Archive for Tax Deductible Expenses
May 17, 2012
John R. Dundon II
Business Expense, Deductible Expense, Disallowed Expenses, Employee Business Expense, Employment Tax, IRS Enforcement, IRS Examination, Tax Abuse, Tax Deductible Expenses, Tax Guidance & Preparation, Trust Fund Recovery Penalty
Tool and Equipment Plans generally require employees to provide their own tools. Some plans purport to receive tax-favored treatment as “accountable plans” under the definition of adjusted gross income in Internal Revenue Code § 62(c). If you are expected to use your own tools and equipment on the job and get reimbursed be very careful in understanding the definition of an “accountable plan” because the Internal Revenue Service has established a compliance team to address significant concerns with certain Employee Tool and Equipment Plans that purport to receive tax-favored treatment as accountable plans. It’s all spelled out in the Alert. Here’s the facts as I understand.
1. According to ILM 201120021 a reimbursement or other expense allowance arrangement that pays an amount regardless of whether an expense is paid or incurred or reasonably expected to be paid or incurred by the employee in performing services for the employer violates the business connection requirement of an accountable plan under Treas. Reg. § 1.62-2(d)(3)(i). Accordingly, payments made under the arrangement are treated as made under a nonaccountable plan. Amounts treated as paid under a nonaccountable plan must be included in the employee’s gross income for the taxable year, are subject to withholding and payment of employment taxes, and must be reported as wages or other compensation on the employee’s Form W-2.
2. The IRS’ Chief Counsel issued the following Advice – ILM 200745018 concluding that an employer’s tool reimbursement plan does not satisfy the requirements of an accountable plan.
3. IRS Revenue Ruling 2005-52 holds that tool allowances paid to employees are not paid under an accountable plan because the substantiation and return of excess requirements are not met.
4. A Coordinated Issue Paper Revised on July 2,2008 concludes that Employee Tool and Equipment Plans under which amounts are paid to employees for the use of their tools and equipment, do not meet the accountable plan requirements.
5. An IRS Private Letter Ruling (200930029) states that an employer’s expense reimbursement plan satisfies the business connection, substantiation, and return of excess requirements of an accountable plan. Payments made under the Plan were allowed exclusion from the Technician’s income and not considered wages subject to the withholding and payment of employment taxes because the Plan only reimbursed covered costs that the Technician substantiated.
If you are an employer that requires your employees to provide their own tools you may want to review and understand this private letter ruling and only provide reimbursement for tool expense upon written substantiation (aka receipt). It is best practice to understand the nuances of accountable and nonaccountable tool and equipment plans. A blanket payment made to an employee on a regular and consistent basis is usually considered income subject to employment tax regardless of what it is called.
November 17, 2011
John R. Dundon II
IRS Appeal, IRS Audit, IRS Enforcement, IRS Examination, IRS Mediation, IRS Penalties, Tax Abuse, Tax Credit, Tax Deductible Expenses, Tax Fraud, Tax Guidance & Preparation, Tax Problems & Requests, United States Treasury
Treasury Regulation 1.274-5 allows for a deduction without complete documentation if you can show that you have ‘substantially complied’ with adequate adequate record keeping requirements.
This statute is code for … be nice to your examiner.
Basically the practice of disallowing amounts claimed because there is no documentary evidence available to establish precise amounts beyond a reasonable doubt ignores commonly recognized business practice as well as the fact that proof may be established by credible oral testimony. As such close approximations of items not fully supported by documentary proof can frequently be established through reliable secondary sources and collateral evidence.
It is always best practice to inform the examiner what has been reconstructed in that it builds credibility. It’s also best to demonstrate that your expenditures are reasonable in relation to income, and that if questioned you can prove that your other financial affairs are in order. The bottom line is that tax records can be and routinely are reconstructed to serve as substantiation if under examination.
