News Archive April 2015
Tax & Business Alert
Welcome to this month's edition of the Tax & Business Alert. Our goal is to provide you with current articles on various tax & business topics. The articles are intended to keep you up to date on trends and issues that may impact your business and personal financial affairs. Please contact us if you have questions about any of the issues discussed.
Abstract: Taxpayers who run up tax losses in a business must be prepared to prove that one of the material participation tests was passed to avoid having the losses characterized as a passive activity loss (PAL) that cannot be currently deducted. In general, an individual taxpayer can meet the material participation standard by passing one of seven tests outlined in the regulations and described in this article.
Contemporaneous record keeping key to avoiding loss limitations
Taxpayers who run up tax losses in a business must be prepared to prove that one of the material participation tests was passed to avoid having the losses characterized as a passive activity loss (PAL) that cannot be currently deducted. Adequate contemporaneous records that detail the taxpayer’s tasks and time spent in the activity are crucial in attempting to sidestep the PAL rules. Records created after-the-fact are better than nothing, but they are much less believable than contemporaneous records. If losses are disallowed by the IRS, interest and penalties may be added to the unpaid taxes.
In general, an individual taxpayer can meet the material participation standard by passing one of the following seven tests outlined in the regulations:
- More-than-500 hours. This test is passed if the taxpayer spends more than 500 hours in the activity during the tax year in question.
- More-than-100 hours and more-hours-than-anyone-else. This test is passed if the taxpayer participates in the activity for more than 100 hours during the tax year and no other taxpayer participates more, including taxpayers who are not owners.
- Substantially all. This test is passed if the individual’s participation in the activity for the year constitutes substantially all of the participation in the activity for all individuals (including nonowners).
- Significant participation activity. This test is met if the individual’s aggregate participation in all activities in which he or she participated for more than 100 hours during the year (significant participation activities) exceeds 500 hours for the year.
- Material participation in the last five years. This test is passed if the individual materially participated in the activity for any five tax years during the 10 immediately preceding years.
- Personal service activity. This test is passed if the individual materially participated for any three preceding tax years by performing services in the fields of health, law, engineering, architecture, accounting, actuarial science, performing arts, or consulting.
- Facts and circumstances. This test is passed if, based on all facts and circumstances, the taxpayer is found to have participated in the activity on a regular, continuous, and substantial basis during the year in question.
In attempting to pass the material participation tests, taxpayers can prove their participation levels by any reasonable means. This can include identifying the types of work performed and the approximate number of hours spent performing such work with contemporaneous appointment books, calendars, narrative summaries, and the like. Several court decisions have said that, while the regulations permit flexibility regarding what it takes to prove material participation, courts are not required to accept after-the-fact “ballpark guesstimates” or a taxpayer’s unverified, undocumented, and presumably self-serving testimony.
Abstract: Normally, retirement plan distributions made to a nonspouse beneficiary after the account owner’s death are taxable at the time they are received and cannot be rolled over to the beneficiary’s own IRA. However, employer-sponsored retirement plans are required to offer nonspouse beneficiaries the option to roll over inherited amounts tax-free in a direct rollover to an inherited IRA. This article lists the special rules that apply to an inherited IRA.
Special rules for inherited IRAs
Normally, retirement plan distributions made to a nonspouse beneficiary after the account owner’s death are taxable at the time they are received and cannot be rolled over to the beneficiary’s own IRA. However, employer-sponsored retirement plans are required to offer nonspouse beneficiaries the option to roll over inherited amounts tax-free in a direct (trustee-to-trustee) rollover to an inherited IRA. No taxes will be due on the inherited IRA rollover until the beneficiary receives a distribution from the inherited IRA. An inherited IRA is an IRA that has been acquired by a beneficiary on the death of someone other than a spouse.
- The following special rules apply to an inherited IRA:
- The IRA must be a brand-new IRA set up for the specific purpose of receiving the inherited account.
- The IRA must be specially titled in the deceased account owner’s name.
- No other contributions may be made to the IRA.
