Archive for the ‘depreciation’ Tag
Back to Basics Part XXX – Form 8829 Expenses for Business Use of Your Home
Filed under: Back to Basics, Home Office | Tags: business use of home, depreciation, Form 8829, home daycare, home office, mortgage interest, Publication 587, real property taxes, Schedule C, simplified method, utilities
Leave a comment Originally published in the Cedar Street Times
December 25, 2015
Merry Christmas!
My vision of Santa’s workshop is that it is built into his home at the North Pole. Being that it is quite chilly there, why would you want to leave the warmth of one building to go to another? It is also highly unlikely that he would need a separate office “in-town” at the North Pole. Betting on the idea that it is built into his home, he would certainly seem eligible for a home office deduction.
Whether or not he would use the Form 8829 – Expenses for Business Use of Your Home would depend on his legal structure, however. Is he Santa Claus, sole proprietor? Is it Santa Claus, Inc. of which he is a greater than 2% shareholder employee? Or maybe it is Santa’s Workshop, LLC? If it is an LLC, it is possible it could be a Single Member LLC if the North Pole has community property laws. If that is the case, Santa and Mrs. Claus would be treated as one member and the entity disregarded for federal tax purposes. Well, I suppose that is for Santa and the IRS to worry about! Maybe we should focus on you instead…
If you use part of your home for business purposes, you may be able to claim a home office deduction using Form 8829 – Expenses for Business Use of Your Home. The space must be used exclusively and regularly for business purposes and it must be your principal business location – meaning that it must be the main place where managerial activities occur for your business, and you have no other space where substantial managerial activities occur.
You can claim this deduction as a sole proprietor, but also as an employee, if your employer expects you to maintain an office in your home and provides no other fixed location for you to work. It is best if this type of arrangement is spelled out in your employment agreement.
The Form 8829 is used specifically for sole proprietors filing a Schedule C. If you are an employee claiming a home office deduction, or a partner, or if you are filing in conjunction with a Schedule F for a farm, you must use the “Worksheet to Figure the Deduction for Business Use of Your Home” in Publication 587 to calculate the expenses instead. It essentially accomplishes the same purpose, except whereas the Form 8829 is filed with the returns, the worksheet is not.
The Form 8829 and the worksheet in Publication 587 focus on calculating a deduction based on actual expenses. There is a relatively new simplified method also. It allows you to deduct a flat $5 per square foot up to a maximum of $1,500 a year.
We will now spend some time focusing on the Form 8829 itself. If you would like to read a more in-depth analysis on the home office deduction discussed above, I wrote a three part series on this topic on July 26, August 9, and August 23 of 2013. You can find them on my website at:
https://blog.tlongcpa.com/2013/07/26/home-office-new-option-for-2013/
Part I of the Form 8829 determines the business percentage you will use to apply to the home office expenses you incur. You divide the business use square footage by the total square footage to determine the percentage that will be applied to the expenses.
Home daycare providers have special rules as they are allowed to use the space for both personal use and work use. They have an additional calculation in Part I where they divide the total hours for the year that the space was used for daycare services, by the total number of hours in the year. This percentage is then multiplied by the square footage percentage to finally arrive at the reduced percentage to apply to the expenses.
Part II of the Form 8829 is where you will list all your expenses of maintaining your home, such as property taxes, mortgage interest, insurance, utilities, repairs, etc. The direct column is for expenses that were 100 percent deductible and should not have the business use percentage applied. Perhaps you repainted your home office only. This would be an example of a direct expense. If you had painted the entire house, then you would list it under indirect expense. The business use percentage would then limit your deduction to the relative portion of the home used for business.
A home office deduction is generally not allowed to create a loss on your schedule C with the exception of the portion related to real property taxes and mortgage interest since they would have been deductible on Schedule A anyway. If the other operating expenses of your home office create a loss, that loss is suspended and carried over to future years. Part II has additional lines to handle any carried over losses from prior years as well. The amount of deduction from the bottom of Part II carries over to your Schedule C for deduction on that form.
Part III handles the depreciation expense on your home – basically its wear and tear over time. Depreciation is a use-it-or-lose-it concept, so you are better off taking it if eligible. Some tax preparers incorrectly advise people not to take depreciation expense on their home in order to avoid tax recapture problems when they sell. What they are failing to grasp is that recapture is based on depreciation that was “allowed or allowable.” So even if you do not take the depreciation expense when you were entitled to it, you have to treat it as if you did take it when you sell, and you would still be subject to any of the same recapture taxes. Part III is a feeder calculation back into the depreciation expense line in Part II.
Part IV is essentially the final summary of any carryovers available for the next year.
If you have questions about other schedules or forms in your tax returns, prior articles in our Back to Basics series on personal tax returns are republished on my website at www.tlongcpa.com/blog .
Travis H. Long, CPA, Inc. is located at 706-B Forest Avenue, PG, 93950 and focuses on trust, estate, individual, and business taxation. Travis can be reached at 831-333-1041.
Back to Basics Part XXII – Form 6251 – AMT
Filed under: Back to Basics | Tags: 6251, adjustment, Alternative Minimum Tax, Alternative Minimum Taxable Income, AMT, AMT patch, AMTI, depreciation, employee business expenses, ESPP, home equity debt, investment advisory fees, ISO, itemized deductions, minimum tax credit, mortgage interest, parallel, preference, real estate taxes, standard deduction, state taxes, Tentative Minimum Tax
Leave a comment Originally published in the Cedar Street Times
September 4, 2015
AMT, or “Alternative Minimum Tax” was enacted in 1969 in response to a disturbing report by the Secretary of the Treasury that 155 taxpayers with adjusted gross incomes over $200,000 paid zero tax on their 1967 tax returns.
