Tax Regulations

S Corporation and Reasonable Compensation

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If your company is organized as an S corporation, you may wonder whether it is better to take income from the company as salary or as cash distributions. Of the two options, distributions carry the least tax cost because they are not subject to employment taxes. But that doesn’t mean you shouldn’t take a paycheck from your firm. As a matter of fact, you must pay yourself a reasonable compensation.

IRS Warning about Reasonable Compensation

Over the years, the IRS has made a point of warning S corporations not to attempt to avoid federal employment taxes by having corporate officer/shareholders treat their compensation as cash distributions, payments of personal expenses, or loans instead of as wages. According to the IRS, distributions must be treated as wages to the extent the amounts are reasonable compensation for services rendered to the corporation.

What Is a “Reasonable” Compensation?

Thus, in order to avoid problems with the IRS, you should be sure to take a reasonable amount of salary if you receive any direct or indirect payments from your company. However, the tax law has no hard-and-fast guidelines regarding what is considered “reasonable compensation.” When the issue has come up in court, the determination has been based on the facts and circumstances of the particular case. Therefore, various factors have come into play, including:

  • Duties and responsibilities
  • Time and effort devoted to the business
  • Training and experience
  • What comparable businesses pay for similar services
  • Timing and manner of paying bonuses to key people
  • Payments to employees who are not shareholders
  • The corporation’s dividend-paying history
  • Compensation agreements
  • The use of a formula to determine compensation

The IRS has a special page dedicated to S corporation compensation where you can find out more information.

An Exception

What about an S corporation officer who doesn’t perform any services for the corporation — or whose services are very minor? In this relatively unusual situation, assuming the officer receives no direct or indirect pay, he or she would not be considered an employee.

For more help with individual or business taxes, connect with us today.

Planning for Divorce

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If you are getting a divorce, taxes are probably not highest on your list of concerns. Still, you should consider a number of tax-related issues.

File Jointly or Separately?

For tax purposes, the law determines a person’s marital status on the last day of the tax year. Thus individuals who separate, but don’t divorce, during the year typically will need to make a choice. They will have to choose between filing jointly or separately.

Filing separately may result in the loss of valuable tax credits and deductions. For example, the American Opportunity Tax Credit is not available to a married taxpayer who files a separate return. Typically, filing jointly will result in the lowest overall tax.

One reason to consider filing separately is for protection from the other spouse’s future tax liabilities. Generally, spouses who sign joint returns have joint and several liability — meaning that they are each fully liable for unpaid tax liabilities arising out of the return. Moreover, the IRS has the right to pursue the party who is best able to pay the full amount quickly. Thus the two filers have to work out the issues of fairness between them. The “innocent spouse” rules and/or the “separate liability” election may provide protection in some circumstances.

Property Settlements in a Divorce

Dividing property in connection with a divorce generally has no immediate consequences for either spouse. However, if the spouse who receives property in the divorce settlement later sells it, there may be a gain to report for tax purposes. So, potential taxes should be a consideration in deciding which spouse will receive which property.

Note that a spouse who receives property in a divorce figures any gain on a subsequent sale of the property using the transferring spouse’s basis (e.g., cost), not the property’s value when it was received.

Example. Michelle receives 10 acres of unimproved land in her divorce settlement. Her ex-husband bought the land for $25,000. It’s now worth $100,000. If Michelle sells the land for $100,000, she will have to report a taxable gain of $75,000. This is the difference between the $100,000 selling price and the $25,000 cost basis.

Personal Residence

If a divorcing couple sells their home while they are still married, they are entitled to exclude up to $500,000 of gain from their taxable income if otherwise eligible for the exclusion. If one spouse simply transfers the ownership of the home to the other spouse as part of the divorce settlement, there is no taxable gain or loss at the time of transfer. However, should that spouse later sell the house while he or she is unmarried, only a $250,000 exclusion would be available.

Retirement Benefits

A divorce settlement often determines how the spouses will divide the retirement plan benefits between them. However, an employer may distribute retirement plan benefits to a former spouse only after receiving a court-issued document that meets the requirements for a qualified domestic relations order (QDRO). The benefits are taxable to the former spouse who receives them pursuant to a QDRO.

