, the bank maintained thousands of secret accounts for U.S. customers with as much as $3 billion in total assets under management in those accounts, it said.
Wow!!!
The superseding indictment issued July 21 named as defendants Markus Walder, former head of North America Offshore Banking with Credit Suisse; Susanne D. Ruegg Meier, a former manager with the bank; and Andreas Bachmann, a former banker with a Credit Suisse subsidiary. Additionally, Josef Dorig, the founder of a Swiss trust company, was also charged.
Four other defendants—Marco Parenti Adami, Emanuel Agustino, Michele Bergantino, and Roger Schaerer, were charged in a February indictment for their roles in the conspiracy, DOJ said. The bankers engaged in illegal cross-border banking that was designed to assist U.S. customers in evading their income taxes by opening and maintaining secret bank accounts with Credit Suisse or with other Swiss banks, DOJ said. As of 2008, the bank maintained thousands of secret accounts for U.S. customers with as much as $3 billion in total assets under management in those accounts, it said.
Wow!!!
Hip-Hop Rapper "JA Rule" gets hit with tax evasion!
Rapper Ja Rule Sentenced to 28 Months For Failing to Pay $1.1 Million in Taxes
Rapper Jeffrey “Ja Rule” Atkins was sentenced to 28 months in prison for failing to pay more than $1.1 million in federal taxes for five years, the Justice Department announced July 18 (United States v. Atkins, D.N.J., No. 2:11-mj-03044, sentencing 7/18/11 ).
The sentencing in the U.S. District Court for New Jersey came four months after Atkins pleaded guilty for three counts of failing to file tax returns on more than $3 million of income earned in calendar years 2004, 2005, and 2006.
Although Atkins pleaded guilty to charges specifically related to tax years 2004-2006, his sentence took into account the tax loss for all five years, including 2007 and 2008, which resulted in a total loss to the government of $1,137,912, according to DOJ.
In addition to the prison term, which is to run concurrently with his sentence on unrelated state charges, Atkins was sentenced to one year of supervised release.
According to court documents, Atkins was the sole shareholder of ASJA Inc. and Rule Tours Inc. Atkins admitted that during the five tax years from 2004 through 2008, he received music royalty income from ASJA Inc. and music tour and live performance-related income from Rule Tours Inc. but failed to pay taxes on the income.
Stacey Richman in the Bronx, N.Y., represented Atkins. Joseph Mack of the U.S. Attorney's Office in Newark, N.J., represented the government.
Rapper Jeffrey “Ja Rule” Atkins was sentenced to 28 months in prison for failing to pay more than $1.1 million in federal taxes for five years, the Justice Department announced July 18 (United States v. Atkins, D.N.J., No. 2:11-mj-03044, sentencing 7/18/11 ).
The sentencing in the U.S. District Court for New Jersey came four months after Atkins pleaded guilty for three counts of failing to file tax returns on more than $3 million of income earned in calendar years 2004, 2005, and 2006.
Although Atkins pleaded guilty to charges specifically related to tax years 2004-2006, his sentence took into account the tax loss for all five years, including 2007 and 2008, which resulted in a total loss to the government of $1,137,912, according to DOJ.
In addition to the prison term, which is to run concurrently with his sentence on unrelated state charges, Atkins was sentenced to one year of supervised release.
According to court documents, Atkins was the sole shareholder of ASJA Inc. and Rule Tours Inc. Atkins admitted that during the five tax years from 2004 through 2008, he received music royalty income from ASJA Inc. and music tour and live performance-related income from Rule Tours Inc. but failed to pay taxes on the income.
Stacey Richman in the Bronx, N.Y., represented Atkins. Joseph Mack of the U.S. Attorney's Office in Newark, N.J., represented the government.
IRS Removes Debt Indicator for 2011 Tax Filing Season
IRS Removes Debt Indicator for 2011 Tax Filing Season
By Sandra Block, USA TODAY
The IRS said Thursday that it will no longer provide tax preparers and lenders with information that helps them decide whether to offer taxpayers a refund anticipation loan, a move that could sharply reduce the sale of the products.
The IRS said that starting with next year's filing season, it will no longer provide tax preparers and partner financial institutions with a code known as the "debt indicator," which signals whether some or a part of a taxpayer's refund may be withheld to pay government debts. Lenders have used this information to determine whether to offer a taxpayer a refund anticipation loan, which is a short-term loan backed by the taxpayer's refund.
In an interview Thursday, IRS Commissioner Douglas Shulman said the debt indicator began in the early 1990s to encourage tax preparers to file tax returns electronically. The use of the information to market refund anticipation loans was a "side effect," he says.
Now, more than 70% of tax returns are filed electronically, and the debt indicator is no longer necessary, he said.
Consumer groups, long critical of refund anticipation loans, applauded the decision. "We are pleased that IRS has decided to stop aiding and abetting high cost RALs that siphon off hundreds of millions in taxpayers' hard-earned money and federal benefits meant to lift the working poor out of poverty," said Chi Chi Wu, staff attorney for the National Consumer Law Center.
Fees on some refund anticipation loans translate into annual percentage rates of 50% to nearly 500%, the NCLC said.
But H&R Block, which offers the loans, said the IRS decision will make the loans more expensive for low-income taxpayers who need them.
"Restricting the debt indicator does not eliminate the need for refund anticipation loans," H&R Block chief executive Alan Bennett said. "As a result of the IRS's decision, the nearly 8 million low- to moderate-income consumers who select this product each year will likely be forced to seek higher-cost — and often unregulated — credit."
John Hewitt, chief executive of Liberty Tax Service, called the IRS decision "a disappointing decision for consumers."
"We are emerging from the greatest financial downturn since the Great Depression," he said. "This really isn't the time to take financial options away from those who choose them, and more importantly need them. "
Copyright 2010 The Associated Press. All rights reserved. This material may not be published, broadcast, rewritten or redistributed.
By Sandra Block, USA TODAY
The IRS said Thursday that it will no longer provide tax preparers and lenders with information that helps them decide whether to offer taxpayers a refund anticipation loan, a move that could sharply reduce the sale of the products.
