When you own more than one business, you need to consider the grouping rules that apply for passive-loss purposes.

Should one of your businesses lose money, you may not deduct the losses from that business during the current tax year unless you

1. materially participate in the business or, if grouped, materially participate in the group; or
2. do not materially participate but have passive income from other sources against which to deduct your passive business losses.

Example. Sam Warren, MD, operates a medical practice and starts a new physical therapy business (his second business) in which he will not materially participate. The physical therapy business is going to lose money during its first years of operation. If Dr. Warren wants to deduct the losses from his physical therapy business, he has one choice: group that business with his medical practice.

Dr. Warren knows that he will have tax losses in his physical therapy business during its start-up years. Because he will not materially participate in the physical therapy business, the tax code deems his losses passive. He may deduct his passive losses

• against his passive income from other sources (excess passive losses are carried forward); and
• in total, when he sells or otherwise disposes of his entire interest in the passive activity.

This is ugly.

First, Dr. Warren has no other passive income. The medical practice, his only other business or activity, is an active business that produces active income.

Second, he does not plan on selling the physical therapy business anytime soon, so he would not realize any benefit from the accumulation of his carried-forward passive losses.

His solution: the group.

If Dr. Warren’s physical therapy business loses $175,000 as he projects, he can write off that $175,000 because the grouping makes him a material participant.

Without the grouping, he does not materially participate in the physical therapy business. Without material participation, his $175,000 loss is a passive-loss deductible against only passive income, of which he has none.

The medical practice income is active income, not passive income.

When he makes the grouping election, the law combines the two businesses for material participation purposes. Let’s say he works 2,000 hours a year in his medical practice. With grouping, he now works 2,000 hours a year in the combined activity, and that makes the loss from the physical therapy business deductible.

If you would like to have a tax-savings strategy developed, please email me directly at sp@merchbooks.com.

If you do some work at home, you’re probably using your home internet connection. Are your monthly internet expenses deductible? Maybe.

The deduction rules depend on your choice of business entity (proprietorship, corporation, or partnership).

Deduction on Schedule C

If you operate your business as a sole proprietorship or as a single-member LLC, you file a Schedule C to report your business income and expenses. As a Schedule C taxpayer, you may deduct ordinary and necessary expenses, which include business-related internet subscription fees.

You can deduct your use of your home internet whether or not you claim the home-office deduction, as follows:

• If you claim the home-office deduction on your Form 1040, the internet expense goes on line 21 (utilities) of IRS Form 8829 as either a direct or an indirect expense.
• If you do not claim the home-office deduction, enter the business portion of your internet expenses as utilities expenses on line 25 of your Schedule C.

Deduction When You Operate as a Corporation

When you operate your business as a corporation, you are an employee of that corporation. Because of the Tax Cuts and Jobs Act (TCJA), the only way for you to reap the benefits of the home internet deduction is to have your corporation reimburse you for the expense. In the case of a reimbursed employee expense,

• the corporation deducts the expense as a utility expense, and
• you receive the reimbursement as a tax-free reimbursed employee business expense.

Why is the reimbursement method the only way for the corporate owner to get the deduction? The TCJA eliminated the 2018-2025 deduction for miscellaneous itemized expenses. These include unreimbursed employee expenses, such as internet connection fees.

Deduction When You Operate as a Partnership

If you have deductible home internet expenses and operate as a partner in a partnership, you have two ways to get a tax benefit from the home office:

1. Deduct the cost as an unreimbursed partner expense (UPE).
2. Or get reimbursed from your partnership via an accountable plan (think “expense report”).

Substantiating Your Home Internet Expense Deduction

Where business owners can run into trouble with the IRS is in substantiating their internet expense deduction.

You should have no problem showing the total cost for your home internet connection—just total your monthly bills. The problem is in establishing what percentage of the total cost was for business, because only that percentage is deductible.

Ideally, you should keep track of how much time you use your home internet connection for business and how much time for personal use. A simple log or notation on your business calendar or appointment book—indicating approximately how many hours you were online for business each day while working at home—should be sufficient.

Google it, and you can find software and apps that will track your internet use.

Instead of tracking your home internet use every day throughout the year, you could use a sampling method such as that permitted for tracking business use of vehicles and other listed property. There is no logical reason the IRS shouldn’t accept such a sampling for internet use.

If you would like to have a tax-savings strategy developed, please email me directly at sp@merchbooks.com.

It isn’t easy to make predictions, especially about the future. But there is one prediction we’re confident in making: you will have substantial out-of-pocket expenses for health care after you retire. Personal finance experts estimate that an average retired couple age 65 will need at least $300,000 to cover health care expenses in retirement.

You may need more.

The time to save for these expenses is before you reach age 65. And the best way to do it may be to open a Health Savings Account (HSA). After several years, you could have a fat HSA balance that will help pave your way to a comfortable retirement.

