Hobby or Business? Why It Matters
Millions of Americans have hobbies such as sewing, woodworking, fishing, gardening, stamp and coin collecting, but when that hobby starts to turn a profit, it might just be considered a business by the IRS.
Definition of a Hobby vs. a Business
The IRS defines a hobby as an activity that is not pursued for profit. A business, on the other hand, is an activity that is carried out with the reasonable expectation of earning a profit.
The tax considerations are different for each activity, so it’s important for taxpayers to determine whether an activity is engaged in for profit as a business or is just a hobby for personal enjoyment.
Of course, you must report and pay tax on income from almost all sources, including hobbies. But when it comes to deductions such as expenses and losses, the two activities differ in their tax implications.
Is Your Hobby Actually a Business?
If you’re not sure whether you’re running a business or simply enjoying a hobby, here are nine factors you should consider:
- Whether you carry on the activity in a businesslike manner.
- Whether the time and effort you put into the activity indicate you intend to make it profitable.
- Whether you depend on income from the activity for your livelihood.
- Whether your losses are due to circumstances beyond your control (or are normal in the startup phase of your type of business).
- Whether you change your methods of operation in an attempt to improve profitability.
- Whether you, or your advisors, have the knowledge needed to carry on the activity as a successful business.
- Whether you were successful in making a profit in similar activities in the past.
- Whether the activity makes a profit in some years, and how much profit it makes.
- Whether you can expect to make a future profit from the appreciation of the assets used in the activity.
An activity is presumed to be for profit if it makes a profit in at least three of the last five tax years, including the current year (or at least two of the last seven years for activities that consist primarily of breeding, showing, training, or racing horses).
The IRS says that it looks at all facts when determining whether a hobby is for pleasure or business, but the profit test is the primary one. If the activity earned income in three out of the last five years, it is for profit. If the activity does not meet the profit test, the IRS will take an individualized look at the facts of your activity using the list of questions above to determine whether it’s a business or a hobby. It should be noted that this list is not all-inclusive.
Business Activity: If the activity is determined to be a business, you can deduct ordinary and necessary expenses for the operation of the business on a Schedule C or C-EZ on your Form 1040 without considerations for percentage limitations. An ordinary expense is one that is common and accepted in your trade or business. A necessary expense is one that is appropriate for your business.
Hobby: If an activity is a hobby, not for profit, losses from that activity may not be used to offset other income. You can only deduct expenses up to the amount of income earned from the hobby. These expenses, with other miscellaneous expenses, are itemized on Schedule A and must also meet the two percent limitation of your adjusted gross income in order to be deducted.
What Are Allowable Hobby Deductions?
If your activity is not carried on for profit, allowable deductions cannot exceed the gross receipts for the activity.
Note: Internal Revenue Code Section 183 (Activities Not Engaged in for Profit) limits deductions that can be claimed when an activity is not engaged in for profit. IRC 183 is sometimes referred to as the “hobby loss rule.”
Deductions for hobby activities are claimed as itemized deductions on Schedule A, Form 1040. These deductions must be taken in the following order and only to the extent stated in each of three categories:
- Deductions that a taxpayer may claim for certain personal expenses, such as home mortgage interest and taxes, may be taken in full.
- Deductions that don’t result in an adjustment to the basis of property, such as advertising, insurance premiums, and wages, may be taken next, to the extent gross income for the activity is more than the deductions from the first category.
- Deductions that reduce the basis of property, such as depreciation and amortization, are taken last, but only to the extent gross income for the activity is more than the deductions taken in the first two categories.
If your hobby is regularly generating income, it could make tax sense for you to consider it a business because you might be able to lower your taxes and take certain deductions.
If you’re still wondering whether your hobby is actually a business, help is just a phone call away.
Minimizing Tax on Mutual Fund Activities
Tax law generally treats mutual fund shareholders as if they directly owned a proportionate share of the fund’s portfolio of securities and you must report as income any mutual fund distributions, whether or not they are reinvested. Thus, all dividends and interest from securities in the portfolio, as well as any capital gains from the sales of securities, are taxed to the shareholders.
Whether you’re new to mutual funds or a seasoned investor who wants to learn more, these tips will help you avoid the tax bite on mutual fund investments.
First, you need to understand how distributions from mutual funds are taxed. There are two types of taxable distributions: (1) ordinary dividends and (2) capital gain distributions.
Ordinary Dividends. Distributions of ordinary dividends, which come from the interest and dividends earned by securities in the fund’s portfolio, represent the net earnings of the fund. They are paid out periodically to shareholders. Like the return on any other investment, mutual fund dividend payments decline or rise from year to year, depending on the income earned by the fund in accordance with its investment policy. These dividend payments are considered ordinary income and must be reported on your tax return.
Qualified dividends. Qualified dividends are ordinary dividends that are subject to the same the zero or 15 percent maximum tax rate that applies to net capital gain. In 2017, the maximum rate of tax on qualified dividends is 20 percent on any amount that otherwise would be taxed at the 39.6% tax rate, 15 percent on any amount that would otherwise be taxed at rates greater than 15% but less than 39.6%, and zero percent on any amount that would otherwise be taxed at a 10% or 15% rate.
