Income from Foreign Sources

by Kenneth Hoffman in , , ,


Many U.S. citizens earn money from foreign sources. But unless it is exempt under federal law, taxpayers sometimes forget that they have to report all such income on their tax return.

As such, some U.S. taxpayers living abroad have failed to timely file U.S. federal income tax returns or Reports of Foreign Bank and Financial Accounts (FBARs). Some of these taxpayers have recently become aware of their filing requirements and want to comply with the law.

Effective September 1, 2012, taxpayers who are low compliance risks are able to get current with their tax requirements without facing penalties or additional enforcement action. These taxpayers generally have simple tax returns and owe $1,500 or less in tax for any of the covered years.

U.S. citizens are taxed on their income regardless of whether they live inside or outside the United States. The foreign income rule also applies regardless of whether the person receives a Form W-2, Wage and Tax Statement, or Form 1099.

Foreign source income includes earned and unearned income, such as:

  • Wages and tips
  • Interest
  • Dividends
  • Capital gains
  • Pensions
  • Rents
  • Royalties

But there is some good news. Citizens living outside the United States may be able to exclude up to $95,100 of their 2012 foreign source income if they meet certain requirements. This will increase to $97,600 in 2013.

If you're married and you and your spouse both work abroad and meet either the bona fide residence test or the physical presence test, each of you can choose the foreign earned income exclusion. Together, you can exclude as much as $190,200 for the 2012 tax year.

If you earn income from outside the country, please be sure to meet with me about it. I can advise you on how to address all of the tax implications of this situation.

Kenneth Hoffman counsels Entrepreneurs, Professionals and Select Individuals in taking control of their taxes, and businesses. Discover how I can help you overcome your tax and business challenges. To start the conversation or to become a client, call Kenneth Hoffman at (954) 591-8290 Monday - Friday between 8:30 a.m. to 1:00 p.m. for a no cost consultation, or drop me a note.

If you found this article helpful, I invite you to leave a commit and  please share it on twitter, facebook or your favorite social media site and  with your friends, family and colleagues. Thank you.


Tax Issues and the Home Office

by Kenneth Hoffman in , ,


With unemployment still near the highest rate in decades, it is not surprising to find many people working out of their homes. Now may be a good time to review the criteria for claiming a deduction for the business use of part of a person’s residence.

Your home office must be used in a trade or business activity. You cannot take a deduction if you use your home for a profit-seeking activity that is not a trade or business. For example, if you use part of your home to manage your personal investments, you cannot take a home office deduction.

The home office must be used regularly and exclusively for business. You must regularly use a room or other separately identifiable area of your home only for your business. You do not meet this requirement if you use the area for both business and personal purposes. For example, an attorney who writes legal briefs at the kitchen table cannot claim a home office deduction for the kitchen.

You do not have to meet the exclusive-use test if you use part of your home to store inventory or product samples or as a day care facility.

Your home office must be one of the following:

  • Your principal place of business. Your home office also will qualify as your principal place of business if you use it regularly for administrative activities and you have no other fixed location where you conduct substantial administrative activities; or
  • A place to meet with patients, clients or customers in the normal course of your business. Using your home for occasional meetings and telephone calls is insufficient; or
  • A separate structure not attached to the dwelling unit used for trade or business purposes. The structure does not have to be your principal place of business or a place where you meet patients, clients or customers. For example, John operates a floral shop in town. He grows plants in a greenhouse behind his home and sells them in his shop. He uses the greenhouse exclusively and regularly in his business. Even though it is not his principal place of business, because it is separate from his dwelling, he can deduct the expenses for its use.

If you are an employee, you must use your home office for the convenience of your employer. If the employer does not require the employee to work from home and provides an office or work space elsewhere, a home office is likely to be considered a matter of the employee’s convenience and therefore not deductible.

Even if the taxpayer’s home office meets the above rules, the deduction may be limited. Expenses attributable to business use that you could deduct even if the home were not used for business, such as home mortgage interest and real estate taxes, are fully deductible. Otherwise, home office expenses are deductible only to the extent of gross business income, reduced by other allowable business expenses unrelated to the home; any expenses that are not deductible due to the income limitation may be carried forward.

Kenneth Hoffman counsels Entrepreneurs, Professionals and Select Individuals in taking control of their taxes, and businesses. Discover how I can help you overcome your tax and business challenges. To start the conversation or to become a client, call Kenneth Hoffman at (954) 591-8290 Monday - Friday between 8:30 a.m. to 1:00 p.m. for a no cost consultation, or drop me a note.

If you found this article helpful, I invite you to leave a commit and  please share it on twitter, facebook or your favorite social media site and  with your friends, family and colleagues. Thank you.


Home Ownership by Unmarried Individuals

by Kenneth Hoffman in , , ,


If you co-own a home with someone who is not your spouse, such as a significant other or sibling, special tax rules apply to you during the period of ownership as well as at the time of sale. Watch for dollar limitations and allocations of tax benefits.

Mortgage interest

Interest on acquisition debt to buy, build, or substantially improve a principal residence plus one other designated home cannot exceed $1 million. Interest on home equity debt is limited to borrowing up to $100,000. To qualify for either acquisition debt or home equity debt, the debt must be secured by the first or second home.

The same $1.1 million combined debt limit applies to joint filers and single individuals. However, unmarried co-owners with total mortgages exceeding $1.1 million on their first and/or second homes must allocate the limit between them and deduct only a proportionate share of the interest paid. The allocation can be based on any reasonable method, such as by:

  1. The amount of mortgage payments during the year. For example, if one owner made all of the mortgage payments, that owner would be entitled to deduct 100% of the mortgage interest, up to the dollar limits.
  2. The percentage of home ownership. For example, if the home is owned 50/50, then each owner could deduct half of the total mortgage payments, regardless of which one actually made the payments.

Real estate taxes

There is no limit on the amount of real estate taxes that can be deducted. Again, co-owners can allocate the deduction for property taxes in any reasonable manner. Again, this can be done according to the percentage of ownership or the actual real estate taxes paid in the year.

Recapture of the homebuyer credit

If co-owners claimed a first-time homebuyer credit for the purchase of principal residence several years ago, recapture of the credit to the extent required is allocated in the same way in which the credit was originally claims. For example, if two people bought a home in 2008 and claimed the $7,500 credit, $500 of that credit must be recaptured in 2012. The amount that each owner recaptures depends on how much of the credit each owner claimed. If they split the credit, then each recaptures $250 on his or her personal income return.

Home sale exclusion

Gain on the sale of a principal residence (other than gain allocated to nonqualified use of the home) can be excluded up to a set dollar limit as long as you used the home as your principal residence for at least 2 of the 5 years preceding the date of sale. The dollar limit for a single individual is $250,000 of gain.