In its simplest form, AMT is a separate taxation system with its own set of rules that runs parallel to the regular tax system. You are supposed to run the calculations under both systems, and if the AMT system says you owe more tax than the regular system, then you pay the incremental difference as “AMT.” That incremental difference shows up as additional tax on Line 45 (2014) of your Form 1040. The calculation of AMT is summarized on Form 6251 and accompanying worksheets, as well as AMT versions of traditional schedules.
The irony of the AMT system is that most of the loopholes it was originally designed to prevent, no longer exist, and it has become a tax that affects the middle and upper-middle class more than the wealthy, yet we still have it and all of its complications. Today, those who are subject to it, despise its existence, and not many people fully understand it, tax practitioners included.
For people still preparing returns by hand, AMT is an absolute nightmare since many of your other schedules have to be calculated a second time using AMT rules. For instance, depreciation rules differ between the AMT system and the regular system, as accelerated depreciation methods are generally not allowed. This means you have to keep an entirely separate set of depreciation schedules just for AMT. And to make matters more complicated, California does not conform to all of the Federal AMT rules either. So now you end up with four sets of depreciation schedules – Federal regular, CA regular, Federal AMT, and CA AMT.
I do not think I have ever seen a hand-prepared return done correctly when AMT is involved. (Actually, in the last ten years, I do not think I have seen any hand-prepared returns done correctly!)
So when do you hit AMT? It depends. AMT is calculated on taxable income under about $185,000 at a flat 26 percent rate, and income over that mark at 28 percent. There is a $53,600-$83,400 AMT exemption amount depending on filing status.
Compared to the regular system, the standard deduction is thrown out (meaning itemizing is your only option), your normal exemptions for yourself, spouse and dependents get the boot, as do many itemized deductions such as state taxes, real estate taxes, mortgage interest on home equity debt (if the funds were not used to improve your home), unreimbursed employee business expenses, tax preparation fees, investment advisory fees and more.
As mentioned before, depreciation methods are not as generous, also ISOs and ESPPs have less tax-friendly rules, investment interest can be hacked, and a whole bunch of other specific differences that apply to certain situations.
Since some people will have more AMT adjustments and preferences than other people, there is no set dollar threshold that will trigger AMT. That said, I feel that I rarely see it for a Married Filing Joint return with under $100,000 of adjusted gross income. It also starts phasing out for people with high incomes. The top AMT rate is 28 percent, but has fewer deductions than the regular system. Besides a handful of lower brackets, the regular system also has 33, 35 and 39.6 percent brackets, but with more deductions. At some point, however, the higher tax rates outweigh the additional deductions and the regular system results in more tax than the AMT system. You may pay no AMT once you get to $600,000 or $700,000 of income, depending on your AMT adjustments.
People in AMT that are employees often feel trapped, especially those in the sales industry that are used to generating a lot of deductions from vehicle mileage and other expenses their employers do not reimburse. It does not matter how many unreimbursed expenses they come up with, they will all get thrown out in the AMT system.
For people that flip back and forth between years of AMT and no AMT, there can be a minimum tax credit generated by the AMT you paid that can be helpful. If you paid AMT in one year, and the next year the regular tax system is higher than the AMT system, you can get a credit against your regular tax to the extent of the difference between the two tax systems limited to the credit amount generated by certain deferral type AMT adjustments/preferences. Got it? Just trust me, sometimes it can help! There are also sometimes when flipping can be a negative…fairness is not always the result of our tax system.
The best news we have had about AMT in recent years was that in 2013 Congress finally legislated an annual inflation adjustment for the AMT exemption. For years Congress was in a habit of passing an AMT patch in late December or January to make up for the fact that the exemption was not inflation adjusted, and would return to 1993 levels if nothing was done.
Tax professionals were biting their nails some years wondering if it would happen. The impacts on middle class Americans would have been tremendous, and many were oblivious. I read estimates in 2011 that 4 million taxpayers were subject to the AMT, but without a patch that number would have swelled to 31 million! I can remember running scenarios for a family making around $100,000 and realizing they would have a surprise tax bill of an additional $2,000 or so without a patch.
The form itself is only two pages. Part I is a summary of all the adjustments and preferences that differ from the regular tax system, to arrive at Alternative Minimum Taxable Income (AMTI). Part II deals with calculating your AMT exemption, your Tentative Minimum Tax (tax calculation under the AMT system), and then the AMT itself (the amount your Tentative Minimum Tax exceeds the regular tax system amount). Part III is a supplemental calculation that feeds into Part II when your return includes capital gains, qualified dividends, or the foreign earned income exclusion.
If you have questions about other schedules or forms in your tax returns, prior articles in our Back to Basics series on personal tax returns are republished on my website at www.tlongcpa.com/blog .
Travis H. Long, CPA is located at 706-B Forest Avenue, PG, 93950 and focuses on trust, estate, individual, and business taxation. He can be reached at 831-333-1041.
Back to Basics Part XIX – Form 4797 – Sales of Business Property
Filed under: Back to Basics | Tags: Capital Gains, code head, depreciation, Form 4797, recapture, Sales of Business Property, Section 1245, Section 179, tax accountants
Leave a comment Originally published in the Cedar Street Times
July 24, 2015
Imagine you are reviewing your recently completed personal tax returns in great detail…oh, wait – I am dreaming…imagine that just before fanning all the pages of your returns and stuffing them in a drawer with half used rolls of Scotch tape, a bag of cotton balls, and a few cat toys, your eye happens to land on line 14 on the first page of your tax returns – other income, with a $4,440 figure in it!
