Gambling — Income Tax Conundrum

Gambling is a recreational activity for many taxpayers, and as one might expect, the government gets a cut if you win. In fact, there are far more issues related to gambling than you might imagine, and they may be impacting your taxes more than you know. So here is a rundown on the many issues that can affect you. Gambling takes many forms – horse racing, lotto tickets and scratchers, casino games, etc. – but they are all subject to taxation rules.

Reporting Winnings – Many individuals believe that they only have to report the winnings for which they receive a Form W2-G. Unfortunately, the IRS has a different viewpoint. Although you may be able to offset your reported gains with gambling losses, the IRS anticipates that you will also have had gambling winnings that were under the W2-G reporting threshold and will raise this issue during an audit.

Gambling Losses – The good news is that you can deduct gambling losses if you itemize your deductions, but only to the extent of your gambling income. In other words, you can’t have a net gambling loss on your tax return. Bad news: if you don’t itemize your deductions, you will have to pay taxes on the entire winnings even if you have a net gambling loss, as is the case for most individuals.

Documenting Losses – The next logical question is: how are you going to document your gambling losses if audited? Don’t rush down to the track and start collecting discarded tickets, since they generally aren’t acceptable documentation because of their ready availability. The IRS has published guidelines on acceptable documentation to verify losses. They indicate that an accurate diary or similar record that is regularly maintained by the taxpayer, supplemented by verifiable documentation, will usually be acceptable evidence for substantiation of wagering winnings and losses. In general, this diary should contain at least the following information:

(1) The date and the type of specific wager or wagering activity,
(2) The name of the gambling establishment,
(3) The address or location of the gambling establishment,
(4) The names of other persons (if any) present with taxpayer at the gambling establishment, and
(5) The amounts won or lost.

Save all available documentation, including items such as losing lottery and keno tickets, checks, and casino credit slips. You should also save any related documentation such as hotel bills, plane tickets, entry tickets, and other items that would document your presence at a gambling location. If you are a member of a slot club, the casino may be able to provide a record of your electronic play. You might also obtain affidavits from responsible gambling officials at the gambling facility. With regard to specific wagering transactions, your winnings and losses might be further supported by:

  • Keno – Copies of keno tickets purchased by the taxpayer and validated by the gambling establishment.
  • Slot Machines – A record of all winnings by date and time that each machine was played.
  • Table Games – The number of the table at which the taxpayer was playing as well as casino credit card data indicating whether credit was issued in the pit or at the cashier’s cage.
  • Bingo – A record of the number of games played, the cost of tickets purchased, and the amounts collected on winning tickets.
  • Racing – A record of the races, entries, amounts of wagers, and amounts collected on winning tickets and lost on losing tickets. Supplemental records include unredeemed tickets and payment records from the racetrack.
  • Lotteries – A record of ticket purchase dates, winnings, and losses. Supplemental records include unredeemed tickets, payment slips, and winning statements.

Online Gambling – If you gamble online, there is a good chance that the account is with a casino operating out of a foreign country. In this case, you should be aware that all U.S. citizens and resident aliens with a financial interest in or signature authority over foreign accounts with an aggregate balance of over $10,000 any time during the prior calendar year must complete FinCEN Form 114 online reporting those accounts to the Treasury by April 15th of the subsequent year or face draconian penalties (a six-month extension is available).

Other Tax Side Effects of Gambling – Because gambling income is reported in full as income and the losses are an itemized deduction, gambling winnings increase a taxpayer’s adjusted gross income (AGI) for the year. An individual’s AGI is used to limit other tax benefits, and having gambling income can have an adverse impact on your taxes. For instance, when you itemize your deductions, your medical expenses are currently reduced by 10% of your AGI. If you are receiving Social Security benefits, those benefits can become more taxable when gambling winnings are included in your AGI. The same applies to the cost of your Medicare insurance premiums, which are based on your AGI from two years prior.

Another very noticeable side effect is the cost of a family’s health insurance through a government marketplace. Under the Affordable Care Act, lower-income individuals receive a tax credit that reduces the cost of their insurance. However, their AGI is used to determine the amount of their credit – the higher their income, the lower the credit, and the lower the credit, the higher their insurance premiums.

If you generally claim the dependent exemption for a qualified relative – say, your mother – and Mom happens to hit a jackpot at the local casino, you may end up being unable to claim her exemption for the year of the winnings if the gambling winnings pushed Mom’s income over the annual gross income limit for claiming her exemption, which for 2017 is $4,050.

If you have questions about how these issues will affect your specific tax situation, please give us a call.

