Do you have an activity that you do on the side that you think of as a business? Are you claiming losses on your personal tax return (Schedule C, Form 1040)? Will the IRS allow those losses?
I have had a few questions lately about what the IRS considers to be a hobby and what it considers to be a business. If a business, losses are deductible. If a hobby, you can only deduct expenses up to your revenue and therefore are unable to deduct a loss.
The IRS likes to claim that money-losing sideline activities are hobbies rather than businesses. The federal income tax rules for hobbies have been anti-taxpayer for years, and an unfavorable change enacted in the Tax Cuts and Jobs Act (TCJA) made things even worse for 2018-2025.
If you have such an activity, I should have your attention.
Here’s the deal: if you can show a profit motive for your now-money-losing sideline activity, you can classify that activity as a business for tax purposes and deduct the losses. If you can't, you don't get to deduct the losses.
Factors that can prove (or disprove) such for-profit intent include:
If you have a loss-producing activity that you consider a business but the IRS might consider a hobby, it would be wise to firm up your supporting factors to make sure that it looks and smells more like a business than a hobby.
Well, that was quick...what a difference a week makes.
Due to the overwhelming pressure from CPAs, State Societies, Enrolled Agents and other organizations, the IRS announced late on Tuesday February 15th that certain domestic partnerships and S corps qualify for special relief from having to prepare the new K-2 and K-3 forms if they have no foreign activities, foreign partners, or shareholders. The IRS said, "For 2021, these qualifying domestic partnerships and S corporations will not have to file the new schedules,” ... “We are taking this step in response to feedback we received from the tax community and our stakeholders. The IRS will provide full details of this relief soon.”
It seems we have an extra year to get processes in place to determine if the individual taxpayer owners of pass-through entities are eligible to file Form 1116 to claim a foreign tax credit and thus the entity needs to file the K-2/K-3 forms. Hopefully, it won't be as hectic in 2023 when trying to file next tax season.
Last year in June, the IRS issued two new form schedules to accompany pass-through entity returns (Forms 1065 and 1120S) starting in the 2021 tax year - The Schedule K-2 and K-3. The K-2 consists of 11 parts over 19 pages and the K-3, 13 parts over 20 pages. The purpose of these schedules is to help reduce money laundering, better improve international activity reporting and to report foreign activity at the entity level to the individual owners. The IRS also issued draft instructions shortly after issuing the schedules which stated that the forms would be required if the entity had foreign transactions (“Who Must File: The partnership need not complete this schedule if the partnership does not have items of international tax relevance (typically, international activities or foreign partners)”) .
A couple of weeks ago, the IRS issued final instructions and with them a trap. Instead of the trigger for the schedules being at the entity level, the trigger now resides at the individual owner level. Even if the entity did not have foreign transactions, the entity must file these schedules if the owner claims a foreign tax credit (Form 1116) on their personal returns.
As such, every pass-through entity needs to determine if it has items of international tax relevance with respect to its direct and indirect owners. A U.S. entity with no foreign-sourced income, no assets generating foreign-sourced income, no foreign taxes paid or accrued, and no foreign owners may still need to report information on Schedules K-2 and K-3 if an owner is eligible to claim a credit for foreign taxes paid on other sources of foreign income on their own tax return.
The forms are required if the entity lacks positive evidence that each owner is not eligible to claim a foreign tax credit on their return. Put another way, if the entity is unsure if an owner may be claiming a foreign tax credit on their return, these new forms are required.
Penalties for failing to file these forms can be as much as $570 per missing form.
The process of gathering, analyzing, and reporting all of this data that is now required is complex and may consume a substantial amount of time, resources, and significantly increase the cost to complete properly.
Costs for return preparation when these forms are required will double or triple when compared to returns without them.
To avoid penalties and be in compliance, I will be requiring positive evidence from each entity owner that they are not subject to filing Form 1116 as part of their individual returns or I will prepare the extra schedules and charge for them.
There is still a lot unknown and undetermined about these new forms, as they are complex and extensive and may require many filers to be placed on extension.
If you are a business owner, the US government would like to get to know your business.