You are scratching your head trying to remember getting $4,440 for something. Your cat, perched above, is just staring at you…or maybe judging you. You take the bait and crack open the return to find the referenced Form 4797. “Oh, of course, the office equipment I sold! But wait, I bought it for $15,000 and sold it for $10,200 – isn’t that a loss? Why do I have $4,440 of income?”
Anyone that has ever had his or her own business or a rental property has almost definitely sold or disposed of an asset related to the activity. Some do it every few years, and others do it every year. Perhaps it was a piece of equipment as in our example above, or maybe it was an office desk, a vehicle, or a rental home. Whatever it was, and every year you did it, you were required to file a Form 4797 – Sales of Business Property – our topic for discussion today. If you would like to catch up on our Back to Basics series on personal tax returns, prior articles are republished on my website at www.tlongcpa.com/blog .
Although only a two-page form, the Form 4797 can be complicated to tame as it requires an understanding of a lot of concepts and code sections in order to put it to rest. There are also unique rules that apply to different industries, such as day-traders, farmers, financial institutions, and all of you that are in an industry generating deferred gains from qualifying electric transmission transactions (who has ever even heard of that?!). Reading much beyond the first page of the instructions will either put you to sleep or leave you with more questions than when you started.
The form itself can require you to be a bit of a “code head.” Tax accountants that memorize and relate everything to the Internal Revenue Code section numbers sometimes get this label. The whole second page of the form is a dedication to code heads and is meaningless to the average person. To fill out this page you have to know what code section the property you are disposing falls under.
Aside from the challenges presented in preparing the form, what most people need to know is that when business assets are disposed they are generally going to wind up on this form. It is also key to understand the interplay with past depreciation expense claimed.
Getting back to our example, the question remains why you had $4,440 of income related to selling equipment for less than it was purchased?
In this case, a $15,000 piece of equipment was purchased for your business. Under the normal rules, you are not allowed to take a $15,000 deduction in the year of purchase. Instead, you depreciate the equipment and spread the expense out over a number of tax years. You can elect a “straight-line” amount – meaning the same amount each year, but most people stick with the standard accelerated schedules which allow you to take the majority of the expense deduction in the early years.
In this case it would be MACRS 5-Year Property (which actually gets depreciated over six years). The first year you get to take 20 percent of the purchase price as an expense ($3,000). In the second year you get to take 32 percent ($4,800). So after two years you have already depreciated over half the cost – $7,800. This depreciation expense taken reduces your cost basis in the asset. So instead of saying your cost was $15,000, your new adjusted cost basis is $7,200 ($15,000-$7,800)
On the first day of the third year you decide to sell it. Due to depreciation rules you are allowed another $1,440 of depreciation expense for selling it in the third year further reducing your basis to $5,760. A buyer pays you $10,200. The sale price less the adjusted cost basis yields a taxable gain of $4,400 ($10,200 – $5,760). This gain is also taxed at ordinary rates (not lower capital gains rates) since when you took the deductions, you were able to deduct them against ordinary income. This is called depreciation recapture.
Be glad it was only $4,440 of taxable income. If you had taken a section 179 deduction to elect to write off the entire amount in the year it was placed in service, your basis would have been zero, and you would have had $10,200 of ordinary income.
If for some reason you were able to sell the equipment for more than you bought it for – say $16,000, you would have had the $4,400 of depreciation recapture at ordinary rates, plus a $1,000 long term capital gain. Tangible property such as this is called Section 1245 property.
The first section of the form generally deals with sales of items that have been held over one year. The second section generally deals with the sale of assets held less than a year, and the third section generally deals with calculating depreciation recapture for various types of property. You can also have asset sales that show up in parts one or two, but also in part three. Part four deals with recapturing depreciation under section 179 and when business use of assets drops below 50 percent.
Travis H. Long, CPA is located at 706-B Forest Avenue, PG, 93950 and focuses on trust, estate, individual, and business taxation. He can be reached at 831-333-1041.
Back to Basics Part XVII – Form 4562 – Depreciation and Amortization
Filed under: Back to Basics | Tags: 5-year, 7-year, ACRS, ADR, ADS, amortization, asset class, Asset Classes, bonus depreciation, conventions, declining balance, depreciation, Depreciation Policy, half-year, listed property, MACRS, mid-month, mid-quarter, Modified Accelerated Cost Recovery System, Section 179, special depreciation, useful life
Leave a comment Originally published in the Cedar Street Times
June 26, 2015
If you want to take a relatively simple concept and complicate it to the nth degree, then you will fall in love with depreciation expense! I am sure there have been numerous doctoral candidates in the accounting field that have written their dissertations on the topic of depreciation. There are so many angles – matching the expense of an asset with the revenues it generates, shifting economic policies, grandfathering of legacy rules, and of course politics and lobbyists. Today we will be talking about Form 4562 – Depreciation and Amortization. If you would like to catch up on our Back to Basics series on personal tax returns, prior articles are republished on my website at www.tlongcpa.com/blog .
At its core, the concept of depreciation expense is rooted in what accountants call the “matching principle.” You are trying to spread out the cost of purchasing an asset for your business or investment activity over the years that it is useful to you – thus allocating the expense to the periods of revenue that result from the asset. Take a pencil for example. You purchase the pencil at the beginning of the year. You use it to write notes, draft reports, and fill out forms, which lead to revenue throughout the year. By the end of the year you are left with a short stub, riddled with bite marks and a half-used blue pencil top eraser with a split down the side…so you throw it away. On your tax returns you have a $50,000 of revenue, offset by a $0.25 deduction for the pencil that helped generate the revenue. Clearly, the revenue and the expense were matched in the same period.
