Harless Tax Blog

Harless Tax Blog

Is Your Business A Hobby in the Eyes of the IRS?

Thursday, July 31, 2014

Investing in a “side business” when the main source of your net worth is derived from other businesses may result in a target on your back from the IRS. The Service continues to audit specific activities at a very high rate that have elements of pleasure, recreation or a hobby. Activities such as aviation, boat chartering, equine activities and vacation rentals are typically scrutinized under IRC Section 183, otherwise known as the hobby loss rules. 

Typically, an activity will be reviewed over a period of years. In general, Section 183 of the Internal Revenue Code, enacted in 1969, provides that if a business engaged in by an individual, partnership or subchapter S corporation shows a profit in two years within a five year period (beginning with the first profit year), it will be presumed to be engaged in for profit, with a separate special election available for a new enterprise. If the activity is one engaged in for profit, then losses resulting from the business may be deducted from other income. Note that this period is extended to seven years in an agricultural business such as a farm or horse breeding operation.

Fortunately, we are not dealing in absolutes. Basically, without profits, the burden of proof shifts to the taxpayer in an audit situation to show that this is a business with a profit motive. The IRS regulations provide nine objective factors which have been used in the Courts to determine whether or not an activity is engaged in for profit.

1. THE MANNER IN WHICH THE TAXPAYER CARRIES ON THE ACTIVITY.

2. THE EXPERTISE OF THE TAXPAYER OR HIS ADVISORS.

3. THE TIME AND EFFORT EXPENDED BY THE TAXPAYER IN CARRYING ON THE ACTIVITY.

4. EXPECTATION THAT THE ASSETS USED IN ACTIVITY WILL INCREASE IN VALUE.

5. THE SUCCESS OF THE TAXPAYER IN OTHER ACTIVITIES.

6. THE TAXPAYER'S HISTORY OF INCOME OR LOSSES IN THIS ACTIVITY.

7. THE AMOUNT OF OCCASIONAL PROFITS, IF ANY, WHICH ARE EARNED.

8. THE FINANCIAL STATUS OF THE TAXPAYER.

9. ELEMENTS OF PERSONAL PLEASURE OR RECREATION.

The IRS does not add up positive and negative factors. Court cases have typically focused on the manner in which the taxpayer carries on the activity. Therefore, it is important to create a business plan, maintain accurate books and records, track time and effort, and make appropriate adjustments each year with a profit motive in mind. Devote considerable time to the business, even withdraw or reduce your time in other businesses, to demonstrate your commitment to the activity. If there is a legitimate reason for losses, document these reasons, such as accidents, economic downturns, and other setbacks.

It is important to note that experts, such as a Certified Public Accountant, should be engaged from the outset to establish a good defense should there be an audit. This is typically not a “do-it-yourself project.” Trusted advisors can assist with a business plan so that solid financial projections are developed, a marketing plan is established, accounting software is used, and a separation of business and personal income and expenses. An advisor can also assist with the timing of income and deductions to aid in developing profit years.

If you do receive the dreaded audit notice, all is not lost. At the agent/manager level, the process tends to be very robotic, a review of the factors above, a checklist of sorts. The Service has become very aggressive and economic substance is very real. For this reason, settlement at this level may not be recommended. To be successful, the accountant can perform an economic study for the industry and can minimize weaknesses in the specific situation. Engage experts who have expertise in the audit and appeals process. In a strong case, legal counsel can be retained specifically trained in the Tax Court arena. 

In summary, establish your purpose for starting this business, form a business plan, and be flexible enough to adjust operations with a goal towards a profitable business.

Tips on Travel While Giving to Charity

Monday, July 21, 2014


Do you plan to donate your services to charity this summer? Will you travel as part of the service? If so, some travel expenses may help lower your taxes when you file your tax return next year. Here are five tax tips you should know if you travel while giving your services to charity.

1. You can’t deduct the value of your services that you give to charity. But you may be able to deduct some out-of-pocket costs you pay to give your services. This can include the cost of travel. All out-of pocket costs must be:

• unreimbursed,

• directly connected with the services,

• expenses you had only because of the services you gave, and

• not personal, living or family expenses.

