by Sudip Patel | Jun 12, 2022 | Tax Planning
Is Your Sideline Activity a Business (Good) or a Hobby (Not Good)?
Do you have a sideline activity that you think of as a business?
From this sideline activity, are you claiming tax losses on your Form 1040?
Will the IRS consider your sideline a business and allow your loss deductions?
The IRS likes to claim that money-losing sideline activities are hobbies rather than businesses. The federal income tax rules for hobbies have been anti-taxpayer for years, and now an unfavorable change enacted in the Tax Cuts and Jobs Act (TCJA) made things even worse for 2018-2025.
If you have such an activity, we should have your attention.
Here’s the deal: if you can show a profit motive for your now-money-losing sideline activity, you can classify that activity as a business for tax purposes and deduct the losses.
Factors that can prove (or disprove) such intent include:
- Conducting the activity in a business-like manner by keeping good records and searching for profit-making strategies.
- Having expertise in the activity or hiring advisors who do.
- Spending enough time to justify the notion that the activity is a business and not just a hobby.
- Expectation of asset appreciation: this is why the IRS will almost never claim that owning rental real estate is a hobby, even when tax losses are incurred year after year.
- Success in other ventures, which indicates that you have business acumen.
- The history and magnitude of income and losses from the activity: occasional large profits hold more weight than more frequent small profits, and losses caused by unusual events or just plain bad luck are more justifiable than ongoing losses that only a hobbyist would be willing to accept.
- Your financial status: “rich” folks can afford to absorb ongoing losses (which may indicate a hobby) while ordinary folks are usually trying to make a buck (which indicates a business).
- Elements of personal pleasure: breeding race horses is lots more fun than draining septic tanks, so the IRS is far more likely to claim the former is a hobby if losses start showing up on your tax returns.
If you would like to have a tax-savings strategy developed, please email me directly at sp@merchbooks.com.
by Sudip Patel | May 4, 2022 | Tax Planning
Working at a tender age is an American tradition. What isn’t so traditional is the notion of kids contributing to their own IRA, especially a Roth IRA. But it should be a tradition, because it’s a really good idea.
Here’s what you need to know about IRAs for kids. Let’s start with the Roth IRA option.
Roth IRA Contribution Basics
The only federal-income-tax-law requirement for a child to make an annual Roth IRA contribution is to have enough earned income during the year to cover the contribution. Age is completely irrelevant.
So if a child earns some cash from a summer job or part-time work after school, he or she is entitled to make a Roth contribution for that year.
For both the 2021 and 2022 tax years, your working child can contribute the lesser of
- his or her earned income for the year, or
- $6,000.
While the same $6,000 contribution limit applies equally to Roth IRAs and traditional IRAs, the Roth option is usually better for kids.
Key point. A contribution for your child’s 2021 tax year can be made as late as April 15, 2022. So, there’s still time for that.
Modest Contributions to Child’s Roth IRA Can Amount to Big Bucks by Retirement Age
By making Roth contributions for a few years during the teenage years your kid can potentially accumulate quite a bit of money by retirement age.
But realistically, most kids won’t be willing to contribute the $6,000 annual maximum even when they have enough earnings to do so.
Say the child contributes $2,500 at the end of each of the four years. Assuming a 5 percent return, the Roth account would be worth about $82,000 in 45 years. Assuming an 8 percent return, the account value jumps to a whopping $259,000. Wow!
You get the idea. With relatively modest annual contributions for just a few years, Roth IRAs can be worth eye-popping amounts by the time your “kid” approaches retirement age.
If you would like to have a tax-savings strategy developed, please email me directly at sp@merchbooks.com.
by Sudip Patel | Mar 23, 2022 | Tax Planning
Let’s say you own the building.
Now, let’s say that you rent this building to your business.
With no tax planning, you have a self-rental, and that
- makes rental income from this building non-passive, meaning that it cannot offset any passive losses (very bad); and
- makes rental losses from this building passive losses, meaning that you likely cannot deduct the losses this year (also very bad).
So, there you have it: with no tax planning, you get the worst of both worlds.
Solution
But wait—there’s a solution (often overlooked).
Under a special grouping rule, you can qualify to group your separately owned rental building with your separately owned business and treat the two of them as one activity for purposes of the passive loss rules.
Ownership
Rental. Your ownership of the rental might be as an individual, an S corporation, or an LLC. For this strategy, you can use any of these forms for your ownership.
Business. You can own the business as a proprietorship, an S corporation, or an LLC—all these forms work for this strategy.
Note that the C corporation does not work.
Two into One
What makes two into one possible? Your ownership!
The regulations say that if each owner of the business has the same proportionate ownership interest as each owner of the rental, then the taxpayers may group the business and rental activities as one activity.