But what about the stapler that you also bought at the same time as the pencil? You bought a quality, metal stapler for $25. It could be sitting on your desk until you retire, and then get passed on to your successor! Let us assume it helps you earn revenue for 25 years before becoming the victim of a careless office prank. The matching principle would say you take the $25 and spread it out over the 25 years of its useful life, taking a $1 of expense each year against the revenue it helped you earn all those years. You would of course have to track the stapler on a schedule and each year update it for the depreciation expense taken. It would be helpful to have a column for the accumulated total of depreciation you had taken over the years so you know what is left to deduct as well.
That is depreciation expense in its simplest form. Unfortunately, the tax code is anything but simple – sometimes for good reasons, and sometimes for not so good reasons. A full explanation of depreciation rules would require thousands of pages of text. Here are some of the key concepts to help you swim with depreciation. It is important to note that depreciation is not a choice. There are choices within the depreciation laws, but you cannot just say – I do not want to participate.
Depreciation vs. Amortization – essentially a matter of semantics. Depreciation is the word used in association with tangible assets purchased; amortization is the word used in association with intangible assets purchased, such as goodwill, patents, and copyrights.
Depreciation Policy – it would be impractical to track every asset you buy that has a useful life of more than a year (like the stapler!), so depreciation policies are developed in accordance with limits established by law. For instance, everything over $500 will be depreciated, and everything below that will just be expensed in the year it is purchased.
Asset Classes – the IRS has pre-determined the periods and methodology for depreciating the vast majority of assets. The Modified Accelerated Cost Recovery System (MACRS) is the system used for depreciation today. Inside that there is the general depreciation system and the alternative depreciation system (ADS) (ADS is mainly used for assets held outside the U.S.). Inside the more common general depreciation system there are 3-year, 5-year, 7-year, 10-year, 15-year, etc. on up to 50-year asset classes. For instance, off-the-shelf computer software is 3-year property; machinery, equipment, and computers in a business are 5-year property; and land improvements are 15-year property.
So you do not just pick the expected useful life in your opinion – you use what the IRS says, instead. Of course there are always strange nuances – such as furniture in a business is 7-year property but furniture in a residential rental is 5-year property. Or the fact that the residential rental house you own is 27.5-year property, but an entire “motorsports entertainment complex” is only 7-year property (think NASCAR lobbyists). These classes are generally “accelerated” as well, meaning you do not simply divide the cost by the number of years and depreciate it ratably. That would be “straight-line depreciation.” Instead there are methods such as 200% Declining Balance and 150% Declining Balance that front-load the depreciation expense in the early years, resulting in less in the later year.
There are also “conventions” depending on the asset class and date it is placed in service during the year when you first acquire it. These include “half-year,” mid-quarter,” and “mid-month,” and determine how you calculate the depreciation in the first year. To make matters more complicated, the tax laws have changed over the years, but the system that was in place when you placed the asset in service governs it for life. MACRS was established in 1986. Prior to that, there were several other systems with their own sets of rules: the Accelerated Cost Recovery System (ACRS) was used from 1981-1985, and prior to that, the Asset Depreciation Range (ADR) system was used. It is still possible to have assets under ADR, ACRS, and MACRS! To say that software is necessary is an understatement. It certainly works wonders with the calculations, but you still have to understand the laws and options to make the right selections and decisions.
Section 179 Deduction – from year-to-year the political and economic environments dictate an incredibly powerful deduction under IRS Code Section 179. This code section is kind of like an override that allows you to elect to expense assets in their entirety in the year purchased rather than spreading the deduction out over a period of years. The code section was created in 1958 when it had a $2,000 cap. The amounts were slowly raised up to $25,000 by 2003. Since then, each year Congress has made huge overrides to the codified $25,000 amount jumping it to $100,000, $125,000, $250,000, and even $500,000 where it has been for the last five years, but it generally defaults back to the $25,000 figure where it currently sits for 2015, unless Congress “saves the day” again. Many business owners have come to rely on this for large purchases, but it is good to remember, it may not be there. Certain assets do not get 179 treatment or there are modified rules. Vehicles for instance are not eligible unless it is a vehicle with a gross weight rating of over 6,000 pounds. Even then, the depreciation amount has been capped at $25,000 in recent years on those particular vehicles. For assets you want to elect to claim the 179 treatment, you still must go through the formal process of setting them up on a depreciation schedule and reporting them on the Form 4562.
Bonus Depreciation/Special Depreciation – these are additional concepts that Congress has created over the years allowing more depreciation in certain circumstances. One of the concepts with special depreciation has been that the assets must be brand new (not purchased in used condition). This was certainly a policy implemented to try to stir the economy.
Other Rules – there are a host of other rules, such as how to handle assets that you exchange for other ones (like trading in a vehicle), what do you do if you convert the asset to personal use, or use assets for both business and personal use, what do you do when you sell assets, etc. And there are lots of very pointed rules that clearly address certain industry desires such as “qualified second generation biofuel plant property,” which apparently was important enough to the masses to warrant half a column among the sea of information that could have been presented in the condensed 22 pages of instructions to the Form 4562!
The Form 4562 itself is two pages long. The first section deals with reporting any assets for which you are electing to take a Section 179 deduction. The next section deals with Special Depreciation. The third section deals with reporting assets under the regular MACRS depreciation asset classes, but you only have to list the assets on the form during the first-year they are placed in service – not every year. Your separately maintained depreciation schedules will track them for all years. Depreciation schedules need not be submitted to the IRS with your returns, but should be maintained for reference and in the event of an audit. The fourth section is a summary. The majority of the second page deals with automobiles and listed property, which are required to be reported each year, since they have special limiting rules. Listed property includes certain types of property that often have mixed personal and business use, so the IRS wants to monitor these more closely. The final section is for amortizable assets. As with depreciable assets, you only have to list amortizable assets in the first year they are placed in service.
