As part of the 2020 Tax Update and Review Conference Virtual Conference series, we field questions from our students throughout the presentation. We have highlighted some of the common questions and the answers you might find valuable.
Lesson 4, the second part of business issues, includes excess business losses, disallowance of business interest, real estate professional, repairs and capital improvements (cap & repair regs), cannabis issues, reasonable compensation for s-corporation working shareholders, employee retention credit, deferral of employer payroll taxes, Families First Coronavirus Response Act, self-employment tax, farming and fishing averaging, tax penalties, underpayment of estimated taxes, household employees, gift planning, Installment agreements and small employer HRA.
QUESTION: If a schedule C and pay child age 15 to help file, sort, help w/ payments etc. When issuing a 1099 to child for wanting to start a Roth - how do I exclude the SE Tax as it is child under 18 on her return? 1099 would make do schedule C to report income for Roth.
ANSWER: Unfortunately, there is no way a child age 15 working for a parent can meet the criteria to be an independent contractor. The child is a W-2 employee. If the business is unincorporated, wages paid to the child under age 18 are not subject to social security taxes. Pub 15 specifically requires income tax withholding but specifically exempts Social Security withholding for a child under the age of 18. So, file a W-2. Nowhere in the W-2 instructions of Pub 15 does the IRS provide instructions how ID that this is a W-2 for a child under 18. We recommend the SS wages box and the withholding box not be blank but enter $0.00 in both.
QUESTION: Regarding FFCA Sick Leave Pay, are S-Corporation owners eligible use this credit if they contract COVID? Are there any limitations for S-Corp owners if they are employees?
ANSWER: Equivalent childcare leave and sick leave credit amounts are available to self-employed individuals under similar circumstances. These credits will be claimed on their income tax return and will reduce estimated tax payments.
An eligible self-employed individual is defined as an individual who regularly carries on any trade or business, and would be entitled to receive qualified sick leave wages or qualified family leave wages under the FFCRA if the individual were an employee of an eligible employer (other than himself or herself) that is subject to the requirements of the FFCRA.
Eligible self-employed individuals are allowed an income tax credit to offset their federal self-employment tax for any taxable year equal to their “qualified sick leave equivalent amount” or “qualified family leave equivalent amount.”
More information is available is available beginning on page 3.33.04 of the Big Book of Taxes.
QUESTION: If someone has increased wages due to a PPP loan (normal were $75,000 and PPP loan provided $25,000) and they do a SEP-IRA, can they do the SEP-IRA 25% on a $100K wages or $75K wages?
ANSWER: They have $100K of wages, the corporation cannot deduct the full $100K of wages because the $25K PPP portion is forgiven but can they take the full 25% SEP-IRA deduction on a $100K of wages. The taxpayer has $100K of personal income.
QUESTION: Can you pay back the PPP loan and take the Employee Retention Credit instead?
ANSWER: A Paycheck Protection Program Loan makes an employer ineligible for the Employee Retention Credit created in the CARES Act. However, where an employer returned the loan funds, the employer will be eligible to claim the retention credit.
The employee retention credit is a refundable payroll tax credit and is 50% of qualified wages, up a maximum wage of $10,000 per employee. (Act Sec. 2301(a)). Thus, $5,000 is the maximum credit for qualified wages paid for any employee.
So, you will need to carefully analyze the benefit of the employee retention credit, because once the PPP Loan funds are retuned there is no going back.
QUESTION: With respect to gifting – If a couple gifts $30,000 to each child in a year, does an IRS form need to be filed outlining the details? If so, what is the form?
ANSWER: As long as annual gifts are less than the annual exception which is currently $15,000 per person there are not any forms required to be completed. Thus, a married couple can each gift $15,000 ($30,000 combined) with no reporting requirements. If the annual exception is exceeded, the Form 709-Gift Tax return must be filed.
QUESTION: How does one 'elect' to defer payment of SE tax in 2020? Is there somewhere on the 1040 form that this detail is input?
ANSWER: For self-employed individuals, the deferral applies to 50% of the Self-Employment tax liability (including any related estimated tax liability). Thus, they simply reduce their estimated tax payments accordingly. Then the deferral is handled on the Schedule SE. I have attached the draft Schedule SE and its instructions.
QUESTION: Is the safe harbor for high income taxpayers the lower of the two amounts?
ANSWER: The only absolute safe harbor is 110% of the prior year’s tax.
QUESTION: Is there a way to get the interest accessed by the IRS removed/abated?
ANSWER: Yes, reasonable cause and first-time abatement. I suggest you refer to chapter 10.01 in the seminar text (Big Book of Taxes) specifically pages 10.01.04 through 10.01.08.
QUESTION: Are you saying you ONLY need to prepare Part 6 or do we need to file a complete 706?
