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 3, the first half of business issues, includes a variety of issues encountered by self-employed individuals plus profit motive and hobbies, Form 1099-K AND 8300, failed business expenses, spouses and partnership rules, at-risk rules, start-up and organizational expenses, above-the-line health insurance, employing family members, partner expenses, MACRS/ADS property, bonus depreciation, qualified improvement property, Sec 179, employee or independent contractor, intangibles, meals & entertainment, vehicle expenses, travel expenses, travel outside the U.S., home office, NOLs, personal property rentals, real property rentals, short-term rentals, vacation home rentals, installment sales, 1031 exchanges and the Sec 199A deduction including how to determine whether or not an individual is a specified service trade or business and rentals as qualified trades or businesses.
QUESTION: About room rental – if the room is not used by the client for any purpose except rental, do the expenses have to be allocated based on days used?
ANSWER: Yes, because it falls under the vacation home rental rules
ROOM RENTAL - Expenses allocable to a portion of a dwelling unit rented out are deductible under the vacation home rules. The amount of the deductible rental expenses would be the expenses attributable to that portion of the unit. And the days to be taken into account under that limitation rule would be the days on which the portion of the unit is rented at fair rental during the tax year and the days on which the portion of the unit is used for any purpose during the tax year.
Any reasonable method for dividing the expenses may be used. The two most common methods for allocating expenses, such as mortgage interest and heat for the entire house, are based on the number of rooms in the house and square footage of the home.
- Mortgage interest and taxes.
- Operating expenses (examples: repairs, utilities, maintenance, insurance)
Under Sec 210 of the Taxpayer Certainty and Disaster Tax Relief Act of 2020, for 2021 and 2022 taxpayers will be able to deduct 100% of business meal expenses where the food or beverages is provided by a restaurant, provided:
- The expense is an ordinary and necessary expense paid or incurred during the taxable year in carrying on any trade or business.
- The expense is not lavish or extravagant under the circumstances.
- The taxpayer, or an employee of the taxpayer, is present at the furnishing of the food or beverages.
The food and beverages are provided to a current or potential business customer, client, consultant, or similar business contact. Final regulation 1.274-12(b)(3) defines “business associate” as a “person with whom the taxpayer could reasonably expect to engage or deal in the active conduct of the taxpayer's trade or business such as the taxpayer's customer, client, supplier, employee, agent, partner, or professional adviser, whether established or prospective.”
Entertainment is still not deductible.
QUESTION: For health insurance (3.00.05) - S-Corp owner, can family insurance premiums also be included? Personal question - we have 4 plans. Mine is now through business (was a marketplace one last year), son is through State Child Health Ins, husband is disabled, so we have Medicare and Medigap. I have never taken my son's premiums or husband's as deductions (just paid personally and no deduction).
ANSWER: Yes, but I suggest you read the seminar text (Big Book of Taxes) beginning on pages 3.00.08 through 3.00.09 for extensive coverage of the issue.
QUESTION: Is Airbnb income subject to SE tax?
ANSWER: Profit from a rental activity that is reported on Schedule E is not subject to self-employment (SE) tax. But what about short-term rentals reported on Schedule C – are they subject to SE tax? Even though Pub 527, Page 12, indicates taxpayers “may” have to pay self-employment tax on short-term rental income, the “may” applies to real estate dealers. To quote Pub 334, “You are a real estate dealer if you are engaged in the business of selling real estate to customers with the purpose of making a profit from those sales. Rent you receive from real estate held for sale to customers is subject to SE tax. However, rent you receive from real estate held for speculation or investment is not subject to SE tax.” (IRC Sec 1402(a)(1))
QUESTION: Is the annual party for the business 100% deductible or 50%?
