Work and Play – Can’t Tell the Difference

Chuck Runyon, my friend and a founder of Anytime Fitness, has the following on the wall in his office:

work and play

This so resonates with me.  My job as a tax accountant is not a job.  It’s way too fun!  I hope that’s true for all.  If not, make it so.

 

Stones Tour Continues

Two shows down, Minneapolis and Atlanta. Three to go – Milwaukee, Kansas City, and Raleigh. What a blast!  Life is fun.

CRIMINALS LOOTED PRIVATE DATA FROM 100,000 IRS ACCOUNTS

IRS has issued a statement indicating that criminals gained unauthorized access to information on approximately 100,000 tax accounts through IRS’s “Get Transcript” application.  The data included taxpayers’ Social Security information, date of birth, and street address.

The matter is under review by the Treasury Inspector General for Tax Administration as well as the IRS’s Criminal Investigation unit, and the “Get Transcript” application has been shut down temporarily.

IRS has taken a number of steps to protect taxpayers:

  • Sending a letter to all of the approximately 200,000 taxpayers whose accounts had attempted unauthorized accesses, notifying them that third parties appear to have had access to taxpayer Social Security numbers and additional personal financial information from a non-IRS source before attempting to access the IRS transcript application.  Although half of this group did not actually have their transcript account accessed because the third parties failed the authentication tests, the IRS is still taking an additional protective step to alert taxpayers.
  • Offering free credit monitoring for the approximately 100,000 taxpayers whose Get Transcript accounts were accessed to ensure this information isn’t being used through other financial avenues.  Taxpayers will receive specific instructions so they can sign up for the credit monitoring.  The IRS noted that these outreach letters will not request any personal identification information from taxpayers.  In addition, the IRS is marking the underlying taxpayer accounts on its core processing system to flag for potential identity theft to protect taxpayers going forward – both right now and in 2016.

These letters will include additional details for taxpayers about the credit monitoring and other steps.

The IRS notes that this incident only involves its application involving transcripts.  It does not involve other IRS systems, such as core taxpayer accounts, or other applications, such as Where’s My Refund.

Stones.
The Rolling Stones play in the Twin Cities June 3rd.  A family affair for me.  More to report next week…

Start Paying Your Children

If you can get your children to work for your business or work around the house, start paying them.

The pay must be fair for the services provided.

If the work is for your trade or business, you obtain a tax deduction for the compensation. The Federal and State tax savings may be approximately 40% to 50% of the amount paid.

If your business is a sole proprietorship or a partnership owned by you and your spouse, no FICA taxes are due until they reach age 18.

They could use the money to fund a Roth IRA or pay for college.

The maximum Roth IRA contribution for 2015 is $5,500. Just think of the funds they could accumulate in a tax free vehicle, if this is done every year.

Under current law, they can earn $6,300 before paying any federal tax.

If they are in college and you don’t claim them as a dependent, they can earn about $26,000 without paying federal tax after a $2,500 tuition credit.

Many taxpayers don’t receive any benefit for claiming a dependent exemption for a child due to the phase out rules. Also, many don’t receive any tuition credit for their children’s college tuition due to the income threshold requirements.

This is a no brainier. Don’t miss the opportunity.  Get the kids working and on the payroll.

 

June and July Stones Tour

The Stones are back, all in their 70s, but still rocking. Funny, my first concert was in the 70s. Who would have thought?

The US tour will be in June and July this year.  I am ready to go, right after getting everyone’s second quarter tax estimates out by June 15th. This time the grandkids are coming too. I will have to beg and/or bribe them.

Work Enough to Avoid 3.8% Investment Income Medicare Tax

How many hours do you need to work for a trade or business to avoid the 3.8% Investment Income Medicare tax?

Most believe it is greater than 500 hours per year. This is not necessarily true.

Internal Revenue Code (IRC) section 1411 assesses a 3.8% Medicare tax on certain types of investment income that exceed certain income level thresholds.

One of the types of investment income is passive activity trade or business income as defined in IRC section 469.

Basically, IRC section 469 indicates that income from a trade or business operated as a sole proprietorship, partnership/LLC or S-Corporation is passive if the taxpayer doesn’t materially participate in the activity.

Generally, material participation requires one to work more than 500 hours per year for the trade or business activity. There are several special rules that treat one as materially participating at a lower level of hours.

There are also special rules that specify if certain activities generate income they are not passive (and therefore not subject to the 3.8% Investment Income Medicare tax), but if they generate a loss they are passive.