The IRS said that starting with next year's filing season, it will no longer provide tax preparers and partner financial institutions with a code known as the "debt indicator," which signals whether some or a part of a taxpayer's refund may be withheld to pay government debts. Lenders have used this information to determine whether to offer a taxpayer a refund anticipation loan, which is a short-term loan backed by the taxpayer's refund.
In an interview Thursday, IRS Commissioner Douglas Shulman said the debt indicator began in the early 1990s to encourage tax preparers to file tax returns electronically. The use of the information to market refund anticipation loans was a "side effect," he says.
Now, more than 70% of tax returns are filed electronically, and the debt indicator is no longer necessary, he said.
Consumer groups, long critical of refund anticipation loans, applauded the decision. "We are pleased that IRS has decided to stop aiding and abetting high cost RALs that siphon off hundreds of millions in taxpayers' hard-earned money and federal benefits meant to lift the working poor out of poverty," said Chi Chi Wu, staff attorney for the National Consumer Law Center.
Fees on some refund anticipation loans translate into annual percentage rates of 50% to nearly 500%, the NCLC said.
But H&R Block, which offers the loans, said the IRS decision will make the loans more expensive for low-income taxpayers who need them.
"Restricting the debt indicator does not eliminate the need for refund anticipation loans," H&R Block chief executive Alan Bennett said. "As a result of the IRS's decision, the nearly 8 million low- to moderate-income consumers who select this product each year will likely be forced to seek higher-cost — and often unregulated — credit."
John Hewitt, chief executive of Liberty Tax Service, called the IRS decision "a disappointing decision for consumers."
"We are emerging from the greatest financial downturn since the Great Depression," he said. "This really isn't the time to take financial options away from those who choose them, and more importantly need them. "
Copyright 2010 The Associated Press. All rights reserved. This material may not be published, broadcast, rewritten or redistributed.
IRS extends filing deadline for small charities to Oct. 15
By Sandra Block, USA TODAY
The IRS will provide a reprieve for thousands of non-profit soup kitchens, amateur sports leagues and veterans organizations that missed a May 17 deadline to file an annual return with the government or lose their tax-exempt status.
The IRS new filing deadline for the non-profits is Oct. 15, IRS Commissioner Douglas Shulman said Monday.
The 2006 Pension Protection Act included a provision requiring all non-profits, except churches and church-related groups, to file an annual return with the IRS. Previously, non-profits with annual revenue of less than $25,000 were excluded from the requirement.
Under the law, any organization that fails to file a return for three consecutive years will have its tax-exempt status revoked. On May 17, the three-year clock ran out for many non-profits that haven't filed a return since 2007.
Once a charity or non-profit loses its tax-exempt status, it must apply for a new exemption and pay a user fee of up to $850. The organization could also be liable for taxes on any revenue earned before the exemption is renewed. In early 2011, the IRS plans to publish a list of charities and non-profits that have lost their tax-exempt status. Once the notice is published, donations to those organizations will no longer be tax-deductible.
In the months leading up to the May 17 deadline, the IRS sent more than 1 million notices to small non-profits with information about the new requirement. Still, the Urban Institute estimates that 292,000 organizations have yet to comply.
The IRS also announced that it has created a searchable database of names and last-known addresses for more than 300,000 organizations that could be at risk of losing their tax-exempt status. Many of the organizations on the list may no longer be operating, according to the IRS.
Non-profits with less than $25,000 in annual revenue can fulfill the requirement by filling out a 990-N, an abbreviated online form.
Small charities "do great work in communities across the United States and are vital to the vibrancy of our nation," Shulman said. "The last thing we want to do here at the IRS is have these groups lose their tax-exempt status because they haven't filed a short, simple form."
The non-profits database is available at www.irs.gov.
The IRS will provide a reprieve for thousands of non-profit soup kitchens, amateur sports leagues and veterans organizations that missed a May 17 deadline to file an annual return with the government or lose their tax-exempt status.
The IRS new filing deadline for the non-profits is Oct. 15, IRS Commissioner Douglas Shulman said Monday.
The 2006 Pension Protection Act included a provision requiring all non-profits, except churches and church-related groups, to file an annual return with the IRS. Previously, non-profits with annual revenue of less than $25,000 were excluded from the requirement.
Under the law, any organization that fails to file a return for three consecutive years will have its tax-exempt status revoked. On May 17, the three-year clock ran out for many non-profits that haven't filed a return since 2007.
Once a charity or non-profit loses its tax-exempt status, it must apply for a new exemption and pay a user fee of up to $850. The organization could also be liable for taxes on any revenue earned before the exemption is renewed. In early 2011, the IRS plans to publish a list of charities and non-profits that have lost their tax-exempt status. Once the notice is published, donations to those organizations will no longer be tax-deductible.
In the months leading up to the May 17 deadline, the IRS sent more than 1 million notices to small non-profits with information about the new requirement. Still, the Urban Institute estimates that 292,000 organizations have yet to comply.
The IRS also announced that it has created a searchable database of names and last-known addresses for more than 300,000 organizations that could be at risk of losing their tax-exempt status. Many of the organizations on the list may no longer be operating, according to the IRS.
Non-profits with less than $25,000 in annual revenue can fulfill the requirement by filling out a 990-N, an abbreviated online form.
Small charities "do great work in communities across the United States and are vital to the vibrancy of our nation," Shulman said. "The last thing we want to do here at the IRS is have these groups lose their tax-exempt status because they haven't filed a short, simple form."
The non-profits database is available at www.irs.gov.
Business Professor is World's No. 1 International Business Scholar; School Ranked No. 20 in the World : University of Miami School of Business
Congrats to Professor Lou! He taught me both undergrad and graduate! An awesome, awesome professor. It's good to be a Miami Hurricane!
Business Professor is World's No. 1 International Business Scholar; School Ranked No. 20 in the World : University of Miami School of Business
Business Professor is World's No. 1 International Business Scholar; School Ranked No. 20 in the World : University of Miami School of Business
IRS has announced the spring 2010 issue of the Statistics of Income (SOI) Bulletin
IRS has announced the availability of the spring 2010 issue of the Statistics of Income (SOI) Bulletin, which features information on high-income individual income tax returns filed for tax year 2007, individual noncash charitable contributions in 2007, gift taxes returns filed in 2008, and trust income from the 2002 through 2006 period.