ANSWER: It would appear that the expense would be 100% deductible, based upon #1:
Employer-Provided Meals - The 50% rule will apply to employers providing meals through an in-house cafeteria effective for 2018 through 2025. (IRC Sec. 274(n)(2) as amended by TCJA Sec. 13304(b)(1)) Previously the employer could deduct 100% of these costs. And as of January 1, 2026, an employer’s deduction for meals for the convenience of the employer, including in-house cafeterias, is disallowed. (IRC Sec. 274(o) as amended by TCJA Sec. 13304(d)(2))
The 50% limit doesn't apply to:
- Recreational, etc., Expenses for Employees - Expenses for recreational, social, or similar activities (including facilities therefor) primarily for the benefit of employees (other than employees who are highly compensated employees (within the meaning of section 414(q))) are fully deductible. For purposes of this paragraph, an individual owning less than a 10-percent interest in the taxpayer's trade or business shall not be considered a shareholder or other owner, and for such purposes an individual shall be treated as owning any interest owned by a member of his family (within the meaning of section 267(c)(4)). A highly compensated employee is an employee who (1) was a 5% owner at any time during the determination year or the preceding year, or (2) for the preceding year, received more than $125,000 in compensation from the employer and, if the employer elects, also was in the “top-paid group” (top 20%) of employees for that year. The compensation figure for 2020 is $130,000 up from $125,000 in 2019.
- Employer-provided Food and Beverages - Expenses for food and beverages (and facilities used in connection therewith) furnished on the business premises of the taxpayer primarily for his employees are fully deductible. (Code Sec 274(e)(1)) Prior to the TCJA, the code said that food or beverage expenses that are excludable from the gross income of the recipient under the de minimis fringe benefit rules are allowed in full. (Code Sec. 274(n)(2)(B) prior to being stricken by TCJA) The term “de minimis fringe” (Code Sec 132(e)) means any property or service the value of which is (after taking into account the frequency with which similar fringes are provided by the employer to the employer's employees) so small as to make accounting for it unreasonable or administratively impracticable.
- Employee, Stockholder, etc., Business Meetings – Expenses incurred by a taxpayer which are directly related to business meetings of his employees, stockholders, agents, or directors are not limited by the 50% rule. (Code sec 274(e)(5))
QUESTION: Are you allowed to deduct 100% of meals that are purchased for the convenience of the employer (e.g. food is brought in so employees can continue to work while they eat from their desk)?
ANSWER: Prior to TCJA, expenses for food and beverages (and facilities used in connection therewith) furnished on the business premises of the taxpayer primarily for his employees are fully deductible. (Code Sec 274(e)(1)) Prior to the TCJA, the code said that food or beverage expenses that are excludable from the gross income of the recipient under the de minimis fringe benefit rules are allowed in full. (Code Sec. 274(n)(2)(B) prior to being stricken by TCJA) The term “de minimis fringe” (Code Sec 132(e)) means any property or service the value of which is (after taking into account the frequency with which similar fringes are provided by the employer to the employer's employees) so small as to make accounting for it unreasonable or administratively impracticable.
Under TCJA, The 50% rule will apply to employers providing meals through an in-house cafeteria effective for 2018 through 2025. (IRC Sec. 274(n)(2) as amended by TCJA Sec. 13304(b)(1)) Previously the employer could deduct 100% of these costs. And as of January 1, 2026, an employer’s deduction for meals for the convenience of the employer, including in-house cafeterias, is disallowed. (IRC Sec. 274(o) as amended by TCJA Sec. 13304(d)(2))
Of course, you would still have to satisfy the requirements of “convenience of the employer” see Reg. 1.119-1.
And your client may be running afoul of the state's labor laws having the employees working during a meal break. That is probably a bigger concern than the tax issue if one of the employees takes it to the labor board.
QUESTION - We had a typo on client's tax return which caused taxpayer to have additional tax liabilities and we had to pay for the error that we made. Was the amount that we paid because of our error tax-deductible? Thank you.
ANSWER: Yes, that would be a cost of doing business and therefore a business deduction. As an aside, most preparers just pay the penalties and interest because they would have owed the tax anyway.
QUESTION: Would a home-worker be considered a nanny?
ANSWER: Yes, a nanny, among others who work in the home under the direction and control of their employer, would be considered a household employee.
However not all individuals hired to work in a taxpayer’s home are considered household employees. For example, a taxpayer may hire a self-employed gardener who handles the yard work for the taxpayer and others in the taxpayer’s neighborhood. The gardener supplies all tools and brings in other helpers needed to do the job. Under these circumstances, the gardener isn’t an employee and the person hiring him/her isn’t responsible for paying employment taxes.
For additional information see chapter 11.04 of the Big Book of Taxes (the seminar text).