However if you are a hot head and freak out on your examiner or demonstrate any other behavior that may lead an examiner to not give you the benefit of the doubt as to the efficacy of collateral evidence you may as well just take your matter to appeals and start the process over. When it comes to reconstruction of evidence it seems to all be about demonstrating and maintaining personal credibility as a law abiding human being. If you are not that then I suggest saving all of your receipts.
IRS Notice 2011-82 makes available the ability for taxpayers to pass along their unused estate & gift tax exclusion amounts to their surviving spouse if an estate tax return is filed. This new portability election allows estates of married taxpayers to pass along the unused part of their exclusion amount ($5 million cap in 2011) to their surviving spouse,which in theory should eliminate the need to do silly things like re-title property etc.
It is expected that most estates of people who are married will want to make the portability election, including people who are not required to file an estate tax return for some other reason. The only way to make the election is by properly and timely filing an estate tax return on Form 706. As bizarre as this seems, there are no special boxes to check or statements needed to make the election. The estate tax return is due nine months after the date of death. Estates unable to meet this deadline can request an automatic six-month filing extension by filing Form 4768. Estates of those who died before 2011 are not eligible to make this election. Stay tuned in further regulation on the matter.
The Affordable Care Act increased the amount of the Adoption Tax Credit and made it fully refundable, which means it can increase the amount of your refund or decrease the amount of your tax liability in the immediate tax year. Additionally:
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The adoption tax credit, which is as much as $13,170, offsets qualified adoption expenses making adoption possible for some families who could not otherwise afford it. Taxpayers who adopt a child in 2010 or 2011 may qualify if you adopted or attempted to adopt a child and paid qualified expenses relating to the adoption.
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Taxpayers with modified adjusted gross income of more than $182,520 in 2010 may not qualify for the full amount and it phases out completely at $222,520. The IRS may make inflation adjustments for 2011 to this phase-out amount as well as to the maximum credit amount.
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You may be able to claim the credit even if the adoption does not become final. If you adopt a special needs child, you may qualify for the full amount of the adoption credit even if you paid few or no adoption-related expenses.
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Qualified adoption expenses are reasonable and necessary expenses directly related to the legal adoption of the child who is under 18 years old, or physically or mentally incapable of caring for himself or herself. These expenses may include adoption fees, court costs, attorney fees and travel expenses.
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To claim the credit, you must file a paper tax return and IRS Form 8839, Qualified Adoption Expenses, and you must attach documents supporting the adoption. Documents may include a final adoption decree, placement agreement from an authorized agency, court documents and the state’s determination for special needs children. You can still use IRS Free File to prepare your return, but it must be printed and mailed to the IRS with all required documentation.
Failure to include required documents will delay processing of your return.
The IRS is committed to processing adoption credit claims efficiently and at the same time safeguard against improper claims. If your return is selected for review, please keep in mind that it is necessary for the IRS to ensure the legal criteria are met before the credit can be paid. If you are owed a refund beyond the adoption credit, you will still receive that part of your refund while the review is being conducted.
If you invest money seeking employment in your current vocation by taking such action as updating your resume and/or attending career fairs you may be able to deduct some of the expenses as miscellaneous deductions on the Schedule A of IRS Form 1040 based on the following general criteria.
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To qualify for a deduction, the expenses must be spent on a job search in your current occupation. You may not deduct expenses you incur while looking for a job in a new occupation.
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You can deduct employment and outplacement agency fees you pay while looking for a job in your present occupation. If your employer pays you back in a later year for employment agency fees, you must include the amount you receive in your gross income, up to the amount of your tax benefit in the earlier year.
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You can deduct amounts you spend for preparing and mailing copies of your resume to prospective employers as long as you are looking for a new job in your present occupation.
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If you travel to an area to look for a new job in your present occupation, you may be able to deduct travel expenses to and from the area. You can only deduct the travel expenses if the trip is primarily to look for a new job. The amount of time you spend on personal activity compared to the amount of time you spend looking for work is important in determining whether the trip is primarily personal or is primarily to look for a new job.