Dividends from foreign corporations are qualified where their stock or ADRs (American depositary receipts) are traded on U.S. exchanges or with IRS approval where U.S. tax treaties cover the dividends. Dividends from mutual funds qualify where a mutual fund is receiving qualified dividends and distributing the required proportions thereof.
Capital gain distributions. When gains from the fund’s sales of securities exceed losses, they are distributed to shareholders. As with ordinary dividends, these capital gain distributions vary in amount from year to year. They are treated as long-term capital gain, regardless of how long you have owned your fund shares.
A mutual fund owner may also have capital gains from selling mutual fund shares.
Capital gains rates. The beneficial long-term capital gains rates on sales of mutual fund shares apply only to profits on shares held more than a year before sale. Profit on shares held a year or less before sale is considered ordinary income, but capital gain distributions are long-term regardless of the length of time held before the distribution.
Starting with tax year 2013, long term capital gains are taxed at 20 percent (39.6% tax bracket), 15 percent for the middle tax brackets (25%, 28%, 33%, and 35%), and 0 percent for the 10% and 15% tax brackets.
At tax time, your mutual fund will send you a Form 1099-DIV, which tells you what earnings to report on your income tax return, and how much of it is qualified dividends. Because tax rates on qualified dividends are the same as for capital gains distributions and long-term gains on sales, these items combined in your tax reporting, that is, qualified dividends added to long-term capital gains. Capital losses are netted against capital gains before applying the favorable capital gains rates, and losses will not be netted against dividends.
Medicare Tax. Starting with tax year 2013, an additional Medicare tax of 3.8 percent is applied to net investment income for individuals with modified adjusted gross income above $200,000 (single filers) and $250,000 (joint filers).
Minimizing Tax Liability on Mutual Fund Activities
Now that you have a better understanding of how mutual funds are taxed, here are seven tips for minimizing the tax on your mutual fund activities.
1. Keep Track of Reinvested Dividends
Most funds offer you the option of having dividend and capital gain distributions automatically reinvested in the fund–a good way to buy new shares and expand your holdings. While most shareholders take advantage of this service, it is not a way to avoid being taxed. Reinvested ordinary dividends are still taxed (at long-term capital gains rates if qualified), just as if you had received them in cash. Similarly, reinvested capital gain distributions are taxed as long-term capital gain.
Tip: If you reinvest, add the amount reinvested to the “cost basis” of your account, i.e., the amount you paid for your shares. The cost basis of your new shares purchased through automatic reinvesting is easily seen from your fund account statements. This information is important later on when you sell shares.
2. Be Aware That Exchanges of Shares Are Taxable Events
The “exchange privilege,” or the ability to exchange shares of one fund for shares of another, is a popular feature of many mutual fund “families,” i.e., fund organizations that offer a variety of funds. For tax purposes, exchanges are treated as if you had sold your shares in one fund and used the cash to purchase shares in another fund. In other words, you must report any capital gain from the exchange on your return. The same tax rules used for calculating gains and losses when you redeem shares apply when you exchange them.
Note: Gains on these redemptions and exchanges are taxable whether the fund invests in taxable or tax-exempt securities.
3. Do Not Overlook the Advantages of Tax-Exempt Funds
If you are in the higher tax brackets and are seeing your investment profits taxed away, then there is a good alternative to consider: tax-exempt mutual funds. Distributions from such funds that are attributable to interest from state and municipal bonds are exempt from federal income tax (although they may be subject to state tax).
The same applies to distributions from tax-exempt money market funds. These funds also invest in municipal bonds, but only in those that are short-term or close to maturity, the aim being to reduce the fluctuation in NAV that occurs in long-term funds.
Many taxpayers can ease the tax bite by investing in municipal bond funds for example.
Note: Capital gain distributions paid by municipal bond funds (unlike distributions of interest) are not free from federal tax. Most states also tax these capital gain distributions.
Although income from tax-exempt funds is federally tax-exempt, you must still report on your tax return the amount of tax-exempt income you received during the year. This is an information-reporting requirement only and does not convert tax-exempt earnings into taxable income.
Your tax-exempt mutual fund will send you a statement summarizing its distributions for the past year and explaining how to handle tax-exempt dividends on a state-by-state basis.
4. Keep Records of Your Mutual Fund Transactions
It is crucial to keep the statements from each mutual fund you own, especially the year-end statement.
By law, mutual funds must send you a record of every transaction in your account, including reinvestments and exchanges of shares. The statement shows the date, amount, and number of full and fractional shares bought or sold. These transactions are also contained in the year-end statement.
In addition, you will receive a year-end Form 1099-B, which reports the sale of fund shares, for any non-IRA mutual fund account in which you sold shares during the year.
Why is recordkeeping so important?
When you sell mutual fund shares, you realize a capital gain or loss in the year the shares are sold. You must pay tax on any capital gain arising from the sale, just as you would from a sale of individual securities. (Losses may be used to offset other gains in the current year and deducted up to an additional $3,000 of ordinary income. Remaining loss may be carried for comparable treatment in later years.)
The amount of the gain or loss is determined by the difference between the cost basis of the shares (generally the original purchase price) and the sale price. Thus, to figure the gain or loss on a sale of shares, it is essential to know the cost basis. If you have kept your statements, you will be able to figure this out.