QUESTION: Don't I have to take Section 179 before I take bonus depreciation?
ANSWER: That is correct. In fact, where you have the option to use both, it is better to use bonus because there are no recapture requirements for bonus depreciation like there is Sec 179 if the asset is taken out of service early.
QUESTION: My understanding is that according to AB5, if we as the preparer list that payment as a deduction and the client should have paid their vendor as an employee, the client gets fined $5k per incorrectly issued 1099 and the preparer gets fined $5k for each as well. And those are the minimum fines.
My question is what kind of due diligence are we required to do in order to avoid that penalty? For example, can I have my client sign something saying they attest the 1099s that were issued follow the AB5 rules?
ANSWER: Like I indicated earlier, I did not believe the $5,000 would apply to a preparer when preparing the employers' tax return or the workers. So, we research AB5 and there is no mention of that penalty.
The penalty you are referring to was instituted way back in 2011 long before AB5 was ever passed. Here is a cite:
[SB 459] "SEC. 2. Section 2753 is added to the Labor Code, to read:
- (a) A person who, for money or other valuable consideration, knowingly advises an employer to treat an individual as an independent contractor to avoid employee status for that individual shall be jointly and severally liable with the employer if the individual is found not to be an independent contractor. (b) This section does not apply to the following persons: (1) A person who provides advice to his or her employer. (2) An attorney authorized to practice law in California or another United States jurisdiction who provides legal advice in the course of the practice of law."
So, you are only subject to a penalty if you knowingly advise an employer to treat an individual as an independent contractor to avoid employee status.
QUESTION: Where would I find processes and planning strategies on how a company would implement this benefit? (Employing Family Members).
ANSWER: The following is from pages 3.00.05 and 3.00.06 of the seminar text (Big Book of Taxes).
Strategy - Employing a Child - By employing a child, the income tax advantages include obtaining a business deduction for a reasonable salary paid to that child and reducing the self-employment income and tax of the parents (business owners) by shifting income to the child. Since the salary paid to a child is considered earned income, it is not subject to the “Kiddie Tax” rules that apply to children through age 18 and full-time students ages 19 through 23. The Kiddie Tax won’t apply at all to the 19- through 23-year-old student who has earned income that exceeds one-half of his or her total support, another incentive to employ a child in some situations.
The maximum standard deduction available to the child in 2020 is $12,400 (up from $12,000 in 2019). Therefore, the standard deduction eliminates all tax on that amount of income if the child is paid $12,400 in compensation.* If the business is unincorporated, wages paid to the child under age 18 are not subject to social security taxes. Not only are there significant income tax advantages to employing the child, but the parent-employer may provide him or her with fringe benefits, such as group-term life insurance and qualified pension plan contributions.
Strategy - Employing a Spouse - Reasonable wages paid to a spouse entitles the employer-spouse to a business deduction. The wages are subject to FICA taxes, and the spouse may qualify for Social Security benefits to which he or she might not otherwise be entitled. In addition, the spouse may also be eligible to receive coverage under the business’ qualified retirement plan, and the employer-spouse may obtain a business deduction for health insurance premium payments made on behalf of the employed spouse. While maintaining the same family coverage, the business deductions could be increased by providing the spouse with family health insurance coverage as an employee. These wages are subject to income tax.
Please keep in mind that when a family member is employed in a family business, the wages should be reasonable for the work performed and that the services performed are necessary to the business.
*Actually, only $12,050 of wages would need to be paid since the Kiddie Tax rules allow as the standard deduction for 2020 the lesser of $12,400 or the sum of $350 plus earned income, with a minimum standard deduction of $1,100. Thus $12,400 - $350 = 12,050.
The child may also make deductible contributions to an IRA for 2020 of the lesser of earned income or $6,000. By combining the standard deduction and the maximum deductible IRA contribution, a child could earn $18,400 of wages and pay no income tax. If the child balks at contributing his or her hard-earned money to an IRA, the parent might consider giving the child part or all of the IRA contribution as a gift.
QUESTION: Regarding start-up expenses - is each category entitled to $5000 or is the the total $5000 for all expenses?
