November 2018 Business Due Dates

November 13 – Social Security, Medicare and Withheld Income Tax

File Form 941 for the third quarter of 2018. This due date applies only if you deposited the tax for the quarter in full and on time.

November 15 – Social Security, Medicare and Withheld Income Tax

If the monthly deposit rule applies, deposit the tax for payments in October.

November 15 – Nonpayroll Withholding

If the monthly deposit rule applies, deposit the tax for payments in October.

November 2018 Individual Due Dates

November 13 – Report Tips to Employer

If you are an employee who works for tips and received more than $20 in tips during October, you are required to report them to your employer on IRS Form 4070 no later than November 13. Your employer is required to withhold FICA taxes and income tax withholding for these tips from your regular wages. If your regular wages are insufficient to cover the FICA and tax withholding, the employer will report the amount of the uncollected withholding in box 12 of your W-2 for the year. You will be required to pay the uncollected withholding when your return for the year is filed.

Getting Started with Accounts in QuickBooks Online

QuickBooks Online was built to work with transactions downloaded from your online financial institutions. Here’s how to work with them.

The ability to import transactions from financial institutions into QuickBooks Online is definitely one of the best things about the site. You may have even signed up for that very reason. By now, you’ve probably already set up at least one connection. But are you using all of the QuickBooks Online’s account tools? There’s a lot you can do once you’ve imported in data from your bank or credit card provider. We’ll explore these features in this column and the next.

First Steps

If you’re a new subscriber, you may not have established these critical links yet. It’s an easy process. Start by clicking the Banking link in the left vertical navigation pane. In the upper right corner, click Add Account and enter the name of your financial institution if it’s not pictured. Then follow the instructions you’re given on the screen. These can vary depending on the bank or credit card provider, but you’re always at least asked to enter the user name and password that you use to log into each online.

Need help with this? Let us know.

Viewing Your Transactions

Once you’ve made a successful connection, you’ll be returned to the Bank and Credit Cards page. You should see a card-shaped graphic at the top of the screen for each account you’ve linked. Click on one. The table that opens is not your account register. The view here defaults to For Review, which refers to transactions you’ve downloaded. The All tab should also be highlighted; we’ll get to Recognized transactions later.


When you first download transactions into QuickBooks Online, before you’ve done anything with them, many will appear under For Review.

There’s a lot going on here, so don’t be surprised if you’re confused. Review each transaction by clicking on it. QuickBooks Online will have guessed at how it should be categorized, but you can change this by opening the list in the category field and selecting the correct one. It’s critical that you get this right, since it will have an impact on reports and income taxes. If you need to Split it between multiple categories, click on that button found to the right.

If the transaction is Billable, check that box and choose a customer from the drop-down list. If you don’t see this box, click the gear icon in the upper right and select Account and Settings | Expenses. Check to see that Make Expenses and Items Billable is turned On (click on Off, then check the appropriate box to turn it on).

Next, determine how you want to process the transaction by clicking on one of the three buttons at the top of the transaction box. Do you want to accept it and Add it to that account’s register? Do you want QuickBooks Online to Find (a) Match for it (like a payment that matches an invoice, for example)? Or, do you want to Transfer it to another account? Once you’ve made one of these three selections, the transactions that you’ve added or matched will move under the In QuickBooks tab (where you can still Undo them) and will be available in the account’s register.

Other Options


You can save time by using QuickBooks Online’s Batch Actions tool.

Say you run across some duplicate or personal transactions that you don’t want to appear in the current account’s register. Check the box in front of each, then click the arrow in the Batch Actions box. Select Exclude Selected. They’ll then be available under the Excluded tab. You can also Accept or Modify multiple transactions simultaneously by using this tool.

So far, you’ve been viewing All your transactions. Click on Recognized to the right of it. These are transactions that are already familiar to QuickBooks Online because they’ve appeared before and/or have been matched, or because you’ve created Bank Rules for them (we’ll address that concept next month). You’ll need to address these the same way you did the transactions in the For Review section; you can either Add or Transfer them.