Keep in mind that besides the regular depreciation schedules, you also typically have to maintain separate state depreciation schedules, which can have their own rules. California, for instance, does not conform to Section 179 deductions among many other things. In addition, you should track Alternative Minimum Tax (AMT) versions of the federal and state schedules as they can differ as well, should you be impacted by AMT.
Travis H. Long, CPA is located at 706-B Forest Avenue, PG, 93950 and focuses on trust, estate, individual, and business taxation. He can be reached at 831-333-1041.
Back To Basics Part VII – Schedule C
Filed under: Back to Basics | Tags: 1099-Misc, cash basis, community property, cost of goods sold, depreciation, disregarded, EIN, Form 4562, Form 8829, interest income, LLC, material participation, meals and entertainment, per diem, Schedule C, sole proprietorship
Leave a comment Originally published in the Cedar Street Times
January 9, 2015
In this issue, we are discussing Schedule C -Profit or Loss from Business. Prior articles are republished on my website at www.tlongcpa.com/blog if you would like to catch up on our Back to Basics series on personal tax returns.
Schedule C is generally used to report income and expenses for your self-employment activities for which no partnership exists or no entity has been established (such as a C or S-Corporation or LLC) – in other words, it is used for a sole proprietorship. Of course there are exceptions and wrinkles to the rules. Here are a few common ones. In most states, a husband and wife which own and operate a business together would file a partnership return instead of a Schedule C. However, since California is a community property state, a husband and wife should generally file two Schedule Cs and split the income and deductions based on their distributive shares, even if filing a joint return.
One important reason for doing this is that two Schedule SEs would also be filed reporting the Social Security and Medicare taxes separately for each spouse. They would each be subject to the full taxable wage base for Social Security, but they would also each receive credit for their earnings which would figure into their Social Security checks in retirement.
An LLC with only one member that is operating a business would also report the business activity on a Schedule C instead of a 1065 Partnership return. Since you can’t have a partnership between you and yourself, the formal entity structure is disregarded for federal tax purposes and reported like a sole proprietorship. In community property states such as California, a husband and wife that both own and operate the business are actually considered one member for LLC purposes. If they were the only two owners, the entity would be disregarded, but they would then report on two Schedule Cs as discussed above.
Now that we have discussed who uses the form, let’s move to the form itself. The initial section of Schedule C asks for identifying information – the name of the business, the type of business, address, etc. If you have an employer identification number you can enter that as well. This would be required if you have employees on payroll. You can also obtain one if you simply do not want to hand out your Social Security number whenever a formal taxpayer identification number is needed – such as for filing 1099-Misc forms for independent contractors.
There are also some other direct questions regarding your basis of accounting, level of participation, and filing compliance. Most small businesses under $10 million in annual revenues operate by the cash method of accounting as it has many advantages. Material participation is a tightly defined standard by the IRS which can affect your ability to take losses in a down year. The questions on 1099 filings are loaded questions designed to help the IRS easily identify businesses that are not filing required 1099s for payments to independent contractors, for interest received, etc.
In Part I Income, you list your gross receipts, subtract sales returns and allowances, subtract cost of goods sold (which are detailed in Part III) and then add other income such as interest income or certain credits. Part III Cost of Goods Sold is mainly geared towards retailers, wholesalers, and manufacturers. It provides a place to detail beginning and ending inventory and any associated labor and material costs associated with production of the goods. Even taxpayers on a cash basis are generally required to track inventory. Cash basis typically means you get the deduction when you spend the cash, and you record the income when you get the cash. But with inventory, you do not get the deduction until the inventory is sold or disposed.
In Part II you detail all your expenses. The instructions to Schedule C do a pretty good job of explaining what types of expenses they want on each line. Some of the lines are supported by additional forms such Form 4562 Depreciation and Amortization feeding into Schedule C line 13 for Depreciation. Line 24b for Meals and Entertainment is unique as most qualified meals and entertainment are allowed only a 50 percent deduction. Another unique aspect is that preset per diem rate deductions are allowed for self-employed individuals (and employees) for meals, entertainment, and incidental expenses in lieu of tracking actual receipts. Some of these per diems are quite generous depending on the location of travel, and taxpayers can sometimes get a much larger deduction than the amount they actually spend.
Line 30 for expenses for business use of your home is another example where an entirely separate form (Form 8829) is used to calculate the deduction. There is also an alternative simplified method introduced with the 2013 returns that gives you $5 square foot for business space (up to $1,500) without having to track actual expenses on Form 8829.
Line 32 contains a few questions about whether your investment in the business is “at-risk” or not. Basically they are asking if you are financially liable if things go south, and could you lose the money you have injected into the business in the past. This affects your ability to take losses in down years.
Part IV details your vehicle deduction for standard mileage rate users. For 2014, this amount is 56 cents a mile. If you track actual expenses instead, you would not fill out this part.
Part V is for any additional expenses not discussed in Part II.
In two weeks we will continue our Back to Basics series with Schedule D – Capital Gains and Losses
Travis H. Long, CPA is located at 706-B Forest Avenue, PG, 93950 and focuses on trust, estate, individual, and business taxation. He can be reached at 831-333-1041.