Not everyone can have an HSA. But you can if you’re self-employed or your employer doesn’t provide health benefits. Some employers offer, as an employee fringe benefit, either HSAs alone or HSAs combined with high-deductible health plans.

An HSA is much like an IRA for health care. It must be paired with a high-deductible health plan with a minimum annual deductible of $1,400 for self-only coverage ($2,800 for family coverage). The maximum annual deductible must be no more than $7,050 for self-only coverage ($14,100 for family coverage).

An HSA can provide you with three tax benefits:

1. You or your employer can deduct the contributions, up to the annual limits.
2. The money in the account grows tax-free (and you can invest it in many ways).
3. Distributions are tax-free if used for medical expenses.

No other tax-advantaged account gives you all three of these benefits.

You also have complete flexibility in how to use the account. You may take distributions from your HSA at any time. But unlike with a traditional IRA or 401(k), you do not have to take to take annual required minimum distributions from the account after you turn age 72.

Indeed, you need never take any distributions at all from your HSA. If you name your spouse the designated beneficiary of your HSA, the tax code treats it as your spouse’s HSA when you die (no taxes are due).

If you maximize your contributions and take few distributions over many years, the HSA will grow to a tidy sum.

If you would like to have a tax-savings strategy developed, please email me directly at sp@merchbooks.com.

Could you increase your tax deductions by switching from the IRS mileage rate to the actual-expense method? If so, you will be happy to learn you can make that switch.

When you choose the mileage rate, you elect out of the actual-expense method and also elect out of MACRS depreciation.

This does not mean that you are locked out forever. The IRS grants you two ways to escape from your original mileage-rate decision and switch to the actual-expense method.

Escape 1: The Early Escape

You can make an early escape out of your choice regarding the IRS mileage rate and totally undo that original decision. But you generally have to hurry to do that.

The “hurry” part means that you must amend your tax return before the original due date, including extensions.

Example. You bought a new vehicle in 2021, and when you filed your tax return on April 15, 2022, you chose the IRS mileage-rate method. Now, you realize that was a mistake. You have until 11:59 p.m. on October 17, 2022, to file an amended return and elect actual expenses, including the Section 179 deduction, bonus depreciation, and MACRS depreciation.

In other words, when you amend your return before the final extended filing date, you undo your original tax return position and replace it with the one in the amended return.

Once the final extended filing date passes (September 15 for calendar-year corporations and October 17 for individuals), your ability to undo the original return is gone.

But you can still come out ahead with the later escape.

Escape 2: The Later Escape

In the later escape, you simply switch from the IRS mileage-rate to the actual-expense method, using straight-line depreciation over the vehicle’s remaining useful life.

It’s possible to switch from the IRS mileage-rate to the actual-expense method with MACRS depreciation, but you need the consent of the IRS commissioner. Forget that. Getting consent is too expensive, too time-consuming, and too likely to face rejection.

And besides, the switch to straight-line depreciation works very well, as you’ll see.

To make the switch to the straight-line depreciation method, you need to know your vehicle’s

1. adjusted basis,
2. remaining useful life, and
3. estimated salvage value at the end of its useful life.

Your adjusted basis is the original cost (or other basis) reduced by depreciation. Inside the IRS mileage rate is depreciation at so much a mile. For 2022, the depreciation that’s inside each 58.5- and 62.5-cent mile is 26 cents.

Example. You paid $45,000 for the business portion of your vehicle and drove it 5,000 business miles. Depreciation on the 5,000 miles is $1,300 (5,000 times 26 cents). Your adjusted business basis is $43,700 ($45,000 minus $1,300).

Your official “estimated useful life” is how long you expect to keep the vehicle. That’s easy. Say you estimate that you will keep the vehicle for three more years. So, three years is the estimated useful life at the time of your switch.

Next, you estimate your salvage value by using the Kelly Blue Book or other respected valuation guide. Here, you establish what you think you can reasonably sell the vehicle for at the end of its estimated useful life. Make sure to print or otherwise capture the valuation evidence for your tax file.

IRS grants a bonus reduction in salvage value. If you estimate your vehicle’s useful life at three years or more, you can reduce your salvage value estimate by an amount equal to 10 percent of your basis in the property.

Example. Say you estimate a salvage value of $15,000 on a vehicle with an adjusted basis of $43,700. By using the 10 percent bonus reduction in salvage value, you can reduce your estimated salvage value by $4,370, giving you a salvage value of $10,630 ($15,000 – $4,370).

Straight-line depreciation. With an adjusted basis of $43,700, and salvage value of $10,630, you are going to depreciate $33,070 ($43,700 – $10,630) over three years. Assuming there’s no change in your business mileage, your depreciation deduction for each of the three years is $11,023.

If your estimated salvage value is less than 10 percent of your adjusted basis at the time of the switch from the IRS mileage rate to actual expenses, you use the IRS salvage-value bonus to simply make your salvage value zero.