Example: In 2012, you purchased 100 shares of Fund JKL at $10 a share for a total purchase price of $1,000. Your cost basis for each share is $10 (what you paid for the shares). Any fees or commissions paid at the time of purchase are included in the basis, so since you paid an up-front commission of two percent, or $20, on the purchase, your cost basis for each share is $10.20 ($1,020 divided by 100). Let’s say you sell your Fund JKL shares this year for $1,500. Assume there are no adjustments to your $ 1,020 basis, such as basis attributable to shares purchased through reinvestment. On this year’s income tax return, you report a capital gain of $480 ($1,500 minus $1,020).
Note: Commissions or brokerage fees are not deducted separately as investment expenses on your tax return since they are taken into account in your cost basis.
One of the advantages of mutual fund investing is that the fund provides you with all of the records that you need to compute gains and losses–a real plus at tax time. Some funds even provide cost basis information or calculate gains and losses for shares sold. That is why it is important to save the statements. However, you are not required to use the fund’s gain or loss computations in your tax reporting.
5. Re-investing Dividends & Capital Gain Distributions when Calculating
Make sure that you do not pay any unnecessary capital gain taxes on the sale of mutual fund shares because you forgot about reinvested amounts. When you reinvest dividends and capital gain distributions to buy more shares, you should add the cost of those shares (that is, the amount invested) to the cost basis of the shares in that account because you have already paid tax on those shares.
Failure to include reinvested dividends and capital gain distributions in your cost basis is a costly mistake.
6. Don’t Forget State Taxation
Many states treat mutual fund distributions the same way the federal government does. There are, however, some differences. For example:
- If your mutual fund invests in U.S. government obligations, states generally exempt, from state taxation, dividends attributable to federal obligation interest.
- Most states do not tax income from their own obligations, whether held directly or through mutual funds. On the other hand, the majority of states do tax income from the obligations of other states. Thus, in most states, you will not pay state tax to the extent you receive, through the fund, income from obligations issued by your state or its municipalities.
- Most states don’t grant reduced rates for capital gains or dividends.
7. Don’t Overlook Possible Tax Credits for Foreign Income
If your fund invests in foreign stocks or bonds, part of the income it distributes may have been subject to foreign tax withholding. If so, you may be entitled to a tax deduction or credit for your pro-rata share of taxes paid. Your fund will provide you with the necessary information.
Tip: Because a tax credit provides a dollar-for-dollar offset against your tax bill, while a deduction reduces the amount of income on which you must pay tax, it is generally advantageous to claim the foreign tax credit. If the foreign tax doesn’t exceed $300 ($600 on a joint return), then you may not need to file IRS form 1116 to claim the credit.
If you have any questions about the tax treatment of mutual funds, please call.
Tax Implications of Crowdfunding
Crowdfunding websites such as Kickstarter, GoFundMe, Indiegogo, and Lending Club have become increasingly popular for both individual fundraising and small business owners looking for start-up capital or funding for creative ventures. The upside is that it’s often possible to raise the cash you need, but the downside is that the IRS might consider that money taxable income. Here’s what you need to know.
What is Crowdfunding?
Crowdfunding is the practice of funding a project by gathering contributions online from a large group of backers. Initially used by musicians, filmmakers, and other creative types to raise small sums of money for projects that were unlikely to turn a profit, now it is used to fund a variety of projects, events, and products–and has even become an alternative to venture capital for some.
Are Funds I receive Taxable?
All income you receive, regardless of the source, is considered taxable income in the eyes of the IRS–and that includes crowdfunding dollars.
Say you develop a prototype for a product that looks promising. You run a Kickstarter campaign to raise additional funding, setting a goal of $15,000 and offer a small gift in the form of a t-shirt, cup with a logo or a bumper sticker to your donors.
Your campaign is more successful than you anticipated it would be and you raise $35,000–more than twice your goal. Let’s look at how the IRS might view your crowdfunding campaign:
Taxable sale. Because you offered something (a gift or reward) in return for a payment pledge it is considered a sale. As such, it may be subject to sales and use tax.
Taxable income. Since you raised $35,000, that amount is considered taxable income. But even if you only raised $15,000 and offered no gift, the $15,000 is still considered taxable income and should be reported as such on your tax return–even though you did not receive a Form 1099-K from a third party payment processor (more about this below).
Generally, crowdfunding revenues are included in income as long as they are not:
- Loans that must be repaid;
- Capital contributed to an entity in exchange for an equity interest in the entity; or
- Gifts made out of detached generosity and without any “quid pro quo.” However, a voluntary transfer without a “quid pro quo” isn’t necessarily a gift for federal income tax purposes.
Income offset by business expenses. You may not owe taxes however, if your crowdfunding campaign is deemed a trade or active business (not a hobby) in that your business expenses might offset your tax liability.
Factors affecting which expenses could be deductible against crowdfunding income include whether the business is a start-up and which accounting method you use (cash vs. accrual) for your funds. For example, if your business is a startup you may qualify for additional tax benefits such as deducting startup costs or applying part or all of the research and development credit against payroll tax liability instead of income tax liability.
Timing of the crowdfunding campaign, receipt of funds, and when expenses are incurred also affect whether business expenses will offset taxable income in a given tax year. For instance, if your crowdfunding campaign ends in October but the project is delayed until January of the following year it is likely that there will be few business expenses to offset the income received from the crowdfunding campaign since most expenses are incurred during or after project completion. As such, you would not be able to offset any income from funds raised during your crowdfunding campaign in one tax year with business expenses incurred the following tax year.