Not All Interest Is Deductible For Taxes

A frequent question that arises when borrowing money is whether or not the interest will be tax deductible. That can be a complicated question, and unfortunately not all interest an individual pays is deductible. The rules for deducting interest vary, depending on whether the loan proceeds are used for personal, investment, or business activities. Interest expense can fall into any of the following categories:

  • Personal interest – is not deductible. Typically this includes interest from personal credit card debt, personal car loan interest, home appliance purchases, etc.
  • Investment interest – this is typically paid on debt incurred to purchase investments such as land, stocks, mutual funds, etc. However, interest on debt to acquire or carry tax-free investments is not deductible at all. The annual investment interest deduction is limited to “net investment income,” which is the total taxable investment income reduced by investment expenses (other than expenses related to investments that produce non-taxable income). The investment interest deduction is only allowed to taxpayers who itemize their deductions.
  • Home mortgage interest – includes the interest on a taxpayer’s primary home and a single second home. However, the debt for which the interest is deductible is generally limited to $1 million of home acquisition debt (debt used to purchase or substantially improve the home(s)) and $100,000 of equity debt between the first and second homes. Both the acquisition debt and the equity debt must be secured by the home(s) to be deductible as home mortgage interest. In addition, home mortgage interest is only deductible by those who itemize their deductions. Tax Tip: Equity debt can be used to purchase personal use items, and thereby a tax deduction for the interest paid on that loan is allowed.
  • Passive activity interest – includes interest on debt that’s for business or income-producing activities in which the taxpayer doesn’t “materially participate” and is generally deductible only if income from passive activities exceeds expenses from those activities. The most common passive activities are probably real estate rentals. For rental real estate activities, there is a special passive loss allowance of up to $25,000 for taxpayers who are active but not necessarily material participants in the rental. The $25,000 phases out for taxpayers with adjusted gross income between $100,000 and $150,000.
  • Trade or business interest – includes interest on debts that are for activities in which a taxpayer materially participates. This type of interest can generally be deducted in full as a business expense.

Because of the variety of limits imposed on interest deductions, the IRS provides special rules to allocate interest expense among the categories. These “tracing rules,” as they are called, are generally based on the use of the loan proceeds. Thus interest expense on a debt is allocated in the same manner as the allocation of the debt to which the interest expense relates. Debt is allocated by tracing disbursements of the debt proceeds to specific expenditures, i.e., “follow the money.”

These tracing rules, combined with the restrictions associated with the various categories of interest, can create some unexpected results. Here are some examples:

Example 1: A taxpayer takes out a loan secured by his rental property and uses the proceeds to refinance the rental loan and buy a car for personal use. The taxpayer must allocate interest expense on the loan between rental interest and personal interest for the purchase of the car, and even though the loan is secured by the business property, the personal loan interest portion is not deductible.

Example 2: The taxpayer borrows $50,000 secured by his home to be used in his consulting business. He has no other equity debt on his home. He deposits the $50,000 into a checking account he only uses for his business. He cannot deduct the interest on his business and must instead deduct the interest as home equity debt interest on his Schedule A (if he itemizes his deductions), as the debt is secured by his home and is less than the $100,000 limit for equity indebtedness.

Example 3: The taxpayer owns a rental property free and clear and wants to purchase a home. He obtains a loan on the rental to purchase the home. Under the tracing rules, the taxpayer must trace the use of the funds to their use, and as the debt was not used to acquire the rental, the interest on the loan cannot be deducted as rental interest. The funds can be traced to the purchase of the taxpayer’s home. However, for interest to be deductible as home mortgage interest, the debt must be secured by the home, which it is not. Result: the interest is not deductible anywhere.

As you can see, it is very important to plan your financing moves carefully, especially when equity in one asset is being used to acquire another. Please call us for assistance in applying the various interest limitations and tracing rules to ensure you don’t inadvertently get some unexpected results.

Ignoring Those IRS Notices Only Makes It Worse

Remember those 1099s, W-2s, K-1s and other informational forms you receive each year reporting your interest, dividends, sales, wages, retirement income, IRA withdrawals, health insurance forms and other items having to do with your tax return? Well, the IRS also gets this information and feeds it into its computers. Thanks to modern computer technology, the IRS is able to match that information to what you reported on your tax return, and if something significant is omitted or there’s a discrepancy with the numbers, the IRS is going to send you a letter asking for an explanation or a tax payment. You will also receive correspondence if you don’t file a return and the data the IRS has indicates that you should have filed. It has form letters for just about every possible situation.

Most frequently, these notices will include a proposed tax due, plus interest and/or penalties, along with an explanation of the examination process and how you can respond. However, the letters must, by law, advise you of your rights and other information. Thus, these letters can become overly lengthy and are sometimes difficult to understand. That is why it is important to have a trained eye review them before you take any action.

Do not procrastinate or throw the letter in a drawer hoping the issue will go away. After a certain period of time, another letter will automatically be produced. And, as you might expect, each succeeding letter will become more aggressive and more difficult to deal with, and it may reach the point where you might have to go to tax court to argue your case or pay whatever amount of money the IRS is demanding.