High-income individuals. For tax year 2007, there were 4,535,623 individual income tax returns that reported adjusted gross income (AGI) of $200,000 or more, and 4,576,315 returns with expanded income of $200,000 or more. These high-income returns represented 3.172% and 3.201%, respectively, of all returns for 2007.
Compared to AGI, expanded income is a more comprehensive measure of income, and it is based entirely on items available from individual income tax returns. Specifically, expanded income is AGI plus tax-exempt interest, nontaxable Social Security benefits, the foreign-earned income exclusion, and tax preference items for alternative minimum tax purposes; less unreimbursed employee business expenses, moving expenses, investment interest expense to the extent it does not exceed investment income, and miscellaneous itemized deductions not subject to the 2%-floor.
Individual noncash charitable contributions in 2007. For 2007, 23.8 million individuals who itemized deductions reported $58.7 billion in deductions for noncash charitable contributions. Of these taxpayers, 6.9 million reported $52.8 billion in deductions for charitable contributions on Form 8283, Noncash Charitable Contributions.
This form is used by individuals when the amount of their deductions for all noncash donations on Schedule A, Itemized Deductions, exceeds $500.
Both the number of taxpayers filing Form 8283 and the amount of their donations increased between 2006 and 2007. The number of filers increased 12.3% from 6.2 million in 2006, and the amount claimed in donations increased 12.8% from $46.8 billion in 2006.
Gift tax returns filed in 2008 for 2007 gifts. The population of 2007 donors was 257,485. They transferred a total of $45.2 billion through gifts. A wide range of asset types was gifted, but 86.7% of all gifts were in the form of cash, real estate, and stock. Cash was the predominant type of asset gifted, representing 46% of the total, while corporate stock accounted for 24% and real estate 17%. The vast majority of returns filed, 96.3%, were nontaxable; the total amount of gift taxes incurred on the remaining 3.7% was $2.8 billion. A variety of methods were used to gift property, the most popular of which was a direct transfer, which accounted for 74.3% of all gifts. Additional gifts were given through trusts. Male and female recipients were almost evenly represented, with the majority (75.4%) of donees being children and grandchildren. The majority of gift tax returns, almost 52%, were filed by female donors.
Trust income from the 2002 through 2006 period. Of the more than 400,000 simple trusts analyzed in a panel study, total income was $15 billion in 2002 and reached $26 billion in 2006. Total deductions grew from $12 billion to $15 billion over the same period for simple trusts. For the more than 700,000 complex trusts analyzed in the panel study, reported total income increased from $28 billion in tax year 2002 to $60 billion in tax year 2006. Total deductions increased from $15 billion in 2002 to $20 billion in tax year 2006 for complex trusts.
Unemployed? A tax break awaits you for 2009!
As of mid-March, a record 5.6 million people were receiving unemployment benefits. Those benefits are taxable. However, for those drawing unemployment in 2009, the American Recovery and Reinvestment Act makes the first $2,400 of unemployment benefits exempt from tax.
For married couples, the tax exemption applies separately to each spouse. This means that if both you and your spouse claim unemployment benefits this year, you can exclude the first $2,400 of your unemployment benefits and your spouse can exclude the first $2,400 of his or her unemployment benefits received in 2009.
For unemployment benefits received beyond the first $2,400, which are subject to tax, unemployed workers can opt to have income tax withheld from those benefit payments. For further details about filling out a Form W-4V - Voluntary Withholding Request, read our article on unemployment.
Be Happy!
There comes a time in your life when you have to let go of all the pointless drama and the people who create it and surround yourself with people who make you laugh so hard that you forget the bad and focus solely on the good. After all life is too short to be anything but happy!
To File or Not To File
To File or Not To File
You must file a tax return if your income is above a certain level. The amount varies depending on filing status, age and the type of income you receive.
For example, a married couple both under age 65 generally is not required to file until their joint income reaches $17,900. However, self-employed individuals generally must file a tax return if their net income from self employment was at least $400.
Check the “Individuals” section of the IRS Web site at IRS.gov or consult the instructions for form 1040, 1040A, or 1040EZ for specific details that may affect your need to file a tax return with IRS this year.
Even if you don’t have to file, here are six reasons why you may want to file:
1. Federal Income Tax Withheld. If you are not required to file, you should file to get money back if Federal Income Tax was withheld from your pay, if you made estimated tax payments, or had a prior year overpayment applied to this year's tax.
2. Recovery Rebate Credit. If you did not qualify or did not receive the maximum amount for the 2008 Economic Stimulus Payment, you may be entitled to a Recovery Rebate Credit when you file your 2008 tax return.
3. Earned Income Tax Credit. You may qualify for the Earned Income Tax Credit, or EITC, if you worked, but did not earn a lot of money. EITC is a refundable tax credit meaning you could qualify for a tax refund.
4. Additional Child Tax Credit. This credit may be available to you if you have at least one qualifying child and you did not get the full amount of the Child Tax Credit.
5. First time Homebuyer Credit. If you bought a main home after April 8, 2008, and before July 1, 2009 and did not own a main home during the prior 3 years, you may be able to take this refundable credit.
6. Health Coverage Tax Credit. Certain individuals, who are receiving certain Trade Adjustment Assistance, Alternative Trade Adjustment Assistance, or pension benefit payments from the Pension Benefit Guaranty Corporation, may be eligible for a Health Coverage Tax Credit when you file your 2008 tax return.
For more information about filing requirements and your eligibility to receive tax credits, email Questions@TheTaxDiva.com.
What to Do If You Are Missing a W-2
What to Do If You Are Missing a W-2
Did you get your W-2? These documents are essential to filling out most individual tax returns. You should receive a Form W-2, Wage and Tax Statement, from each of your employers each year. Employers have until February 2, 2009 to provide or send you a 2008 W-2 earnings statement either electronically or in paper form. If you haven’t received your W-2, follow these steps:
1. Contact your employer. If you have not received your Form W-2, contact your employer to inquire if and when the W-2 was mailed. If it was mailed, it may have been returned to the employer because of an incorrect or incomplete address. After contacting the employer, allow a reasonable amount of time for them to resend or to issue the W-2.