Non-Taxable Gift. If money is donated or pledged without receiving something in return, it may be considered a “gift,” and the recipient does not pay any tax. Up to $14,000 per year per recipient may be given by the “gift giver.”
How do I Report Funds on my Tax Return?
Companies that issue third party payment transactions (e.g. Amazon if you use Kickstarter or PayPal if you use Indiegogo) are required to report payments that exceed a threshold amount of $20,000 and 200 transactions to the IRS using Form 1099-K, Payment Card and Third Party Network Transactions.
These minimum reporting thresholds apply only to payments settled through a third-party network; there is no threshold for payment card transactions.
Form 1099-K includes the gross amount of all reportable payment transactions and is sent to the taxpayer by January 31 if payments were received during the prior calendar year. Include the amount found on your Form 1099-K when figuring your income on your tax return, generally, Schedule C, Profit or Loss from Business for most small business owners.
Don’t Get Caught Short.
If you’re thinking of using crowdfunding to raise money for your small business startup or for a personal cause, consult a tax and accounting professional first.
Don’t make the mistake of using all of your crowdfunding dollars on your project and then discovering you owe tax and have no money with which to pay it.
Tax Breaks for Hiring New Employees
If you’re thinking about hiring new employees this year, you won’t want to miss out on these tax breaks.
1. Work Opportunity Credit
The Work Opportunity Tax Credit (WOTC) is a federal tax credit for employers that hire employees from the following targeted groups of individuals:
- A member of a family that is a Qualified Food Stamp Recipient
- A member of a family that is a Qualified Aid to Families with Dependent Children (AFDC) Recipient
- Qualified Veterans
- Qualified Ex-Felons, Pardoned, Paroled or Work Release Individuals
- Vocational Rehabilitation Referrals
- Qualified Summer Youths
- Qualified Supplemental Security Income (SSI) Recipients
- Qualified Individuals living within an Empowerment Zone or Rural Renewal Community
- Long Term Family Assistance Recipient (TANF) (formerly known as Welfare to Work)
The tax credit (a maximum of $9,600) is taken as a general business credit on Form 3800 and is applied against tax liability on business income. It is limited to the amount of the business income tax liability or social security tax owed. Normal carry-back and carry-forward rules apply.
For qualified tax-exempt organizations, the credit is limited to the amount of employer social security tax owed on wages paid to all employees for the period the credit is claimed.
Also, an employer must obtain certification that an individual is a member of the targeted group before the employer may claim the credit.
Note: The Protecting Americans from Tax Hikes Act of 2015 (the PATH Act) retroactively allows eligible employers to claim the Work Opportunity Tax Credit (WOTC) for all targeted group employee categories that were in effect prior to the enactment of the PATH Act, if the individual began or begins work for the employer after December 31, 2014 and before January 1, 2020.
For tax-exempt employers, the PATH Act retroactively allows them to claim the WOTC for qualified veterans who begin work for the employer after December 31, 2014, and before January 1, 2020.
2. Payroll Tax Deduction – R & D Tax Credit
Starting in 2016, startup businesses (C-corps and S-corps) with little to no revenue that qualify for the research and development tax credit can apply the credit against employer-paid Social Security taxes instead of income tax owed. Sole proprietorships, as well as Partnerships, C-corps and S-corps with gross receipts of less than $5 million for the current year and with no gross receipts for the previous year, can take advantage of the credit. Up to $250,000 in payroll costs can be offset by the credit.
3. Disabled Access Credit and the Barrier Removal Tax Deduction
Employers that hire disabled workers might also be able to take advantage of two additional tax credits in addition to the WOTC.
The Disabled Access Credit is a non-refundable credit for small businesses that incur expenditures for the purpose of providing access to persons with disabilities. An eligible small business is one that earned $1 million or less or had no more than 30 full-time employees in the previous year; they may take the credit each, and every year they incur access expenditures. Eligible expenditures include amounts paid or incurred to:
1. Remove barriers that prevent a business from being accessible to or usable by individuals with disabilities;2. Provide qualified interpreters or other methods of making audio materials available to hearing-impaired individuals;
3. Provide qualified readers, taped texts, and other methods of making visual materials available to individuals with visual impairments; or
4. Acquire or modify equipment or devices for individuals with disabilities.
The Architectural Barrier Removal Tax Deduction encourages businesses of any size to remove architectural and transportation barriers to the mobility of persons with disabilities and the elderly. Businesses may claim a deduction of up to $15,000 a year for qualified expenses for items that normally must be capitalized. Businesses claim the deduction by listing it as a separate expense on their income tax return.
Businesses may use the Disabled Tax Credit and the Architectural/Transportation Tax Deduction together in the same tax year if the expenses meet the requirements of both sections. To use both, the deduction is equal to the difference between the total expenditures and the amount of the credit claimed.
4. Indian Employment Credit
The Indian Employment Credit provides businesses with an incentive to hire certain individuals (enrolled members of an Indian tribe or the spouse of an enrolled member) who live on or near an Indian reservation. The business does not have to be in an empowerment zone or enterprise community to qualify for the credit, which offsets the business’s federal tax liability.