When co-owners are unmarried, each can exclude his or her share of gain up to this dollar limit. The dollar limit does not have to be apportioned between the owners. For example, if a home that is co-owned equally by 2 unmarried individuals is sold for a gain of $550,000, one-half of the gain, or $275,000 is allocated to each owner. Each owner can exclude up to $250,000 of gain on their personal income tax returns.

Kenneth Hoffman counsels Entrepreneurs, Professionals and Select Individuals in taking control of their taxes, and businesses. Discover how I can help you overcome your tax and business challenges. To start the conversation or to become a client, call Kenneth Hoffman at (954) 591-8290 Monday - Friday from 8:30 a.m. to 1:00 p.m. for a no cost consultation, or drop me a note.


Rental Real Estate and Real Estate Professionals

by Kenneth Hoffman in , ,


Introduction

If you have a rental property, whether it's a small strip center, a home you inherited from your parents, or just a vacation home that you rent during the off season, your rental losses are generally limited through the passive activity rules. The passive activity rules only allow losses from passive activities to offset income from passive activities. Some activities, like real estate rentals, are inherently passive. Other activities, such as a LLC or S corporation that operates a retail business isn't passive per se, but to the member or shareholder it's passive unless that individual materially participates in the activity. (For a definition of material participation, go to our article Material Participation.)

There's a special exception for rental real estate. If you can show you actively participate in the activity, losses of up to $25,000 a year can be used to offset ordinary income as long as your adjusted gross income (AGI) is $100,000 or less. For every $1 of AGI over $100,000, the $25,000 exemption is reduced by $0.50. Thus, if your AGI exceeds $150,000, none of the losses come under the exemption. Instead, the losses can only be used to offset passive income from rental real estate or carried forward to be used under the same rules in subsequent years. Any accumulated losses can also be deducted on the disposition of the property.

The $25,000 exemption may be cold comfort for many taxpayers. It's pretty easy to broach the $100,000 AGI threshold (which hasn't changed since it was put in the law in 1986). And, as a result, the limitation allows the losses to be used only when you're in a lower bracket.
 

Real Estate Professionals

Some investors have another option. "Qualifying taxpayers" also known as "real estate professionals" can deduct rental property losses without the limitations discussed above. For example, you've got three rental properties where the net losses from the properties total $75,000. If you qualify, the entire $75,000 can be deducted. A taxpayer is a real estate professional if:

The taxpayer owns at least one interest in rental real estate, more than one-half of the personal services the taxpayer performs in trades or businesses during the tax year are performed in real property trades or businesses in which the taxpayer materially participates, and the taxpayer performs more than 750 hours of service during the tax year in real property trades or businesses in which the taxpayer materially participates.

Real property trade or business, as defined here, means any real property development, redevelopment, construction, reconstruction, acquisition, conversion, rental, operation, management, leasing, or brokerage trade or business. If you are an employee of the business, the work only counts if you are at least a 5-percent owner at all times during the year. For example, you have a 50%-interest in an LLC in the construction business.

Taxpayers who have a number of properties may meet the 750-hour threshold by simply working on the properties. For example, Sue owns five single-family properties and a seven-unit strip mall. She also has at least one property she's rehabbing at all times. She not only does recordkeeping, banking, and administrative functions for the properties, she oversees maintenance, renovations, gets building permits, etc. Her time spent at these activities during the year exceeds 750 hours and, aside from a couple of hours a week working for her husband's business, that's her only trade or business. Sue qualifies as a real estate professional.

Fred is in much the same situation as Sue. He has a number of rental properties and materially participates in the management for 800 hours during the year. However, Fred is a attorney who spends 1,200 hours a year in his legal practice, almost all drafting leases and purchase and sale agreements for real estate. Since he doesn't spend more than one-half of his time performing personal services in the real property trade or businesses (he's in the legal profession), he doesn't meet the second part of the test above.

Some other points:

A husband and wife can't combine their time to meet the 750-hour requirement. One party has to meet the requirement on their own. Meeting the material participation requirement may not be easy. There are seven possible ways to do so, but it can still be difficult. For a complete discussion see our article Material Participation. Only your participation in rental real estate can be used to determine if you materially participate in the rental real estate activity. Material participation is much more than approving tenants, repair work, etc. and sending a check to the management company. If you hold the property in your own name or as the sole member of an LLC the ownership and grouping rules are simple. However, the grouping of rental activities can get more complicated if you have interests in pass-through entities such as partnerships or S corporations that hold real estate. Check with your tax advisor. Short-term rentals (where the average rental period is less than seven days at a time) such as a vacation home, aren't part of the rules here and participation in such an activity doesn't count toward meeting the 750-hour requirement. That's considered a separate trade or business.If you provide significant services to the tenants that are not usually provided with a lease of real estate, the activity may not be a rental. For example, you own a strip mall, and in addition to the usual maintenance, you organize special events for the center, help with cooperative advertising, etc.

Grouping Election

Generally, you have to meet the 750-hour and more than half of your personal services in the real estate activity for each property. However, you can make an election to group all your properties for purposes of meeting the requirement and deducting the losses. You can do this by filing a statement with your original return for the tax year for which the election is to first apply. Simply grouping the properties, deducting the net losses and checking the box on the second page of Schedule E won't meet the requirement. While there is no set wording, you must state the election is made under IRC Sec. 469(c)(7)(A) and that you want to group all your interests in rental real estate as a single rental real estate activity. The election, once made is irrevocable unless there's a material change in the your circumstances. Talk to your tax advisor.

In a recent revenue procedure (Rev. Proc. 2011-34, IRB 2011-24) the IRS recognized that many taxpayers were not aware of the requirement to file a statement to group the properties. The revenue procedure provides a means for taxpayers to make a late election that will be considered as timely filed. In order to meet the requirements of the procedure, you must have filed consistently with having made an election on any return that would have been affected if you had timely made the election. You must have filed all required federal income tax returns consistent with the requested aggregation to be effective. You must also have timely filed the returns. A return will be treated as timely filed if the return is filed within 6 months after its due date, including extensions. You must also have a reasonable cause for failure to file the statement.

If you can't comply with the requirements of Rev. Proc. 2011-34, you may still be able to correct a late filed election, but you'll have to apply for a letter ruling.

Audit Issues

If you're audited you can expect the agent to scrutinize the facts to make sure you qualify as a real estate professional. If you have a regular job, meeting the more than one-half requirement will be difficult, and the IRS knows it. Meeting the 750-hour requirement is not easy, nor is the material participation requirement. The best approach is to keep a log or diary of your activities, detailing work performed, hours, etc. It'll help if you can substantiate your entry with receipts, invoices, etc. For example, a trip to the hardware store on 6/11 can be substantiated with a receipt for plumbing supplies. While there are other ways to substantiate your time, a well-kept, contemporaneous log or diary should forestall any questions by the agent.

Documentation is More Than Invoice and Canceled Check

Tax Court cases are often good guides to what happens in practice. In one recent case (C. Michael and Gwendolyn E. Willcock, T.C. Memo. 2010-75) the taxpayer lost several deductions. If some of the facts below sound familiar, you should be taking a look at your recordkeeping.