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You cannot deduct job search expenses if there was a substantial break between the end of your last job and the time you begin looking for a new one.
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You cannot deduct job search expenses if you are looking for a job for the first time.
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The amount of job search expenses that you can claim on your tax return is limited. You can claim the amount that is more than 2 percent of your adjusted gross income. You figure your deduction on Schedule A.
For more information about job search expenses, see IRS Publication 529, Miscellaneous Deductions.
Many medical costs are deductible including the cost of treatment to alleviate conditions or diseases and the cost of prescriptions and certain diagnostic services. Additional deductible medical expenses include:
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Capital expenses for special equipment installed in, or improvements made to, a home that provides a medical benefit; these include wider doorways, entrance ramps, modified bathroom or kitchen equipment, and swimming pools for therapeutic purposes.
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Cosmetic surgery, if necessary to improve a deformity related to a congenital abnormality, accident, or disease.
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Dental treatments, including braces and dentures.
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Meals and lodging, if the stay is at a hospital or similar institution to obtain medical care.
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Orthopedic shoes (extra cost over regular shoes).
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Prosthetic limbs.
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Oxygen and equipment used to relieve medical breathing problems.
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Smoking cessation programs and prescribed drugs to alleviate nicotine withdrawal.
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Visual alert systems for the hearing-impaired.
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Medical aids such as wheelchairs, hearing aids, crutches, needles, and other diagnostic devices such as blood sugar kits.
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Guide dogs or other animals used by taxpayers who are visually or hearing impaired or are otherwise disabled.
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Weight loss programs as treatment for a specific disease; obesity is a disease as long as diagnosed by a physician. The Tax Court has allowed the extra cost for special diets over the cost of a normal diet when prescribed by a physician to alleviate a specific medical condition.
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Alcohol and drug addiction treatment, meals, and lodging at a therapeutic center for addictions.
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Tuition for day-camp programs designed for children with disabilities.
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The cost of hand controls for a vehicle for the physically handicapped, or the extra cost to design a vehicle to hold a wheelchair.
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Detachable items such as air conditioners, heaters, humidifiers, and air cleaners used for the benefit of a sick person or for the relief of allergies or other respiratory ailments.
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Laser eye surgery that meaningfully promotes the proper function of the eyes; vision correction with eyeglasses or contact lenses is also allowed.
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Out-of-pocket transportation expenses for medical reasons
Medical expenses that are not deductible include the following:
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Maternity clothes.
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Teeth-whitening.
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Diaper services (unless needed to relieve the effects of a particular disease).
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Dancing lessons, even if recommended by a physician.
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Funeral expenses.
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Exercise programs to improve general health, even if recommended by a physician.
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Marijuana, even if legal under state law when prescribed by a physician in the state where the taxpayer lives.
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Health club dues (unless they are related to a specific medical condition).
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Vitamins and other nutritional supplements (unless prescribed by a physician as treatment for a specific, diagnosed medical condition.
You may only deduct the amount of expenses in excess of 7.5% of adjusted gross income. If deductions on Schedule A (including medical expenses) are not more than the standard deduction, they may not prove helpful on the federal return, though in many states they may become advantageous.
Medical expenses are reduced by payments from insurance or other sources. Payments received for the permanent loss or use of a member or function of the body, for loss of earnings related to a physical injury, or damages due to personal injury or sickness do not reduce expenses.
The one thing that many people over look is that excess reimbursements for medical expenses may need to be included in income. If you are reimbursed the amount up to the deduction must be included in income if it was previously deducted.
Taxpayers may also be able to claim expenses for themselves as well as other qualifying persons. A good example of this might be expenses for a parent for whom over half the support is provided.
The Internal Revenue Service announced that it reached an agreement with the Millennium Multiple Employer Welfare Benefit Plan (Millennium Plan) which is presently the subject of a bankruptcy proceeding filed on June 9, 2010, in the U.S. Bankruptcy Court for the Western District of Oklahoma (Case No. 10-13528). Those disrespecting the Code have been brought down. Kudos to the IRS!