2. Your volunteer work must be for a qualified charity. Most groups other than churches and governments must apply to the IRS to become qualified. Ask the group about its IRS status before you donate. You can also use the Select Check tool on IRS.gov to check the group’s status.

3. Some types of travel do not qualify for a tax deduction. For example, you can’t deduct your costs if a significant part of the trip involves recreation or a vacation. For more on these rules see Publication 526, Charitable Contributions.

4. You can deduct your travel expenses if your work is real and substantial throughout the trip. You can’t deduct expenses if you only have nominal duties or do not have any duties for significant parts of the trip.

5. Deductible travel expenses may include:

• air, rail and bus transportation,

• car expenses,

• lodging costs,

• the cost of meals, and

• taxi or other transportation costs between the airport or station and your hotel.

For more see Publication 526, Charitable Contributions. You can get it on IRS.gov or by calling 800-TAX-FORM (800-829-3676).

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LTC Options

Wednesday, July 16, 2014

[source: FA-Mag.com]
Annuities
For those who cannot qualify for insurance, an annuity with an attached LTC or “confinement care” rider might make the most sense. The latter is similar to the chronic-care option. A fixed indexed annuity with an income rider that can also be used for confinement care will double the contractual income guarantee when the confinement care is triggered. That happens whenever the insured person can no longer do two of six activities done in daily living—bathing, dressing, toileting, continence, feeding and transferring out of or into bed.

“Only by spending some quality time with one’s professional advisor can a decision be made,” says W. Allen Johnson, executive vice president at iTrust Advisors in Syracuse, N.Y. “If an annuity is recommended as part of the financial plan, then the withdrawal features for a chronic illness should be explored.”

In general, these annuities function much like their life-insurance counterparts. They don’t require a physical exam but do require a large up-front investment. On the other hand, premiums never increase. “Generally, the LTC component is two or three times the face value of the annuity,” says Melchiorre. “If you don’t use that component, you can redeem the accumulated value of the annuity down the road or annuitize it to get income for other purposes.”

This option has swelled in popularity since a 2010 ruling that classified withdrawals for qualifying LTC expenses as tax free—unlike confinement-care benefits, which are taxable. Either way, the distributions reduce the annuity’s accumulated value.

Deciding among all these options depends on where your clients are coming from. “Let’s say they have held an annuity they bought at 55 for 10 years, which now has a death benefit of $100,000,” says Steve Williams, vice president of Financial Planning Strategy at BMO Private Bank in Chicago. “And now that they are age 65, they start to worry about [an] LTC event. By doing a 1035 [tax-free] exchange to an annuity with LTC rider, they can typically get anywhere from $300,000 to $400,000 LTC coverage. If it is new money, then the permanent policy [universal or whole] with [an] LTC rider is typically a better option.”

Leveraging Life Insurance Cash Value
Even if you reject these hybrid options, life insurance can still be used to help fund LTC expenses. First, accelerated death benefits—usually available at an additional cost—allow you to take “a tax-free advance on your death benefit while you’re still alive,” says Melchiorre, “but you must be terminally ill or severely cognitively impaired.” In most cases, eligibility must be recertified annually. (“Terminally ill” is typically defined as having less than two years to live.)

Generally capped at 50% of the total death benefit, the distributions usually go for an immediate need, though at times they can be used for monthly LTC services. There are “limitations on what is considered covered or qualified care,” says Celeste Moya, vice president of product analysis at NFP International Insurance Solutions in Austin, Texas. “Qualified care generally includes care within a facility—nursing home, hospice care, etc.—and expenses related to room and board at any one of these facilities. However, there is no standard across the industry.”

Another option for the chronically or terminally ill is a viatical settlement or, for those with a less urgent need, a life settlement. Both are ways of selling a life policy to a third party. They are solutions of last resort. Many desperate senior citizens have been swindled. “The amount of the sale must be greater than the cash surrender value of the insurance policy, but less than the death benefit,” Melchiorre says. With viatical settlements, you may receive between 60% and 90% of the policy’s face value. If you are terminally ill, the proceeds are not subject to tax. If you’re chronically ill but not deemed terminal, the proceeds are only tax-free if used to pay for LTC needs that aren’t covered by other insurance.