ANSWER: No, the entire 706 must be completed, Part 6 is only the part dealing with portability. That is the problem with the portability election, a surviving spouse needs to pay for an expensive return to preserve portability. That will become a bigger concern after 2015 when the estate tax exemption drops back to pre-TCJA levels.
QUESTION: I have a client who is single and selling her house. She will have a gain of $450,000 before Sec 121 exclusion. So, her taxable gain after Sec 121 exclusion will be $200,000. To defer all the gain by reinvesting in a QOF, does the client have to invest the $450,000 or the gain after Sec 121 of $200,000? When the deferred long-term gain is included in the 2026 tax return, is it taxed at the long-term tax rates of 2026?
ANSWER: First time I have encountered the idea of deferring home gain into a QOF. The code says any capital gain can be deferred so it would apply to home gain since it is a capital gain. The reportable capital gain would be the amount after the Sec 121 exclusion so $200,000 could be invested into the QOF. I had not previously seen a citation on this so went looking and found the following in Pub 523…
Pub 523 - TIP: If you have gain that can't be excluded, you generally must report it on Form 8949, Sales and Other Dispositions of Capital Assets, and Schedule D (Form 1040 or 1040-SR), Capital Gains and Losses. Report the sale on Part I or Part II of Form 8949 as a short-term or long-term transaction, depending on how long you owned the home. In addition, you may be able to temporarily defer capital gains invested in a. Qualified Opportunity Fund (QOF). You may also be able to permanently exclude capital gains from the sale or exchange of an investment in a QOF if the investment is held for at least 10 years. For more information, see the Instructions for Form 8949.
The deferred gain retains its character so as of now it would be taxed as a long-term capital gain in 2026. BUT…Biden wants to tax all capital gains as ordinary income. I would assume there would be an exception for QOFs, but we don’t know for sure. Tough to do any planning in the current environment.
QUESTION: Is it enough to be a real estate agent who owns and manages their own rental properties?
ANSWER: No, there other requirements that I have cut/pasted from page 3.26.01 of the Big Book of Taxes:
A taxpayer is a real estate professional (qualifying taxpayer) for a particular tax year if he meets BOTH of the qualifications below:
- QUALIFICATION #1 - More than half of the personal services (see below) the taxpayer performs during that year are performed in real property trades or businesses (see below) in which the taxpayer materially participates (Code Sec. 469(c)(7)(B)(i)), AND
- QUALIFICATION #2 - The taxpayer performs more than 750 hours of services during that year in real property trades or businesses in which he materially participates. (Code Sec. 469(c)(7)(B)(ii))
A taxpayer who owns at least one interest in rental real estate and who meets the above tests is a real estate professional. (Reg § 1.469-9(b)(6))
Being a Full-Time Real Estate Professional Isn’t Enough – The IRS audited two years of returns of a couple that filed joint returns and disallowed their rental losses, contending the losses were passive losses (taxpayers’ incomes exceeded the cap for the $25,000 loss allowance so no amount of loss was allowed). The taxpayers’ position was that the wife’s full-time occupation as a real estate professional meant that all rental losses are automatically nonpassive and deductible, regardless of material participation. The key question before the court was whether the taxpayers must establish their material participation in their rental real estate activities separate and apart from the wife’s undisputed material participation in her profession as a real estate agent. The Court concluded that they must, but had not, because she kept no records documenting the hours spent in her rental activities since she (erroneously) thought that as a real estate professional she didn’t have to prove material participation in the rental activities. (Gragg v Comm., U.S. Court of Appeals, Ninth Circuit; 14-16053, August 4, 2016, affirming DC Calif. decision)
QUESTION: So, what kind of account can cannabis businesses use?
ANSWER: From Page 3.28.03 of the Big Book of Taxes - According to federal law, banks and financial services companies cannot knowingly establish accounts with businesses that sell illegal drugs. Banks that handle marijuana money can be charged with money laundering. Businesses restricted to cash are also “targets for assaults” that endanger the public. The lack of banking services can lead marijuana businesses to have problems making federal deposits using the required electronic funds transfer. The business has to make arrangements for its payroll service or another trusted third party to make electronic deposits on its behalf. Some credit unions and small banks that are chartered by their state, not the federal government, have tried to fill the void by offering basic banking services to the cannabis industry.
The IRS has established a payment option for individual taxpayers who need to pay their taxes with cash. In partnership with ACI Worldwide’s OfficialPayments.com and the PayNearMe Company, individuals can now make a payment without the need of a bank account or credit card at certain retail establishments nationwide. There is a $1,000 limit and the number of deposits is limited by the type, generally only two per month. Details at: https://www.irs.gov/payments/pay-with-cash-at-a-retail-partner
QUESTION: How do you claim these COVID-related self-employment credits? Are they expenses on the schedule C or is it a credit against the tax? I understand the principle, but not the application.