Under the agreement the terms of the Order Confirming Modified Plan dated June 16, 2011, the Millennium Plan will terminate its operations, liquidate its assets and distribute approximately $80 million in assets to individual participants. The agreement with the IRS resolves certain issues relating to an IRS investigation into the design, marketing, operation and management of the Millennium Plan. In my opinion this is a case of morally bankrupt people engaging in suspect behavior to pad their pockets with ill-gotten gains. They make me sick to my stomach. The agreement with the IRS also provides a procedure for resolving hundreds of income tax and penalty examinations of employers and employees who participated in the Millennium Plan. Finally, the agreement with the IRS addresses tax issues relating to the liquidation of the Millennium Plan, including information reporting and income tax withholding requirements.
Section 6103 of the Internal Revenue Code strictly controls the disclosure of tax information. In connection with this agreement, the Millennium Plan consented to the IRS issuance of the IRS news release announcing the settlement on the hopes I suspect that no one is surprised in 2012.
July 5, 2011
John R. Dundon II
Appeals & Audit Resolution, Audit Reconsideration, Business Expense, Correspondence Audit, Deductible Expense, Disallowed Expenses, Entity Classification, IRS Audit, IRS Examination, Tax Deductible Expenses
The IRS has developed a rule of thumb for analyzing business losses called the Hobby Loss Rule of Thumb that basically says if a business reports a net profit in 3 out of the last 5 years it is presumed to be a for-profit business. Similarly if a business reports a net loss in more than 2 out of the last 5 years it is presumed to be a not-for-profit hobby. Whether you have a business or a hobby is important to the IRS because your hobby expenses are only deductible up to hobby revenue each year and additional losses cannot be carried to another tax year to offset gains like they could if you had a business.
In that most new businesses often incur losses at first, it is quite common for a business to have a year or two of losses before becoming profitable. In fact I have seen MANY businesses with several years of losses before ever making a profit. Generally speaking the burden of proof as to whether you are in a business or just have an expensive hobby is on you the tax payer. So be sure to document everything that can help demonstrate your profit motive. You can also prove your profit motive using the following nine factors listed in IRS Publication 535 Business Expenses:
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You carry on the activity in a businesslike manner. To determine this ask yourself questions like, do you have customers? Do you have suppliers? Do you make anything? What do you sell? Do you have letterhead and a business card? How do you keep and reconcile your financial records? Do you have an Taxpayer Identification Number? How are you structured organizationally?
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The time and effort you put into the activity indicate you intend to make it profitable. How much personal time and energy do you spend on the venture? What personal sacrifices are you making to the betterment of the venture?
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You depend on income from the activity for your livelihood.
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Your losses are due to circumstances beyond your control or are normal in the start-up phase of your business.
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You change your methods of operation in an attempt to improve profitability. How do you document operational procedures?
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You, or your advisers, have the knowledge needed to carry on the activity as a successful business.
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You were successful in making a profit in similar activities in the past.
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The activity makes a profit in some years, and how much profit it makes, and
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You can expect to make a future profit from the appreciation of the assets used in the activity.
An audit to defend your business losses involves a relatively detailed review of your income and your expenses for your business. The IRS Examiner will examine your accounting records, receipts, invoices and bank statements looking for income that might be unreported or deductions that might be overstated. The IRS may also question whether certain expenses are directly related to your business. Demonstrate that you are in business for yourself, and you will succeed in defending your business losses against an IRS examination.
I think the bottom line is that if you really have a business you are best served to have a separate and distinct taxpayer identification number with the IRS regardless of your business structure. For whatever it is worth as of today I have not encountered a single situation where the IRS believed that an entity structured as a corporation was actually a hobby so in addition to getting the taxpayer ID number, consider incorporating as a sub-chapter S corporation.