Most importantly, don’t automatically pay an amount the IRS is requesting unless you are positive it is correct. Quite often, you really do not owe the amount being billed, and it will be difficult and time consuming to get your payment back.

It is always good practice to have a tax professional review the correspondence and respond to the IRS in a timely manner. Also, note that these “love letters” from the IRS will come by regular mail, not email. If you receive an email from someone claiming to be from the IRS and demanding a tax payment, this communication will be a fraud, since the IRS does not use email for this purpose. Please call this office immediately in regards to any notice you receive about your tax returns.

Hurricane Disaster Loss Tax Ramifications

With the historic flooding and damage caused by recent hurricanes, President Trump has declared the affected areas disaster areas. If you were an unlucky victim and suffered a loss as a result of these disasters, you may be able to recoup a portion of that loss through a tax deduction. When you suffer a casualty loss within a federally declared disaster, you can elect to claim the loss in one of two years: the tax year in which the loss occurred or the immediately preceding year.

Income Tax Casualty Loss – By taking the deduction for a 2017 disaster area loss on the prior year (2016) return, you may be able to get a refund from the IRS before you even file your tax return for 2017, the loss year. You have until six months after the original due date of the 2017 return to make the election to claim it on your 2016 return, in most cases by filing an amended 2016 return to claim the disaster loss. Before making the decision to claim the loss in 2016, you should consider which year’s return would produce the greater tax benefit, as opposed to your desire for a quicker refund.

If you elect to claim the loss on either your 2016 original or amended return, you can generally expect to receive the refund within a matter of weeks, which can help to pay some of your repair costs.

If the casualty loss, net of insurance reimbursement, is extensive enough to offset all of the income on the return, whether the loss is claimed on the 2016 or 2017 return, and results in negative income, you may have what is referred to as a net operating loss (NOL). When there is an NOL, the unused loss can be carried back two years and then carried forward until it is all used up (but not more than 20 years), or you can elect to only carry the unused loss forward.

Determining the more beneficial year in which to claim the loss requires a careful evaluation of your entire tax picture for both years, including filing status, amount of income and other deductions, and the applicable tax rates. The analysis should also consider the effect of a potential NOL.

Ordinarily, casualty losses are deductible only to the extent they exceed $100 plus 10% of your adjusted gross income (AGI). Thus, a year with a larger amount of AGI will cut into your allowable loss deduction and can be a factor when choosing which year to claim the loss.

For verification purposes, keep copies of local newspaper articles and/or photos that will help prove that your loss was caused by the specific disaster.

As strange as it may seem, a casualty might actually result in a gain. This sometimes occurs when insurance proceeds exceed the tax basis of the destroyed property. When a gain materializes, there are ways to exclude or postpone the tax on the gain.

Extension of Filing and Payment Due Dates – The IRS has announced that Hurricane Harvey and Irma victims have until Jan. 31, 2018, to file certain individual and business tax returns and make certain tax payments.

This tax relief postpones various tax filing and payment deadlines that occurred starting on:

  • Aug. 23, 2017 for Harvey victims,
  • September 4, 2017 for Irma victims in Florida, and
  • September 5, 2017 for Irma victims in Puerto Rico and the Virgin Islands.

As a result, affected individuals and businesses will have until Jan. 31, 2018, to file returns and pay any taxes that were originally due during this period. This includes:

  • The Sept. 15, 2017 and Jan. 16, 2018 deadlines for individuals making quarterly estimated tax payments.
  • The 2016 income tax returns that received a tax-filing extension until Oct. 16, 2017. The IRS noted, however, that because tax payments related to these 2016 returns were originally due on April 18, 2017, those payments are not eligible for this relief and may be subject to late payment penalties.
  • A variety of business tax deadlines are also affected, including the Oct. 31 deadline for quarterly payroll and excise tax returns. Businesses with extensions, including among others, calendar-year partnerships whose 2016 extensions run out on Sept. 15, 2017 and calendar-year tax-exempt organizations whose 2016 extensions run out on Nov. 15, 2017, also have the additional time. The disaster relief page on www.irs.gov has details on other returns, payments and tax-related actions qualifying for the additional time.
  • In addition, the IRS is waiving late-deposit penalties for federal payroll and excise tax deposits normally due during the first 15 days of the disaster period. Check out the disaster relief page for the time periods that apply to each jurisdiction.

The IRS automatically provides filing and penalty relief to any taxpayer with an IRS address of record located in a disaster area. Thus, taxpayers need not contact the IRS to get this relief. However, if an affected taxpayer receives a late filing or late payment penalty notice from the IRS that has an original or extended filing, payment or deposit due date falling within the postponement period, the taxpayer should call the number on the notice to have the penalty abated.