ANSWER: I assume you are referring to the Families First Coronavirus Response Act. From Page 3.33.04 of the Big Book of Taxes: Equivalent childcare leave and sick leave credit amounts are available to self-employed individuals under similar circumstances as employees except these credits will be claimed on their income tax return and will reduce estimated tax payments.
QUESTION: If an employer is behind on 941 payments from prior quarters, but has sick leave to pay due to an employee having COVID, would the IRS honor the credit for sick leave wages on 7200 or would they likely apply the credit to past amounts due? Actual scenario a new client of mine is currently dealing with! Thank you!
ANSWER: I am assuming you are referring to the Families First Coronavirus Response Act. Participating in that program is not optional and the Government reimburses the employer in two ways; (1) by allowing the employer a credit against payroll tax and (2) if the payroll deposit is not enough request payment via form 7200. Since this is a government mandated program for which the government must reimburse the employer, I don’t believe they can apply the credit against past due amounts. But I am only guessing and have no experience with that issue and the Form 7200 does mention the issue.
QUESTION: Are you aware of any reason why a 25% owner of a partnership would receive a W2 for wages? I can't find anything on this.
ANSWER: You mean the partnership issued him a W-2? If so, that is incorrect. It should have been guaranteed payments to partners.
QUESTION: PPP Loan proceeds have to be used for payroll (60%+) and if not then have to be repaid to the lender? If this is true and funds are paid to the officer/employee does the ER get a deduction for this wage payment? Is there any portion of the PPP Loan that turns into a grant?
ANSWER: The expenses that are used to justify PPP loan forgiveness are not deductible. However, expenses or payroll that does not make up the forgiveness and are part of the loan that must be repaid would certainly be deductible.
QUESTION: For real estate professionals, what does "more than 50% personal services" mean?
ANSWER: To qualify as a real estate professional an individual must meet two qualifications: • QUALIFICATION #1 - More than half of the personal services (see below) the taxpayer performs during that year are performed in real property trades or businesses (see below) in which the taxpayer materially participates (Code Sec. 469(c)(7)(B)(i)), AND
QUALIFICATION #2 - The taxpayer performs more than 750 hours of services during that year in real property trades or businesses in which he materially participates. (Code Sec. 469(c)(7)(B)(ii))
QUESTION: What happens if you did not file a form 706 on the deceased taxpayer? Should I amend to add to the final return?
ANSWER: A 706 is a separate estate tax return is not attached to nor filed with the 1040. Generally, a 706 is not required if the deceased’s estate is less than $11.4 Million. But there is a portability issue that you may want to read about on page 11.05.04 of the Big Book of Taxes (the course text).
QUESTION: For a first-time home buyer who uses IRA funding to repair the newly purchased home at age 55, will the 10% penalty be waived if the property is not a US property (not a luxury property, just a regular home to be used at the time of retirement)?
ANSWER: It must be their primary residence and purchased within 120 days after the withdrawal. There is nothing that restricts it from being located in the U.S.
First-Time Homebuyer Exception - To qualify for treatment as a first-time homebuyer distribution, the distribution must meet all the following requirements:
- It must be used to pay qualified acquisition costs before the close of the 120th day after the day the distribution was received.
- It must be used to pay qualified acquisition costs for the main home of a first-time homebuyer (defined later) who is any of the following:
- Taxpayer, taxpayer’s spouse
- Taxpayer or spouse's child or grandchild
- Taxpayer or spouse's parent or other ancestor
When added to all the taxpayer’s prior qualified first-time homebuyer distributions, if any, the total distributions cannot be more than $10,000. A husband and wife meeting the definition of first-time homebuyers and purchasing an eligible home together can each withdraw up to $10,000 from each of their respective IRAs without incurring any penalty for early withdrawal.
QUESTION: Why wouldn't a plumber, whose principal asset is his knowledge and skill in plumbing, be an SSTB?
ANSWER: That is because the final regulations defined “reputation and skill” and it does not include plumbers, painters mechanics etc. See the excerpt below which defines reputation and skill for purposes of Sec 199A. The excerpt is taken from page 3.24.08 for the seminar text (the Big Book Taxes):
Reputation or Skill - The original legislation included in its list of trades or businesses that were SSTBs, those where the principal asset of a trade or business is the reputation or skill of one or more of its employees or owners. Did this mean, for example, that a self-employed plumber who provided his skill for the business wouldn’t be eligible for the 199A deduction? Luckily, in a taxpayer-friendly interpretation, the tax regulations have generally defined “reputation and skill” to mean:
(1) Receiving income for endorsing products or services for which the individual provides endorsement services;
(2) Licensing or receiving income for the use of an individual’s image, likeness, name, signature, voice, trademark, or any other symbols associated with the individual’s identity; or
(3) Receiving appearance fees or income (including fees or income to reality performers performing as themselves on television, social media, or other forums, radio, television, and other media hosts, and video game players).