One of the rules requires if one participates more than 100 hours in a year for a trade or business  activity, and all that person’s “100 plus hour and less than 501 hour trade or businesses activities” don’t exceed 500 hours in total, the income from the activity is not passive. Therefore, it is also not subject to the 3.8% Investment Income Medicare tax. This rule gets missed a lot. It should be fairly easy to get 101 hours. That is 2 hours a week.

One should review all trade or business activity income reflected on their tax returns and determine how many hours they need to work to “materially participate” or qualify for the above special 100 plus hours rule.

Note, if one has large passive losses, treating income activities as passive may result in more tax savings, than avoiding the 3.8% Investment Income Medicare tax.

Antigua

Jan and I just spent a week in Antigua, sailing with Becky, Bill, Dick, Cathy, Bill and Pam. Awesome time. Relaxed, snorkeled, and read (tax stuff of course). Saw Eric Clapton’s spot. Wish it was Mick Jagger’s. I would have climbed the cliff to get in.

ROTH TIME

It is time to fund Roth IRAs. A Roth IRA is an awesome tax free investment vehicle. Anything that is tax free should be considered.

One can contribute the lower of their earned income or $5,500 in 2014 and 2015 and an additional $1,000 each if age 50 or older.

If you haven’t done it for 2014, you have up to April 15, 2015 to do it. I also recommend doing the 2015 contribution as soon as possible. Why wait?

If one’s income is below a certain level, he/she can fund a Roth IRA. If it is at or above the level, the amount one can contribute gets reduced, ultimately to zero. The phase out rule.

The income level and phase out ranges are as follows:

  • 2015
    • Married Filing Jointly: AGI $183,000-$193,000
    • Head of Household or Single: AGI $116,000-$131,000
  • 2014
    • Married Filing Jointly: AGI $181,000-$191,000
    • Head of Household or Single: AGI $114,000-$129,000
  • 2015 and 2014
    • Married Filing Separately: AGI $0-$10,000

If one’s income exceeds the above, there is still a way to fund a Roth IRA.

Consider making a traditional non-deductible IRA contribution and converting it to a Roth shortly thereafter. This strategy may not make sense if you already have funds in a traditional IRA, SEP, SAR-SEP or Simple IRA. The rules treat a portion of the converted amount as coming from all IRA accounts and therefore some of the conversion could be taxable.

Like the regular contribution to a Roth IRA, If you haven’t done the conversion technique for 2014, you have up to April 15, 2015 to do it. I also recommend doing the 2015 contribution and conversion as soon as possible. Why wait?

Also, consider funding a Roth IRA for your children or grandchildren, subject to the same limits above. If they don’t have earned income, consider having them perform household duties and pay them by funding the Roth IRA. Unless they are using their own funds or you are paying them for household services with the contribution, the contribution will be considered a gift.

Again, If you haven’t done it for them for 2014, you have up to April 15, 2015 to do it. I also recommend doing the 2015 contribution as soon as possible. Why wait?


FLORIDA

I am out of the freezing cold in Minnesota and at The View in Florida for a few days. It’s sunny, warm weather and lots of fun. Nothing better.  Well maybe.  I can’t wait for tax season to start. That is better.

Congress Does It Again: A Short-Term Extender Bill

Several tax law provisions expired on December 31, 2013.  We have been waiting for legislation extending these expired provisions all year.  We finally got it last week.

It is good news and bad news.  The good news is the expired provisions were extended.  The bad news is they are only extended through December 31, 2014.

Some of the major items extended include the following:

  • Research and Development tax credit
  • Work Opportunity and Empowerment Zone tax credit
  • New Markets tax credit
  • Various energy tax credits
  • $500,000 Section 179 expensing limit
  • 50% Bonus Depreciation
  • Section 179D expensing for certain energy efficient commercial building property
  • S-Corporation 5 year Built-in gains recognition period
  • Tax free transfers from IRAs to Charities

I think what Congress did is ridiculous. They continue to play games with small businesses by failing to make these provisions permanent and/or waiting all year to extend them.  Bonus depreciation was a provision added to the law to spur investment to help the economy. What good does it do to pass it in mid-December and have it expire on December 31?

I understand my clients that can use the extended provisions, welcome them.  However, how can they do tax planning?  Come on Congress!  Let us know what tax law we can expect sooner than later.  In the past, they extended the provsions for at least two years.  Now, we all need to wait again to see what the rules will be in 2015.

Some believe the short term extension was done so we don’t have the law fixed for 2015.  This way congressman Ryan, the new Chairman of the House Ways and Means Committee, can try to get overall tax reform passed in 2015.

I am sitting on the edge of my seat waiting.  (That was a joke.)