I wanted to take a moment this morning to make you aware of an upcoming broad sweeping requirement that will most likely begin in 2022. The Corporate Transparency Act (CTA) is a historic new law (1/1/2021 with a delayed start) impacting millions of America's existing small corporations and LLCs and other business entities registered to do business in the United States. The CTA also applies to newly formed entities and requires disclosure of personal ownership information to the U.S. Treasury Department's Financial Crimes Enforcement Network (FinCEN).
The proposed regulations are still in the comment period, but the comment period ends in February and then Treasury officials will most likely begin to prepare the forms and reporting infrastructure and set the reporting due dates. Willful violations are subject to substantial monetary ($500/day up to $10,000) and criminal penalties, including prison time. Accordingly, you do not want to wait to comply once the reporting process is finalized.
The purpose of the Corporate Transparency Act is to improve U.S. national security by helping to prevent the misuse of corporations and LLCs for money laundering, cyber-crime, fraud, tax evasion, human and drug trafficking, proliferation of weapons of mass destruction and the financing of terrorism. This new legislation marks the first time in history the federal government will maintain a private government database of company ownership for law enforcement purposes.
Items that will need to be reported include:
It is currently proposed to file an initial filing and one upon any changes to the information included in the initial filing.
To prepare for compliance, if any uncertainty exists as to the beneficial ownership of a company you are a part of, immediately start identifying who the owners are and gather the needed information to avoid significant civil and criminal penalties.
Please keep this one on your radar. I will update as more information becomes available.
If you have tried to talk with the IRS lately, you probably weren’t successful.
Last week, the IRS gave an update on its backlog. Normally, the IRS has about 1 million returns that are waiting to be processed when the new tax year begins. Currently, the IRS has about six times that many returns waiting to be processed. On top of that, there are other amended income tax returns and other payroll tax returns and amendments generated to claim Employee Retention Credits in their inbox. Congress also tasked them to manage the advanced child tax credits and continued economic recovery payment (or stimulus) payments which added to their workload. Inbound call volume increased fourfold while the workforce still feels impact of COVID, that resulted in the IRS only able to answer a fraction of the calls.
Refunds have been delayed which has led to the question “Where is my refund?” Your accountant can’t answer that question. Only the IRS can answer that and the IRS has warned that more people will be asking the question as refund processing delays continue. If you can’t talk to them, what should you do?
Thankfully, the IRS has prepared some online and application tools you can use to get an answer. Even if the answer is “Still in Process”, it is better to hear that quickly than after being on hold for three hours on the phone.
The first method is the IRS website, https://www.irs.gov. On the home page is a list of frequently asked topics under the “How can we help you?” Header. Click the “Get your Refund Status” and input some information from your tax return to identify yourself and get your answer. You can also find information about the advanced child tax credit you received and stimulus payments in 2021 that you will need to prepare your 2021 tax returns under other options in that menu.
The second method is to create an IRS account with ID.me (See the “Sign into Your Account” option). You are able get a whole bunch of information about your tax account, including your refund, after you go through the somewhat challenging account setup which includes uploading photo ID and a live selfie in addition to validation using a credit card and credit report. With this account setup, you can also use the IRS2Go app on your cell phone and make tax payments.
The third option is the least preferred, but is to call them. Plan on a long wait if you are lucky enough to not have the system tell you to try again later and hang up on you.
Use should also use direct deposit when claiming a refund as the process is much faster than issuing a check.
While we are all frustrated from the continued impact of the pandemic, may we continue to exercise patience and flexibility as we deal with others – including the IRS.
Once again, the annual tax season is about to begin. The IRS has announced that it will begin accepting returns on January 24th, 2022. The IRS also said that it is still behind on processing millions of prior year returns, refunds and correspondence so we can expect some on-going frustration that we will have a chance to practice patience with.
To help alleviate the stress of tax season, the following suggestions for getting ready for tax time will be beneficial whether you prepare your own tax returns or use a professional.
Look at last year’s return or the organizer your preparer sends out (not all preparers use organizers) to help you refresh your memory about what documents were used last year and might be needed again.
Gather the following documents and put them in one place, whether electronically or paper. These represent your income and deductions. Having them in one place will prevent the dreaded document hunt or help prevent missing something that should be on your return:
It seems like taxes are a game sometimes. When you know the rules, you can play the game better and save a lot in taxes. The tax code contains the basic rules for this game, and once you know the rules, you can apply the correct strategies.