Car and Truck Expenses

The IRS denied the taxpayers' claimed deductions for car and truck expenses for tax years 2002 and 2003, respectively. In 2002 the taxpayers drove an Audi and a Land Rover, both of which were claimed to have been driven solely for business purposes. The taxpayer's wife had veneers (cosmetic dental applications) applied to her teeth by petitioner husband. The taxpayers claimed that any time petitioner wife drove anywhere in one of the vehicles she was "a walking, talking billboard for the dental office" because of the veneer work the husband had performed. Additionally, each vehicle had a license plate holder that displayed the name of the dental practice. The husband used the vehicles to perform various tasks for the dental practice, such as purchasing office supplies. During 2002 and 2003, the taxpayers owned four vehicles: a GMC Envoy, an Audi, a Land Rover, and a Chevy Tahoe. The wife testified that she drove the Audi until the lease expired, after which she drove the Land Rover.

The taxpayers started leasing the Land Rover on May 1, 2002, and the dental practice claimed deductions for lease payments with respect to both the Land Rover and the Audi during 2002. They leased the Audi until February 10, 2003. During 2002 and 2003 the taxpayers also reported a $750 monthly expense for "GMAC", which is reflected in their car and truck expenses for 2002 and 2003. It was unclear which vehicle these payments were for. The vehicles were owned or leased by the taxpayers individually, not by the dental practice; however, the dental practice claimed the deductions.

The Court noted a taxpayer is entitled to deduct transportation expenses incurred in carrying on a trade or business. Commuting expenses, however, incurred in going from a taxpayer's residence to his or her place of business and returning are nondeductible personal expenses. When a taxpayer uses a car for personal as well as for business purposes, he or she must allocate expenses between personal and business use. The taxpayers did not allocate their expenses.

The law requires that sufficient records be maintained to establish the amount of any deduction claimed. A taxpayer must indicate mileage, including total business, commuting, and other personal mileage, percentage of business use, date placed in service, use of other vehicles, after-work use, whether the taxpayer has evidence supporting claimed business use, and whether or not the evidence is written. The taxpayers did not provide this information.

Section 274(d)(4) provides that no deduction is allowed for listed property (e.g., cars, trucks) as defined by Section 280F(d)(4) unless the taxpayer substantiates by adequate records or corroborative evidence (1) the amount of such expense, (2) the time and place of use, (3) the business purpose of the expense, and (4) the business relationship of the taxpayer to the persons using the property. Pursuant to Section 280F(d)(4) listed property includes, with certain exceptions, "any passenger automobile" or "other property used as a means of transportation".

The IRS denied these deductions, claiming that the taxpayers failed to adequately substantiate the expenses or provide information that the amounts were incurred as ordinary and necessary business expenses. In order to substantiate the expenses the taxpayers offered canceled checks and credit card bills for various items such as repairs and gas. Additionally, the taxpayers offered a series of handwritten calendars that detail their daily work schedules, but not the particular use of the vehicles for which expenses were claimed. They used their cars for personal as well as business purposes; however, the taxpayers claimed all use was business related because each vehicle had a license plate holder that displayed the name of the dental practice. They contended that even when the vehicles were being used for personal reasons they provided a valuable advertising service to the dental practice. They did not maintain records allocating personal and business use of their cars. They also commuted to the dental practice from their home daily, but did not make an allocation for any commuting to and from the dental practice.

The taxpayers failed to prove that the vehicles were used in the conduct of a trade or business as defined under section 162. In addition, they failed to maintain adequate records to substantiate the use of their vehicles under Section 274. The Court disallowed the deductions in full.

Section 179 Expense Deduction

The dental practice claimed Section 179 expense deductions for tax year 2003 for $38,630. The IRS partially disallowed the section 179 expense deduction for 2003 claimed in regard to the GMC Envoy. On the dental practice's return, the taxpayers reported that the GMC Envoy was placed in service on November 18, 2003, and that it was used solely for business purposes. They purchased the GMC Envoy after the lease for the Land Rover expired. The lease on the Land Rover ended sometime after 2003, i.e., in 2004. The Court noted it appeared that the taxpayers retained the Land Rover lease through 2003, and purchased the GMC Envoy after 2003. The GMC Envoy bore a license plate holder with the name of the dental practice. The GMC Envoy was titled in the taxpayers' names rather than in the name of the dental practice, which claimed the deductions.

Subject to certain restrictions, a taxpayer may elect to deduct as a current expense the cost of any Section 179 property, that is acquired by purchase, used in the active conduct of a trade or business and placed in service during the taxable year.

The dental practice claimed Section 179 deductions for tax year 2003 of $38,630. The IRS disallowed the Section 179 deduction claimed in 2003 for the GMC Envoy the taxpayers claimed was used solely for business purposes. The Court noted it was unclear whether the taxpayers placed the item in service in 2003 or in 2004 after the lease on the Land Rover expired. They offered no other evidence to corroborate their claimed placed-in-service date. The Court sided with the IRS in denying the deduction.

Travel Expenses

The IRS disallowed travel expenses of $5,082 for 2002, which the taxpayers claim they incurred during a business trip to Hawaii for a dental conference. They were in Hawaii from May 3 through 12, 2002. They testified that the dental conference was held from May 7 through 10, 2002. The taxpayers presented the Court an invoice for the purchase of dental equipment which they claim they purchased in Hawaii during the conference. The invoice, however, states only when the equipment was purchased, not where it was purchased.

The Court noted the taxpayers offered no probative evidence to substantiate their attendance at the seminar, nor did they offer any probative evidence to support the business purpose of the trip. The taxpayers produced no evidence supporting any of the expenses claimed, which included meals, first-class airline tickets, and taxi fees. The Court held the taxpayers failed to substantiate that their claimed expenses were in any way related to their dental practice. The Court allowed only the travel expenses allowed by the IRS.

Professional Fees

The taxpayers deducted professional fees of $10,080.50 for tax year 2002, which amount they claimed was paid to the pastor of the taxpayers' church. The taxpayers hired the pastor to instruct the wife in the areas of networking and marketing so that she could be a more effective salesperson and marketer for the dental practice. These instructional sessions purportedly occurred in the taxpayers' home and, for a brief period of time, over the telephone. They presented copies of Forms 1099-MISC, Miscellaneous Income, in support of these claimed expenses for consulting. No Social Security number is listed for the pastor on either form, and no evidence was offered to confirm that the tax forms were actually delivered to the pastor. The pastor did not testify at trial. The taxpayer wife's testimony was contradictory. The Court held the taxpayers did not meet their burden of substantiating the expenditures and denied the deduction.
 