If you’re new to QuickBooks Online, this may all sound pretty complicated. It can be at first. But once you’ve worked with downloaded transactions for a while, you’ll understand the flow much better. If you’re not clear on the process from the start, it can lead to trouble. Contact us at your convenience. We’d be happy to sit down with you and go through it all using your own company’s data; the familiarity may help.

Most Common Types of IRS Tax Problems

Receiving notification from the Internal Revenue Service that there’s some kind of problem is one of the most bone-chilling situations an American taxpayer can experience. Just receiving an envelope with a return address from the IRS can strike fear. There are many different reasons that the IRS might reach out, but some are more common than others.

Here are the top issues that would cause a taxpayer to hear from the IRS or require you to resolve an issue:

  • An Error On Your Tax Return – Nobody’s perfect, and filling out tax returns is not an easy thing. If you’ve made a mistake, whether it’s something simple like filing status or number of dependents or something bigger like total income or incorrectly claiming a deduction, if you discover it on your own, all you need to do is file an amended return using form 1040X, the Amended Individual Income Tax Return. If the mistake means that you owe more money, quickly submitting the amount that you owe will help you avoid having to pay too much in penalties or interest. It’s not at all unusual for the IRS to discover mistakes – especially math mistakes – and they will generally notify you that they have made corrections on your behalf.
  • Mismatched/Underreported Income – Along the lines of the mistakes referenced above, there is a specific form that the IRS will send you if they determine that the amount of income you report on your tax return is different from what has been reported by employers. That form is the CP2000 Notice, and the agency will send it to you, notifying you of the corrected amount, should they review your return and feel that it is appropriate.
  • Failure to File a Tax Return – Filing a tax return isn’t necessarily required if you don’t owe money or if you’re owed a tax refund, but it’s not a good idea. Failing to file a return when you’re owed a refund puts you at risk of losing out on receiving the money you’ve owed – you have just three years to amend the problem if you want to get your money. For those who are in arrears to the IRS, there is a significant negative outcome to failing to file a return, including having to pay a “failure to fee” penalty that can go as high as 25 percent of your unpaid tax bill: 5 percent of the amount you owe, plus interest, will be charged for each month for up to five months
  • You Owe the IRS for Taxes Not Paid – When the IRS calculates that you have not paid them the full amount that you owe, they will send you notification of what they believe the difference is via form CP14.
  • You Owe the IRS Penalties and Fees – When you don’t pay your taxes or you fail to file a return, the IRS will notify you that you owe them penalties, and possibly interest.
  • You Owe the IRS But Can’t Afford to Pay – There are many taxpayers who find themselves facing a tax bill that they are simply unable to pay all at once. If you fall into this category, the IRS does offer the option of paying in installments. To request this type of payment plan, contact the agency. If even paying in small increments is outside of your ability, you may be able to negotiate a reduced tax bill through what is called an Offer in Compromise.
  • Tax Debt Resulting in Tax Levy – If you are unable or unwilling to satisfy your tax debt, the IRS may opt for a tax levy, which is the legal seizure of your property in lieu of payment. A tax levy can take the form of real property such as real estate, your vehicle or personal property, or your wages, the money in your bank accounts or your financial accounts. Notification that a levy is being issued against you comes via either notice LT11, CP504, CP90, or CP91.
  • Notification that A Tax Lien Has Been Filed – If you have failed to pay your tax debt, the IRS may take action to protect its own interests ahead of other creditors by filing a tax lien. This comes in the form of Letter 3172, which will be sent to both you and your other creditors to let them know of the government’s claim against your financial assets, personal property and real estate. By sending this letter out, the government ensures that it will benefit from the liquidation of any of your property in order to satisfy the amount that it is owed. Once a lien has been placed on your property, it is extremely difficult to get out of until you’ve paid up.