The credit is 20 percent of the excess of the current qualified wages and qualified employee health insurance costs (not to exceed $20,000) over the sum of the corresponding amounts that were paid or incurred during the calendar year of 1993 (not a typo).
5. State Tax Credits
Many states use tax credits and deductions as incentives for hiring and job growth. Employers are eligible for these credits and deductions when they create new jobs and hire employees that meet certain requirements. Examples include the New Employment Credit (NEC) in California, the Kentucky Small Business Tax Credit, and Empire Zone Tax Credits in New York.
Wondering what tax breaks your business qualifies for?
Call today and speak to a tax and accounting professional you can trust.
Defer Capital Gains using Like-Kind Exchanges
If you’re a savvy investor, you probably know that you must generally report as income any mutual fund distributions whether you reinvest them or exchange shares in one fund for shares of another. In other words, you must report and pay any capital gains tax owed.
But if real estate’s your game, did you know that it’s possible to defer capital gains by taking advantage of a tax break that allows you to swap investment property on a tax-deferred basis?
Named after Section 1031 of the tax code, a like-kind exchange generally applies to real estate and was designed for people who wanted to exchange properties of equal value. If you own land in Oregon and trade it for a shopping center in Rhode Island, as long as the values of the two properties are equal, nobody pays capital gains tax even if both properties may have appreciated since they were originally purchased.
Section 1031 transactions don’t have to involve identical types of investment properties, they just have to be of “like-kind.” In other words, personal properties of a like class are like-kind properties; however, livestock of different sexes is not considered like-kind properties. Furthermore, personal property used predominantly in the United States and personal property used predominantly outside the United States are not like-kind properties. For example, you can swap an apartment building for a shopping center, or a piece of undeveloped, raw land for an office or building. You can even swap a second home that you rent out for a parking lot.
There’s also no limit as to how many times you can use a Section 1031 exchange. It’s entirely possible to roll over the gain from your investment swaps for many years and avoid paying capital gains tax until a property is finally sold. Keep in mind, however, that gain is deferred, but not forgiven, in a like-kind exchange, and you must calculate and keep track of your basis in the new property you acquired in the exchange.
Section 1031 is not for personal use. For example, you can’t use it for stocks, bonds, and other securities, or personal property (with limited exceptions such as artwork).
Properties of unequal value
Let’s say you have a small piece of property, and you want to trade up for a bigger one by exchanging it with another party. You can make the transaction without having to pay capital gains tax on the difference between the smaller property’s current market value and your lower original cost.
That’s good for you, but the other property owner doesn’t make out so well. Presumably, you will have to pay cash or assume a mortgage on the bigger property to make up the difference in value. This is referred to as “boot” in the tax trade, and your partner must pay capital gains tax on that part of the transaction.
To avoid that you could work through an intermediary who is often known as an escrow agent. Instead of a two-way deal involving a one-for-one swap, your transaction becomes a three-way deal.
Your replacement property may come from a third party through the escrow agent. Juggling numerous properties in various combinations, the escrow agent may arrange evenly valued swaps.
Under the right circumstances, you don’t even need to do an equal exchange. You can sell a property at a profit, buy a more expensive one, and defer the tax indefinitely.
You sell a property and have the cash put into an escrow account. Then the escrow agent buys another property that you want. He or she gets the title to the deed and transfers the property to you.
Mortgage and other debt
When considering a Section 1031 exchange, it’s important to take into account mortgage loans and other debt on the property you are planning to swap. Let’s say you hold a $200,000 mortgage on your existing property, but your “new” property only holds a mortgage of $150,000. Even if you’re not receiving cash from the trade, your mortgage liability has decreased by $50,000. In the eyes of the IRS, this is classified as “boot, ” and you will still be liable for capital gains tax because it is still treated as “gain.”
Advance planning required
A Section 1031 transaction takes advance planning. You must identify your replacement property within 45 days of selling your estate. Then you must close on that within 180 days. There is no grace period. If your closing gets delayed by a storm or by other unforeseen circumstances, and you cannot close in time, you’re back to a taxable sale.
Find an escrow agent that specializes in these types of transactions and contact your accountant to set up the IRS form ahead of time. Some people just sell their property, take cash and put it in their bank account. They figure that all they have to do is find a new property within 45 days and close within 180 days. But that’s not the case. As soon as “sellers” have cash in their hands, or the paperwork isn’t done right, they’ve lost their opportunity to use this provision of the code.
Personal residences and vacation homes
Section 1031 doesn’t apply to personal residences, but the IRS lets you sell your principal residence tax-free as long as the gain is under $250,000 for individuals ($500,000 if you’re married).
Section 1031 exchanges may be used for swapping vacation homes, but present a trickier situation. Here’s an example of how this might work. Let’s say you stop going to your condo at the ski resort and instead rent it out to a bona fide tenant for 12 months. In doing so, you’ve effectively converted the condo to an investment property, which you can then swap for another property under the Section 1031 exchange.
However, if you want to use your new property as a vacation home, there’s a catch. You’ll need to comply with a 2008 IRS safe harbor rule that states in each of the 12-month periods following the 1031 exchange you must rent the dwelling to someone for 14 days (or more) consecutively. In addition, you cannot use the dwelling more than the greater of 14 days or 10 percent of the number of days during the 12-month period that the dwelling unit is rented out for at fair rental price.