In addition, the IRS will work with any taxpayer who lives outside of a disaster area but whose records necessary to meet a deadline occurring during the postponement period are located in the affected area. Taxpayers qualifying for relief who live outside the disaster area need to contact the IRS at 866-562-5227. This also includes workers assisting the relief activities who are affiliated with a recognized government or philanthropic organization.

The tax relief is part of a coordinated federal response to the damage caused by severe storms and flooding and is based on local damage assessments by FEMA. For information on disaster recovery, visit disasterassistance.gov.

For information on government-wide efforts related to:

If you need further information on filing extensions, casualty and disaster losses, your particular options for claiming a loss, or if you wish to amend your 2016 return to claim your 2017 loss, please give us a call.

Tax Reform Framework Released

President Trump announced a nine-page framework for tax cuts on September 27, 2017. The Framework capitalizes on many ideas previously presented in the President’s Tax Outline and in the House Republican Blueprint. Congressional tax-writing committees have a lot of work to do in refining the details, but it gives us an idea of where tax reform may be headed.

Individual Tax Rates

The current rates now fall into seven brackets, ranging from 10% to 39.6%. The proposed plan would consolidate the current individual tax brackets into three: 12%, 25% and 35%. An additional top tax rate may be added and apply to the “highest-income taxpayers,” but it fails to mention the income level at this might take effect, or the rate that would be imposed.

The plan also does not specify which income levels would be taxed at each rate— and if the highest rate is set at 35 percent—it would greatly benefit the wealthiest taxpayers, who currently pay a top rate of 39.6 percent on income greater than $418,400 for single filers.

Child and Dependent Care Credits

Although the rate applied to the lowest income bracket would increase, typical families in the existing 10 percent bracket may be better off because of a larger child tax credit as well as an increase in the standard deduction. The child tax credit would be “significantly” increased, including a refundable portion offered to taxpayers who have higher levels of income than current law allows.

A new, non-refundable credit of $500 for those caring for non-child dependents (such as an elderly parent) would be added.

Standard and Itemized Deductions

Most itemized deductions would be eliminated, meaning that large medical expenses, state and local income taxes, real estate taxes, investment expenses and investment interest expense would no longer be deductible. However, home mortgage interest, charitable contributions, and tax benefits encouraging work, higher education and retirement savings would be retained.

The standard deduction and personal exemptions would be combined into one larger standard deduction: $12,000 for single filers and $24,000 for married taxpayers filing jointly. Home mortgage interest, charitable contributions, and tax benefits encouraging work, higher education and retirement savings would be retained. This means that Such a revision of the tax code, if enacted, would greatly increase the number of taxpayers choosing the standard deduction. The new, single deduction would be higher for many filers, except those who claim multiple children

The Alternative Minimum Tax (AMT) and the federal estate tax and generation-skipping transfer tax would be repealed under this framework. It is suspected that that the repeal will apply to gift taxes, as well.

Business and Corporate Taxes

The tax rate would be reduced for regular or “C” corporations from 35% to 20%. The corporate Alternative Minimum Tax (“AMT”) would be eliminated along with other methods to reduce the double taxation of corporate earnings.

Many small businesses are structured as “S” corporations, partnerships, limited liability companies (LLCs), or sole proprietorships; all of which pass through business profits and losses to their owners’ personal tax returns. Thus, “C” corporation income taxes may be avoided but the owners face personal tax rates as high as 39.6%. Pass-throughs now make up about 95 percent of businesses in the country and the bulk of corporate tax revenue for the government.

Under the proposed framework, business income from these “pass-through entities” would be taxed at a rate no higher than 25%. Such a measure would need to be drafted carefully in order to prevent personal income of wealthy individuals from being reclassified into lower-taxed business income. Whether these distributions would then be subject to a second level of tax at the individual owner level also needs to be addressed.

Deductions and Tax Credits

Most special deductions and tax credits, other than the R&D credit and the low-income housing tax credit, would be eliminated. It’s not clear which deductions will be eliminated; however, the Section 199 deduction was specifically mentioned as being eliminated.

Replace system of taxing companies’ worldwide income with a 100% exemption for dividends from foreign subsidiaries in which U.S. parent has a 10% stake or more. Reduce tax rate and tax on a global basis the foreign profits of U.S. multinational corporations.

Tax Write Offs for Depreciable Assets

Businesses that invest in depreciable assets, other than buildings, after September 27, 2017 would write them off immediately. This tax benefit, with no upper limit, would be in place for at least five years. As a tradeoff, the tax-deductibility of interest expense incurred by most taxable corporations would be partially limited.

If you have questions about how the proposed tax reform might affect you, please call us.