Here’s the basic strategy:
To avoid the higher rates, here are seven possible tax planning strategies.
Examine your portfolio for stocks that you want to unload, and make sales where you offset short-term gains subject to a high tax rate such as 40.8 percent with long-term losses (up to 23.8 percent).
In other words, make the high taxes disappear by offsetting them with low-taxed losses, and pocket the difference.
Use long-term losses to create the $3,000 deduction allowed against ordinary income. (You are allowed to deduct up to $3,000 of capital losses a year.)
Again, you are trying to use the 23.8 percent loss to kill a 40.8 percent rate of tax (or a 0 percent loss to kill a 12 percent tax, if you are in the 12 percent or lower tax bracket).
As an individual investor, avoid the wash-sale loss rule. Under the wash-sale loss rule, if you sell a stock or other security and purchase substantially identical stock or securities within 30 days before or after the date of sale, you don’t recognize your loss on that sale. Instead, the code makes you add the loss amount to the basis of your new stock.
If you want to use the loss in 2021, then you’ll have to sell the stock and sit on your hands for more than 30 days before repurchasing that stock.
If you have a lot of capital losses or capital loss carryovers and the $3,000 allowance is looking extra tiny, sell additional stocks, rental properties, and other assets to create offsetting capital gains.
If you sell stocks to purge the capital losses, you can immediately repurchase the stock after you sell it—there’s no wash-sale “gain” rule.
Do you give money to your parents to assist them with their retirement or living expenses? How about children (specifically, children not subject to the kiddie tax)? If so, consider giving appreciated stock to your parents and your non-kiddie-tax children. Why? If the parents or children are in lower tax brackets than you are, you get a bigger bang for your buck by
If you are going to make a donation to a charity, consider appreciated stock rather than cash, because a donation of appreciated stock gives you more tax benefit.
It works like this:
Here is an example. You bought a publicly traded stock for $1,000, and it’s now worth $11,000. If you give it to a 501(c)(3) charity, the following happens:
Two rules to know:
If you could sell a publicly traded stock at a loss, do not give that loss-deduction stock to a 501(c)(3) charity. Why? If you sell the stock, you have a tax loss that you can deduct. If you give the stock to a charity, you get no deduction for the loss—in other words, you can just kiss that tax-reducing loss goodbye.
These stock strategies have a long history in tax planning and can benefit you. Use them now that you know them.
As the end of the year approaches, you may be considering what equipment and asset purchases you need to make for your business before the end of the year to get a current year tax deduction.
If you use the asset in your business, you can deduct the full cost using regular depreciation, bonus depreciation, or IRC Section 179 expensing.
Regular depreciation takes three to 39 years depending on the property involved (deducting a portion of the cost each year over the useful life of the asset), while bonus depreciation allows you to deduct 100 percent of the cost of personal property in one year through 2022. Up to $1,050,000 of personal property may also be deducted in one year under IRC Section 179 subject to profit limitations.
If you are considering buying personal property (such as a car, a computer, or other equipment) or real property (such as a building), if you use the property for personal purposes, it’s not deductible. If used for both business and personal, the asset must be used more than 50% for business in order for a portion of the cost to be deducted. If used more than 50% for personal purposes, there is no deduction.
Depreciation won’t begin if you purchase property with the intent of beginning a new business. You must actually be in business to claim depreciation. This doesn’t require that you make sales or earn profits—only that your business is a going concern.
Also, depreciation doesn’t begin the moment you purchase property for your business. It begins only when you place property in service in your business. You don’t have to use the property to place it in service, but the property must be available for use in your active business. This could occur after you purchase the property.
Finally, if you use regular depreciation, you must apply rules called conventions to determine the month in which your depreciation deduction begins. The earlier in the year, the larger your deduction for the first year.
The default rule is that regular depreciation for personal property begins July 1 the first year (mid-year convention). But if you purchase 40 percent or more of your total personal property for the year during the fourth quarter, your depreciation begins at the midpoint of the quarter in which it is placed in service (mid-quarter convention).
First-year depreciation for real property begins at the middle of the month during which the property is placed in service (mid-month convention).
Buying needed equipment and assets for your business before the end of the year can lower your taxable income. (P.S. You should never buy something you don’t need to get a tax deduction.)