Property Taxes on Equipment, Furniture, Tools, Etc. Due April 1
Filed under: General | Tags: assessed, assessor, audit, Board of Equalization, BOE-571-A, BOE-571-L, Business property tax, California Constitution, computers, construction in progress, depreciation, due date, equipment, furniture, improvements, intangible, land improvements, leased equipment, leasehold improvements, machinery, Monterey County Assessor's office, property, Revenue and Taxation Code, structural improvements, supplies, tangible, tax, tools, vehicles
Leave a comment Originally published in the Cedar Street Times
March 7, 2014
Many people starting up a small business for the first time are surprised to learn that there are business personal property taxes due each year on the value of everything from the chair they sit in, to their computer, to the pads of paper in the supply closet. Most people are familiar with property taxes assessed on their home each year, but a business is also taxed on all of its personal property. When I say personal property, I mean anything that is tangible, but is not real property (real estate). Intangible assets like copyrights, patents, goodwill, or even software are generally not subject to tax.
This business property tax is established in the California Constitution and the Revenue and Taxation Code. It falls under the jurisdiction of the California Board of Equalization (the same group that handles sales tax), but it is administered by and filed with the assessor’s office of each county. For most businesses, the form to file is BOE-571-L (BOE-571-A for agricultural businesses), and it is due on April 1st of each year. Even though the form is due on April 1st, there is a grace period, and you technically have until May 7th to postmark the form so it will not be delinquent. (This is much appreciated by CPAs that are working to get income tax returns completed by April 15!) It is also important to note that the reporting covers your property that existed as of January 1st, and not as of the date you fill out the form.
Maybe you have been in a business for a few years, or maybe 20 years in unusual cases and have never seen a request for this form. Are you in trouble? There is an interesting rule that states if the total cost of your business personal property is under $100,000, you do not have to voluntarily start filing the form. That would cover a lot of small businesses. However, if you receive a request from the assessor’s office to file the form, you must file every year going forward. As information sharing has become more mainstream among various government agencies, it is fairly common to get a request in the first year or two you operate, even as a tiny sole proprietor.
The BOE-571-L asks you to break down your property into various categories and by year of purchase. As the property gets older, it is assessed less each year. (Tip: retain a copy of your submitted form for reference when filing for the next year.) Each form is processed by hand. The assessors appreciate having attached lists that identify more specifically the property you list in the various categories and years. As you will see on the form, it is not always clear which category to put things in. For instance, the word equipment is used in four different categories, and you might not be sure where it should be included. Categories are assessed and depreciated at different rates, so the assessor has a better chance of assessing you the correct tax if you provide more information. If you have questions, you can call the Monterey County Assessor’s office at 831-755-5035 and ask for the business property tax department. They are generally available to answer any questions you may have.
It is probably fairly obvious that computers, printers, copiers, furniture, equipment, machinery, and tools are assessed. In addition, the supplies you have on hand for your business are assessed. If you do not have a good idea of this value, one approach, or instance, may be to take your office supplies account in your accounting records and divide by 12 if you think you keep about a month of supplies on hand.
Leased property such as a copy machine, is an area that people sometimes overlook. Your lease agreement will indicate whether you, or the company you lease from is responsible for the property taxes. If you are responsible, you need to report it on your BOE-571-L. Licensed vehicles through the Department of Motor Vehicles (DMV) do not need to be reported here whether owned or leased, as they are being taxed through the DMV.
Structural improvements, fixtures, land improvements, construction in progress, and land development are required on the form as well. Generally, however, structural improvements, land improvements, and land development information is not assessed by the business property tax division and is passed along to the real property division for them to decide whether or not to assess it, or wait for the next time the property as a whole is assessed. Construction in progress would be assessed by the business property tax department: i.e. – you have spent $200,000 in construction on a building that is not complete at the end of the year. Once the building was completed, the business property tax department would stop assessing it, and the real property department would start assessing it.
Fixtures such as counters, sinks, lights, bolted down equipment, etc. would generally be assessed by the business property tax department. If you are a tenant and pay for any leasehold improvements, you should report and will be assessed on those as well. Most leases are written that the property becomes the landlord’s after the tenant moves out of the space.
One final issue that often comes up in an audit is whether or not the business has property that was purchased and immediately expensed on its books and tax returns, and therefore do not show up on depreciation schedules, which is often the main source for reportable property. In the code, there is no immateriality exclusion for something as small as a stapler, but in practice the auditor is not going to assess you on those items. You should look for more significant items, however, such as the $400 in books you bought for your business library.
Prior articles are republished on my website at www.tlongcpa.com/blog.
IRS Circular 230 Notice: To the extent this article concerns tax matters, it is not intended to be used and cannot be used by a taxpayer for the purpose of avoiding penalties that may be imposed by law.
Travis H. Long, CPA is located at 706-B Forest Avenue, PG, 93950 and focuses on trust, estate, individual, and business taxation. He can be reached at 831-333-1041.
Home Office Part III – How Big is My Deduction?
Filed under: Home Office | Tags: 39-year, business use of home, cable, carryover, daycare, deduction, depreciation, Form 2106, Form 8829, furniture, home office, improvements, insurance, janitorial, landscaping, maintenance, miscellaneous itemized deductions, mortgage interest, repairs, satellite, Schedule A, Schedule C, square foot, taxes, trash, utilities, water
Leave a comment Originally published in the Cedar Street Times
August 23, 2013
Four weeks ago, I discussed a new simplified option for calculating the home office deduction that is effective for 2013. Two weeks ago I discussed the rules to qualify for a home office deduction. In this final installment on home office deductions, we will discuss the standard method of determining your deduction, which will still yield the greatest benefit for most people – especially in high cost localities. (If you missed the prior two articles, you can find them on my website at www.tlongcpa.com/blog.)
The standard method of calculating your home office deduction is done on a Form 8829 or on tax worksheets. It typically starts with a square footage calculation of the livable space in your home, and a calculation of the portion used exclusively for your business activity, to determine the percentage used by the business. You can use a calculation based on the number of rooms in the house if they are similarly sized, but in practice hardly anybody uses this method.