Dependency Exemption

The spouse who has legal custody of a child generally claims the dependency exemption. But this tax advantage is negotiable and can change from year to year. The custodial spouse can waive his or her right to the exemption, allowing the noncustodial spouse to claim it.

Tax Credits

Claiming a child as a dependent may impact other tax benefits. For example, if a child is attending college, the spouse who claims the student as a dependent can claim either the American Opportunity Tax Credit or the Lifetime Learning tax credit for tuition paid, assuming they meet the eligibility requirements. The law also allows a child tax credit of up to $1,000 annually for each qualifying dependent child under age 17.

Alimony vs. Child Support

Payments that qualify as alimony under the tax law are deductible by the paying spouse. They are taxable income to the recipient spouse. Child support payments, on the other hand, are not deductible by the paying spouse. And they are not included in the recipient spouse’s income. The IRS characterizes payments that are linked to an event or date relating to a child — such as high school graduation or a 21st birthday — as child support rather than alimony.

These are just some of the tax planning issues that could be important in a divorce situation. Contact us today, as always, we’re available for planning assistance.

Contractor Versus Employee – The Status of Your Worker

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Contractor versus employee – be sure you’re using the correct classifications for your staff!

You probably already know the primary difference when it comes to contractor versus employee. You only pay contractors or freelancers a fee for their work. While with employees, you’re also responsible for employment taxes and often other benefits.

Control and independence

The IRS itself states that “…there is no ‘magic’ or set number of factors that ‘makes’ the worker an employee or an independent contractor.” And you can’t use just one factor to make the determination. For example, you can’t call an individual an independent contractor simply because he or she works out of a home office instead of yours. Rather, you have to look closely at the whole relationship between your company and them. You need facts. In addition, you need to consider the “…degree of control and independence” involved, in three different categories.

Behavioral control – contractor versus employee

Do you as the employer have the right to control how the individual works? In general, there are four ways to measure that:

  • Type of instructions given. Do you tell the individual how, when, and where to work? What equipment to use? Where to buy supplies and services? What sequence to follow?
  • Degree of instruction. How detailed are the instructions?
  • Evaluation system. How do you evaluate the worker? Do you evaluate how he/she does the work or just the end result?
  • Training. Do you offer initial and periodic training, or is the individual responsible for his or her own?

Financial control – contractor versus employee

There are several questions to consider here. Does the individual:

  • Pay for a significant percentage of the equipment used?
  • Have a lot of unreimbursed expenses?
  • Have the opportunity to make a profit or loss?
  • Feel free to work for other businesses?
  • Generally receive consistent wages for each pay period?

Type of relationship – contractor versus employee

How would you and the individual characterize your relationship with each other? Do you have a written contract? Do you offer employee benefits? Also, did you hire him or her expecting that the relationship would go on indefinitely? Furthermore, are the individual’s contributions to the company a “key activity” of the business?

As you can see, it’s more complicated than you might think. In addition, the IRS takes this issue very seriously, and has been known to follow up with companies where at least some of the classifications were suspected to be in error. Hence, it is important to give proper attention to this issue.

The Form SS-8

If you still can’t determine whether an individual is an employee or independent contractor after going through all the above questions, you–or someone who works for you–can complete and file an IRS Form SS-8. This is a rather lengthy document designed to help determine a worker’s employment status.

We’re always available to consult with you on various issues of tax law. Request a free consultation or call us at 832-919-8448.

Home Office and S Corporation Shareholder

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Can you still get a deduction for your home office if you are an S corporation shareholder? The answer is yes.

There are two options. Either you rent a portion of your home to the S corporation as office or storage space, or the S corporation reimburses you for the home office use under an accountable plan.

First option: renting a portion of your home office to the S corporation

If you rent a portion of your home to the S corporation, you must do it so at fair market value. Otherwise, the IRS may reclassify the excess rent over the fair market value as wage income, resulting in additional payroll taxes and penalties. Or, the IRS can argue that the rent is a disguised distribution.