It seems to happen each year. I eFile a completed tax return and receive a notice that the eFile was rejected because another return has already been filed with that social security number. Each year, thousands of people become the victims of identity theft and fraud. Whether claiming someone else’s refund, opening a loan or taking money out of a bank account that isn’t theirs – it seems that crime pays and that money is what drives thieves to steal your identity and commit fraud.
What can you do about it? Here are some steps you can take to make it a little bit harder for the bad guys.
Freeze your credit report at each credit reporting agency.
Freezing your credit report prevents people with your identity information from opening loans or credit cards in your name. A lending institution will not issue the credit when an account freeze is in place. When you need it, you can unfreeze your account to obtain the credit you need and then lock it again afterwards. You can also create credit reports for your children and lock them too.
Request an Identity Protection PIN from the IRS.
After a fraudulent tax return is filed using your information, there is a lengthy process to report the fraud and the IRS will issue identity protection PINs that must be included when filing return or the agency will not accept them. You don’t have to wait to become a victim. You can request one from the IRS website now. The agency will send you a new PIN every year to include when filing your return. Don’t lose the PIN and make sure you provide it to your CPA at tax time. Having an identity protection PIN helps prevent thieves from claiming a refund to their bank account at your expense.
Setup your Social Security Administration account online.
Another way thieves attempt to gain at your expense is to request Social Security benefits using your information. The funds go to their bank accounts and you may not even know it has happened. One way to help prevent this is to set up your online account at the ssa.gov website. If your account is already setup, thieves can’t open one before you.
Use pass phrases and different pass phrases at each account.
Remembering all of our passwords can be hard. I know I personally had to reset a few passwords for services I don’t access frequently just this week. Because it becomes hard to remember every password, people often become complacent and use the same password for everything. Having only one password is not good advice. Because data leaks happen, it is best to have a different password for each account or service. Better still is to use pass phrases instead of passwords for each account or service. Some sites require a certain length, special characters, numbers and capital and lowercase letters which makes it even harder to remember. When you sign up for a new The Flintstones fan page, rather than setting up a password such as “Fl!ntst0ne” you should think of a phrase related to the account you are setting up such as “Wilma.I’mHom3”.
You should also make sure that your banking and financial account passwords and pass phrases are different from all the passwords and phrases you use.
Turn on multifactor authentication.
Another way to help protect yourself is to use multi-factor authorization on the accounts. After inputting your newly minted strong pass phrase, you can have the service send you a text or email with a number to use to prove that it is you that is accessing the account. Experts seem to recommend use of text over email for multi-factor authorization as you have to have the phone in hand to receive the text whereas your email could be accessed from anywhere.
Consider using a password manager.
If it is too hard to remember all of your passwords and phrases, consider getting a password manager to assist rather than reverting back to simple passwords. These are secure tools that keep track of your passwords and phrases and keep them private while allowing you to login with a master password or phrase. These are available for phones and for your computer.
Ensure the websites are secure before you input your information.
Making sure that the website you are visiting is the correct one before you begin to type your information is also important. Look for the padlock symbol next to the website address to show the site is secure and verify you are at the correct place.
Question your email.
Spam blockers filter out millions of emails a day but spam, junk and phishing (posing as something else to obtain your credentials) messages still get through. Before clicking on anything in the email, use common sense – are you expecting this “your account has been locked” or “we have detected fraud” or “_________” email. If not, tread cautiously. Hover over the sender’s email address and see if it is coming from who it should – “PayPal Support (email@example.com)” is probably not from PayPal as they don’t send email from a gmail address. You can stop, report the message and then mark it as spam or phishing, delete it and move on. You can also do the same with links in the message – are they taking you to the anticipated site? If the message purports to be from someone you know and seems weird, call them and ask if they sent it.
Avoid online personal trivia games or questionnaires on social media and other sites.
While these may be fun to see the promised result, be it your personality type, how you will die, etc., these “games” are often used to help gather personal information about you that can be used to create fraudulent accounts in your name. Be wary of anything that ask questions about your birthday, month, year and/or any of the questions you might see when setting up security questions.
This blog allows you to experience the raw, gut wrenching drama of human conflict through accounting in each of its three stages: preparing to do battle, the thrill of victory and the agony of defeat.