Technically, the rental and the business need to pass the appropriate-economic-unit test, which gives great weight both to the extent of common control and to the extent of common ownership.
You have no problem here because you have both 100 percent control and 100 percent ownership of both the business and the rental. This puts you home free on this test.
And if you are married, you can include your spouse in the mix.
If you would like to have a tax-savings strategy developed, please email me directly at sp@merchbooks.com.
by Sudip Patel | Mar 2, 2022 | Tax Planning
Many employers are struggling to hire and retain employees during the COVID-19 pandemic and the resulting “great resignation.”
If you’re one of those employers (or about to become one), examine your use of tax-free fringe benefits. It’s one of the proven ways to help keep good employees. Such benefits are deductible by you, the employer, but tax-free to the employee.
Common examples of tax-free benefits are health insurance and paid vacation.
But there is another potential employee fringe benefit: free meals (usually, lunch). Free meals not only make your employees happy, but keep them on the premises and generally make them more productive as well.
The deduction is scheduled to end in 2026. So, if this is a perk you want to give your employees, the time is now.
But not all employee meals are a tax-free fringe benefit. Meals qualify for tax-free treatment if they are furnished
- in kind (no cash alternative for not taking the meal),
- on the employer’s business premises, and
- for the convenience of the employer.
The most common way to pass the convenience test is to establish that employees can’t get their own meals within a reasonable time. But the widespread availability of meal delivery services such as Grubhub, DoorDash, and Uber Eats makes it harder for the employer to pass the convenience test.
Employers who want to provide tax-free meals to employees under the “not enough time” test should prohibit use of meal delivery services and document why such services are not viable for them—for example, due to disruption or security concerns.
If you would like to have a tax-savings strategy developed, please email me directly at sp@merchbooks.com.
by Sudip Patel | Mar 1, 2022 | Tax Planning
Imagine this: your Schedule C business buys a home at the beach, uses it solely as an entertainment facility for business, pays off the mortgage, and deducts all the expenses.
Now say, 10 years later, without any tax consequence to you, you start using the beach home as your own.
Is this possible? Yes. Are there some rules on this? Yes. Are the rules difficult? No.
Okay, so could you achieve the same result if you operate your business as a corporation? Yes, but the corporation needs to rent the property from you or reimburse you for the facility costs, including mortgage interest and depreciation—because you want the title to always be in your name, not the corporation’s name.
The beach home, ski cabin, or other entertainment facility must be primarily for the benefit of employees other than those who are officers, shareholders, or other owners of a 10 percent or greater interest in the business, or other highly compensated employees. In this situation, you create
- 100 percent entertainment facility tax deductions for the employer (you or, if incorporated, your corporation), and
- tax-free use by the employees.
The employee facility deduction is straightforward. It has three splendid benefits for the small-business owner:
- You deduct the facility as a business asset.
- Your employees get to use the facility tax-free.
- You own the property and can use it personally without tax consequences once you no longer need it for business use. (Note that when you sell, you will have a gain or loss on the sale and some possible recapture of depreciation.)
If you would like to have a tax-savings strategy developed, please email me directly at sp@merchbooks.com.
by Sudip Patel | Feb 5, 2022 | Tax Planning
As a business owner, you are obligated to collect and remit payroll taxes for your employees. But you are not required to collect and remit payroll taxes for independent contractors.
That’s why it’s important to correctly classify workers as either employees or independent contractors.
But here’s the problem: the rules for correctly classifying workers as either employees or independent contractors are unclear and confusing.
And what happens if you misclassify a worker as an independent contractor? Then you can find yourself owing hundreds of thousands of dollars in back employment taxes, penalties, and interest.
But wait! If this happens to you, the safe harbor of Section 530 may provide relief.
The Section 530 safe harbor was passed by Congress as part of the Revenue Act of 1978 in response to complaints by business owners that the IRS was being too aggressive in reclassifying their workers as employees.
The possible good news for you is that the Section 530 safe harbor prevents the IRS from retroactively reclassifying your independent contractors as employees and subjecting you to federal employment taxes, penalties, and interest.
Reclassifications, if any, go forward only. You are not on the hook for any money as of the date of any reclassifications.
To qualify for the Section 530 safe harbor, you must meet all the following requirements:
- You must have filed all federal tax and information returns consistent with treating the individuals as independent contractors.
- You must show that you never treated the individuals in question, or other workers in substantially similar positions, as employees for federal employment tax purposes.
- You must show that you had a reasonable basis for classifying the individuals as independent contractors.
You can meet the reasonable basis requirement by showing that you relied on any one of a number of authorities, including judicial precedents or administrative rulings, a prior worker classification tax audit, or industry practice.
Your classifications of workers for federal purposes do not have to match your classifications for state law purposes.
If you would like to have a tax-savings strategy developed, please email me directly at sp@merchbooks.com.