The rental income must be reported on schedule E on your personal tax return. However, due to the fact that you lease your home space to your employer, there are limitations on the deductions you can take. You can only claim the deductions that would be deductible in the absence of any business use, generally mortgage interest and real estate taxes.

In addition, because you rent property to a business in which you materially participate, the “self-rental” rules apply, which re-characterise the rental income as active income, while the rental loss remains passive.

The advantage of renting your home office to the S corporation is that it reduces the net income of the S corporation, thus reducing the “reasonable salary” threshold, giving you some savings on the self-employment tax.

Second option: reimbursement under an accountable plan

The company must have an accountable plan in order to take advantage of this options.

Per the IRS, “to be an accountable plan, your employer’s reimbursement or allowance arrangement must include all of the following rules:

  1. Your expenses must have a business connection — that is, you must have paid or incurred deductible expenses while performing services as an employee of your employer.
  2. You must adequately account to your employer for these expenses within a reasonable period of time.
  3. You must return any excess reimbursement or allowance within a reasonable period of time.”

See IRS Publication 463 for more information.

You must use your home office exclusively and regularly for business.

You have to comply with all the requirements for the home office deduction, including the principal place of business test.

When you have multiple work locations, to determine whether or not your home office is your principal place of business, “you must consider:

  • The relative importance of the activities performed at each place where you conduct business, and
  • The amount of time spent at each place where you conduct business.

Your home office will qualify as your principal place of business if you meet the following requirements:

  • You use it exclusively and regularly for administrative or management activities of your trade or business.
  • You have no other fixed location where you conduct substantial administrative or management activities of your trade or business.”

See IRS Publication 587 for more details about the business use of your home.

With this option you save, not only on self-employment taxes, by reducing the “reasonable salary” threshold, you also save on income taxes, because you don’t have to pick any income on the personal return, as was the case with the rental scenario.

In addition, if you have a qualified home office and another work space, like a shop, the commuting miles between your home and your other work place are now becoming deductible. Actually you can deduct the cost of any trips you make from your qualified home office to another business location, like meeting clients, for example. Don’t forget that you also need to reimburse these miles under the Accountable Plan.

To learn more about tax rules and regulations, request a free consultation or call us at 832-919-8448.

Casualty Loss Tax Deduction for Hurricane Harvey Victims

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Flooded Houston residential street can be seen after Hurricane Harvey hit Texas. You may be able to claim a casualty loss tax deduction for the damages you suffered.
Hurricane Harvey floods residential street in Houston, Harris County, Texas, U.S. on Sunday, Aug. 27, 2017.

My heart goes out to all the victims and their families of Hurricane Harvey and I wish well to all those affected! If you did suffer a loss as a result of this disaster, you may be able to claim a casualty loss tax deduction.

You can elect to claim the loss in either of two years: the tax year in which the loss occurred (2017) or the immediately preceding year (2016). In order to determine the most beneficial year in which to claim the loss, you need to evaluate your tax situation for both years. The higher your marginal tax rate, the more valuable the casualty deduction is for you. One other consideration is how  fast you want the refund. If you need help for paying for some of the restoration costs, you might consider claiming  the deduction in 2016 . This allows you to get the refund from IRS before you even file your 2017 tax return.

What’s a casualty?

A “casualty” is the destruction of property from some sudden, unexpected, or unusual event. If you have progressive deterioration, for example, from pest infestation or a water leak, that does not qualify.

For more information about “casualty losses” see IRS Publication 547.

Casualty loss tax deduction for personal property

If  you held the destroyed property for personal (nonbusiness) use, your casualty loss tax deduction is the lesser of (1) the decline in the property’s value or (2) your basis in the property (usually, its cost). You must further reduce this calculated loss by any salvage value or insurance proceeds you might have received.

Two additional tax rules apply before you can take the deduction. First, you must reduce the loss by a $100 “floor”. Second, you can claim the deduction only to the extent it (combined with any other casualty losses) exceeds 10% of your adjusted gross income (AGI).