2. Contact the IRS. If you still do not receive your W-2 by February 17th, contact the IRS for assistance at 800-829-1040. When you call, have the following information:
* Employer's name, address, city, and state, including zip code;
* Your name, address, city and state, including zip code, and Social Security number; and
* An estimate of the wages you earned, the federal income tax withheld, and the period you worked for that employer. The estimate should be based on year-to-date information from your final pay stub or leave-and-earnings statement, if possible.
3. File your return. You still must file your tax return on time even if you do not receive your Form W-2. If you have not received your Form W-2 by February 17th, and have completed steps 1 and 2 above, you may use Form 4852, Substitute for Form W-2, Wage and Tax Statement. Attach Form 4852 to the return, estimating income and withholding taxes as accurately as possible. There may be a delay in any refund due while the information is verified.
4. File a Form 1040X. On occasion, you may receive your missing documents at a later date and some may have conflicting information. You may receive a Form W-2 or W-2C (corrected form) after you filed your return using Form 4852, and the information differs from what you reported on your return. If this happens, you must amend your return by filing a Form 1040X, Amended U.S. Individual Income Tax Return.
Form 4852, Form 1040X, and instructions are available on the IRS Web site, IRS.gov or by calling 800-TAX-FORM (800-829-3676).
Tax Facts About Capital Gains and Losses
Tax Facts About Capital Gains and Losses
Do you have questions about reporting gains and losses on your tax return? Here are some facts from the IRS.
Do you have questions about reporting gains and losses on your tax return? Here are some facts from the IRS.
- Almost everything you own and use for personal purposes, pleasure or investment is a capital asset.
- When you sell a capital asset, the difference between the amount you sell it for and your basis, which is usually what you paid for it, is a capital gain or a capital loss.
- You must report all capital gains.
- You may deduct capital losses only on investment property, not on property held for personal use.
- Capital gains and losses are classified as long-term or short-term, depending on how long you hold the property before you sell it. If you hold it more than one year, your capital gain or loss is long-term. If you hold it one year or less, your capital gain or loss is short-term.
- Net capital gain is the amount by which your net long-term capital gain is more than your net short-term capital loss.
- The tax rates that apply to net capital gain are generally lower than the tax rates that apply to other income and are called the maximum capital gains rates. For 2008, the maximum capital gains rates are 0%, 15%, 25% or 28%.
- If your capital losses exceed your capital gains, the excess can be deducted on your tax return, up to an annual limit of $3,000 ($1,500 if you are married filing separately).
If your total net capital loss is more than the yearly limit on capital loss deductions, you can carry over the unused part to the next year and treat it as if you incurred it in that next year. - Capital gains and losses are reported on Schedule D, Capital Gains and Losses, and then transferred to line 13 of Form 1040.
For more information about reporting capital gains and losses, get Publication 17, Your Federal Income Tax, and Publication 550, Investment Income and Expenses, available on the IRS Web site at IRS.gov or by calling 800-TAX-FORM (800-829-3676).
Email us at Questions@TheTaxDiva.com
Happy Tax Season 2009!
What Income is Taxable?
What Income is Taxable?
While most income you receive is generally considered taxable, there are some situations when certain types of income are partially taxed or not taxed at all. Some common examples of items that are not included in your income are:
* Adoption Expense Reimbursements for qualifying expenses
* Child support payments
* Gifts, bequests and inheritances
* Workers' compensation benefits
* Meals and Lodging for the convenience of your employer
* Compensatory Damages awarded for physical injury or physical sickness
* Welfare Benefits
* Cash Rebates from a dealer or manufacturer
* Economic Stimulus Payment received in 2008
Some income may be taxable under certain circumstance, but not taxable in other situations. Examples of items that may or may not be included in your income are:
Life Insurance. If you surrender a life insurance policy for cash, you must include in income any proceeds that are more than the cost of the life insurance policy. Life insurance proceeds paid to you because of the death of the insured person are not taxable unless the policy was turned over to you for a price.
Scholarship or Fellowship Grant. If you are a candidate for a degree, you can exclude amounts you receive as a qualified scholarship or fellowship. Amounts used for room and board do not qualify. All other items—including income such as wages, salaries and tips—must be included in your income, unless it is specifically excluded by law. Taxable income may be in a form other than cash. One example of this is bartering, which is an exchange of property or services. The fair market value of goods and services exchanged is fully taxable and must be included as income on Form 1040 of both parties.
These examples are not all-inclusive. For more information, visit the IRS Web site at IRS.gov to view or download Publication 525, Taxable and Nontaxable Income from the Forms and Publications section or call 800-TAX-FORM (800-829-3676).
Please email questions to Questions@TheTaxDiva.com
Forgiven mortgage debt relief in the Mortgage Forgiveness Debt Relief Act of 2007
Addressing the subprime lending crisis, Congress recently passed and the President signed into law a new measure giving tax breaks to homeowners who have mortgage debt forgiven. Under preexisting law, the debt forgiven by a lender, such as for short sales and refinances, was generally taxable to the borrower as debt discharge income. With the passage of the Mortgage Forgiveness Debt Relief Act of 2007, a taxpayer does not have to pay federal income tax on up to $2 million of debt forgiven for a loan secured by a qualified principal residence. The change in the tax law applies to debts discharged from January 1, 2007 to December 31, 2009. Here are the details.
Discharge of indebtedness income: background.
For income tax purposes, a discharge of indebtedness—that is, a forgiveness of debt—is generally treated as giving rise to income that's includible in gross income. However, a discharge of indebtedness doesn't give rise to gross income if it: (1) occurs in a Title 11 bankruptcy case, (2) occurs when the taxpayer is insolvent, (3) is a discharge of qualified farm indebtedness, or (4) is a discharge of qualified real property business indebtedness.