LTC Benefit Accounts
Life policies with a cash value can also be converted to an LTC benefit account—a “privately funded irrevocable account funded by the sale of a life insurance policy,” says Chris Orestis, CEO of Life Care Funding, a senior care advocacy group in Portland, Maine.

The account is held by a professional administrator, who makes monthly tax-free payments on your behalf directly to LTC providers you designate. All levels of care and health conditions are eligible. Even funeral expenses are included. There are no premiums, and most types of insurance qualify for conversion, including group and term plans. It’s an allowed method for spending down assets to qualify for Medicaid, too, unlike other uses of a life policy’s cash value.

But your need for care must be imminent, if not immediate.

Treasury: Retirement Accounts Can Include Longevity Annuities To Limit Drawdowns

Friday, July 11, 2014

Retirees with 401(k) plans and individual retirement accounts will have more flexibility to purchase annuities that don’t start paying out until age 80 or 85, under final rules from the U.S. Treasury Department. {Source: Financial Advisor}

The rules announced today provide a new way for retirees to limit the drawdowns of their account balances that are now required starting after age 70 1/2. Instead, under the rules, they could use as much as 25 percent of their account balances up to $125,000 to purchase deferred annuities.

“As boomers approach retirement and life expectancies increase, longevity income annuities can be an important option to help Americans plan for retirement and ensure they have a regular stream of income for as long as they live,” Mark Iwry, deputy assistant Treasury secretary for retirement policy, said in a statement.

The Treasury Department’s final rules give the government’s blessing to the concept of longevity insurance, which hasn’t taken hold in the market, in part because of the required distribution rules and because of relatively high fees that deter potential purchasers.

About one in five 401(k) plans offers annuities as a choice, according to the Treasury Department.

Longevity annuities carry some risk, primarily that the retiree will die before receiving a payout. The final rules, first proposed in 2012, allow for return of premiums as a death benefit.

New York Life Insurance Co. was the largest seller of deferred-income annuities last year, followed by Massachusetts Mutual Life Insurance Co. and Northwestern Mutual Life Insurance Co., according to data from the Limra Secure Retirement Institute.

Those three companies account for 90 percent of the market, according to Limra.

Iwry announced the final rule at a conference of the Insured Retirement Institute, whose members include MetLife Inc. and American International Group Inc.

In Bankruptcy, Inherited IRAs Are Up For Grabs

Friday, June 27, 2014



Are inherited IRAs protected from bankruptcy creditors? Earlier this month, the U.S. Supreme Court said no. (Clark v. Rameker, 6/12/14.) [Source: Investors Business Daily]

So IRA owners may want to reconsider their beneficiary designations. Despite the added cost and complexity, leaving your IRA to a trust can be a safe move.

To grasp the issue, consider a hypothetical Art Young, who has a sizable IRA. If Young files for bankruptcy, that account likely will be beyond creditors' reach.

"The bankruptcy act of 2005 said that retirement funds are protected from creditors," said Ed Slott, an IRA expert in Rockville Centre, N.Y.

Bankruptcy filers are allowed to keep certain assets to meet basic needs and make it less likely they'll need public support.

Now suppose that Young dies after naming his son Brad as his IRA beneficiary. If Brad subsequently files for bankruptcy, does the IRA he inherited from his father still qualify as a retirement fund, exempt from creditors?

The Supreme Court unanimously turned thumbs down. Three reasons were given for denying that beneficiaries hold protected retirement funds.

First, an IRA beneficiary who inherits can't make additional contributions to that account. Qualified individuals can put money into retirement accounts such as traditional IRAs and Roth IRAs. Tax breaks encourage such outlays.

But inherited IRAs are only for withdrawals.

Second, beneficiaries must take minimum distributions and pay any resulting tax, regardless of age. "Even a 5-year-old IRA beneficiary, who certainly isn't retired, must withdraw something," Slott said.

Third, the 10% early withdrawal penalty doesn't apply to inherited IRAs. Unless certain exceptions are met, withdrawals from traditional and Roth IRAs before age 59-1/2 will lead to fines.

"Nothing about the inherited IRA's legal characteristics would prevent (or even discourage) the individual from using the entire balance of the account on a vacation home or sports car immediately after her bankruptcy proceedings are complete," the Supreme Court noted in its opinion.