- No other amounts may generally be rolled into or out of the IRA.
- Minimum required distributions will need to be made over the beneficiary’s life expectancy starting the year after the IRA owner’s death.
Abstract: It may seem easy to give money to relatives for educational or medical purposes, but doing so can result in a tax hit. This article explains why it’s important to make any payment directly to the organization or service provider.
Avoid gift treatment by paying expenses directly
The annual exclusion for gifts remains at $14,000 for 2015. (Married couples can gift up to $28,000 combined.) This limit applies to the total of all gifts, including birthday and holiday gifts, made to the same individual during the year. However, any payment made directly to the medical care provider (for example, doctor, hospital, etc.) or educational organization for tuition is not subject to the gift tax and, therefore, is not included in the $14,000 limit.
So, when paying tuition or large medical bills for parents, grandchildren, or any other person who is not your dependent minor child, be sure to make the payment directly to the organization or service provider. Don’t give the funds to the parent or other individual first and have them pay the school, doctor, or hospital. By doing so, you have made a gift to that person, subject to the $14,000 limit. In summary, make direct payments to schools or medical providers and avoid taxable gifts that could be subject to the gift tax or reduce the payer’s unified credit.
Caution: Direct payments of tuition reduce the student’s eligibility for financial aid on a dollar-for-dollar basis. However, if the gift were made directly to the student, only 20% of the gifted assets would be counted as assets of the student for financial aid purposes. Accordingly, careful analysis of the trade-offs between the gift tax exclusion and impairment of financial aid eligibility should be considered.
Abstract: This article mentions a couple of important tax deadlines for April and June.
Besides being the last day to file (or extend) your 2014 personal return and pay any tax that is due, 2015 first quarter estimated tax payments for individuals, trusts, and calendar-year corporations are due today. So are 2014 returns for trusts and calendar-year estates, partnerships, and LLCs, plus any final contribution you plan to make to an IRA or Education Savings Account for 2014. SEP and Keogh contributions are also due today if your return is not being extended.
Second quarter estimated tax payments for individuals, trusts, and calendar-year corporations are due today.
Abstract: Accounting for rental income might at first seem like a simple concept, but in practice it may not be so simple. What is the difference between “rental income” and “advance rent”? How does one account for a security deposit, or property or services received in lieu of rent? How is personal use of a vacation home or other rental property treated? This article addresses those questions.
What landlords should know about rental income and expenses
Rental income is any payment received for the use or occupation of property. Rental income is generally included in gross income when actually or constructively received. Cash basis taxpayers report income in the year received, regardless of when it was earned. Expenses of renting property can be deducted from gross rental income. Rental expenses are generally deducted by cash basis taxpayers in the year paid.
Advance rent is any amount received before the period that it covers. Include advance rent in rental income in the year received, regardless of the period covered or the accounting method used.
Do not include a security deposit in income when received if it is to be returned to the tenant at the end of the lease. If part or all of the security deposit is retained during any year because the tenant does not live up to the terms of the lease, include the amount retained in income for that year. If an amount called a security deposit is to be used as a final payment of rent, it is advance rent. Include it in income when received.
If the tenant pays any expenses that are the landlord’s obligations, the payments are rental income and must be included in income. These expenses may be deducted if they are otherwise deductible rental expenses. Property or services received in lieu of rent are reportable income. Include the fair market value of the property or services in rental income. Services at an agreed upon or specified price are assumed to be at fair market value unless there is evidence to the contrary.
Personal use of a vacation home or other rental property requires that the expenses be allocated between the personal and rental use. If the rental expenses exceed rental income, the rental expenses will be limited.
Tax & Business Alertis designed to provide accurate information regarding the subject matter covered. However, before completing any significant transactions based on the information contained herein, please contact us for advice on how the information applies in your specific situation. The information contained in this newsletter was not intended or written to be used and cannot be used for the purpose of (1) avoiding tax-related penalties prescribed by the Internal Revenue Code or (2) promoting or marketing any tax-related matter addressed herein. Tax & Business Alert is a trademark used herein under license.