In this week’s episode, the topic is passive income exceptions.  As I discussed in last week’s episode 163, there are two types of passive income activities.    Rental Income
 Business Activity Income from activities that the taxpayer doesn’t materially participate in.   Non Passive Income consists of: Wages
1099s
Interest
Dividends
Lottery Winnings
Royalties
Annuities
Gains on stocks and bonds
Guarantee payments
Income from any activity from which the taxpayer actively participates   There are two exceptions for being able to passive losses. 1. $25,000 exception for losses
2.  Real Estate Professional $25,000 allowance for loss
Taxpayer can not be a foreign taxpayer
Taxpayer must 10% ownership of the activity at all times during the tax year
$100,000 Modified AGI Limitation (single / married filing separate)
$200,000 Modified AGI Limitation (married filing jointly Material participation in an activity includes: 1. Taxpayer must have 500 hours in the activity
2. Your participation was substantially all the participation in the activity including the participation of individuals who did not own any interest in the activity.
3. You participated in the activity for more than 100 hours during the tax year and you participated at least as much as any other individual
4. You materially participated in the activity for any of the five of the previous ten years
5. The activity is a personal service activity in which you materially participated for any three preceding tax years.  (Personal services include health (including veterinary services), law, architecture, engineering, accounting, performing, consulting, actuarial science.
6. Based on all the circumstances and facts you participated in the activity on a regular, continuous, and substantial basis during the year.
7.  The activity is a significant participation activity and you participated in all significant activity for more than 500 hours.   Spouse participation - Your spouse’s participation is combined into your participation.   For example, if you had 300 hours and your spouse had 250 hours, then you have 550 hours and your spouse has 550 hours.
 
Real Estate Professional
 Material participation in each specific rental
 50% rule of personal services must be performed in real estate
 750 hours rule
 5% ownership rule in the activity at all times during the tax year.   Click here for the IRS Publication 925

The topic for this episode is “Nonpassive Income”.

There are two types of passive income:

1. Rental income - passive income from rental activities (Condos, Commercial Property, Houses, Apartments)

2. Business income where the taxpayer does not materially participate.

The following types of income generally are not passive income:

(a) Portfolio income, including interest, dividends, royalties, annuities and gains on stocks and bonds
(b) Lottery winnings
(c) Salaries, wages, Form 1099-Misc. commissions and retirement income
(d) Guaranteed payments for services
(e) Income from any activity in which the taxpayer materially participates

Passive income is generally reported on Schedule E. Rental Income is report on page one of the Schedule E. Income from partnerships, S-Corps, LLCs are reported on page two of the Schedule E.

Passive income can be reported on the Form 4797, Sale of Business Property or the Schedule D, Capital Gain and Losses when you have a disposition of the passive investment activity or an asset used in a passive activity.

Passive income can also be reported on Schedule C and F for income producing activities in which the taxpayer does not materially participate

In order to deduct passive income losses from a passive activity, you must have passive income from that passive activity. You can no deduct passive losses from other types of income (wages, dividends, interest, other partnership activity, social security benefits, retirement income, etc.)

In this episode, I discuss tax fraud, where a caller tells you or leaves a voicemail message informing you that you owe additional tax and if you don’t pay before the end of the day you will be arrested and you assets will be seized.

Things to know about this type of tax fraud is:

1. The IRS or the states will not contact you by phone to inform you that you owe additional tax. The IRS and the states will send you a notice by the mail.

2. The IRS or the states will not request that you pay this additional tax liability by phone using debit cards, credit cards, gift certificates, green dot cars, and iTune cards.

3. The IRS doesn’t have a foreign bank account number for you to wire or transfer money to. The IRS is a division of the U.S. Treasury Department.

4. The IRS and states allow you to appeal and audit decision or to respond to a notice.

5. If you have questions about the caller or a notice, you should call your taxpreparer, a tax professional, the IRS (1-800-829-1040), or me (615-873-0477).

Don't be fooled by the tax scam.   The IRS can't accept iTunes cards as payment.

 

In this episode, I discuss the IRS rules on whether your business is a business or a hobby.

Does your business have:

A. Necessary Business Expenses
B. Ordinary Business Expenses

Is your business an “Ordinary Business”?

The factors as to whether your business is a hobby or business are:

1. Do you make the time and effort into your business to make a profit?

2. Do you the taxpayer need the income from the activity and depend upon it?

3. Is the losses in your business from the startup costs and are they beyond your control?

4. If you’re not making a profit, what are you doing to become profitable? What steps are you taking to become profitable?

5. Do you have the knowledge to carry on the activities of your business?

6. Have you had similar businesses in your past that were profitable?

7. If you’ve been in business for sometime has your business made a profit in three out of the last five years?

8. Can you expect to make a profit in future from the appreciation of assets?

The basic theme is that your business need to make profit especially in three of the last five?

Without a profit motive, I introduce passive income and losses in this episode. With passive losses, your losses are limited to the income from the that business income and can not be taken against other income sources listed on your tax return.