Turning To A Trust

The bottom line is that the Supreme Court has ruled that inherited IRAs are much different than traditional or Roth IRAs. Thus, inherited IRAs don't qualify as retirement funds for a bankruptcy exemption.

What does this mean for IRA owners? You might want to evaluate your current IRA beneficiaries to see if they're likely to run into financial difficulties.

"Often, IRA beneficiaries are not as careful with the money as the people who earned it," Slott said.

If you think future financial problems could surface, one approach is to designate an irrevocable trust as your IRA beneficiary. The people for whom the money is intended can be named as trust beneficiaries.

Why A Partnership Loss May Not Be Deductible

Thursday, June 12, 2014

When an individual receives a Schedule K-1 from a partnership reflecting a loss, there are several things to consider before deciding if the loss can be deducted. In order to determine deductibility, a partner's basis and at risk limitations need to be evaluated. See original Article here from Accounting Today>

First and foremost, a partner must have adequate basis in the partnership in order to consider the deductibility of the partnership loss. A taxpayer's tax basis in a partnership interest (often called the partner's outside basis) represents the partner's cost for tax purposes and is used to measure the taxable gain or loss upon disposition of the partnership interest.

In addition, a partner's tax basis can (1) limit the partner's ability to deduct a partnership loss; (2) cause a cash distribution to be taxable instead of tax-free; and (3) affect the basis of property received as a distribution.

A partner's initial basis equals the amount of money contributed, plus the adjusted basis of property contributed, plus the partner's share of the partnership's liabilities.

All liabilities of the partnership are classified into three categories. First is recourse debt, which is debt that a partner would be responsible to pay back if there is an economic risk of loss on the debt, such as security deposits and loans made by partners to the partnership.

Next is nonrecourse debt, which is debt a partner is not liable to repay if the entity cannot. The last type of liability is qualified non-recourse debt, such as a mortgage held by a financial institution.

Typically, all three types of liabilities are allocated to the partners in the same proportion as the profit and loss allocation, except for recourse debt, which is allocated based on whoever bears the risk of economic loss.

Once a partner passes the basis test, the next test to be applied is that of the “at risk” rules of Section 465 of the Tax Code. The at-risk rules are applicable at the partner level, rather than the partnership level, and are designed to ensure that a taxpayer deducts losses only to the extent he or she is economically or actually at risk for the investment.

A partner is considered at risk with respect to an activity for (1) the amount of money and the adjusted basis of other property contributed to the activity; and (2) amounts borrowed for use in the activity if the partner is personally liable for repayment of the borrowed amount or has pledged property, other than property that is used in the activity, as security for the borrowed amount. The primary distinction between basis and at risk— thereby causing losses to be deductible for one while not the other—are the nonrecourse liabilities. A partner's share of the nonrecourse liabilities can increase their basis, but not the at risk limitation. In order to deduct these losses, partners may be tempted to guarantee partnership debt. Depending on the type of partnership, limited partnership (LP) or limited liability company (LLC), the impact on the at risk limitation can be different than the desired result.

In a recent IRS communication, the IRS distinguished the LLC guarantee from a debt guarantee in a limited partnership. Generally a limited partner in an LP who guarantees partnership debt is not at risk with respect to the guaranteed debt, because the limited partner has a right to seek reimbursement from the partnership and the general partner for any amounts that the limited partner is called upon to pay under the guarantee. However, in the case of an LLC, all members have limited liability with respect to LLC debt. In the absence of any co-guarantors or another similar arrangement, an LLC member who guarantees LLC debt becomes personally liable for the guaranteed debt and is therefore at risk in relation to the debt.

As you can probably tell, this is a very complex area, and navigating the rules should be done in coordinated consultations between the client’s attorney and tax advisor. We do recommend that clients consult with a tax advisor to discuss their liabilities to ensure their basis and at risk limitations are being properly reported.

Christie Butcher, CPA, MST, is a senior tax manager at Kessler Orlean Silver CPAs, in Deerfield, Ill. She can be contacted at cbutcher@koscpa.com.