We will see what happens.

 

Merry Christmas

Merry Christmas to all!  I hope you have a great Christmas week.  I know I am.

My entire family will be at our house on Christmas Eve; 3 parents, 4 children, assuming our Son in the Military can come (he returned to the USA last week after serving in Afghanistan for several months), and 9 grandchildren.  It will be awesome.

Tax Gossip – Rumors on Section 179 Expensing and Bonus Depreciation

My colleague recently attended an event where a Congressman who is on the U.S. House of Representatives Ways and Means Committee said it is very likely that 179 expensing and bonus depreciation will be extended in early December before the session break or in early January and applied retroactively.

I hope so. We will see.

For now, I recommend you run year-end planning calculations under both scenarios – no extension of the rules and if they are extended.

YEAR END PLANNING

It is time for year-end tax planning. This should be started in November, not late December.  The following are some of the issues that should be discussed with your advisor.

  1. Deferring or accelerating income
  2. Deferring or accelerating deductions
  3. Purchasing assets before year-end
  4. Selling assets before year-end
  5. Proper documentation and policies for accruing and deducting bonuses
  6. Inventory costing methods
  7. Writing off bad debts
  8. Maximizing the domestic production deduction
  9. Loss planning to make sure losses are not limited under the basis, at risk or passive activity rules
  10. Entity structure for new ventures and 831(b) captive instance planning.
  11. Other items that may reduce you tax burden.

Each of these categories have several tax planning techniques that can be implemented. One must consider the business and economic impact of them in addition to the tax savings.

Also, have your advisor prepare a tax projection for 2014 and illustrate the impact of the planning techniques.

Get on it as soon as you can.

DISNEY and TAXES

I am off to Orlando for a great tax conference. I can’t wait. I am like a kid heading to Disney World. In fact, Cammy and Patrick, our two oldest grandkids, are coming along. Disney at night and on the weekend. I refuse to skip out of the conference. It is going to be a good week.

LLC Members Self Employment Tax

Many tax professionals are changing their stance on how to treat business income allocated to LLC Members for Self Employment Tax (SET) purposes.

In general, per Internal Revenue Code Section (IRC) 1402(a), taxpayers who are allocated business income from an entity taxed as a partnership (e.g., general partnership, limited partnership, LLCs) are subject to SET on such income. However, an exception applies for income allocated to Limited Partners (IRC section 1402(a)13). This exception does not apply to payments for services to such partners as “guaranteed payments.”

That being said, the treatment of LLC members has been somewhat controversial. Are they Limited Partners for purposes of these rules? The IRS has attempted to issue regulations twice, but has never finalized them. The IRS has provided very little guidance on this matter. There have been some recent court cases and a new Chief Council Advice (201436049) that address specific taxpayers’ situations.

It appears that both the courts and the IRS are looking at the type of business income as well as the taxpayers’ role (active vs investor), but not their status as a limited partner under state law. In essence, the IRS and certain courts are applying a special definition of “Limited Partner” under section 1402(a)(13), based on the intent of the law, not their status under State law.

So what do we do?  

Many professionals are treating all Limited Liability Company members’ business income as exempt from SET. Some treat only business service income as subject to SET and some treat all business income as subject to SET.

I believe each situation needs to be reviewed to determine the best position to take. Whether the income is a return on investment or a result of the owner’s services is a key factor. The type of income also matters (service vs. other.) There is no specific rule here. One might want to look at the passive loss rules and apply the material participation test. This type of concept is in the proposed regulation issued by the IRS that was never finalized.

At a minimum, make sure owners who are providing services to the entity are paid a reasonable “guaranteed payment” for such service.

Some advisors recommend using S-Corporations to minimize the SET. Subject to a requirement to pay reasonable compensation, S-Corporation income is not subject to SET. However, the partnership tax rules are generally much better and more flexible compared to the S-Corporation rules. When all else is equal, I always recommend creating entities that can use the partnership tax rules.

One may consider setting up separate S-Corporations for each LLC member to hold their LLC units. This should help avoid the Self Employment Tax on the LLC income and also allow the LLC to treat its taxpayers as employees.

This issue should be part of year-end planning discussions.

 

Personal Update

There’s been lots going on lately. Our Stillwater Condo overlooking the St. Croix River has been expanded by adjoining the small one next door. What a project that was – Jan blew my budget away. Fall has arrived and the boat in Minnesota is put away for the year, but the one in Florida is all ready to go! Our Grandkid’s dancing and hockey activities are in full swing now, lots of fun spectating to look forward to there.

And of course, I’m still reading tax articles daily. Life is good!!