Janitorial Services Expense

The IRS reduced the dental practice's claimed janitorial expenses for both 2002 and 2003. With respect to 2002, the dental practice claimed janitorial expenses of $20,226. The only expenses in dispute were certain expenses of $12,208 in connection with payments claimed to have been made to the "Sotelos", a landscaping service. The taxpayers testified that these expenses were reported on their 2002 income tax return, and represented expenses incurred for landscaping services provided to the dental practice. All of the invoices from the Sotelos were addressed to petitioners at their home address, and were not addressed to the dental practice, or sent to the dental practice address.

Of the disallowed amount, $1,500 represents an amount the taxpayers claim to have paid to their son on behalf of the condominium association where the dental office is located. The taxpayers claimed that they paid their son to provide landscaping upgrades to the dental practice. However, they presented no documentation supporting this claimed expense. The remaining $6,074 reflected a payment to their son, as evidenced by a Form W-2 petitioners generated. The taxpayers provided no evidence of the services which their son purportedly provided for this amount.

The Court found the taxpayers failed to substantiate that these claimed expenses had a business purpose or that the services were even provided to their business, rather than to them personally. The Court disallowed the expenses.

Loan to Son

The IRS used the bank deposits method of proof to reconstruct the taxpayers income and determined unexplained deposits of $8,500 should be included in income. Deposits in a taxpayer's bank account are prima facie evidence of income, and the taxpayer bears the burden of showing that the deposits were not taxable income but were derived from a nontaxable source. The bank deposits method assumes that all money deposited in a taxpayer's bank account during a given period constitutes taxable income, but the Government must take into account any nontaxable source or deductible expense of which it has knowledge. The taxpayers claimed the $8,500 was repayment of a loan made to the taxpayers' son. The taxpayers were able to show two checks, one for $7,200 and another for $1,300 written on their son's account and deposited soon thereafter in their account. (The taxpayers also were able to show payments for $8,500 out of their account for the purchase of the car.)

Supporting Documentation

The case discussed above is far from unique. In fact, it's the type of issues CPAs encounter regularly. A canceled check and an invoice sometimes isn't sufficient to completely secure the deduction. Moreover, small businesses are particularly vulnerable to a challenge. Taxpayers often make it worse by mixing business and personal finances. Here are some points to keep in mind.

Keep it all business. You'll reduce questions from the IRS (and make your accountant's job easier) if you keep your business account all business. For many small business owners that's tough to do. Many owners are perpetually short of cash to pay their personal expenses. If you must, you may be better off writing one large check (e.g., the annual real estate tax for your home and don't try to deduct it) rather than a bunch of small ones. The one large one will be easier to trace and it won't look like you're trying to deduct personal expenses.

Keep good deposit records. If you're paid by check or cash, be able to match deposits with invoices. Try to deposit funds daily. That's especially important if you have a significant number of transactions each day. Document deposits from non-sale sources. For example, the business needs a cash infusion; you loan it $5,000. Document the loan and make sure the check is deposited at or about the same time. Keep a copy of the check and the bank statement showing the amount so you can trace the funds from your personal (or other business, etc.) account to the business account. Keep records of asset sales, repayment of loans to shareholders or employees, etc.

Expenses paid personally. Instead of getting that cell phone in the business name, you do it personally because you can save $6 per month. Great, but now you've made your accounting more complicated. You should probably pay the expense personally and put in an expense report for the amount. Make sure you can show the business use. Talk to your accountant for his suggestions. Unless there's some compelling reason to pay it personally, do it through the business.

Travel and entertainment. Always an IRS hot point. You should know what you need--time, place, amount, person entertained, business discussed, etc. But you may want to take it further. If there's any chance of it looking like pleasure, keep a detailed diary. For example, business trip to Plattsburgh, NY in January? No one is going to suspect a pleasure motive (unless you have family there). You can probably get away with the normal IRS requirements. Business trip to Fort Lauderdale the next week? Keep a diary. Obvious you were on business? To you maybe, but not to an IRS agent. Be even more careful if you're actually combining business and pleasure on the same trip. Seminars? Use the diary and keep the workbooks, notes, etc. from the lectures.

Details of work performed. The plumber you called to install a new sink in the office could just as easily put a new tub in your home. The auto repair shop could work on the business truck or your personal auto. Get a detailed invoice showing the work performed, the location, vehicle identification, etc. And make sure you send out 1099s (if applicable) at the end of the year. Have invoices mailed to the appropriate address--business or personal.

Items purchased with dual purpose. Some businesses use items that could be used personally. In some cases, that could be "listed property" such as cameras, computers, audio equipment, etc. You need to keep a diary of business vs. personal usage. (There are exceptions; check with your accountant.) But there are other items that don't show up on the IRS list where you could be questioned. Be sure you can document the business use. Gas purchases for the business vehicle--record in a diary and keep with the vehicle.

Consider standard mileage method. In some cases you might come out ahead using the standard mileage method (see our article Standard Mileage or Actual Expenses?). Even if you don't, the IRS can't challenge your expenses, only your business mileage if you use the standard mileage method.

Document confusing issues. You've got two car loans from the Chatham National Bank--one for your personal vehicle, one for the business. You diligently write a personal check for your car and a business check for the business truck. But if you're audited could you prove which was which? Keep a copy of the loan documentation along with details of the purchases. Same thing for business credit card payments. Make sure you can match the monthly statement to the check or withdrawal amount for the business card.

Conflicting documentation. If you keep contemporaneous records, chances are you won't have this problem. But on more than one occasion we've seen court cases where the court looks beyond the plane ticket and credit card statement, etc. In one case the court looked at the taxpayer's car log showing he drove 500 miles to a distant city on the same day a plane ticket showed he flew there. Or a trip to the bank on a Sunday. Reconstructing records later often results in these problems. And it won't be just that one 500-mile car trip that's disallowed. The court threw out his log, finding it unreliable.

More information. For more information on documentation, see our article Expense Documentation.

Kenneth Hoffman counsels Entrepreneurs, Professionals and Select Individuals in taking control of their taxes, and businesses. Discover how I can help you overcome your tax and business challenges. To start the conversation or to become a client, call Kenneth Hoffman at (954) 591-8290 Monday - Friday from 8:30 a.m. to 1:00 p.m. for a no cost consultation, or drop me a note.

If you found this article helpful, I invite you to leave a commit and  please share it on twitter, facebook or your favorite social media site and  with your friends, family and colleagues. Thank you.


Timing of Deduction for Start-Up Expenses

by Kenneth Hoffman in , ,


Section 195 of the tax code generally requires taxpayers to capitalize start-up expenditures. Fortunately, the first $5,000 of such expenditures can be expensed in the year in which an active trade or business begins, if the total such expenditures don't exceed $50,000. Expenditures in excess of $5,000 (or where the $5,000 allowance is phased out because of the $50,000 cap) can be amortized over not less than 180 months (15 years). The rule shouldn't be ignored. If a proper election to expense the expenditures isn't made, all the expenditures must be capitalized.