 

Hurricane Harvey Tax Ramifications and Casualty Loss

With the historic flooding and damage caused by Hurricane Harvey, President Trump has declared the affected area a disaster area. If you were an unlucky victim and suffered a loss as a result of this disaster, you may be able to recoup a portion of that loss through a tax deduction. When you suffer a casualty loss within a federally declared disaster, you can elect to claim the loss in one of two years: the tax year in which the loss occurred or the immediately preceding year.

Income Tax Casualty Loss – By taking the deduction for a 2017 disaster area loss on the prior year (2016) return, you may be able to get a refund from the IRS before you even file your tax return for 2017, the loss year. You have until six months after the original due date of the 2017 return to make the election to claim it on your 2016 return, in most cases by filing an amended 2016 return to claim the disaster loss. Before making the decision to claim the loss in 2016, you should consider which year’s return would produce the greater tax benefit, as opposed to your desire for a quicker refund.

If you elect to claim the loss on either your 2016 original or amended return, you can generally expect to receive the refund within a matter of weeks, which can help to pay some of your repair costs.

If the casualty loss, net of insurance reimbursement, is extensive enough to offset all of the income on the return, whether the loss is claimed on the 2016 or 2017 return, and results in negative income, you may have what is referred to as a net operating loss (NOL). When there is an NOL, the unused loss can be carried back two years and then carried forward until it is all used up (but not more than 20 years), or you can elect to only carry the unused loss forward.

Determining the more beneficial year in which to claim the loss requires a careful evaluation of your entire tax picture for both years, including filing status, amount of income and other deductions, and the applicable tax rates. The analysis should also consider the effect of a potential NOL.

Ordinarily, casualty losses are deductible only to the extent they exceed $100 plus 10% of your adjusted gross income (AGI). Thus, a year with a larger amount of AGI will cut into your allowable loss deduction and can be a factor when choosing which year to claim the loss.

For verification purposes, keep copies of local newspaper articles and/or photos that will help prove that your loss was caused by the specific disaster. As strange as it may seem, a casualty might actually result in a gain. This sometimes occurs when insurance proceeds exceed the tax basis of the destroyed property. When a gain materializes, there are ways to exclude or postpone the tax on the gain.

Extension of Filing and Payment Due Dates – The IRS has announced that Hurricane Harvey victims in parts of Texas have until Jan. 31, 2018, to file certain individual and business tax returns and make certain tax payments.

This tax relief postpones various tax filing and payment deadlines that occurred starting on Aug. 23, 2017. As a result, affected individuals and businesses will have until Jan. 31, 2018, to file returns and pay any taxes that were originally due during this period. This includes:

  • The Sept. 15, 2017 and Jan. 16, 2018 deadlines for individuals making quarterly estimated tax payments.
  • The 2016 income tax returns that received a tax-filing extension until Oct. 16, 2017. The IRS noted, however, that because tax payments related to these 2016 returns were originally due on April 18, 2017, those payments are not eligible for this relief and may be subject to late payment penalties.
  • The Oct. 31 deadline for quarterly payroll and excise tax returns by certain businesses. In addition, the IRS is waiving late-deposit penalties for federal payroll and excise tax deposits normally due on or after Aug. 23 and before Sept. 7, if the deposits are made by Sept. 7, 2017. Details on available relief can be found on the IRS web site related to disaster relief.

The IRS automatically provides filing and penalty relief to any taxpayer with an IRS address of record located in the disaster area. Thus, taxpayers need not contact the IRS to get this relief. However, if an affected taxpayer receives a late filing or late payment penalty notice from the IRS that has an original or extended filing, payment or deposit due date falling within the postponement period, the taxpayer should call the number on the notice to have the penalty abated.

In addition, the IRS will work with any taxpayer who lives outside the disaster area but whose records necessary to meet a deadline occurring during the postponement period are located in the affected area. Taxpayers qualifying for relief who live outside the disaster area need to contact the IRS at 866-562-5227. This also includes workers assisting the relief activities who are affiliated with a recognized government or philanthropic organization.

The tax relief is part of a coordinated federal response to the damage caused by severe storms and flooding and is based on local damage assessments by FEMA. For information on disaster recovery, visit disasterassistance.gov.

For information on government-wide efforts related to Hurricane Harvey, please visit: https://www.usa.gov/hurricane-harvey.

If you need further information on filing extensions, casualty and disaster losses, your particular options for claiming a loss, or if you wish to amend your 2016 return to claim your 2017 loss, please give our office a call.

Startups: Research Credit Can Offset Payroll Taxes

A little-known tax benefit for new, qualified small businesses is the ability to apply a portion of their research credit – no more than $250,000 – to pay the employer’s share of their employees’ FICA withholding requirement (the 6.2% payroll tax). This can be quite a benefit, as in their early years, start-up companies generally do not have any taxable profits for the research credit to offset; quite often, it is in these early years when companies make expenditures that qualify for the research credit. This can substantially help these young companies’ cash flow.

