Archive for the ‘S-corporations’ Tag

Back to Basics Part IX – Schedule E

Originally published in the Cedar Street Times

February 6, 2015

So you decided to put your home up for rent for two weeks surrounding the AT&T Pebble Beach National Pro-Am.  Fortunately for you, it was rumored that Arnold Palmer once spent the afternoon on your front lawn.  As a result, there are so many prospective renters that you are having to beat them away with golf clubs.

Finally you settle on a renter and a nice fat $40,000 check for two weeks!  Score!  But then you remember this pesky thing you do each year called taxes, and you start wondering how you are going to report this on your tax returns.  The surprising answer is that it won’t get reported at all.  There is a rule which states if you rent your home for 14 days or less during the year, you do not have to report the income.  All $40,000 is tax free!  But what if your renters need an extension of one day?  Don’t do it!  If you do, the entire amount is now taxable on Schedule E.

In this issue, we are discussing Schedule E – Supplemental Income and Loss.  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 E is a two-page form used to report income from rental real estate, royalties, and income from partnerships, s-corporations, trusts, and estates.  Part I handles the reporting of income and expenses of rental real estate and royalties.  There is a section regarding rental real estate that asks for the number of days rented at fair market value and the number of days of personal use.  This information is necessary in order to apply limitations regarding the rental of personal residences and vacation homes.  Any personal use will affect the allowable deductions to some extent.  (See my articles “Renting Your Vacation Home” on my website originally published August 10 and 24 of 2012 for more details.)

All expenses related to caring for your rental real estate can be deducted.  Besides costs such as property taxes, interest, repairs, etc., you can also use the standard mileage rate (56 cents per mile for 2014) to deduct any rental related mileage you drive.  If your property requires you to travel away from home overnight, you can deduct lodging and 50 percent of your meals as well.

If rental property generates a loss, there are several tests that must be applied near the bottom of Schedule E page one to determine if the losses will be allowed, or suspended for use in future years.  You can only take losses to the extent that you have an investment at-risk.  Form 61K-198 is used to determine this.  There are also rules limiting the amount of losses you can use against other income if the losses come from passive activities.  Rental real estate is generally considered a passive activity, and Form 8582 is used to determine if your losses will be limited.

Part II of Schedule E begins on page two and summarizes income and losses from flow through activities of partnerships and s-corporations.  Your share of these activities is reported to you on a Form K-1.   Again, at-risk and passive activity loss limits are applied.  Your basis in the underlying partnership or s-corporation activity as well as your level of participation and type of ownership interest are considered in these calculations.

Part III covers your share of estate and trust activities reported to you on a K-1 in a similar fashion as in part II.  The main difference being that there are generally no at-risk limitations to worry about.

Part IV covers income or losses from Real Estate Mortgage Investment Conduits.  These are essentially mortgage-backed securities: a solid product which earned a bad reputation during the financial crisis from 2007-2010 when sub-prime mortgages were bundled and sold together.

Part V summarizes the income and losses from the first four parts of Schedule E and pulls in farm land rentals as well which are calculated on a separate Form 4835.

Getting back to your $40,000 two-week rental.  It turns out that the Arnold Palmer that spent an afternoon on your front lawn was simply a glass of watered-down iced tea and lemonade, and your renters backed out.  Better luck next time…

In two weeks we will discuss Schedule F – Profit or Loss from Farming.

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.

What are Your Chances of Being Audited? Part I – Audit Statistics

Originally published in the Cedar Street Times

May 16, 2014

I have a diverse base of clients, but there is one thing that many of them have in common: they all know the phrase, “…but I don’t want to raise any red flags.”  The part prior to the “but” generally explains how he or she wants to push the limits and minimize the tax liability.  Then I let them in on a little secret, “Did you know the IRS is partially color blind?”

I say this because a component of audit selection is a random statistical process whereupon everyone gets a chance to spin the audit wheel.  But the majority of returns are selected for audit because of, well, “red flags.”  In this issue I will speak about some of the juicy numbers of audit likelihood, and in two weeks, we will discuss some of the methods of selection and possible red flags.

Looking back over the past 16 years of data released by the IRS, you will probably find comfort in knowing that the overall audit selection rate for individuals has generally been close to or under one percent.  In 2013 there were 1,404,931 audits on the 145,819,388 tax returns filed, or a 0.96 percent audit rate!  When most people think of an audit, however, they think of having to meet with a beady-eyed pencil pusher whose sole mission in life is to cause them stress and shake down every last dime out of their pocket.  In reality, only about 25 percent of those audited actually meet with an auditor in a “field audit.”  So now your odds are only 1 out of every 424 people!

The majority of the audits are handled by correspondence mail, and are generally very narrowly focused just asking you to send in supporting documentation on a limited scope of items.  It is less intrusive, but sometimes can actually be more challenging to handle since the auditors do not have to look you in the eye, and are generally hiding behind a cloak of anonymity.  It is also evident from my experience that a lack of training in tax law is prevalent by those reviewing the correspondence audits.

When people are selected for audit, they generally say, “why are they wasting their time on me, shouldn’t they be going after the bigger fish.”  What they are really saying is, “I really don’t care who they audit as long as it isn’t me!”  But to honor their words, you will find that the IRS does in fact follow the money for the most part.  The more money you make, the more likely you are to be audited according to the statistics the IRS releases.

The overall audit rate for individuals making less than $200,000 in 2013 was 0.88 percent.  For those making over $200,000 per year, the rate jumped to 3.26 percent.  And for those making over $1,000,000, the rate jumped to 10.85 percent.  The other big difference is that you are two-and-a-half more times likely to have a field audit than a correspondence audit when making over $200,000 or over $1,000,000.

The overall audit rate for business returns such as C-corporations, S-corporations and Partnerships in 2013 was 0.61 percent of the 9,938,483 returns filed.  Partnerships and S-corporations had the lowest percentage at 0.42 percent, generally since the income passes through and is taxed to the individual owners instead.  C-corporation audit rates, however, vary even more drastically than individual rates – small corporations with less than $10 million in assets had a 0.95 percent audit rate.  Corporations with $10 million to $50 million in assets had a 6.98 percent audit rate, $50 million to $100 million – 15.51 percent, $100 – $250 million – 19.43 percent, and one out of every three corporations with assets over $250 million were audited!  So yes, the IRS does go after the big fish!

Clients will sometimes receive threatening letters indicating that if they do not respond by a certain date, that liens could be placed or their assets could be seized.  I have always found “seizure” to be an overly aggressive choice of words at the early juncture these letters will often arrive, and it is telling that only 547 IRS seizures occurred in the entire country in 2013.

Finally, another interesting statistic for those that find it thrilling to not report income (a.k.a. tax evasion); if you ever have a Special Agent from the Treasury Department show up at your door, I suggest you take that seriously.  They are basically your beady-eyed pencil pushers…but with guns!   There were 4,364 criminal investigation prosecutions recommended in 2013…and the conviction rate was 93.1 percent.  The average sentence for tax and tax related cases was 31 months in prison.  Remember, avoiding taxes through planning, is fine, but evading taxes is a place you never want to be!

Given all these statistics, you may also find it interesting to know that the IRS budget has been cut by close to five percent for 2014, and they have the fewest number of employees in the past 16 years.  I am not sure this is really a good thing, as it will surely reduce the number of qualified individuals trying to wield an already overburdened system, but it will likely mean your risk of audit will be even lower.

In two weeks we will talk more about red flags and audit selection.

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.