What are start-up costs? Start-up costs can include investigatory expenses such as conducting market surveys, analysis of locations, product sources, etc., amounts paid to evaluate several businesses and to determine whether to enter the business and which business to acquire, and preliminary due diligence to assist in a potential acquisition. However, once the business has been identified, additional due diligence such as a review of the acquisition's books and records by an accounting firm and or law firm don't qualify. Other items that qualify include expenses such as pre-opening advertising, hiring initial employees, training, salaries, travel expenses, etc.

    Example--Sue Flood incorporates Madison Dresses, Inc. in April 2009. On May 1 she signs a lease for the store and hires Ann to help her stock the racks, decorate, etc. In addition, Madison is paying $1,000 for rent. Madison opens its doors for business on July 1, 2009. From May 1 through July 1 Madison paid $8,000 in salaries, rent, etc. as pre-opening expenses. On Madison's return for 2009, Sue can deduct $5,000 of the total pre-opening costs. The remaining $3,000 must be amortized over 180 months, beginning in the month business began.

    Tax Tip--Clearly, it makes sense to keep the pre-opening expenses as low as possible. One way is to make sure you have all your resources ready before beginning. In the example above it would have made no sense for Sue to hire Ann on May 1 if the racks, dresses, etc. weren't going to be delivered for two months. A second way may be to begin business before the everything is in place. For example, you're opening a bar and grill in a resort area. The bar portion will be ready quickly, but the inspections and permits for food service will take three months. Open the bar now and the additional costs associated with the food service may be expensed as expansion costs. Caution. Check with your tax adviser on this approach.

Organization expenses fall under a different Code Sections, but the rules are similar. They include the costs of incorporating a corporation (Sec. 248) or of setting up a partnership (Sec. 709). Such expenses include setting up the books of the entity, legal fees in incorporating or organizing the partnerships, etc. (Caution. Not all organization expenses qualify.) Expenditures up to $5,000 can be expensed, if the total such expenses don't exceed $50,000. Expenses in excess of $5,000 must be capitalized and amortized over no less than 180 months.

The next issue to deal with is, when does the business begin? This is a factual issue and it's not often clear. Before looking at the nuances, the first question is, do you need a license or permit? If you haven't got the permit from the town, county, etc., you're most likely not in business. If you need a liquor license to sell wines and spirits, you're not in business until you get that license. Same for a restaurant; you'll need a license. On the other hand, if you had the restaurant but not a liquor license you could open for business and serve food only. There can be exceptions, but make sure you're on firm ground. But just because you have a license doesn't mean you're in business. If you don't need a license, business usually begins when your doors are open to customers. Generally that's also the same time you make your first sale, but not always. If there's any question (e.g., you don't have a fixed establishment, but sell over the phone) try to document the time.

Expansion versus new business. If you're just expanding an existing business, pre-opening expenses shouldn't have to be capitalized. For example, you already operate four restaurants in the local area. You decide to open a fifth. The expenses should be deductible as ordinary business expenses. On the other hand, it you set up a new corporation, LLC, etc. to own and operate the additional restaurant, you'll probably have to treat the costs as start-up expenditures. As always, there are exceptions. Check with your tax advisor.

In a recent case (Thomas J. Woody (T.C. Memo. 2009-93)) in February 2004 the taxpayer started investigating the real estate market so he could acquire real estate for investment or rental. Throughout 2004 the taxpayer looked at many properties he was interested in buying for this real estate investment and rental business. He made multiple offers to purchase properties but was out-bid on most of his offers. In May 2004 he entered into a contract to purchase a property on Bradley Avenue in Camden, New Jersey. However, after a home inspection revealed many defects in the property, he canceled the contract because the seller was not willing to make the needed repairs.

The taxpayer did not purchase any investment or rental property until he purchased the property on Randolph Street in Camden, New Jersey, on December 30, 2004, i.e., the next to last day of the year at issue. At that time, there was no tenant in the property, and he did not secure a tenant until sometime after 2004. Furthermore, there was nothing in the record to indicate that he held the property out for rent in 2004.

Throughout 2004 the taxpayer performed many other tasks in conjunction with his alleged business. He created a name for his endeavor -- Value Property Investments -- and began marketing his services via business cards, flyers, and word of mouth. In May 2004 he completed a business outline with "buying, remodeling, and renting property" being the stated purpose of Value Property Investments. On October 17, 2004, he paid $21,490 to the Wealth Intelligence Academy for certain training classes, which he subsequently attended to acquire real estate investment skills. After he took the Wealth Intelligence Academy courses, his business plan shifted from merely buying, remodeling, and renting to also include what the taxpayer referred to as "flipping" or "wholesaling" However, he never consummated this type of transaction during 2004.

In November 2004 the taxpayer applied, and was approved, for a loan from the U.S. Small Business Administration, and he obtained an employer identification number from the IRS. In December 2004 he obtained a credit card in the name of "Thomas J. Woody Value Property Invest" and opened a checking account in the name of "Mr. Thomas J. Woody D/B/A Value Property Investments".

Despite all of the foregoing activity, he did not purchase any investment property until December 30, 2004, and he did not buy or sell any other property, rent out any property, or hold any property out for rent, nor did he engage in "flipping" or "wholesaling" during tax year 2004.

The IRS disallowed the taxpayer's Schedule C expenses for 2004 because it determined that the taxpayer was not engaged in the active conduct of a real estate investment business as alleged. The taxpayer contended he commenced his real estate investment and rental business on May 1, 2004 when he entered into a contract of sale on the Bradley Avenue property. Thus, he contended that all his expenses associated with his business incurred after that date should be deductible business expenses. The IRS asserted that the taxpayer was not actively engaged in the real estate investment and rental business at any time during 2004, because he did not become actively engaged in business, i.e., by buying, selling, renting, or offering to rent property, until he held the Randolph Street property out for rent some time after 2004.

The Court noted that whether a taxpayer is engaged in a trade or business is determined using a facts and circumstances test under which courts have focused on the following three factors that indicate the existence of a trade or business: (1) whether the taxpayer undertook the activity intending to earn a profit; (2) whether the taxpayer is regularly and actively involved in the activity; and (3) whether the taxpayer's activity has actually commenced.

The Court held the taxpayer's activities did not rise to the level of a trade or business until, at the earliest, the time he purchased the Randolph Street property on December 30 of the year in suit. More likely, his activities did not rise to the level of a trade or business until he held the Randolph Street property out for rent sometime after the close of the year in suit, but the Court did not have to decide that issue.

Opening a new business is a major undertaking and the pre-opening costs can be substantial. To maximize your tax deductions and your cash flow, plan carefully and get good advice both tax and business.

Kenneth Hoffman counsels Entrepreneurs, Professionals and Select Individuals in taking control of their taxes, and businesses. Discover how I can help you overcome your tax and business challenges. To start the conversation or to become a client, call Kenneth Hoffman at (954) 591-8290 Monday - Friday from 8:30 a.m. to 1:00 p.m. for a no cost consultation, or drop me a note.