The next step is to gather your expenses and multiply them by the business percentage you just determined. Add up in separate categories your utilities, water, trash/recycling service, janitorial (house cleaner), repairs and maintenance, homeowner’s or renter’s insurance, and any other recurring expenses used to maintain your house. If you regularly meet with clients at your house, you can generally do the same for your landscape maintenance expenses as well.
If you rent your home, you add up your total rent and multiply it by the business percentage. If you own, you apply the business percentage to your mortgage interest and real estate taxes (the balance go on Schedule A). Some people will throw their internet access fees on the 8829, but often a better deduction is obtained by thinking about actual business use versus personal use, as square footage is not a great metric for internet use. You could then put that directly on your schedule C if you run a business, or Form 2106 if you are an employee with a qualifying home office. If you buy furniture or equipment exclusively for your office, that is generally put on a depreciation schedule and often linked directly to your Schedule C or Form 2106 instead of running it through your business use of home form.
The first telephone line into the house is not deductible at all. A second line could be, however. But in that case it is typically a dedicated business line, and you would put that on your schedule C or Form 2106 in full to get a better deduction. Your cable or satellite service is probably off limits for most people since there is such a high degree of personal use and it is an area subject to abuse. Based on facts and circumstances some people may be able to build a case for part of it – such as a day trader that depends on the financial channels, or if you have a waiting area which clients regularly use to watch television.
If you own the home you need to set up the home and and any improvements on a 39-year depreciation schedule (not 27.5 like a rental home – common mistake) and run depreciation deductions through your business use of home calculation (beyond the scope of this article). Many people fail to do this thinking it is a choice. It is not. There is a use or lose it rule, and you are responsible for depreciation recapture taxes upon the sale of the home whether or not you claimed the deduction. So you might as well take it!
Facts and circumstances and reasonableness will generally rule the day as an overarching principle to the application of all of these rules. Technically, if you only painted your office, you can take 100% of the cost into consideration for your business use of home deduction. On the flip-side, if you painted everything but your office, you shouldn’t really take any deduction. In practice, records are generally not kept that precisely, and the dollar figures are not that large, so you often end up applying the business percentage to everything in that category for the year for practical purposes.
Even after calculating the deduction, there is another hurdle you must pass – you cannot create an overall loss on your Schedule C from business use of home expenses with the exception of real estate taxes, mortgage interest, or casualty losses which would be deductible on Schedule A regardless. If you have a loss, the excess business use of home expenses will get suspended and carried over to a future year when your business is profitable.
Employees have a different hurdle since their home office deduction is an employee business expense which is a miscellaneous itemized deduction subject to a two percent of adjusted gross income floor. So if their total miscellaneous itemized deductions exceed two percent of their adjusted gross income, then the excess is an itemized deduction, and if their itemized deductions exceed the standard deduction, then they can benefit!
Of course there are many other considerations that can come into play depending on your circumstances such as separately metered properties, or separate structures, multiple offices in the same home, or different homes, a daycare home office, etc. This article should be enough to give you the gist, but it is always best to consult with a professional to ensure you are complying with the laws as well as getting all the deductions you deserve.
Prior articles are republished on my website at www.tlongcpa.com/blog.
IRS Circular 230 Notice: To the extent this article concerns tax matters, it is not intended to be used and cannot be used by a taxpayer for the purpose of avoiding penalties that may be imposed by law.
Travis H. Long, CPA is located at 706-B Forest Avenue, PG, 93950 and focuses on trust, estate, individual, and business taxation. He can be reached at 831-333-1041.
Home Office Part I – New Option for 2013
Filed under: Home Office | Tags: $5, 2013-13, 300 sf, 300 square feet, allowed or allowable, business use of home, carryover, carryovers, depreciation, exclusion, garbage, home office, itemized deductions, maintenance, mortgage interest, office-in-home, property taxes, recapture, repairs, Rev. Proc., Revenue Procedure 2013-13, safe harbor, section 121, self-employment, standard mileage deduction, utilities, water
Comments (2) Originally published in the Cedar Street Times
July 26, 2013
In January, the IRS issued Revenue Procedure 2013-13 which discusses a new option for calculating the home office deduction. (You may want to clip this article and put it in your tax file as a reminder.) Instead of tracking the actual expenses of operating your home office such as water, utilities, garbage, repairs and maintenance, depreciation, etc., you can now elect a safe harbor $5 per square foot of qualified office space, up to 300 square feet ($1,500). It is kind of like taking a standard mileage deduction on your car instead of tracking gas and repair receipts, and calculating depreciation expense. Unlike vehicles, however, you can switch methods back and forth from one year to the next.
There are a few interesting provisions that will make it a good option for some people, and a bad option for others. In other words, when preparing your return you will need to analyze the short and long term impacts, and determine which method is best each year. Since the $5 per square foot figure is not adjusted by region or for inflation, individuals living in high cost states like California are at a disadvantage.
If there is more than one person in the house, such as a spouse or roommate, they can each use the safe harbor as long as they are not counting the same space. If one person has more than one office in the home for more than one business, the person can either use actual expenses for all the businesses, or the person must use the safe harbor for all the businesses. However, the maximum deduction allowed is still $1,500 for all the businesses in the home combined, which may have to be allocated pro rata to the businesses based on square footage used by each. If one person has qualified home offices in more than one home, the person can use the safe harbor for one home, but must use actual expenses for the other home.
When claiming the safe harbor deduction, you are allowed to take your property taxes and mortgage interest in full as itemized deductions on Schedule A as well as claiming the safe harbor deduction. On the surface this sounds like a plus, but for self-employed individuals you are effectively converting expenses that used to be on your Schedule C reducing self-employment taxes to itemized deductions which do not reduce self-employment taxes, and perhaps do not even reduce income taxes if you do not itemize.