Under pre-2007 Mortgage Relief Act law, there were no special rules applicable to discharges of acquisition debt on the taxpayer's principal residence. For example, assume a taxpayer who isn't in bankruptcy and isn't insolvent owns a principal residence subject to a $200,000 mortgage debt for which the taxpayer has personal liability. The creditor forecloses and the home is sold for $180,000 in satisfaction of the debt. Under pre-2007 Mortgage Relief Act law, the debtor had $20,000 of debt discharge income. The result was the same if the creditor restructured the loan and reduced the principal amount to $180,000.
New law relief provision.
The 2007 Mortgage Relief Act excludes from a taxpayer's gross income any discharge of indebtedness income by reason of a discharge (in whole or in part) of qualified principal residence indebtedness before Jan. 1, 2010. The exclusion applies where taxpayers restructure their acquisition debt on a principal residence or lose their principal residence in a foreclosure. For example, assume the same facts as in the example above except that the discharge occurs in 2008. Under the 2007 Mortgage Relief Act, the debtor has no debt discharge income when the creditor (1) restructures the loan and reduces the principal amount to $180,000 or (2) forecloses with the result that the $200,000 debt is satisfied for $180,000.
Here is some of the critical fine print in this new relief provision:
Discharge of indebtedness income: background.
For income tax purposes, a discharge of indebtedness—that is, a forgiveness of debt—is generally treated as giving rise to income that's includible in gross income. However, a discharge of indebtedness doesn't give rise to gross income if it: (1) occurs in a Title 11 bankruptcy case, (2) occurs when the taxpayer is insolvent, (3) is a discharge of qualified farm indebtedness, or (4) is a discharge of qualified real property business indebtedness.
Under pre-2007 Mortgage Relief Act law, there were no special rules applicable to discharges of acquisition debt on the taxpayer's principal residence. For example, assume a taxpayer who isn't in bankruptcy and isn't insolvent owns a principal residence subject to a $200,000 mortgage debt for which the taxpayer has personal liability. The creditor forecloses and the home is sold for $180,000 in satisfaction of the debt. Under pre-2007 Mortgage Relief Act law, the debtor had $20,000 of debt discharge income. The result was the same if the creditor restructured the loan and reduced the principal amount to $180,000.
New law relief provision.
The 2007 Mortgage Relief Act excludes from a taxpayer's gross income any discharge of indebtedness income by reason of a discharge (in whole or in part) of qualified principal residence indebtedness before Jan. 1, 2010. The exclusion applies where taxpayers restructure their acquisition debt on a principal residence or lose their principal residence in a foreclosure. For example, assume the same facts as in the example above except that the discharge occurs in 2008. Under the 2007 Mortgage Relief Act, the debtor has no debt discharge income when the creditor (1) restructures the loan and reduces the principal amount to $180,000 or (2) forecloses with the result that the $200,000 debt is satisfied for $180,000.
Here is some of the critical fine print in this new relief provision:
- The tax relief applies to the original purchase price, plus improvements, of the taxpayer's principal residence. It doesn't apply to discharges of second mortgages or home equity loans, unless the loan proceeds were used to acquire, construct, or substantially improve the taxpayer's principal residence. Refinanced indebtedness qualifies to the extent it doesn't exceed the amount of indebtedness being refinanced. (Cash out from refinancing doesn't qualify for the exclusion.)
- The indebtedness must be incurred with respect to the taxpayer's principal residence only. The exclusion rule doesn't apply to second homes, vacation homes, business property, or investment property, since these properties aren't the taxpayer's principal residence.
- The relief provision is not a permanent fixture of the tax code. It only applies to forgiveness during 2007, 2008, or 2009.
- Nontaxable forgiven mortgage debt is capped at $2 million ($1 million for married individuals filing separately).
- When the relief provision applies, the basis of the individual's principal residence is reduced by the amount excluded from income. As a result of this basis reduction rule, the discharged indebtedness is, at least technically, subject to taxation at a later time, when the taxpayer sells or exchanges the principal residence. However, in many cases the reduction won't result in any additional tax, because any gain on that sale or exchange will qualify for the $250,000 ($500,000 for married couples filing jointly) home-sale exclusion.
Please keep in mind that this is only a summary of this important tax relief provision. If you would like more details about this change, or any other aspect of the new law, please do not hesitate to email me at Questions@TheTaxDiva.com.
How to trim the wait if the new tax law change affects you
Shortly before the holiday Congress aprroved a change in the tax law that will prevent the AMT from affecting more than 20 million households. The revision in the tax law came too late to allow the IRS to update all the tax forms to accomodate the change before the 2008 filing season started.
While most taxpayers are not going to be affected, the IRS estimates that 3 to 4 million taxpayers will have to wait until February 11th to file their tax returns.
If you include any of the five forms listed below, the IRS won't process your return until February 11:
While most taxpayers are not going to be affected, the IRS estimates that 3 to 4 million taxpayers will have to wait until February 11th to file their tax returns.
If you include any of the five forms listed below, the IRS won't process your return until February 11:
- Form 8863 - Education credits
- Form 5695 - Residential energy credits
- 1040A, Schedule 2 - Child and dependent care expenses credit
- Form 8396 - Mortgage interest credit
- Form 8859 - D.C. first-time home buyer credit
- File electronically! Taxpayers who file electronically and setup direct deposit of their refunds can expect to see their money in as little as 10 days. So if you have to wait, you can still have your refund by the end of February.
- File an amended return. If you are desperate for your refund, file your return omitting the forms affected by the delay and then amend your return later to claim the remaining refund. This is not the recommened method because some taxpayers will forget or figure the additional amount is not worth the added paperwork and cost if you use a tax professional to prepare the amended return.
- Use a different form to claim the child care expenses credit. The AMT-related changes affect this credit when it's claimed on Form 1040A. Most tax programs will allow you to opt for the long Form 1040.
- Stop giving Uncle Sam an interest-free loan! This is what your refund represents. You are allowing Uncle Sam to hold on to your money throughout the year for FREE! Simply adjust your withholding so that less money is withheld from your paycheck.
For any questions please email Questions@TheTaxDiva.com
Happy Tax Season 2008!
Change will delay tax refunds for millions
More than 3 million people will have to wait until February to get their tax refunds because of Congress' late fix to the alternative minimum tax, the IRS said today.