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Tax Relief for "Superstorm" Sandy

by Kenneth Hoffman in , ,


Hurricane Sandy roared ashore last week, interrupting our regularly scheduled election already in progress. And yes, we'll be addressing election results shortly, especially as we get more guidance on what to expect for your taxes. But we're impressed, as always, with how a natural disaster brings out the best in Americans, and we're pleased to see both Democrats and Republicans joining together to help those most affected by the storm.

The IRS gives generous tax deductions to help make our own generous charitable gifts go further. So this week we're writing to help you make the most of efforts you might make to support storm victims -- or any other year-end charitable gifts.

  • You can deduct up to 50% of your adjusted gross income for cash gifts you make to so-called "501(c)(3) organizations," or public charities working on behalf of storm victims. These include the American Red Cross and similarly recognizable groups.
  • If you give more than $250 in any single gift, you'll need a written receipt from the recipient, dated no later than the filing date of your return.
  • Gifts of food, clothing, furniture, electronics, or household items are deductible at "fair-market value," such as the price you would get for them at a resale shop. Consider using software, available at any office-supply store, for tracking your gifts and their value. You might be surprised at how much you can save!
  • Gifts of cars, trucks, and boats are a little trickier. Congress has cracked down on inflated car and truck deductions. If you donate a vehicle, you can deduct the fair-market value only if the charity actually uses it (such as a church using a van to drive its parishioners). If the charity sells the vehicle, your deduction is limited to the amount the charity actually realizes on the sale. And if that amount is more than $500, you'll have to attach a certification to your return that states the vehicle was sold in an arms-length sale and includes the gross proceeds from that sale.
  • Donations you make by text message are deductible like any other cash gifts. You can use your phone bill to substantiate your deduction.

The IRS cautions us all to seek out qualified charities, and warns that bogus requests for charities that simply don't exist are common after natural disasters. The IRS also announced that they would give businesses and tax preparers affected by the hurricane an extra seven days to file payroll and excise tax returns that were due on October 31.

December 31 is approaching faster than you'd like, and that means time is running out for year-end tax planning. But it's not too late to take concrete steps to cut your 2012 taxes. What are your year-end financial goals? Helping the victims of the storm? Saving for your dream retirement? Helping finance your children's or grandchildren's education? Odds are good that we can help you save taxes while you do it. And remember, we're here for your family, friends, and colleagues too!

Kenneth Hoffman counsels Entrepreneurs, Professionals and Select Individuals in taking control of their taxes, and businesses. Discover how I can help you overcome your tax and business challenges. To start the conversation or to become a client, call Kenneth Hoffman at (954) 591-8290 Monday - Friday from 8:30 a.m. to 1:00 p.m. for a no cost consultation, or drop me a note.

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Capital Gains and Losses It's All In The Timing

by Kenneth Hoffman in , ,


The year’s end has historically been a good time to plan tax savings by carefully structuring capital gains and losses.

If there are losses to date − As an example, suppose the stocks and other capital assets that were sold during the year result in a net loss and that there are other investment assets still owned by the taxpayer that have appreciated in value. Consideration should be given to whether any of the appreciated assets should be sold (if their value has peaked), thereby offsetting those gains with pre-existing losses.

Long-term capital losses offset long-term capital gains before they offset short-term capital gains. Similarly, short-term capital losses offset short-term capital gains before they offset long-term capital gains. Keep in mind that taxpayers may use up to $3,000 of total capital losses in excess of total capital gains as a deduction against ordinary income in computing adjusted gross income (AGI). Individuals are subject to tax at a rate as high as 35% on short-term capital gains and ordinary income. But long-term capital gains are generally taxed at a maximum rate of 15%.

All of this means that having long-term capital losses offsetting long-term capital gains should be avoided, since those losses will be more valuable if they are used to offset short-term capital gains or ordinary income. Avoiding this requires making sure that the long-term capital losses are not taken in the same year as the long-term capital gains. However, this is not just a tax issue; investment factors also need to be considered. It would not be wise to defer recognizing gain until the following year if there is too much risk that the property’s value will decline before it can be sold. Similarly, one wouldn't want to risk increasing a loss on property that is expected to continue declining in value by deferring its sale until the following year.

To the extent that taking long-term capital losses in a different year than long-term capital gains is consistent with good investment planning, a taxpayer should take steps to prevent those losses from offsetting those gains.

If there are no net capital losses so far for the year – If a taxpayer expects to realize such losses in the subsequent year well in excess of the $3,000 ceiling, consider shifting some of the sales and resulting excess losses into the current year. That way, the losses can offset current year gains, and up to $3,000 of any excess loss will become deductible against ordinary income in the subsequent year.

Paper losses or gains on stocks may be worth recognizing (i.e., selling the stock) this year in some situations. But if the stock is sold at a loss with the idea to repurchase it, the repurchase cannot be within a 61-day period (30 days before or 30 days after the date of sale) under the “wash sale” rules. If it is, the loss will not be recognized and will simply adjust the tax basis of the reacquired stock. Careful handling of capital gains and losses can save substantial amounts of tax.

Kenneth Hoffman counsels Entrepreneurs, Professionals and Select Individuals in taking control of their taxes, and businesses. Discover how I can help you overcome your tax and business challenges. To start the conversation or to become a client, call Kenneth Hoffman at (954) 591-8290 Monday - Friday from 8:30 a.m. to 1:00 p.m. for a no cost consultation, or drop me a note.

If you found this article helpful, I invite you to leave a commit and  please share it on twitter, facebook or your favorite social media site and  with your friends, family and colleagues. Thank you.


Business Expense Documentation and Tax Deductions

by Kenneth Hoffman in , , ,


We've often mentioned the importance of adequate documentation to substantiate a business deduction. Ideally you should have a canceled check and an invoice marked paid with the serial number of the item purchased. While that may be viable for certain big-ticket assets, realistically, that's not often the case for most expenses. And the IRS knows that. There are many other ways to document expenses that are acceptable. However, you should be able to show that payment was made (e.g., a canceled check) and the nature of the item purchased (e.g., an invoice with a description of the item).

Travel and entertainment, auto expenses and charitable contributions. There are separate rules for these items, and they're very strict. We won't deal with them here. They'll be detailed in an upcoming report.

Canceled check. The check should have the payee and should show the cancellation on the back. Why the cancellation? In the case of large or unusual purchases, the IRS may check that the payee actually cashed the check.

Checks not returned. Many businesses (and individuals) no longer have their checks returned. The IRS will accept images of the check. In order to be accepted as proof of payment, the statement must exhibit a high degree of legibility and readability. If your bank doesn't send you hard copies of the images, you should be able to download PDF copies of the checks. Don't rely on the bank to save statements and check images. After a certain period of time you may not be able to retrieve them without cost. Download statements and images each month. (That's good advice for other statements where you may no longer receive hard copies such as telephone bills, etc.) You may also be able to show proof of payment by providing:

    an invoice marked "paid",
    a check register or carbon copy of the check,
    and an account statement that shows the check number, date, and amount.