Discrepancies Seen in Nearly Half of Alimony Deductions Reported to IRS

Thursday, May 15, 2014

Nearly half the tax returns on which individuals claimed tax deductions for alimony payments did not match up with their former spouse’s tax returns, showing a total “alimony gap” of over $2.3 billion in 2010, according to a new government report.  by J. Russell George  See Original Article here from Accounting Today >

The report, from the Treasury Inspector General for Tax Administration, found 266,190 tax returns for 2010 in which individuals claimed alimony deductions for which income was not reported on a corresponding recipient’s tax return, or the amount of alimony income that was reported did not agree with the amount of the deduction taken. The 266,190 returns represented approximately 47 percent of all tax returns on which alimony deductions were claimed. In tax year 2010, 567,887 taxpayers claimed alimony deductions totaling more than $10 billion.

TIGTA initiated the audit to evaluate whether there is an alimony reporting gap and to assess controls the Internal Revenue Service has in place to promote alimony reporting compliance. Apart from examining a small number of tax returns, the IRS generally has no processes or procedures to address this substantial compliance gap, TIGTA found.

IRS processes also do not ensure that individuals provide a valid recipient Taxpayer Identification Number, or TIN, when claiming an alimony deduction as required. TIGTA’s analysis of the 567,887 tax year 2010 returns that claimed an alimony deduction identified an estimated 6,500 tax returns claiming an alimony deduction for which the IRS did not identify that the recipient TIN was missing or invalid. In addition, because of errors in IRS processing instructions, the IRS did not assess penalties totaling $324,900 on individuals who did not provide a valid recipient TIN as required.

Individuals who pay alimony can deduct the amount paid from income on their tax return to reduce the amount of tax an individual must pay. Alimony recipients must, in turn, claim the amount received as income on their tax return. An alimony income reporting discrepancy occurs either when individuals claim deductions for alimony which they did not pay or individuals do not report alimony income they received.

“The number and size of the alimony reporting discrepancies on federal tax returns is a concern,” said TIGTA Inspector General J. Russell George in a statement. “The IRS should consider the use of less costly processes, including notifying taxpayers of apparent discrepancies, to expand its ability to address the issue.”

TIGTA recommended that the IRS evaluate its current examination filters to ensure that potentially high-risk tax returns are not inappropriately excluded from examination and develop a strategy to address the significant alimony compliance gap. TIGTA also recommended that the IRS revise processes and procedures to verify that all tax returns include a valid recipient TIN when claiming an alimony deduction and correct errors in IRS processing instructions to ensure that a penalty is accurately assessed on all tax returns on which a valid recipient TIN is not provided.The IRS agreed with three of TIGTA’s recommendations and disagreed with one recommendation. The IRS stated that it enhanced its examination filters and will continue to review and improve its strategy to reduce the compliance gap. In addition, the IRS revised procedures to ensure that penalties are assessed when appropriate. However, because the IRS does not have the authority to deny alimony deductions outside of deficiency processing, it believes verification of the deduction is more efficiently performed in its compliance function.“We have implemented a strategy to address this gap which includes usage of a number of examination filters which we have developed and refined to isolate the most egregious returns for compliance activity,” wrote Karen Schiller, commissioner of the IRS’s Small Business/Self-Employed Division, in response to the report. “... We continue to monitor these examination filters to ensure our strategy adequately addresses the alimony reporting compliance gap.”

However, Schiller disagreed with some of the outcome measures in the TIGTA report and pointed out that the Tax Code does not make the alimony deduction dependent on the provision of the recipient’s Taxpayer Identification Number, so the IRS does not have the authority to deny an alimony deduction during return processing when the payer fails to furnish a valid TIN for the recipient.

“We, therefore, are not able to revise our procedures to deny the alimony deduction if the TIN is not present,” she pointed out. “We have, however, revised our processing instructions to ensure the penalty for failure to provide the recipient TIN is assessed on all applicable returns.”

IRS Expects Millions of Amended Tax Returns

Wednesday, April 30, 2014


The Internal Revenue Service anticipates that nearly 5 million taxpayers will amend their returns by filing Form 1040X this year. [source: AccountingToday.com]

Nearly 46 million returns were electronically filed from home computers as of April 18, more than the total from home computers for all of 2013. The IRS said Friday that it has received more than 131 million tax returns, of which 88 percent were e-filed.