Congress put a one-year freeze on growth of the alternative minimum tax last week, shielding many middle- and upper-middle income taxpayers from first exposure to the tax. But Congress' late action means the Internal Revenue Service won't be able to start processing five AMT-related forms until February, delaying potential refunds for those people until that month.
Between 3 million and 4 million people filed in January of last year using those forms, with many of those people expecting a refund, the IRS said.
The average refund in 2007 was $2,324, the agency said.
"We regret the inconvenience the delay will mean for million of early tax filers, especially those expecting a refund," acting IRS Commissioner Linda Stiff said.
As many as 13.5 million people will have to wait until Feb. 11 to start filing with the five AMT-related forms, but the IRS said filing patterns show only between 3 million to 4 million of those people file during the early tax season anyhow. The IRS was able to reprogram its computers to begin accepting the seven other AMT-related forms when the tax season opens in early January. But the tax packages that will start arriving in the mail beginning after New Year's Day were printed in November, before the AMT fixes were approved by Congress. The IRS has created a special section on its Web site, http://www.irs.gov, with updated copies of AMT forms.
The alternative minimum tax was passed in 1969 and was aimed at about 155 very wealthy families who used deductions to avoid paying any federal income tax. The AMT disallows certain deductions and credits. It was not adjusted for inflation; as a result, over the years it has hit a growing number of middle-income taxpayers. More than 4 million were subject to it in the 2006 tax year. Without the congressional fix, more than 20 million families would have been faced with an extra $2,000 tax hit on average.
The five forms affected by the delay are:
— Form 8863, Education Credits.
— Form 5695, Residential Energy Credits.
— Form 1040A's Schedule 2, Child and Dependent Care Expenses for Form 1040A Filers.
— Form 8396, Mortgage Interest Credit and
— Form 8859, District of Columbia First-Time Homebuyer Credit.
Any taxpayer using those forms will have to wait until February to file their taxes, the agency said. The IRS will begin processing those forms on Feb. 14, and the first refunds for those people will start going out 10 to 14 days later.
More than 100 million people got refunds during the last tax season.
For questions or comments please email us at Questions@TheTaxDiva.com
Congress put a one-year freeze on growth of the alternative minimum tax last week, shielding many middle- and upper-middle income taxpayers from first exposure to the tax. But Congress' late action means the Internal Revenue Service won't be able to start processing five AMT-related forms until February, delaying potential refunds for those people until that month.
Between 3 million and 4 million people filed in January of last year using those forms, with many of those people expecting a refund, the IRS said.
The average refund in 2007 was $2,324, the agency said.
"We regret the inconvenience the delay will mean for million of early tax filers, especially those expecting a refund," acting IRS Commissioner Linda Stiff said.
As many as 13.5 million people will have to wait until Feb. 11 to start filing with the five AMT-related forms, but the IRS said filing patterns show only between 3 million to 4 million of those people file during the early tax season anyhow. The IRS was able to reprogram its computers to begin accepting the seven other AMT-related forms when the tax season opens in early January. But the tax packages that will start arriving in the mail beginning after New Year's Day were printed in November, before the AMT fixes were approved by Congress. The IRS has created a special section on its Web site, http://www.irs.gov, with updated copies of AMT forms.
The alternative minimum tax was passed in 1969 and was aimed at about 155 very wealthy families who used deductions to avoid paying any federal income tax. The AMT disallows certain deductions and credits. It was not adjusted for inflation; as a result, over the years it has hit a growing number of middle-income taxpayers. More than 4 million were subject to it in the 2006 tax year. Without the congressional fix, more than 20 million families would have been faced with an extra $2,000 tax hit on average.
The five forms affected by the delay are:
— Form 8863, Education Credits.
— Form 5695, Residential Energy Credits.
— Form 1040A's Schedule 2, Child and Dependent Care Expenses for Form 1040A Filers.
— Form 8396, Mortgage Interest Credit and
— Form 8859, District of Columbia First-Time Homebuyer Credit.
Any taxpayer using those forms will have to wait until February to file their taxes, the agency said. The IRS will begin processing those forms on Feb. 14, and the first refunds for those people will start going out 10 to 14 days later.
More than 100 million people got refunds during the last tax season.
For questions or comments please email us at Questions@TheTaxDiva.com
Recording The Source For All Deposits In Your Check Register -
5/1/2000 by Sandy Botkin by Sandy Botkin, CPA, Esq.
Too many times people have said at my seminars that they are worried about an audit because they do not the receipts for the documentation taken. Unfortunately, there is more to an audit than worrying about documentation for deductions. They need to worry about the income side as well.
IRS has recently instituted an extra type of audit procedure. Regardless of the type of audit, IRS now asks for all bank records and money market accounts for the year or years covering the audit. At first blush, this may seem strange. If you were being audited for your automobile or travel expenses, why would IRS want to see your yearly bank records? The answer is that IRS is now checking all taxpayers for unreported income.
IRS will match all deposits made into your bank accounts and compare the totals to your reported income. If the deposits exceed what you reported as income, you’d better have a great explanation or IRS will hit you with "unreported income" on the difference.
You might be thinking, "wait a minute, not every deposit is taxable." This is quite true. Gifts and inheritances are tax-free. Reimbursements from insurance companies and by employers for business expenses where a proper accounting was made are also tax-free. Most municipal bond interest is tax-free. I had a student who could never balance his bank account. His idea of balancing an account was to close out one account every six months and open up another one. I hope this doesn’t apply to you! None of these items mentioned are taxable. However, unless you can clearly demonstrate that the deposits came from a tax-exempt source, IRS will construe your deposits as unreported income.
It is now necessary that you record and identify the sources of all deposits in your check register. For example, if you receive a deposit as a commission checks from X Company, the check register would read," commission check from X company." If you were to receive a tax-free reimbursement from your health insurance company, the check register would read," reimbursement from X health insurance company."
Finally, for all non-taxable items, make a copy of the check that you received, and put it in a yearly file. Thus if you receive a reimbursement from your employer for business expenses that you gave an accounting for, you should copy the check.