Another big difference when claiming the safe harbor deduction is that no depreciation expense is allowed to be taken. Traditionally, any depreciation expense taken on your home is required to be recaptured at the time you sell your house, and you must pay tax on it. Even the section 121 exclusion ($250,000 tax-free gain for single/$500,000 for married couples) when living in the house for two out of the last five years will not exempt you from recapture taxes. Occasionally that can produce negative results, but it is usually helpful because it often helps people avoid income AND self-employment tax which are typically higher than recapture rates. Nonetheless, I regularly see tax returns where no depreciation was taken on a home office, to “avoid recapture.” This is incorrect as recapture rules require you to recapture any depreciation “allowed or allowable.” It does not matter whether you took the deduction or not, you are technically still on the hook for the recapture.
One other notable exception in the 15 pages of new rules explaining the safe harbor is that carryover expenses are not allowed for safe harbor years. Ordinarily, if your business produces a loss, you are not allowed to create a bigger loss from business use of home expenses with the exception of the portion of mortgage interest, property taxes, or casualty losses which would have been allowed as itemized deductions even if you had no business. The rest of the expenses get carried over to future years until you make a profit and can use the losses. Using the safe harbor, any loss generated by the safe harbor disappears forever. You would be better off in these years using actual expenses in order to preserve the losses for the future.
At the end of the day, you might as well just continue to track the actual expenses, and let your tax professional figure out which method will give you the best benefit each year.
In two weeks, we will go over the basic requirements in order to claim a home office deduction.
Prior articles are republished on my website at www.tlongcpa.com/blog.
IRS Circular 230 Notice: To the extent this article concerns tax matters, it is not intended to be used and cannot be used by a taxpayer for the purpose of avoiding penalties that may be imposed by law.
Travis H. Long, CPA is located at 706-B Forest Avenue, PG, 93950 and focuses on trust, estate, individual, and business taxation. He can be reached at 831-333-1041.
American Taxpayer Relief Act of 2012
Filed under: General | Tags: $5 million, American Opportunity Tax Credit, American Taxpayer Relief Act of 2012, bypass trust, cancellation of debt, Capital Gains, child tax credit, code section 179, depreciation, estate tax exemption, itemized deduction phaseout, medical expenses, miscellaneous itemized deductions, net investment income, personal residence, Social Security
Leave a comment Originally published in the Cedar Street Times
January 11, 2013
The American Taxpayer Relief Act of 2012 was signed into law January 2, 2013. There was lots in the bill, but I am going to hit on a few that are notable and others that having meaning to a lot of people. I think making the Alternative Minimum Tax patch permanent and indexed for inflation was a huge victory for many taxpayers. That patch has been kicked down the road for years. The indexing will certainly alleviate concerns of a similar problem down the road. Many middle class people do not realize they were on the cusp of paying thousands of dollars more on their 2012 tax returns due in April without this fix.
The estate tax exemption being set permanently at $5 million and also indexed for inflation is huge, especially for Californians that own property. In a lot of ways, this simplifies estate planning for most individuals and will bring into question the need of the typical A-B split for many people that currently have it. Having a B trust, or bypass trust, would require additional tax work in the future, so the ability to eliminate it, could be worth the cost of amending your trust. Family dynamics may of course still dictate a B trust is prudent.
Various other temporary provisions we have been enjoying that were made permanent included marriage penalty relief for joint filers, better rules for student loan interest deductions and dependent care credit rules.
Quite a few things were extended but not made permanent. A big one was extending the exclusion from income of cancelled debt on personal residences for another year. This could be a lifesaver for those still struggling with mortgages that are “underwater.” Deductions for grade school teacher expenses and an above-the-line deduction for qualified tuition and related expenses were other items extended through 2013. More important than the deduction for tuition was the extension of the American opportunity tax credit through 2018 which saves taxpayers up to $2,500 each year as a result of education costs. Enhanced provisions of the child tax credit were also extended through 2018.
Small businesses have had the luxury of writing off high dollar amounts of many capital asset purchases through code section 179. This was slated to return to $25,000, but has been extended through 2013 at $500,000. Bonus depreciation and accelerated expensing of qualified leasehold, restaurant and retail improvements on a 15 year schedule instead of returning to a 39.5 year schedule was also extended.
Bush-era tax rates and capital gains rates have been retained for everyone but the wealthy. For people making over $400,000, their marginal bracket rose from 35% to 39.6%, and their capital gains tax went from 15% to 20%. There is also a new 3.8% medicare tax on investment income for people generally making over $200,000 and a new hospital insurance tax of .9% for people generally making over $200,000. Itemized deduction phaseouts have also returned for high income earners.
Everyday wage earners will be negatively impacted by the return of a 6.2% tax for Social Security rather than 4.2% tax we have had for the past two years, as they will see two percent less in their paychecks as a result. Another negative impact for people with high uninsured medical expenses, is that the threshold for medical itemized deductions has moved from 7.5% of your adjusted gross income to 10%. Individuals 65 and up will still enjoy the 7.5% rate for another three years.
Prior articles are republished on my website at www.tlongcpa.com/blog.
IRS Circular 230 Notice: To the extent this article concerns tax matters, it is not intended to be used and cannot be used by a taxpayer for the purpose of avoiding penalties that may be imposed by law.
Travis H. Long, CPA is located at 706-B Forest Avenue, PG, 93950 and focuses on trust, estate, individual, and business taxation. He can be reached at 831-333-1041.
Travis H. Long, CPA, Inc. Blog 