ANSWER: Start-up costs include amounts paid or incurred to create an active trade or business or to investigate the creation or acquisition of an active trade or business. Organizational costs include the costs of creating a corporation or a partnership. These costs are generally capital expenses, but by election, can be deducted or amortized, starting with the month the active trade or business begins. Each category is entitled to the $5,000 if they otherwise qualify.
QUESTION: Define active participation.
ANSWER: Under Code Sec. 469, to actively participate in a rental real estate activity for purposes of the $25,000 offset, a taxpayer must participate in the activity in a significant and bona fide sense. A taxpayer participates if he or she makes management decisions, e.g., approves new tenants, decides on rental terms, approves capital or repair expenditures or arranges for others to provide services (such as repairs). The taxpayer need not have regular, continuous and substantial involvement in operations. But, a merely formal and nominal participation in management, without a genuine exercise of independent discretion and judgment, is insufficient.
The participation of a taxpayer's spouse is taken into account in determining whether the taxpayer actively participates. (Code Sec. 469(i)(6)(D))
A taxpayer is not treated as actively participating (except as regs may provide) with respect to any interest as a limited partner. (Code Sec. 469(i)(6)(C))
QUESTION: What do you do if the employee won’t change the 1099 to a W-2?
ANSWER: I am a little unsure of your question. It is not up to the worker (employee) to decide whether or not they receive a 1099-NEC or W-2. That is the employer’s responsibility and the employer is the one that risks the penalties from the state's labor department if the employer misclassified the worker. As a preparer, you simply go with whichever form the taxpayer hands you and should not get involved with classification issues.
If you are a CA preparer you should be aware that you are at risk for some nasty penalties over this issue. The following is except from the Big Book of Taxes page 3.09.14.
Paid Advisors Also Subject to Penalty - Under this law, paid advisors (excluding attorneys and employees of the company) who "knowingly advise" employers to treat an individual as an independent contractor to avoid employee status for that individual are jointly and severally liable for any penalties imposed on the employer if the individual is found not to be an independent contractor. (CA Labor Code Section 2753)
QUESTION: If a business is paying a VENDOR with a credit card, I have been told that they can then avoid the requirement to send a 1099-Misc or 1099-NEC (if they would otherwise be required to do so). Can you confirm this? The idea being that the transaction would be reported and included in the 1099-K.
ANSWER: This is from the 2020 1099-MISC/NEC instructions:
Form 1099-K. Payments made with a credit card or payment card and certain other types of payments, including third-party network transactions, must be reported on Form 1099-K by the payment settlement entity under section 6050W and are not subject to reporting on Form 1099-MISC. See the separate Instructions for Form 1099-K.
And this is from 1099-K instructions:
Reporting under sections 6041, 6041A, and 6050W. Payments made by payment card or through a third party payment network after December 31, 2010, that otherwise would be reportable under sections 6041 (payments of $600 or more) or 6041A(a) (payments of remuneration for services and certain direct sales) and 6050W are reported under section 6050W and not section 6041 or 6041A. For purposes of determining whether payments are subject to reporting under section 6050W, rather than section 6041 or 6041A, the de minimis threshold, discussed later under Box 1a, is disregarded.
QUESTION: What constitutes "away from home"? Is it 50 miles?
ANSWER: There is no mileage definition for away from home. It is based upon what constitutes the individual’s tax home.
“Tax home” - is generally the location of a taxpayer’s main place of business (not necessarily the place he/she lives). If taxpayers work regularly in more than one area, the main work location controls--look at such factors as total time, amount of work, and relative income at each location to determine main business place (amount of income is first in order of importance).
For a taxpayer with no main business location, residence may be considered tax home if a taxpayer:
(1) Does some business in the area of his/her residence and actually uses it for lodging while doing business;
(2) Duplicates living expenses at his/her residence because the job requires being away from home;
(3) Has not left the area of his/her traditional home, close family resides there, or taxpayer often uses the home for lodging.
If all three factors apply to the taxpayer, tax home is where the taxpayer’s home is. If only two factors apply, facts and circumstances determine. If only one factor applies, the taxpayer is an itinerant and no away-from-home expenses are deductible.
Example - Determining Tax Home - Tom, an outside salesperson whose territory covers the western U.S., is employed by a firm whose main office is in Denver. Tom spends about one month a year in Denver for both business and nonbusiness purposes, but the majority of the time he is on the road for his sales job.