Examples: Alex Trebek endorsing Colonial Penn Insurance, Shaquille O’Neal – Celebrity Cruise Lines and the General Insurance
(4) Investing and investment management – see description in Reg. 1.199A5(b)(2)(xi)
(5) Trading – see description in Reg. 1.199A-5(b)(2)(xii)
(6) Dealing in securities (as defined in section 475(c)(2)), partnership interests, or commodities (as defined in section 475(e)(2)) – see description in Reg 1.199A-5(b)(2)(xiii)
QUESTION: What about a director of a non-profit corporation and SE tax?
ANSWER: Corporate payments - Fees received for performances of services as a director of a corporation, including director meeting attendance, are SE income. A shareholder’s portion of an S corporation’s taxable income is not SE income. I had never heard of anything special for non-profit directors nor do I see why their pay would not be subject to SE tax like other directors. But I did some research and could not find anything of that nature.
QUESTION: Regarding Families First Coronavirus Response Act, for Self-employed, how do we know what the net income for average daily self-employment is?
ANSWER: - The short answer: the average Daily Self-Employment Income is an amount equal to the net earnings from self-employment for the taxable year divided by 260. (IRS Q&A #62). However I strongly suggest you read pages 3.33.04 through 3.33.05 of the Big Book of Taxes (seminar text) for considerable information and examples related to the FFCRA and self-employed individuals.
QUESTION: Non-resident alien, has business in the US, received 1099 reported on ITIN, has expenses, and has profit. Please clarify, there is no need to compute SE tax?
ANSWER: Generally nonresident aliens don’t pay self-employment tax. Residents of the Virgin Islands, Puerto Rico, Guam, or American Samoa, however, are subject to the tax.
Nonresident and resident aliens employed in the U.S. by an international organization, a foreign government, or a wholly-owned instrumentality of a foreign government are not subject to SE tax.
If the individual is a self-employed nonresident alien living in the United States, they must pay SE tax if an international social security agreement in effect determines they are covered under the U.S. social security system.
If the self-employment income is subject to SE tax, complete Schedule SE and file it with your Form 1040-NR.
QUESTION: Can all "animal" capturing (farming) in the ocean be called farming assuming it is legal? Example, lobster capturing, sea-urchins, etc?
ANSWER: I don’t really understand your question. The code refers to them as fishermen and they enjoy a lot of the same benefits that are available to farmers but they are not called farmers.
QUESTION: When did the late filing penalty change? I thought it was 5% per month with a maximum of 25%.
ANSWER: It has not changed. For as long as I can recall it has been 4.5% per month for filing late and 0.5% per month for paying late for a combined total of 5% with a combined total of 25% for the first 5 months.
The 0.5% penalty for paying late is not limited to 5 months. This penalty will continue to increase to a maximum of 25% until the taxpayer pays the tax in full. The maximum 25% penalty for paying late is in addition to the maximum 22.5% late filing penalty for a total penalty of 47.5%
QUESTION: If a taxpayer has a Form 8300 filing obligation and files late, how is he or she penalized?
ANSWER: The 8300 is due by the 15th day after the date the cash was received. If that date falls on a Saturday, Sunday, or legal holiday, file the form on the next business day.
A minimum penalty of $25,000 may be imposed if the failure is due to an intentional or willful disregard of the cash reporting requirements.
Violations may also be subject to criminal prosecution which, upon conviction, may result in imprisonment of up to 5 years or fines of up to $250,000 for individuals and $500,000 for corporations or both.
QUESTION: Should an Airbnb be reported on Schedule E or C?
ANSWER: That would depend upon the average duration of each rental. When a taxpayer rents property for a short period, special (and sometimes complex) taxation rules come into play, which can make the rents excludable from taxation; other situations may force the rental income and expenses to be reported on Schedule C (as opposed to Schedule E). The following is a synopsis of the rules governing short-term rentals.
The 7-Day and 30-Day Rules: Rentals are generally passive activities. However, an activity is NOT a rental activity if (Reg Sec 1.469-1T(e)(2)(ii)):
- The average customer use of the property is for 7 days or fewer—or for 30 days or fewer if the owner (or someone on the owner’s behalf) provides significant personal services.
- The owner (or someone on the owner’s behalf) provides extraordinary personal services without regard to the property’s average period of customer use. Extraordinary services are where the rental of the property is incidental to providing the services. Examples: Hospital’s boarding facilities and a boarding school’s dormitory room rental.
More related to short term rentals can be found in the seminar text (the Big Book of Taxes) on page 3.17.04.
You can register for the 16-Hour CPE Virtual Tax Update & Review Conference here.