Research Credit – The research credit is equal to 20% of qualified research expenditures in excess of the established base amount. If using the simplified method, the research credit is equal to 14% of qualified research expenditures in excess of 50% of the company’s average research expenditures in the prior three years.

Qualified Research – Research expenditures that qualify for the credit generally include spending on research that is undertaken for the purpose of discovering technological information. This information is intended to be useful in the development of a new or improved business component for the taxpayer relating to new or improved functionality, performance, reliability or quality.

Qualified Small Business (QSB) – To apply the research credit to payroll taxes, a company must be a QSB and must not be a tax-exempt organization. A QSB is a corporation or partnership with these criteria:

  1. The entity does not have gross receipts in any year before the fourth preceding year. Thus, the payroll credit can only be taken in the first 5 years of the entity’s existence. However, this rule does not require a business to have been in existence for at least 5 years.
  2. The entity’s gross receipts for the year when the credit is elected must be less than $5 million.

Any person (other than a corporation or partnership) is a QSB if that person meets the two requirements above after taking into account the person’s aggregate gross receipts received for all the person’s trades or businesses.

Example – The taxpayer is a calendar-year individual with one business that operates as a sole proprietorship. The taxpayer had gross receipts of $4 million in 2016. For the years 2012, 2013, 2014 and 2015, the taxpayer had gross receipts of $1 million, $7 million, $4 million, and $3 million, respectively; the taxpayer did not have gross receipts for any taxable year prior to 2012. The taxpayer is a qualified small business for 2016 because he had less than $5 million in gross receipts for 2016 and did not have gross receipts before 2012 (the beginning of the 5-taxable-year period that ends in 2016). The taxpayer’s gross receipts in the years 2012-2015 are not relevant in determining whether he is a qualified small business in taxable year 2016. Because the taxpayer had gross receipts in 2012, the taxpayer will not be a qualified small business for 2017, regardless of his gross receipts in that year.

The research credit must first be accrued back to the preceding year, where it must be used to offset any tax liability for that year. Then, the excess (up to $250,000 maximum) can be used to offset the 6.2% employer payroll tax. Any amount not used is carried forward to the next year.If you have questions related to the research credit or if your business could benefit from using the credit to offset payroll taxes, please give us a call.

Tax Breaks for Military Personnel

Military service members have special obligations and take risks while performing their service to our country, which impact their tax situation. As a result, they are entitled to a number of special tax breaks. The following are the predominant tax breaks available to military personnel:

  • Residence or Domicile – A military service member does not lose or acquire a residence or domicile for tax purposes due to being absent or present in any tax jurisdiction in the U.S. solely to comply with military orders. Thus, for example, a member of the military who is a resident of Texas and is assigned under military orders to a duty station in California continues to be treated as a Texas resident and is not subject to California state income tax.
    Another special rule exempts any personal service income of a military spouse from being taxed by any state other than the military spouse’s resident state. For the income to be exempt from the nonresident state’s taxes, the couple must have relocated to another state under military orders. They must also share the same “domicile” or true home outside the duty station state where they intend to return and relocate permanently.
  • Moving Expenses – A member of the Armed Forces on active duty who is required to move because of a permanent change of station can deduct the reasonable unreimbursed expenses of moving themselves and members of their household. They are not subject to the 50-mile distance test or 39-week employment test that civilians are subject to for claiming a moving expense deduction. Reasonable expenses include shipping, a moving van, truck rental, travel expenses (not meals), packing, insurance and storage en route, moving pets, and utility connect/disconnect charges.
  • Combat Pay Exclusion – If a member of the Armed Forces serves in a combat zone as an enlisted person or as a warrant officer for any part of a month, all of the military pay that he or she receives for military service that month is excluded from taxation. For officers, the monthly exclusion is capped at the highest enlisted pay plus any hostile fire or imminent danger pay received.
  • Living Allowances – The basic housing allowance and both housing and cost-of-living allowances abroad, whether paid by the U.S. Government or by a foreign government, are excluded from taxation.
  • Home Mortgage Interest and Taxes – A military taxpayer can deduct mortgage interest and real estate taxes on his or her tax return as an itemized deduction, even if they are paid with nontaxable military housing allowance pay.
  • Home Sale Gain Exclusion – In order to claim the $250,000 ($500,000 for qualifying married taxpayers) home gain exclusion, taxpayers must generally own and use the home for 2 of the 5 years immediately prior to the home’s sale. A military taxpayer may choose to suspend the 5-year look-back period for up to 10 years when on qualified official extended duty.
    A military taxpayer who sells his or her primary residence and does not meet the 2- of-5-years ownership and use tests due to a move to a new permanent duty station may qualify for a reduced maximum exclusion amount.
  • Reservist Travel Expenses – Armed Forces reservists who travel more than 100 miles away from home and stay overnight in connection with service as a member of a reserve component can deduct travel expenses as an adjustment to their gross income. This differs from the rules for other employees, who may only deduct job-related travel expenses as a miscellaneous itemized deduction (subject to the 2% of AGI limitation). Thus, this deduction can be taken even if the reservist does not itemize his or her deductions.
  • Reservist Early Withdrawal Exception – Qualified reservists are permitted penalty-free withdrawal from IRAs, 401(k)s, and other arrangements if ordered or called to active duty for a period in excess of 179 days and if the distribution is taken during the active duty period.
  • Extension of Deadlines – The time limit for taking care of certain tax matters can be postponed. The deadlines for filing tax returns, paying taxes, filing claims for refund, and taking other actions with the IRS are automatically extended for qualifying members of the military.
  • Uniform Cost and Upkeep – If military regulations prohibit you from wearing certain uniforms when off duty, the costs and upkeep of those uniforms can be deducted, but the deductible expense must be reduced by any allowance or reimbursement that is received.
  • Joint Returns – Generally, a joint return must be signed by both spouses. However, when one spouse may not be available due to military duty, a power of attorney may be used to file a joint return.
  • Tax Forgiveness – When members of the military lose their life in a combat zone or as the result of a terrorist action, their income taxes are forgiven for the year of their death and for any prior year that ends on or after the first day of service in a combat zone.
  • ROTC Students – Subsistence allowances paid to ROTC students participating in advanced training are not taxable. However, active duty pay – such as pay received during summer advanced camp – is taxable.
  • Transitioning Back to Civilian Life – You may be able to deduct some costs that are incurred while looking for a new job. Such expenses may include travel, resume preparation fees, and outplacement agency fees. Moving expenses may be deductible if your move is closely related to starting work at a new job location and if you meet certain tests.