Taxpayers who need to amend their returns should file this form only after filing the original return, the IRS noted. Generally, for a tax credit or refund, taxpayers must file Form 1040X within three years, including extensions, after the date they filed their original return or within two years after the date they paid the tax, whichever is later. For most people, this means that returns for tax-year 2011 or later can still be amended. 

This year, many same-sex couples may want to consider filing amended returns. A same-sex couple, legally married in a state or foreign country that recognizes their marriage, is now considered married for tax purposes. This is true regardless of whether or not the couple lives in a jurisdiction that recognizes same-sex marriage.

For tax returns originally filed before Sept. 16, 2013, legally married same sex couples have the option of filing amended return to change their filing status to married filing separately or married filing jointly. But they are not required to change their filing status on a prior return, even if they amend that return for another reason. In either case, their amended return must be consistent with the filing status they have chosen. Further details are available on IRS.gov.

As all amended returns must be filed on paper, allow up to 12 weeks for Form 1040X to be processed.  Starting 3 weeks after filing their amended returns, taxpayers can use the “Where’s My Amended Tax Return?” tool on IRS.gov to check the status.

Harless & Associates Appoints Donna Holm Director of Tax

Tuesday, April 29, 2014

Harless & Associates is pleased to announce the appointment of Donna Holm, CPA, MST to Director of Tax for the West Palm Beach offices serving all of South Florida. Holm joined Harless & Associates less than one year ago as an Associate. 

“Donna has been a vital asset to our team at Harless & Associates and has been particularly active in reaching the community through lectures and articles,” said Managing Partner Steve Harless. “Her work assisting women and seniors with complicated tax matters has provided us with an important area of expertise. We are thrilled that Donna has accepted the position of Director of Tax and look forward to many future years serving the South Florida community.”   

Holm graduated with honors from St. Thomas University with a dual BS in Accounting and Business Management and with honors from Florida International University with an MS in Taxation. She has more than 30 years experience in both the public and private sectors, putting that knowledge to use as an Adjunct Professor at Florida Atlantic University, providing instruction in the taxation of individuals, corporations, partnerships, estates and trusts. She began her career with the Internal Revenue Service, moving on to public accounting firms and also owned a CPA practice for more than 10 years. With expertise in healthcare, she has a served as Chief Financial Officer for physician practices, receiving an award for Best Practices from the Medical Group Management Association. Additionally, Holm is a Certified Senior Advisor. Active in various chambers and community organizations, she has been involved in Palm Beach County for nearly 20 years. 

10 Tips for Taxpayers who Owe

Thursday, April 17, 2014

Owing money on your taxes is never fun, and if you've never owed anything before you may be left questioning exactly what to do. Where do you send the money? Sited from AccountingToday.com, here are 10 tips for taxpayers who owe taxes with their tax returns that were provided by the IRS.

  1. Taxpayers should never send cash.
  2. If taxpayers e-file, they can file and pay in a single step with an electronic funds withdrawal. If they e-file on their own, they can use their tax preparation software to make the withdrawal. If they use a tax preparer to e-file, they can ask the preparer to make their tax payment electronically.
  3. Taxpayers can pay taxes electronically 24/7 on IRS.gov. Just click on the ‘Payments’ tab near the top left of the home page for details.
  4. They can also pay by check or money order. They should make their check or money order payable to the “United States Treasury.”
  5. Whether they e-file their tax return or file on paper, taxpayers can also pay with a credit or debit card. The company that processes their payment will charge a processing fee.
  6. Taxpayers may be able to deduct the credit or debit card processing fee on next year’s return. It’s claimed on Schedule A, Itemized Deductions. The fee is a miscellaneous itemized deduction subject to the 2 percent limit.
  7. Taxpayers should be sure to write their name, address and daytime phone number on the front of their payment. Also, they should write the tax year, form number they are filing and their Social Security number.
  8. Taxpayers should complete Form 1040-V, Payment Voucher, and mail it with their tax return and payment to the IRS. They should make sure they send it to the address listed on the back of Form 1040-V. This will help the IRS process their payment and post it to their account. The form is available on IRS.gov.
  9. The IRS reminds taxpayers to enclose payment with their tax return but do not staple it to any tax form.
  10. For more information, call 800-829-4477 and select TeleTax Topic158, Ensuring Proper Credit of Payments. You can also get information in the instructions for Form 1040-V.