An account statement prepared by a financial institution showing check clearance will be accepted as proof of payment if the statement shows:

    the check number,
    the amount of the check,
    the date the check amount was posted to the account by the financial institution,
    and the name of the payee.

Credit/debit cards. If payment is made using a credit card, the IRS requires that you have an account statement that shows the amount of the charge, the date of the charge (i.e., transaction date), and the name of the payee. If payment is made using a credit card, the IRS requires that you have an account statement that shows the amount of the charge, the date of the charge (i.e., transaction date), and the name of the payee. Most likely your credit card company is already mailing you these statements monthly. Cards specifically designed for business like American Express business credit cards will also provide year-end summaries. Note, this will only provide proof of payment.

Electronic funds transfer. If you transfer funds electronically, the IRS will accept an account statement prepared by a financial institution showing an electronic funds transfer as proof of payment if the statement shows:

    the amount of the transfer,
    the date the transfer was posted to the account by the financial institution,
    and the name of the payee.

Invoice. You must have an invoice or other documentation showing what you purchased. A canceled check without an invoice or some other document showing the item purchase could be a problem. Statements from a supplier may be substituted, but only if they show the item. Fortunately, since most businesses are computerized, a supplier could generate a duplicate invoice if an agent insisted on seeing one. But it's best not to rely on that. When paying invoices, write the check number and amount paid on the invoice and the invoice number on the check so that you can cross reference them later if necessary.

Save all invoices. Don't assume the IRS will accept a check written to the telephone company without an invoice. The check could have been for payment of your personal line.

What about independent contractors? Even for small jobs, ask for an invoice. In addition, make sure you give the party a Form 1099, if applicable. No 1099? You could lose the deduction or be subject to penalties. What about those cash payments to some contractors? No invoice and no record of payment probably could mean no deduction.

Cash register tapes. You go to the local hardware store to purchase some fasteners for the business and get only a cash register tape with no details of the items purchased. Will it fly? If the total is relatively small and it's not a common occurrence, and agent should accept it. Write a description of the items on the slip--1 gallon paint for repainting wall; bolts for shelving. Fortunately, most stores now print the detail on the tape.

Caution on tapes. Many businesses, including major big box retailers, use heat sensitive tape to print receipts. The life can vary widely from less than 1 month under poor conditions (the glove box of your truck) to several years under good conditions. Don't take a chance. Make photocopies of the tapes.

Reasons for purchase. The business purpose of most of your purchases may be obvious. An agent is unlikely to question a laser printer cartridge, a computer, a book on how to use a computer program, etc. But be prepared for questions if the invoice or tape shows the purchase of items that normally wouldn't be business related or could be personal as well as business. For example, the purchase of a book with no clear business relationship, power tools by a computer consulting business, etc. Don't take a chance on remembering the reason several years later when you're audited. Write the business reason on the receipt or attach a description to the receipt.

Avoid personal purchases through the business. It's convenient to use a company check or credit card to purchase personal items. Resist the urge. Your accountant may spend time making the entries to adjust your expenses. If he doesn't or misses some that an agent catches, the agent might increase his scrutiny of all your expenses. You could be liable not only for additional taxes and interest but also an accuracy-related penalty. In flagrant cases the IRS may claim fraud, particularly if other indications are present.

Checks made to cash. While you should try to avoid them at all cost, that's nearly impossible. The larger the amount, the more careful you should be. Be sure to indicate on the check what the purchase was for. This is one time when an invoice can be critical. An invoice marked paid in full would certainly help your position.

Cash expenses. Some expenses will be so small that an invoice or even a cash register tape is impractical. You may also be paying in cash rather than by using a check or credit card. Keep a diary showing the date, place, amount, and description of the item purchased or service obtained. For example, "11/20/12, Madison Hardware, $6.25, nuts and bolts for shelving".

Business standards for documentation. Any invoice, contract, etc. should be up to industry standards. For example, a receipt from a local deli for sandwich platters for the office party may be scribbled on an invoice without a number (it should, of course, be dated). But an invoice for a collision repair on the company truck should contain detailed parts and labor, since the shop normally does that for insurance purposes.

Other documentation. You should also retain other documentation that might be used in addition to or in place of an invoice. For example, a contract for services, lease on equipment or office space, warranties on equipment, service contracts, etc.

Petty cash. If you keep a petty cash fund, slips showing expense reimbursements should be sufficient to document the expenses. That's assuming the expenses are small, as one would expect. Make sure that the nature of the expense is clear from the slip. Employees should check that and, if not, write on the slip the type of expenses and the vendor.

Expense reports. We're not talking travel and entertainment here. It's not unusual for an employee to purchase office supplies, small equipment, shop supplies, maybe even items to be used on the manufacturing floor that may be critical. Officers and especially officer/shareholders often pay company expenses out of their own pocket. While it's best to avoid such situations, that's not always possible. The correct procedure is to have the employee file an expense report and attach the documentation. The company should then cut the employee a check for the amount documented. For example, you need a color printer for a rush job. An employee buys an inkjet printer with his own credit card. He should file an expense report and attach the credit card slip and any other documentation from the store.

This can be especially critical when it comes to an employee/owner/shareholder. Without the expense report the company can't take the deduction because it didn't pay for the item; the employee/owner can't take the deduction because it's not a valid deduction. Special rules apply to partnerships and there's an exception if the business has a policy of not reimbursing. Talk to your tax advisor.

Cohan rule. The last resort. It's called the Cohan rule because it evolved from a court case where the taxpayer was George M. Cohan. Cohan claimed travel and entertainment expenses for which he had no receipts. The court allowed him a deduction based upon the fact he was able to convince the court he incurred expenses but did not have proof of payment or the actual amount. Ironically, this rule cannot be applied to travel and entertainment expenses any longer. Now if required, no receipt, no deduction, no exception for those expenses.

How does the Cohan rule work today? If you can show you definitely incurred the expenses and are entitled to a deduction but don't have the receipts or proof of payment, the court may allow a deduction based on an estimate. But there has to be some basis on which the court can make the estimate. For example, you have no receipts to prove your fuel oil expense for 2012 because you inadvertently destroyed the bills. In addition, the company went out of business. Clearly you incurred some charges to heat your building. The court may estimate the expense based on an average of fuel bills for several years.

This is a last resort for a number of reasons. First, you may have to go to court to get the deduction. Second, the court is almost assuredly going to try and underestimate the amount of your deduction. Third, the rule will probably not be applied if you have access to the documentation but don't produce it (e.g., you could ask a vendor to produce the necessary statements, even if it cost you). Fourth, you'll still have to convince the court you incurred the expenses. It may believe your testimony; it may not. You'll be on safer ground if you have some corroborating evidence.

Finally, the court is under no obligation to assist you. Even if your records are destroyed through no fault of your own (e.g., a fire), the court can require you to reconstruct. You'll fare better if you can show the lack of records either isn't your fault or, if it is, there are extenuating circumstances. For example, you normally have excellent documentation but telephone and utility bills for one year were inadvertently discarded.