If you or your spouse have questions about any of the above or questions related to your designated state of residence for state tax-filing purposes, please give us a call.

Using Online Services Such as Airbnb to Rent out Your Home? Better Read This!

Renting out your home or second home for short periods of time is becoming increasingly popular with the advent of online services that match property owners with prospective renters. The online sites providing these services include Airbnb, VRBO, and HomeAway.

There are special (and often complex) taxation rules associated with renting out your home or second home for short periods of time. In some cases, these rules allow the rental income you receive to be tax-free. In other situations, the rental income and expenses may have to be treated as business income and reported on a Schedule C, as opposed to a rental activity reported on Schedule E.

The following is a synopsis of the rules governing short-term rentals.

Rented for Fewer than 15 Days during the Year – When you rent out your home for fewer than 15 days total during the tax year, the rental income is not reportable, and the expenses associated with that rental are not deductible. However, interest and property taxes need not be prorated, and the full amounts of the qualified mortgage interest and property taxes you pay are reported as itemized deductions (as usual) on your Schedule A, if you itemize your deductions.

The 7-Day and 30-Day Rules – Rentals are generally passive activities, meaning that they are not treated as a trade or business and are not subject to self-employment taxes. However, an activity is not treated as a rental if either of these statements applies:

  • The average customer use of the property is for 7 days or fewer—or for 30 days or fewer if the owner (or someone on the owner’s behalf) provides significant personal services, or
  • The owner (or someone on the owner’s behalf) provides extraordinary personal services without regard to the property’s average period of customer use.

If the activity is not treated as a rental, then it will be treated as a trade or business, and the income and expenses, including prorated interest and taxes, will be reported on Schedule C. IRS Publication 527 states: “If you provide substantial services that are primarily for your tenant’s convenience, such as regular cleaning, changing linen, or maid service, you report your rental income and expenses on Schedule C.” Substantial services do not include the furnishing of heat and light, the cleaning of public areas, the collecting of trash, and such.

Exception to the 30-Day Rule – If the personal services provided are similar to those that are generally provided in connection with long-term rentals of high-grade commercial or residential real property (such as public area cleaning and trash collection), and if the rental also includes maid and linen services that cost less than 10% of the rental fee, then the personal services are neither significant nor extraordinary for the purposes of the 30-day rule.

Profits and Losses on Schedule C – Profit from a rental activity is not subject to self-employment tax, but a profitable rental activity that is reported as a business on Schedule C is subject to this tax. A loss from this type of activity is still treated as a passive-activity loss unless you meet the “material participation” test, generally by providing 500 or more hours of personal services during the year or qualifying as a real estate professional. Losses from passive activities are only deductible up to the income amount from other passive activities, but unused losses can be carried forward to future years. A special allowance for real-estate rental activities with active participation permits a loss against nonpassive income of up to $25,000, which phases out when modified adjusted gross income is between $100K and $150K. However, this allowance does NOT apply when the activity is reported on Schedule C.