To take a casualty loss tax deduction for personal property, you must itemize your deductions on Schedule A and complete Form 4684, Casualties and Thefts.

Casualty loss tax deduction for business property

If the disaster totally damaged your trade or business property, you can claim a loss equal to the property’s adjusted basis. This rule prevents your business from taking a casualty loss tax deduction for more than the depreciated value of the property.

If you held the property partly for personal use and partly for business use, you must treat it as two separate properties. You will have to allocate the loss appropriately.

How to deduct the personal property loss in 2016

If you have already filed your 2016 return, you may claim the casualty loss tax deduction by filing an amended return. You have until October 15, 2018, if you are a calendar year taxpayer, to amend your 2016 tax return to claim the casualty loss that occurred during 2017. If you filed an extension for 2016, you have until January 31, 2018  to file your 2016 tax return.

In both cases you must include a statement saying that you are making the election to deduct the loss in the preceding year. You can either make the statement on the return or you can file it with the return. You must include the name or a description of the disaster that gave rise to the loss, the date or dates of the disaster, and the city, town, county or parish, state, and ZIP code where the damaged or destroyed property was located at the time of the disaster.

To learn more about tax rules and regulations, request a free consultation or call us at 832-919-8448.

IRS Gives Tax Relief to Hurricane Harvey Victims

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A photo of a flooded business building after Hurricane Harvey hits Texas
Hurricane Harvey floods business building in Montgomery County, Texas, U.S. on Monday, Aug. 28, 2017

IRS announced yesterday that it gives tax relief to Hurricane Harvey victims. Affected taxpayers have until January 31, 2018 to file certain individual and business tax returns and make certain tax payments.

Eligible Counties for the Hurricane Harvey Tax Relief

As of now, in Texas, the following counties qualify for the tax relief: Aransas, Bee, Brazoria, Calhoun, Chambers, Fort Bend, Galveston, Goliad, Harris, Jackson, Kleberg, Liberty, Matagorda, Nueces, Refugio, San Patricio, Victoria and Wharton. Montgomery County and other affected areas are not on this list yet, but more counties will be added  later, based on the damage assessments by FEMA. Update 8/30/2017: more counties were added by the IRS, to include Colorado, Fayette, Hardin, Jasper, Jefferson, Montgomery, Newton, Orange, Sabine, San Jacinto and Waller Counties.

Tax Relief – Certain Tax Filings and Payment Deadlines Postponed to January 31, 2018

The tax relief postpones to January 31, 2018 various tax filing and payment deadlines that occurred starting on August 23, 2017.

Businesses and individuals that filed extensions for their returns that run out on September 15 and October 16, respectively, have until January 31, 2018 to file their returns. However, keep in mind, that even if you extended your tax return, the 2016 tax was due on April 18th. The extensions extend the time to file, not the time to pay. Thus these payments are not eligible for relief. But, the the 2017 estimated quarterly tax payments get an extension. They were due September 15, 2017, December 15, 2017 and January 16, 1018. Now you have until January 31, 2018 to make these payments.

The quarterly payroll and certain excise tax returns, which were normally due on October 31, 2017 qualify as well for the relief. You have until January 31, 2018 to file them. The IRS will also wave the late-deposit penalties for federal payroll and excise tax deposits normally due after August 23 and before September 7, if you make the deposits by September 7, 2017.

There are other tax filings that qualify and you can read more about them on the IRS disaster relief page:

https://www.irs.gov/uac/tax-relief-in-disaster-situations

Who Qualifies for the Hurricane Harvey Tax Relief

The tax relief applies to taxpayers that have the address of record in the disaster area. The filing and penalty relief is provided automatically, thus you don’t need to contact the IRS to obtain it. In addition, the IRS will work with the taxpayers that, even though they live outside the disaster area, had their records in an affected area. Workers assisting the relief activities affiliated with a recognised government or charitable organisation and other taxpayers qualifying for relief who live outside the disaster area need to contact the IRS at 866-562-5227.

If you need assistance with your accounting or tax fillings, we are here to help. Call us at (832) 919-8448 or request a free consultation.