Corroborating witnesses. Sometimes you can convince the IRS or the court you incurred the expenses by producing witnesses. That may work, but if the witnesses aren't convincing or the court believes the testimony may be biased (they're employees or relatives), it doesn't have to accept their testimony. And that happens in a high percentage of cases. Again, not an approach to rely on.

Too much paper? In many cases you don't have to save paper copies. Electronic versions of statements received from vendors or others will normally suffice, but they must be readable. You can also scan documents and save them as electronic copies. If the documents are signed (e.g. a lease), you might want to retain an original copy. And consider retaining hard copies of important asset purchases. Talk to your tax advisor.

Retention time. You may have heard hold canceled checks and other documents for 3 years, but it's more complicated than that. Technically it's three years from the date you filed the return. But if the IRS suspects you underreported your income, it can go back 6 years. If it believes fraud is present, there is no limit. For assets such as autos, equipment, etc. you should retain all documentation for at least 3 years after the asset is disposed of. And longer retention periods can apply to employment records. If you need a single rule of thumb, use a 7-year holding period for most records. But the best approach is to check with your tax adviser.

Documentation vital. Based on an informal analysis, it appears that more taxpayers lose in Tax Court because they can't substantiate their expenditures than for any other reason. While the IRS sometimes does show some flexibility, it's generally a stickler for records and can disallow the smallest expenditure for lack of them.

Kenneth Hoffman counsels Entrepreneurs, Professionals and Select Individuals in taking control of their taxes, and businesses. Discover how I can help you overcome your tax and business challenges. To start the conversation or to become a client, call Kenneth Hoffman at (954) 591-8290 Monday - Friday from 8:30 a.m. to 1:00 p.m. for a no cost consultation, or drop me a note.

If you found this article helpful, I invite you to leave a commit and  please share it on twitter, facebook or your favorite social media site and  with your friends, family and colleagues. Thank you.


15, 25, 28 Hut!

by Kenneth Hoffman in ,


There's no denying that amateur sports, especially college football, are big business. Together, the 15 top-grossing teams score over $1 billion in revenue, with the University of Texas Longhorns alone generating $71.2 million in profit.

Numbers like that would normally make the "receivers" at the IRS smile. But college football is different. The big Division I schools that sponsor the most competitive teams are all tax-exempt. And the IRS loses again on a juicy revenue stream that's unique to college sports -- required donations, sometimes totaling twice the cost of a season ticket, that fans make to the school to secure those seats.

Back in 1986, boosters couldn't deduct the contributions they made specifically to secure sports tickets. But Louisiana Senator Russell Long, who sat on the Finance Committee, met with lobbyists who argued that his home state Louisiana State University needed tax-deductible contributions to add seats to Tiger Stadium. Long agreed, but didn't want to be seen showing favoritism to his own constituent. So he approached Texas Representative Jake Pickle, whose Austin district included the Longhorns' campus. Together, the two lawmakers cobbled together the sort of backroom deal that makes the rest of us proud to be Americans. They added a provision to the 1986 Tax Reform Act which preserved a 100% deduction -- for just those two schools! Here's how the legislation describes one of them to limit its reach:

"Such institution was mandated by a State constitution in 1876; such institution was established by a State legislature in March 1881; is located in a State capital pursuant to a statewide election in Sept. 1881; the campus of such institution formally opened on Sept. 15, 1883; such institution is operated under the authority of a 9-member board of regents appointed by the governor."

Naturally, every other school in the country complained. So -- did the lawmakers turn red in embarrassment at getting caught with their hands in the cookie jar and shut down the offending provision? Noooooooo . . . two years later, they voted to trim the deduction to 80% of the donation, but extend it to everyone.

How much does this all cost the IRS? Well, nobody really knows. But Ohio State University is the leader in seat-related donations, with $38.7 million. LSU is next with $38 million, and Texas is third with $33.9 million. (In fact, LSU is about to spend $80 million to add 70 more luxury boxes and 6,900 more seats, which should bring in another $15 million in donations.) If the average donor pays 25% in federal tax, that means $22 million in lost tax dollars. And that's just three schools out of 1,000 eligible to collect such donations. Of course, defenders of the deduction argue that it's worth the hit to the Treasury. They note that donations go to support scholarships, facilities, and other university expenses.

This Saturday, it will be hard to turn on a television without hearing about the upcoming election or "Frankenstorm" Sandy. College football will provide a welcome respite to millions of fans across the country. So next time you sit down to watch your favorite team, hoist a cold one to the tax code that helps make their success possible!

Kenneth Hoffman counsels Entrepreneurs, Professionals and Select Individuals in taking control of their taxes, and businesses. Discover how I can help you overcome your tax and business challenges. To start the conversation or to become a client, call Kenneth Hoffman at (954) 591-8290 Monday - Friday from 8:30 a.m. to 1:00 p.m. for a no cost consultation, or drop me a note.

If you found this article helpful, I invite you to leave a commit and  please share it on twitter, facebook or your favorite social media site and  with your friends, family and colleagues. Thank you.


Social Security Taxable Wage Cap Increasing To $113,700 In 2013

by Kenneth Hoffman in , ,


The Social Security Administration has announced an increase in the Social Security taxable wage base in 2013 from $110,100 to $113,700. The $3,600 increase is slightly more than the $3,300 increase from 2011 to 2012. The cap was just $106,800 from 2009 to 2011, as inflation ground to a halt during the economic downturn.

The wage cap is the maximum amount of compensation subject to tax under the Federal Insurance Contributions Act (FICA) for old age, survivors and disability insurance (OASDI) — typically called Social Security tax. FICA imposes both Medicare tax and Social Security tax on compensation received for services at matching employer and employee rates (with self-employed taxpayers effectively paying both shares on self-employment income). Although the Social Security tax is capped, the Medicare portion of FICA tax applies to total earnings, with no limit on the amount.

The Social Security tax rate is generally 6.2% for both employers and employees, but under a special temporary provision it is only 4.2% for individuals in 2012. The rate is scheduled to revert to 6.2% in 2013 without legislative action. The maximum total individual share of Social Security tax is capped at $4,624.20 in 2012 but is scheduled to jump to $7,049.40 in 2013, with a return to the 6.2% rate and the higher wage cap.

S-corporation shareholders should see their tax advisor to understand how this may impact their compensation package.

Kenneth Hoffman counsels Entrepreneurs, Professionals and Select Individuals in taking control of their taxes, and businesses. Discover how I can help you overcome your tax and business challenges. To start the conversation or to become a client, call Kenneth Hoffman at (954) 591-8290 Monday - Friday from 8:30 a.m. to 1:00 p.m. for a no cost consultation, or drop me a note.

If you found this article helpful, I invite you to leave a commit and  please share it on twitter, facebook or your favorite social media site and  with your friends, family and colleagues. Thank you.