If your business is a hobby, you can only deduct the expenses on Form 1040 Schedule A (Itemized Deductions).

The IRS rules for hobby deductions is

“Deductions for hobby activities are claimed as itemized deductions on Schedule A (Form 1040). These deductions must be taken in the following order and only to the extent stated in each of three categories:

1. Deductions that a taxpayer may take for personal as well as business activities, such as home mortgage interest and taxes, may be taken in full.

2. Deductions that don’t result in an adjustment to basis, such as advertising, insurance premiums and wages, may be taken next, to the extent gross income for the activity is more than the deductions from the first category.

3. Business deductions that reduce the basis of property, such as depreciation and amortization, are taken last, but only to the extent gross income for the activity is more than the deductions taken in the first two categories.”
- https://www.irs.gov/uac/business-or-hobby-answer-has-implications-for-deductions

 

 

 

In this episode, I discuss what you need to know about taxes when it comes to being or becoming an entrepreneur.

1. Entity Type - Your entity type determines your tax rate for taxable income

Corporations
Partnerships
Limited Liability Companies
S-Corps
Sole Proprietorship

Corporations are taxed at 34%
Professional Corporations are taxed at 35%

Sole Proprietorships, S-Corps Partnerships, Limited Liabilities are taxed at the individual taxpayer rates

2. Hobbies are not businesses - Your business must have a profit motive

3. If you have employees or collect sales tax, you become a trustee for the state(s) and IRS. They require you to collect the money on their behalf and remit it the IRS or the state(s).

4. Keep good business records. Use a good accounting software package.

5. Know the difference between taxable income and book income.
Book income doesn’t always tie to taxable income because of tax-book differences.

6. As a business, you may be able utilize net operating losses (NOLs) and credits (Work Opportunity Tax Credits, Energy). NOLS can utilized over twenty years and there is also a three year carry-back that you can utilized by amending previous tax returns.

7. Know the federal, state and local licensing requirements for your business.
Alarms, business licenses, permits, etc

8. Know one you could go out of business or sell your business and how that will affect your taxes if don’t have a tax plan in place.

9. Banks require copies of your tax returns for loans covenants that you have with the bank.

 

It's important to keep your tax return and your back up supporting that was used for preparing your tax returns.   As a general rule, you should keep the backup and the tax returns for seven years should you ever need the information in an IRS audit.

While you should keep all the support documentation, the list below is important for IRS audits when it comes to having backup support documentation.

1.  Schedule C Income and Expenses

    (Includes Car Mileage with number of total miles driven,  business miles, personal           miles, and commuting miles driven. 

2.  Form 1040 Alimony deduction 

    (Includes Court Decree showing Alimony)

3.   Medical Expenses on Schedule A

      Examples are Hospitals, Prescriptions, Documents, Assisted Care, Nursing Home,         and any other medical expenses including mileage driven for medical purposes

4.  Charitable Deductions 

     You should have receipts from the charitable organizations for the cash and non-          cash donations that were made including mileage driven for charitable purposes.          Cancelled check copies are not an acceptable substitute for receipts.

 5.  Form 1120 (Corporation), 1120-S (S-Corp), and 1065 (Partnerships and LLCs)             business income and expenses 

 6.   Unreimbursed employee business expenses and home office deduction expenses

 7.  Mortgage Interest Calculation for mortgage equal to or greater than $1.1 million

    

July - Hot summer days and nights and thoughts that turn to business unclaimed property reporting. Recently in unclaimed property, Delaware is being sued by several states because of the state’s unclaimed property rules.

For this episode, I discuss the definition of unclaimed property, what is considered unclaimed property, due diligence, state unclaimed property dates, and remitting unclaimed property.

1. The definition of unclaimed property according to the State of Tennessee is “Unclaimed property is intangible assets (cash, stocks, or bonds) that a company or other entity is holding that belongs to you that have become abandoned. It includes bank accounts, stocks and dividends, wages, refunds, insurance payments, gift certificates, credit balances and overpayments, just to name a few.”

2. Examples of unclaimed property are bank accounts, stocks and dividends, wages, refunds, insurance payments, gift certificates, credit balances and overpayments, etc.

3. About sixty days from the State reporting date, businesses are required to send out a due diligence letter to the unclaimed property owner’s last known address informing the owner that the business may have unclaimed property (ie money) that belongs to the owner. Additionally, the letter should have information on how to claim the unclaimed property and if the owner doesn’t respond in sixty days, the unclaimed property will be turned over to the state.

4. Each state has a reporting date. The reporting date for the majority of the states is October 31st and November 1st. The other states reporting date are scattered throughout the year.

5. When remitting the unclaimed property funds to the state, you will need to fill out the state required paperwork and forms. Some states require that the report and funds be transmitted electronically.

Free software is available to file unclaimed property. The two major unclaimed property software companies are UPExhange (https://up.eagletm.com) and HRSPro (https://wagers.net).

For more information about unclaimed property, please contact me.