Through October 2022, you can buy Series I bonds that pay 9.62 percent interest.

And you receive that rate for six months from the time of purchase.

What happens after that? On November 1, 2022, the U.S. Treasury Department sets a new six-month rate equal to the fixed rate (currently zero) plus the Consumer Price Index inflation rate.

The interest you earn for the first six months gets added to the principal, and you earn interest on that interest during the next six months (think compound interest).

Sounds too good to be true. There’s a trick, right? Not really, but the government keeps your money, both your principal and your interest, for at least one year.

Mechanics

It works like this: You are buying a 30-year bond. The interest rate changes every six months. You can cash out anytime after one year, but if you cash out before five years, you have to forfeit three months of interest (no big deal).

You don’t pay taxes on the interest until you cash out. You get the compounding effect tax-free. It’s like a Roth IRA without age limits and penalties.

Key point. You can’t lose the money you invest or the interest you earn, other than the three months’ worth if you cash in before five years.

When you do cash in, you pay federal income taxes on the interest, but you don’t pay state, county, or city income taxes.

It is possible (albeit unlikely for many of you) to avoid taxes on the interest altogether if you use the monies for qualified higher education expenses.

Okay, So What’s the Downside?

You can’t buy more than $10,000 per year, although if you buy from TreasuryDirect and also utilize your tax refund, you can acquire $15,000 of bonds per year. The I bond purchase limit on a tax return is $5,000—regardless of joint or single filing.

If you’re married, your spouse can buy $10,000, so now you’re up to $25,000 per year.

Now, let’s add in your corporation or corporations. Such entities can purchase up to $10,000 of such bonds per calendar year.

Example. Sam, his spouse, and his two corporations are hot for the 9.62 percent of tax-deferred interest. He has not yet filed his 2022 tax return, which shows a tax refund. With Sam, his spouse, and his two corporations, Sam can buy $45,000 of I bonds in calendar year 2022.

He can do the same during calendar year 2023.

The major downside to the bonds is that you cannot buy more than the annual limits above. There’s no overall limit, just the annual limits.

Inflation and Deflation

The Series I bond is based on inflation. So if inflation drops to zero, cash out that bond. Meanwhile, ride this inflation wave. And remember, your Series I bond cannot go down in value. If your $10,000 I bond earned $985 in interest, the new principal balance is $10,985 and that principal balance never goes down. Deflation can’t hurt it.

If you would like to discuss more, please email me directly at sp@merchbooks.com

Imagine this:

• Tax deduction for you
• Tax-free income for Mom and Dad

It doesn’t have to be Mom and Dad. The tax-free income can go to your brother or sister, or your best friend.

To make this work, you need to have a business reason to travel and stay overnight at the Mom and Dad Hotel.

Say you travel to a convention, rent your parents’ guest room for five days, and pay them $1,000 fair rent. You deduct the $1,000 as a business travel expense. Your parents have $1,000 of tax-free income.

Sound good? Great—let’s see how you can make this work for you by following three rules.

Rule 1: 14-Day Limit on Renting

Mom and Dad can rent out a room in their home or rent their entire house (tax-free) if they rent it out for no more than 14 days during the year. While the rules are generous in allowing your parents not to include this rental income as taxable income, they can’t offset that income with expenses associated with the rental.

Rule 2: More Than 14-Day Personal Use Requirement

To obtain any tax-free rent, Mom and Dad must personally use the place they rent to you for more than 14 days during the year. For a primary residence, this isn’t a problem.

But for second homes or vacation homes, your rental from Mom and Dad or your brothers and sisters creates potential trouble. Why? Because the days of your rental (at fair value or not) count as days of personal use for Mom or Dad and for your brothers or sisters.

Rule 3: Fair Market Rental Rate

When you stay at a commercial hotel, you pay an established commercial rate. So when you stay with Mom and Dad, other family, or friends, you also need to pay a commercial rate, which the IRS refers to as a fair market rental rate.

Form 1099

Tax law says that when you pay business rents that exceed $600 to an individual during a tax year, you must report the total of those business rents to the IRS. Hence, if you pay Mom and Dad more than $600 in rent during any calendar year, you have to give them (and the IRS) a Form 1099.

Mom and Dad’s Tax Return

Mom and Dad should report the rental income from the Form 1099 on their Schedule E for the year.

Then, because the amount is not taxable, they should subtract that amount in the expense section of Schedule E and add a supporting statement such as the following:

Taxpayers rented their personal residence for fewer than 15 days during the taxable year. The rental income was reported on a 1099 and is thus reported as income on Schedule E. That rent is exempt from taxation under IRC Section 280A(g) and is thus removed with the offsetting expense entry on that same Schedule E.

If you would like to have a tax-savings strategy developed, please email me directly at sp@merchbooks.com.