You must report a section 1031 exchange to the IRS on Form 8824, Like-Kind Exchanges and file it with your tax return for the year in which the exchange occurred. If you do not specifically follow the rules for like-kind exchanges, you may be held liable for taxes, penalties, and interest on your transactions.
While they may seem straightforward, like-kind exchanges can be complicated. There are all kinds of restrictions and pitfalls that you need to be careful of. If you’re considering a Section 1031 exchange or have any questions, please call.
Phone Scam Alert: Fake Certified Letters
Taxpayers should be aware of the most recent scam linked to the Electronic Federal Tax Payment System (EFTPS), where fraudsters call to demand an immediate tax payment through a prepaid debit card.
In the latest twist, the scammer claims to be from the IRS and tells the victim about two certified letters purportedly sent to the taxpayer in the mail but returned as undeliverable. The scam artist then threatens arrest if a payment is not made through a prepaid debit card. The scammer also tells the victim that the card is linked to the EFTPS system when, in fact, it is entirely controlled by the scammer. The victim is also warned not to contact their tax preparer, an attorney or their local IRS office until after the tax payment is made.
EFTPS is an automated system for paying federal taxes electronically using the Internet or by phone using the EFTPS Voice Response System. EFTPS is offered free by the U.S. Department of Treasury and does not require the purchase of a prepaid debit card. Since EFTPS is an automated system, taxpayers won’t receive a call from the IRS. In addition, taxpayers have several options for paying a real tax bill and are not required to use a specific one.
The IRS does not use email, text messages or social media to discuss personal tax issues, such as those involving bills or refunds. If you receive such as phone call, do not give out any information. Hang up immediately and contact the Treasury Inspector General for Tax Administration to report the call. Use their IRS Impersonation Scam Reporting web page. Alternatively, call 800-366-4484. You should also report it to the Federal Trade Commission. Use the FTC Complaint Assistant on FTC.gov. Please add “IRS Telephone Scam” in the notes.
Tell Tale Signs of a Scam:
The IRS (and its authorized private collection agencies) will never:
- Call to demand immediate payment using a specific payment method such as a prepaid debit card, gift card or wire transfer. The IRS does not use these methods for tax payments.
- Generally, the IRS will first mail a bill to any taxpayer who owes taxes. All tax payments should only be made payable to the U.S. Treasury and checks should never be made payable to third parties.
- Threaten to immediately bring in local police or other law-enforcement groups to have the taxpayer arrested for not paying.
- Demand that taxes be paid without giving the taxpayer the opportunity to question or appeal the amount owed.
- Ask for credit or debit card numbers over the phone.
For more information about scams, visit the “Tax Scams and Consumer Alerts” page on IRS.gov. If you believe you’ve been a victim of a phone scam, don’t hesitate to call the office for assistance.
Injured or Innocent Spouse Tax Relief: The Facts
You may be an injured spouse if you file a joint tax return and all or part of your portion of a refund was, or is expected to be, applied to your spouse’s legally enforceable past-due financial obligations. Here are seven facts about claiming injured spouse relief.
1. To be considered an injured spouse; you must have paid federal income tax or claimed a refundable tax credit, such as the Earned Income Credit or Additional Child Tax Credit on the joint return, and not be legally obligated to pay the past-due debt.
2. Special rules apply in community property states. For more information about the factors used to determine whether you are subject to community property laws, please call.
3. If you filed a joint return and you’re not responsible for the debt, but you are entitled to a portion of the refund, you may request your portion of the refund by filing Form 8379, Injured Spouse Allocation. If you need assistance filling this out, please contact the office.
4. You may file form 8379 along with your original tax return, or you may file it by itself after you receive an IRS notice about the offset.
5. You can file Form 8379 electronically. If you file a paper tax return you can include Form 8379 with your return, write “INJURED SPOUSE” at the top left of the Form 1040, 1040A or 1040EZ. IRS will process your allocation request before an offset occurs.
6. If you are filing Form 8379 by itself, it must show both spouses’ Social Security numbers in the same order as they appeared on your income tax return. You, the “injured” spouse, must sign the form.
7. Do not use Form 8379 if you are claiming innocent spouse relief. Instead, file Form 8857, Request for Innocent Spouse Relief. This relief from a joint liability applies only in certain limited circumstances. However, in 2011 the IRS eliminated the two-year time limit that applies to certain relief requests. IRS Publication 971, Innocent Spouse Relief, explains who may qualify, and how to request this relief.
Questions? Don’t hesitate to call.
Tax Tips for Legally Married Same-Sex Couples
Under a joint IRS and U.S. Department of the Treasury ruling issued in 2013, same-sex couples, legally married in jurisdictions that recognize their marriages, are treated as married for federal tax purposes, including income and gift and estate taxes. The ruling applies regardless of whether the couple lives in a jurisdiction that recognizes same-sex marriage or a jurisdiction that does not recognize same-sex marriage.
In addition, the ruling applies to all federal tax provisions where marriage is a factor, including filing status, claiming personal and dependency exemptions, taking the standard deduction, employee benefits, contributing to an IRA and claiming the earned income tax credit or child tax credit.