In this episode, I discuss why keeping up with tax laws and court cases is important for both individuals and businesses.

1.  Tax laws are constantly changing.

        What tax laws and court cases today is not true today.  Public opinion of                       corporate inversions and using tax laws to reduce your tax liability is changing in         the public opinion.

 2.  Tax laws can be beneficial to reducing your tax liability.

       Examples are tax amnesty laws and bonus depreciation.

       States use tax amnesty laws to get individuals and businesses to pay their tax              liabilities where they haven't paid or filed taxes.

       Bonus depreciation on newly purchased assets during the current tax year can              reduce your tax liability for businesses, rental property, and Schedule C filers.              Bonus depreciation will be phased out in 2020.

3.  Tax law cases can drag on for years in Federal and State court cases.

      Examples are Gillette vs. California and AT&T vs. Kentucky

4.  Residences rules are important when it comes state laws.

     Examples are South Carolina, New York, New Jersey, and Kansas.

5.  Tax laws are complicated.

     Example that I used were:

    Georgia's weight loss replacement tax exemption is where the supplement are             subject to local sales and use tax laws but not state sales tax.

     Florida - Drop shipments are not subject to sales tax when the taxpayer is located        outside Florida.  

     Market Source Rules

     Out-of-state companies not subject to sales tax nexus rules need to report                  purchases to the state so customers can pay use tax.

In this week’s episode, the topic is “What to expect when you don’t respond to the IRS or file tax returns”.

1. Send notice(s) of delinquency with a date to respond by.
The IRS and the states may send several notices before they send a final tax notice. The notices will have a date to respond by before the IRS will escalate the tax notice to collection for a outstanding tax liability. By not responding to the tax notices, the IRS and the courts will assume the outstanding tax liability is correct and you will not have the option to appeal once the notice has reached the final notice stage.

2. The IRS will prepare a tax return and liability that may not be based on actual taxable income and deductions.
Based on tax forms (1099s, K-1s, W-2s, etc) the IRS or states will prepare and file a tax return on the taxpayer’s behalf using the information the IRS on file for the taxpayer. Some tax authorities will sometimes base an tax liability and assessment based on prior tax history.

3. Place liens against your property
Once the IRS files a tax return on your behalf because you didn’t respond, the IRS can place a lien against the taxpayer’s property (house, real estate, and other personal property) to satisfy a tax debt.

4. Seize property to satisfy a tax liability or judgement.
The IRS and states can seize and sell property to satisfy tax debt.

5. Send a revenue officer.
Revenue officers can show up unannounced to collect tax debt when they expect tax fraud or you don’t respond or resolve a tax issue. Sometimes, the revenue officer will be accompanied by U.S. Marshals or FBI agents.

6. Prosecute
According to the IRS website, the IRS does not like to prosecute taxpayers but it is an option especially if the taxpayer is committing tax fraud.

If you don’t respond to a notice of delinquency within a reasonable timeframe (keep ignoring them), the IRS and the courts will assume that the notice of delinquency is correct and you will be unable to appeal the decision.

For this episode, I discuss some of the reasons why you may be selected for an IRS or State Tax Audit based on research and past experience.

1. Make mathematical errors
Addition, subtraction, multiplication errors even through it’s harder to do with software

2. Leaving off income from W-2s, 1099s, etc
Income from W-2(s), 1099(s), or K-1(s) isn’t being reported on the tax return.

3. Have an off-shore account where you're not reporting income
Hiding money overseas in an off-shore account from which you are earning interest and/or dividends but not reporting the income on your tax return.

4. Large charitable deductions reported on Schedule A
You report large charitable deductions on the tax return that isn’t reasonable to your reported income

5. You’re audited because you’re wealthy
States especially will audit wealthy taxpayers when they are moving to a non-income tax state. The state I use in the example is New York where the taxpayer has moved to Texas or Florida.

6. Randomly selected to be audited
Based on analytics and statistics, your tax return was flagged to be audited.

7. Rounding excessively on your return (rounding up to the nearest 100 or 1,000)
Taking a deduction on Schedule A and rounding up the nearest 100 or 1,000 instead of the nearest dollar.

8. Unreasonable deductions for home office and unreimbursed expenses
Examples are uniforms, mileage, travel, square footage of your home being used as an office, etc...

9. Continue to have Schedule C losses year after year (No profit motive)
You have never shown a business profit on Schedule C

10. Reporting Hobby Losses on Schedule C
Hobbies are not business

11. Get reported to the IRS by a whistle blower
Whistle blowers can get a percentage of the tax and penalties based on the audit if there are changes to a return

12. Use a non-reputable tax preparer to prepare your return
Using a non-reputable tax preparer who is found to have committed tax fraud will likely cause any (all) tax returns that was prepared by them to be audited.

13. Reporting deductions as income and assets and income as deductions and liabilities on a corporate, partnership, S-Corp, limited liability company tax return

In this example, I discussed having negative income, assets, liabilities, and deductions listed on the tax return.