These rules can be complicated; please call us to determine how they apply to your particular circumstances and what actions you can take to minimize your tax liability and maximize your tax benefits from your rental activities.

Are You Ignoring the Household Employee Payroll Rules?

If you hire a domestic worker to provide services in or around your home, you probably have a tax liability that you don’t know about – or one that you do know about but are ignoring. Either situation can come back to bite you. When the worker is your employee, your liability includes both withholding and paying payroll taxes as well as issuing a W-2 after the close of the year.

Sure, it is a lot easier simply to pay your worker in cash so as to avoid federal and state payroll taxes – and all the paperwork that goes with them. Your domestic worker will likely be fully cooperative with a cash deal because he or she can also avoid paying taxes. However, if the IRS or your state employment department finds out about these payments, the result could be very unpleasant for you.

Not everyone who performs services in or around your home is classified as an employee. For instance, a plumber or electrician who makes repairs in your home will generally be a licensed contractor; the government does not classify contractors as employees.

On the other hand, the IRS has conclusively ruled that nannies, housekeepers, senior caregivers, some gardeners and various other domestic workers are employees of the people for whom they work. It makes no difference if you have a written contract with the employee; similarly, the number of hours worked and the amount paid do not matter.

You are probably thinking, “Wait a minute” – perhaps everyone you know pays in cash, and none of them has paid payroll taxes or issued a W-2 for a household employee. However, if a worker gets injured on your property or if you dismiss the worker under less-than-amicable circumstances, it’s a pretty sure bet that your household employee will be the first one to throw you under the bus by reporting you to the state labor board or by filing for unemployment compensation.

Even some big-name people have been caught up in this issue. Just recently (as seems to happen every four years), a presidential nominee, Rep. Mick Mulvaney (R-SC), was revealed to have failed to pay more than $15,000 in taxes on behalf of the nanny for his newborn triplets. He subsequently paid the back taxes and was confirmed as Director of the Office of Management and Budget.

Some individuals try to circumvent the payroll issue by treating a household employee as an independent contractor, incorrectly issuing the household employee a Form 1099-MISC.

Here are the correct actions you should take for domestic employees:

  • Obtain a Federal Employer Identification Number (FEIN), which you will use in lieu of your Social Security Number when filing the required reporting forms. Note: If, as the owner of a sole proprietorship business, you already have a FEIN, you should use that number instead of requesting a separate one as a household employer.
  • Obtain a state ID number for unemployment insurance and state tax withholdings.
  • Withhold Social Security and Medicare taxes from the employee’s pay if it exceeds the annual threshold ($2,000 for 2017).
  • Withhold income tax from the employee if the worker requests and if you agree to do so.
  • File state employment tax returns as required – generally quarterly (although beware that some states require monthly returns) – and make the required deposits for state employment taxes.
  • Prepare a W-2 for the employee and a W-3 transmittal; file them by the end of January.
  • File Schedule H with your federal individual income tax return, and pay all the federal payroll and withholding taxes (i.e., the federal taxes that you withheld from the employee’s pay, plus your matching share of Social Security, Medicare and federal unemployment taxes). Limited exception: If you operate a sole proprietorship with employees, you may include the payroll taxes of your household workers with those of the business’s employees, but you cannot take a business deduction for those taxes. Generally, it is better to keep the personal and business reporting separate.

Some additional issues to consider are as follows:

Overtime – Under the Fair Labor Standards Act, domestic employees are nonexempt workers and are entitled to overtime pay after working 40 hours in a week. Live-in employees are an exception to this rule in most states.

Hourly Pay or Salary – It is illegal to treat nonexempt employees as if they are salaried.

Separate Payrolls – If you own a business with a payroll, you may be tempted to include your household employees on the company’s payroll. The payments to the household employees are personal expenses, however, and are not allowable deductions for a business. Thus, you must maintain a separate payroll for household employees; in other words, you must use personal funds to pay household workers and instead of paying them from a business account.

Eligibility to Work in the U.S. – It is illegal to knowingly hire or continue to employ an alien who is not legally eligible to work in the U.S. When hiring a household employee who works on a regular basis, you and the employee each must complete Form I-9 (Employment Eligibility Verification). You will need to examine the documents that the employee presents to establish the employee’s identity and employment eligibility.

Other Issues – Special situations not covered in this overview include how to handle workers hired through an agency, how to gross up wages if you choose to pay an employee’s share of Social Security and Medicare taxes, and how to treat noncash wages.

Please call this office if you would like assistance with your household employee tax and reporting requirements or with any special issues that apply to your state.