Any same-sex marriage legally entered into in one of the 50 states, the District of Columbia, a U.S. territory or a foreign country is covered by the ruling. However, the ruling does not apply to registered domestic partnerships, civil unions or similar formal relationships recognized under state law.
Legally-married same-sex couples generally must file their federal income tax return using either the married filing jointly or married filing separately filing status.
Individuals who were in same-sex marriages may, but are not required to, file original or amended returns choosing to be treated as married for federal tax purposes for one or more prior tax years still open under the statute of limitations.
Generally, the statute of limitations for filing a refund claim is three years from the date the return was filed or two years from the date the tax was paid, whichever is later. As a result, refund claims can still be filed for tax years 2014, 2015 and 2016. Some taxpayers may have special circumstances, such as signing an agreement with the IRS to keep the statute of limitations open, which permit them to file refund claims for earlier tax years.
In addition, employees who purchased same-sex spouse health insurance coverage from their employers on an after-tax basis may treat the amounts paid for that coverage as pre-tax and excludable from income.
If you need to file a claim for a refund or have any questions about the IRS ruling, please call for assistance.
The Simplified Option for Home Office Deduction
If you’re one of the more than 3.4 million taxpayers who claimed deductions for business use of a home (commonly referred to as the home office deduction)–but haven’t taken advantage of it because you thought it was too complicated–then you might be interested in the simplified option.
Available since tax year 2013, the optional home office deduction is capped at $1,500 per year and is based on $5 a square foot for up to 300 square feet of office space.
Currently, taxpayers claiming the home office deduction are generally required to fill out a 43-line form (Form 8829, Expenses for Business Use of Your Home) often with complex calculations of allocated expenses, depreciation, and carryovers of unused deductions. Taxpayers claiming the optional deduction complete a significantly simplified form requiring taxpayers to complete a short worksheet in the tax instructions, and then enter the result on the tax return. There is a special calculation for daycare providers.
Self-employed individuals claim the home office deduction on Form 1040, Schedule C, Line 30; farmers claim it on Schedule F, Line 32 and eligible employees claim it on Schedule A, Line 21.
Though homeowners using the new option cannot depreciate the portion of their home used in a trade or business, they can claim allowable mortgage interest, real estate taxes and casualty losses on the home as itemized deductions on Schedule A. These deductions need not be allocated between personal and business use, as is required under the regular method. Business expenses unrelated to the home, such as advertising, supplies, and wages paid to employees are still fully deductible.
Current restrictions on the home office deduction, such as the requirement that a home office must be used regularly and exclusively for business and the limit tied to the income derived from the particular business, still apply under the new option.
Regardless of the method used to compute the deduction, business expenses in excess of the gross income limitations are not deductible. Deductible expenses for business use of a home include the business portion of real estate taxes, mortgage interest, rent, casualty losses, utilities, insurance, depreciation, maintenance, and repairs. In general, expenses for the parts of the home not used for business are not deductible.Deductions for business storage are deductible when the dwelling unit is the sole fixed location of the business or for regular use of a residence for the provision of daycare services; exclusive use isn’t required in these cases.
Please contact the office if you would like more details about the simplified home office deduction.
Small Business Tax Tips: Payroll Expenses
Federal law requires most employers to withhold federal taxes from their employees’ wages. Whether you’re a small business owner who’s just starting out or one who has been in business a while and is ready to hire an employee or two, here are five things you should know about withholding, reporting, and paying employment taxes.
1. Federal Income Tax. Small businesses first need to figure out how much tax to withhold. Small business employers can better understand the process by starting with an employee’s Form W-4 and the withholding tables described in Publication 15, Employer’s Tax Guide. Please call if you need help understanding withholding tables.
2. Social Security and Medicare Taxes. Most employers also withhold social security and Medicare taxes from employees’ wages and deposit them along with the employers’ matching share. In 2013, employers became responsible for withholding the Additional Medicare Tax on wages that exceed a threshold amount as well. There is no employer match for the Additional Medicare Tax, and certain types of wages and compensation are not subject to withholding.
3. Federal Unemployment (FUTA) Tax. Employers report and pay FUTA tax separately from other taxes. Employees do not pay this tax or have it withheld from their pay. Businesses pay FUTA taxes from their own funds.
4. Depositing Employment Taxes. Generally, employers pay employment taxes by making federal tax deposits through the Electronic Federal Tax Payment System (EFTPS). The amount of taxes withheld during a prior one-year period determines when to make the deposits. Publication 3151-A, The ABCs of FTDs: Resource Guide for Understanding Federal Tax Deposits and the IRS Tax Calendar for Businesses and Self-Employed are helpful tools.
Failure to make a timely deposit can mean being subject to a failure-to-deposit penalty of up to 15 percent. But the penalty can be waived if an employer has a history of filing required returns and making tax payments on time. Penalty relief is available, however. Please call the office for more information.
5. Reporting Employment Taxes. Generally, employers report wages and compensation paid to an employee by filing the required forms with the IRS. E-filing Forms 940, 941, 943, 944 and 945 is an easy, secure and accurate way to file employment tax forms. Employers filing quarterly tax returns with an estimated total of $1,000 or less for the calendar year may now request to file Form 944,Employer’s ANNUAL Federal Tax Return once a year instead. At the end of the year, the employer must provide employees with Form W-2, Wage and Tax Statement, to report wages, tips, and other compensation. Small businesses file Forms W-2 and Form W-3, Transmittal of Wage and Tax Statements, with the Social Security Administration and if required, state or local tax departments.