He owns a home in Denver where his wife, Tina, lived all year; the home has been the couple’s residence for a number of years. Tom’s tax home is Denver, because he meets all three factors listed above
QUESTION: I have a client who (I believe) is abusing the meals deduction on his S-Corp business. He eats out almost EVERY day! Many times – the meals are JUST for him and do NOT include anyone else. He lives in a remote area and his internet is not great. He spends a LOT of time at a local Starbucks, coffee shops and local restaurants where he uses his laptop. Are those meals deductible?
ANSWER: Unless he is having a business meal with a client, the only way he can deduct his meals is while traveling “away from home”. A taxpayer isn't away from home unless they are away overnight, or at least long enough to require rest or sleep (IRS Pub 463, Page 3).
QUESTION: Slide 3.15.03. Do not carryover home interest or taxes for business use of home. If not itemizing this goes down with insurance etc. Is this not then carried over?
ANSWER: Not sure I completely understand your question. But looking at 3.15.03 it says home office carryover never includes home mortgage interest, property taxes or disaster losses since they allowed currently on Schedule A whether or not a home office is claimed. However, insurance is not a schedule A deduction so would be included along with other expenses in the carryover. Hope this answered your question.
QUESTION: Where do we put expenses for home office/supplies, etc. due to Covid-19? Any word on that?
ANSWER: Unfortunately, TCJA eliminated Tier 2 misc. deductions and that is where the home office deduction for employees is included. So far Congress has done nothing to change that. So, the answer is no deduction for employees on the federal return. Of course, self-employed can still include home office on their business schedule. Some states including California have not conformed to the elimination in which case the home office would be allowed in the state return.
QUESTION: An S-Corp construction co. received payment by checks of sometimes $15K to $25K...Does the company need to file the Form 8300?
ANSWER: The Form 8300 only applies to CASH transactions.
QUESTION: What is going to happen with all the office in home for self-employed if you are still paying rent due to COVID? Probably no deduction?
ANSWER: Interesting question. To qualify for office in the home, the office area must be used exclusively in a taxpayer’s trade or business on a regular, continuing basis. Taxpayer must be able to provide sufficient evidence to show the use is regular. Exclusive use means there can be no personal use (other than de minimis) at any time during the tax year. Use of only a portion of a room is acceptable as long as the taxpayer shows that section is totally for business.
In addition, it must be:
- A place where the taxpayer meets with customers, patients, or clients (just telephone contact with clients isn’t enough to meet this test); OR
- The principal place of business for any trade or business of the taxpayer.
Thus, if the self-employed taxpayer is working at home full time because of COVID I see no reason why the taxpayer cannot deduct the home office and I don’t see why they would be precluded from deducting the rent on the office lease.
QUESTION: Short term real estate rentals do not pay SE tax, correct?
ANSWER: You are correct. Here is an excerpt from the Big Book of Taxes (seminar text) page 3.17.04.
Profit from a rental activity that is reported on Schedule E is not subject to self-employment (SE) tax. But what about short-term rentals reported on Schedule C – are they subject to SE tax? Even though Pub 527, Page 12, indicates taxpayers “may” have to pay self-employment tax on short-term rental income, the “may” applies to real estate dealers. To quote Pub 334, “You are a real estate dealer if you are engaged in the business of selling real estate to customers with the purpose of making a profit from those sales. Rent you receive from real estate held for sale to customers is subject to SE tax. However, rent you receive from real estate held for speculation or investment is not subject to SE tax.” (IRC Sec 1402(a)(1))
QUESTION: Unused PAL's for community property: Taxpayers get divorced. Husband retains the activity. Do the unused PAL's free up for Wife, or do the PAL's go to the Husband who retained ownership? Or is the answer something else?
ANSWER: For separately owned property, the carryover goes to the spouse that owns the property. Where the property is jointly owned by both or is community property:
- And continues to be owned by both after the divorce, 50% of the carryover would go with each spouse.
- Where one spouse retains the property as part of a property settlement, 50% of the carryover becomes an adjustment to the basis of the property and the other 50% continues to be carryover for the spouse that retained the property.
You can register for the 16-Hour CPE Virtual Tax Update & Review Conference here.