If you follow my advice, you will certainly make any IRS audit less painful and make your life less taxing.
This tax tip came from Sandy Botkin’s Tax Strategies for Business Professionals and his Tax Advantage System. For more details or to order either Tax systems or audit proof diary, click here or contact me at www.TheTaxDiva.com.
Too many times people have said at my seminars that they are worried about an audit because they do not the receipts for the documentation taken. Unfortunately, there is more to an audit than worrying about documentation for deductions. They need to worry about the income side as well.
IRS has recently instituted an extra type of audit procedure. Regardless of the type of audit, IRS now asks for all bank records and money market accounts for the year or years covering the audit. At first blush, this may seem strange. If you were being audited for your automobile or travel expenses, why would IRS want to see your yearly bank records? The answer is that IRS is now checking all taxpayers for unreported income.
IRS will match all deposits made into your bank accounts and compare the totals to your reported income. If the deposits exceed what you reported as income, you’d better have a great explanation or IRS will hit you with "unreported income" on the difference.
You might be thinking, "wait a minute, not every deposit is taxable." This is quite true. Gifts and inheritances are tax-free. Reimbursements from insurance companies and by employers for business expenses where a proper accounting was made are also tax-free. Most municipal bond interest is tax-free. I had a student who could never balance his bank account. His idea of balancing an account was to close out one account every six months and open up another one. I hope this doesn’t apply to you! None of these items mentioned are taxable. However, unless you can clearly demonstrate that the deposits came from a tax-exempt source, IRS will construe your deposits as unreported income.
It is now necessary that you record and identify the sources of all deposits in your check register. For example, if you receive a deposit as a commission checks from X Company, the check register would read," commission check from X company." If you were to receive a tax-free reimbursement from your health insurance company, the check register would read," reimbursement from X health insurance company."
Finally, for all non-taxable items, make a copy of the check that you received, and put it in a yearly file. Thus if you receive a reimbursement from your employer for business expenses that you gave an accounting for, you should copy the check.
If you follow my advice, you will certainly make any IRS audit less painful and make your life less taxing.
This tax tip came from Sandy Botkin’s Tax Strategies for Business Professionals and his Tax Advantage System. For more details or to order either Tax systems or audit proof diary, click here or contact me at www.TheTaxDiva.com.
Office at home for telecommuting employees
If you're an employee who “telecommutes”—that is, you work at home, and communicate with your employer mainly by telephone, e-mail, fax, electronic data transfer, express mail services, etc.—you should know about the strict rules that govern whether you can deduct your home office expenses.
You may deduct your home office expenses if your home office is for the convenience of your employer (see below), and if you meet any of the three tests described further below: the separate structure test, the place for meeting patients, clients or customers test, or the principal place of business test.
If you do qualify, you may compute your home office deductions (described below) on a special worksheet. You report the expenses on Schedule A as below-the-line miscellaneous itemized deductions that are deductible only to the extent that they (together with all other miscellaneous itemized deductions) exceed 2% of your adjusted gross income.
You may deduct your home office expenses if your home office is for the convenience of your employer (see below), and if you meet any of the three tests described further below: the separate structure test, the place for meeting patients, clients or customers test, or the principal place of business test.
If you do qualify, you may compute your home office deductions (described below) on a special worksheet. You report the expenses on Schedule A as below-the-line miscellaneous itemized deductions that are deductible only to the extent that they (together with all other miscellaneous itemized deductions) exceed 2% of your adjusted gross income.
Convenience of the employer requirement. The convenience of the employer requirement is satisfied if:
- you maintain your home office as a condition of employment—in other words, if your employer specifically requires you to maintain the home office and work there;
- your home office is necessary for the functioning of your employer's business; or
- your home office is necessary to allow you to perform your duties as an employee properly.
The convenience of the employer requirement means that you must maintain your home office for your employer's convenience, and not for your own. This requirement isn't satisfied if your use of a home office is merely “appropriate and helpful” in doing your job.
Under the above rules, if your employer requires you to telecommute, and doesn't make on-premises office space available for you, your maintenance of a home office for telecommuting will probably be treated as for the convenience of the employer. Otherwise, it's not clear whether your home office will be treated as satisfying this requirement. Therefore, if you can, you should get your employer to put in writing that it's a requirement of your job to work from an office in your home.
Separate structures. You may deduct the costs of a separate structure used as a home office that is not attached to your “dwelling unit.” In other words, the “separate structure” must be an unattached structure on the same property as your home—for example, an unattached garage, artist's studio, workshop, or office building. To qualify for the deduction, the separate structure must be used exclusively and on a regular basis in connection with your activities as an employee. In addition, you must maintain the home office in the separate structure for the convenience of your employer.
Home office used for meeting patients, clients, or customers. Alternatively, you may deduct your home office expenses if you use a home office, exclusively and on a regular basis, and for the convenience of your employer, to meet or deal with patients, clients, or customers of your employer in the normal course of your duties as an employee.
Principal place of business. In addition, you may deduct your home office expenses if you use your home office, exclusively and on a regular basis, as the principal place of business for your work as an employee, and if you maintain the home office for the convenience of your employer.
While there have been many disputes between IRS and taxpayers about whether taxpayers' home offices qualified as their principal places of business, a telecommuter should have no problem establishing that the home office is his or her principal place of business—if the telecommuter does the most important part of his or her work in the home office, and spends most of his or her work time there.
Exclusive and regular use requirements. As noted above, whether the home office is in a separate structure or is a principal place of business (which doesn't have to be in a separate structure), the home office must be used exclusively and on a regular basis in connection with your work as an employee.
The exclusive use requirement means that you must use your home office solely for the purpose of carrying on your work as an employee. Any other use of the home office will result in loss of all deductions for your home office expenses.
For example, if you work in a spare bedroom that contains your desk, computer, fax, files, etc., and if you don't use that bedroom for anything but your work, that room passes the exclusive use test. But if you also use the room to sleep occasional overnight guests, it fails the exclusive use requirement. And if you use the room exclusively for work during your regular workday, but the room reverts to other uses at nights and/or on weekends, it also fails the exclusive use test.