Questions about payroll taxes?
If you have any questions about payroll taxes, please contact the office.
How to Keep Your QuickBooks Data Safe
Your QuickBooks company file contains some of the most sensitive information on your computer. You may have customers’ credit card numbers and employees’ Social Security numbers. An intruder who captured all that data could create tremendous problems for you and a lot of other people.
That’s probably the worst-case scenario. But other situations could also spell disaster for your business, which involves losing your company data through fraud, hacking, or simple technical failures.
The importance of protecting your QuickBooks company file, especially your customer and payroll information, cannot be overstated. Whether someone steals it or it’s inaccessible for another reason, it’s gone. Keeping your business going after such a loss would be very difficult – maybe even impossible. The tips below should help prevent that from happening.
No business owner wants to believe that his or her employees could use their QuickBooks access to commit fraud. But it happens. Your company file contains credit card and checking account data that could be used for nefarious purposes. As we discussed last spring, you can restrict user access to specific areas and actions of QuickBooks.
Figure 1: You can limit your employees who have QuickBooks access to certain areas and activities.
To get started, open the Company menu and select Set Up Users and Passwords | Set Up Users. The User List window opens. It should have at least one entry there, for you (Admin). Click Add User and enter the employee’s name and password in the next window that opens, and then click Next.
Tip: Your QuickBooks license limits you to a specified number of users. If you’re not sure how many you’re allowed, click F2 to open the Product Information page. The number of user licenses that you’ve paid for appears in the upper left.
On the next page of this wizard, click the button in front of Selected Areas of QuickBooks. The following screens will let you define that employee’s access permissions in areas such as Sales and Accounts Receivable, Inventor, and Payroll and Employees. When you’ve clicked through every screen and reviewed the summary displayed, click Finish. Your user will now be able to sign in and access the areas you specified.
You can–and should–take numerous other steps to keep your QuickBooks data safe. If your company is big enough to have a dedicated IT expert, he or she will handle most of this. But there’s a lot you can do on your own to prevent data loss and theft.
Keep Your Operating System and Applications Updated
Figure 2: Don’t ignore this dialog box.
Software companies’ occasional updates offer more than just adding new features and fixing bugs. They sometimes refresh your software to ensure greater security based on new threats. Don’t forget about those all-important antivirus and anti-malware applications, as well as QuickBooks itself.
Keep Your Networks Safe
Just as a cold virus spreads around your office, so too, can unwanted intrusions like computer viruses. Don’t allow an electronic epidemic to get started; take these steps ahead of time to prevent it:
- Discourage employees from excessive web browsing. This can be a hard rule to enforce, as some employees probably need internet access for research, timecard entry, and other work-related tasks. Create a firm policy legislating what workers can and can’t do on company-issued equipment (including tablets and smartphones) or any personal devices that use your wireless network.
- Ask employees to refrain from using public networks on work equipment. Enforce the rules vigorously, and make compliance an element of performance evaluations.
- Minimize app installations on business smartphones. Employees should ask for approval. Viruses and malware get in that way, as well as through some websites and email attachments.
- Use monitoring software. If you can’t afford to pay for “managed IT” (a la carte, third-party IT services), install an application that alerts you to problems.
Use Common Sense
You can fight data loss and theft by being cautious. Be diligent about backups, and if you create them on a local, portable device, don’t leave them in the office; cloud-based storage is a better solution. Shred papers that have sensitive information on them. Log out of QuickBooks when you’re not using it or when you leave your office. Be aware of who may be around you, looking over your shoulder.
Data security is a serious matter. Don’t hesitate to call if you are at all concerned with your own data safety.
Tips for posting on social media
Concerned about the safety of your QuickBooks data when posting on social media? Find out what security measures you can take by calling the office today. If you lose your QuickBooks data and you’ll face serious consequences, so make sure you keep backups in a safe place.
Do you issue smartphones to employees? Make sure they’re not used on public networks.
Finally, even if you don’t have an IT specialist, you can still protect your QuickBooks data from viruses and malware. Call today and find out how.
Tax Due Dates for July 2017
Employees Who Work for Tips – If you received $20 or more in tips during June, report them to your employer. You can use Form 4070.
Employers – Nonpayroll withholding. If the monthly deposit rule applies, deposit the tax for payments in June.
Employers – Social Security, Medicare, and withheld income tax. If the monthly deposit rule applies, deposit the tax for payments in June.
Employers – Social Security, Medicare, and withheld income tax. File Form 941 for the second quarter of 2017. Deposit any undeposited tax. (If your tax liability is less than $2,500, you can pay it in full with a timely filed return.) If you deposited the tax for the quarter in full and on time, you have until August 10 to file the return.
Employers – Federal unemployment tax. Deposit the tax owed through June if more than $500.
Employers – If you maintain an employee benefit plan, such as a pension, profit-sharing, or stock bonus plan, file Form 5500 or 5500-EZ for calendar-year 2016. If you use a fiscal year as your plan year, file the form by the last day of the seventh month after the plan year ends.
Certain Small Employers – Deposit any undeposited tax if your tax liability is $2,500 or more for 2017 but less than $2,500 for the second quarter.
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