The regular basis requirement means that you must use the home office in carrying on your business on a continuous, ongoing or recurring basis. Generally, this means a few hours a week, every week. A few days a month, every month, may do the trick. But occasional, “once-in-a-while” business use won't do.
We can help you figure out whether your home office satisfies the exclusive and regular use tests, and suggest things you might do to make sure that you do pass these tests—for example, removing non-business furniture and fixtures, not letting guests use your home office, keeping the kids out, etc.
What you get if you qualify for home office deductions. If your home office is your principal place of business under the rules noted above, the costs of traveling between your home office and other work locations in the same trade or business, regardless of whether the other work location is regular or temporary, and regardless of its distance, are deductible transportation expenses, rather than nondeductible commuting costs.
If your use of your home office qualifies under any of the above rules, you may take business expense deductions for the following:
Separate structures. You may deduct the costs of a separate structure used as a home office that is not attached to your “dwelling unit.” In other words, the “separate structure” must be an unattached structure on the same property as your home—for example, an unattached garage, artist's studio, workshop, or office building. To qualify for the deduction, the separate structure must be used exclusively and on a regular basis in connection with your activities as an employee. In addition, you must maintain the home office in the separate structure for the convenience of your employer.
Home office used for meeting patients, clients, or customers. Alternatively, you may deduct your home office expenses if you use a home office, exclusively and on a regular basis, and for the convenience of your employer, to meet or deal with patients, clients, or customers of your employer in the normal course of your duties as an employee.
Principal place of business. In addition, you may deduct your home office expenses if you use your home office, exclusively and on a regular basis, as the principal place of business for your work as an employee, and if you maintain the home office for the convenience of your employer.
While there have been many disputes between IRS and taxpayers about whether taxpayers' home offices qualified as their principal places of business, a telecommuter should have no problem establishing that the home office is his or her principal place of business—if the telecommuter does the most important part of his or her work in the home office, and spends most of his or her work time there.
Exclusive and regular use requirements. As noted above, whether the home office is in a separate structure or is a principal place of business (which doesn't have to be in a separate structure), the home office must be used exclusively and on a regular basis in connection with your work as an employee.
The exclusive use requirement means that you must use your home office solely for the purpose of carrying on your work as an employee. Any other use of the home office will result in loss of all deductions for your home office expenses.
For example, if you work in a spare bedroom that contains your desk, computer, fax, files, etc., and if you don't use that bedroom for anything but your work, that room passes the exclusive use test. But if you also use the room to sleep occasional overnight guests, it fails the exclusive use requirement. And if you use the room exclusively for work during your regular workday, but the room reverts to other uses at nights and/or on weekends, it also fails the exclusive use test.
The regular basis requirement means that you must use the home office in carrying on your business on a continuous, ongoing or recurring basis. Generally, this means a few hours a week, every week. A few days a month, every month, may do the trick. But occasional, “once-in-a-while” business use won't do.
We can help you figure out whether your home office satisfies the exclusive and regular use tests, and suggest things you might do to make sure that you do pass these tests—for example, removing non-business furniture and fixtures, not letting guests use your home office, keeping the kids out, etc.
What you get if you qualify for home office deductions. If your home office is your principal place of business under the rules noted above, the costs of traveling between your home office and other work locations in the same trade or business, regardless of whether the other work location is regular or temporary, and regardless of its distance, are deductible transportation expenses, rather than nondeductible commuting costs.
If your use of your home office qualifies under any of the above rules, you may take business expense deductions for the following:
- the “direct expenses” of the home office—e.g., the costs of painting or repairing the home office, depreciation deductions for furniture and fixtures used in the home office, etc.; and
- the “indirect” expenses of maintaining the home office—e.g., the properly allocable share of utility costs, depreciation, insurance, etc., for your home, as well as an allocable share of mortgage interest, real estate taxes, and casualty losses.
Amount limitations on home office deductions. The amount you may deduct as home office expenses is subject to limitations based on the income attributable to your use of the home office, your residence-based deductions that aren't dependent on use of your home for business (e.g., mortgage interest and real estate taxes), and your business deductions that aren't attributable to your use of the home office.
Example: Say your home office occupies 20% of the space in your home. This year, your salary (earned entirely from your work in the home office) is $50,000. The mortgage and real estate taxes on your home total $20,000, $4,000 of which is allocable to the home office. You have $10,000 of additional home office expenses (depreciation, utilities, etc.). And you have $5,000 of expenses that aren't attributable to the use of your home office (supplies, express mail charges, copying charges, etc.). To figure out whether you can deduct your home office expenses, you first subtract the home-office portion of the mortgage and real estate taxes, $4,000, from your salary. This leaves you with $46,000. Then, from this, you subtract your expenses that aren't attributable to your use of the home office, $5,000. This leaves you $41,000. If this figure exceeds the amount of your remaining home-office expenses, here $10,000, you can deduct all of those expenses. If this figure is less than your remaining home-office expenses, your deduction is limited. For example, if your remaining home-office expenses were $45,000 instead of $10,000, you'd only be able to deduct $41,000 instead of the full amount. And the computation gets even more difficult if you earn your salary both in your home office and at other locations, because the limitation formula only takes into account the income attributable to the use of the home office.
Any home office expenses that can't be deducted because of the above amount limitations may be carried over and deducted in later years.
Computers and related equipment. If your use of your home office qualifies under any of the rules discussed above, you may deduct the unreimbursed cost of computers and related equipment that you use in the home office, and the deductions are not subject to the “listed property” restrictions that would otherwise apply.
Effect of home office deductions on later sales of your principal residence. You should be aware that, if you claim any depreciation deductions with respect to the home office, when you sell the residence, any gain attributable to the depreciation deductions will not be eligible for the otherwise available $250,000/$500,000 exclusion for gain on the sale of principal residences. Also, the exclusion won't apply to the portion of your gain allocable to a home office that's separate from the dwelling unit.
We can help. We are prepared to assist you with advice about whether you qualify for the deduction of home office expenses, and how much of these you may deduct—as well as other tax issues that you encounter. Please call us at (800) 282-3149 if you would like to discuss these matters.
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