A notification from the IRS is not something to be ignored. The best step is to take a deep breath, read the notice carefully, and if needed, contact our office for assistance.

Making Two IRA Rollovers in One Year Can Be Costly

Article Highlights:

  • One Rollover per Year Rule
  • Exceptions
  • Tax Consequences
  • Disqualified Rollover
  • Early Withdrawal Penalty

Tax law permits you to take a distribution from your IRA account, and as long as you return the distribution to your IRA within 60 days, there are no tax ramifications. However, many taxpayers overlook that you are only allowed to do that once in a 12-month period, and violating this rule can have some nasty and unexpected tax ramifications.

The one-year period is measured based on the date a distribution is received. If the second distribution is received before the same date one year later, it is a disqualified rollover.

Example – Jack takes a distribution from his IRA on June 30 of year one and subsequently rolls over the distribution (puts the funds back into the IRA) within the 60-day rollover period. Jack must wait until June 30 of year two before another distribution is eligible for a rollover. Any additional distributions taken during the one-year waiting period would be taxable.

Example – A taxpayer received a distribution from his IRA with Chase bank in February, which he immediately rolled into a new IRA with Wells Fargo. Then, in May, he took a distribution from the Wells Fargo IRA and rolled it back into the IRA at Wells within 60 days. Even though he rolled the exact amount back into the same institution within 60 days, the distribution from Chase had started the running of the one-year waiting period. Thus, his second distribution was in violation of the one-year waiting period and was a taxable distribution. The redeposit of what he thought was a rollover was actually a contribution to the IRA.

Like everything taxes, there are exceptions to the one-year rule, including the following:

Direct Transfers – As long as IRA funds are transferred directly between trustees, the transaction is not considered a rollover. A taxpayer can make as many direct transfers in a year as he or she wants; in fact, utilizing direct transfers is the preferred way to move funds from one IRA to another because it eliminates certain tax-return reporting issues.

  • Roth Conversions – Traditional IRA to Roth IRA conversions are not considered rollovers for purposes of the one-year rule.
  • Distributions to and from Qualified Plans – Since the one-year rule only applies to IRA-to-IRA rollovers, rollovers to and from other types of retirement plans are not governed by the one-year rule. However, SEPS and SIMPLE plans are treated as an IRA for purposes of the one-year waiting period.
  • Failed Financial Institutions – An IRA distribution made from a failed financial institution by the Federal Deposit Insurance Corporation is generally disregarded for purposes of applying the one-rollover-per-year limitation.

Tax Consequences – When the one-year rule is violated, any distribution after the first made within the one-year waiting period will not be treated as a rollover, with the following tax consequences:

  • Traditional IRA – In the case of a traditional IRA, the entire distribution will be taxable, and if the taxpayer is under age 59½ at the time of the distribution, the 10% early distribution penalty will apply to the taxable portion.
  • Roth IRA – In the case of a Roth IRA that is a:o Non-Qualified Distribution – A non-qualified distribution is one where the Roth IRA has not met the five-year aging requirements. Five-year aging generally means the Roth IRA has been in existence for a continuous period of five years, although the first and last years do not need to be full years. A distribution from a Roth IRA that has not met the five-year aging requirements would be a non-qualified distribution, and the earnings would be taxable. Of course, the original contributions are never taxable based on a specific distribution sequence: contributions, then conversions from traditional IRAs or rollovers from qualified plans (first the part that was taxed when the funds went into the Roth and then the nontaxable part), and lastly earnings. A 10% early distribution penalty applies to any amount attributable to the part of the conversion or rollover amount that had to be included in income at the time of the conversion or rollover (the recapture amount).

    o Qualified Distribution – No tax or penalty applies if a distribution from a Roth IRA is a “qualified distribution,” which is a distribution made after the five-year aging period is met if the taxpayer:

    – Is age 59½ or older,
    – Is disabled,
    – Is deceased, or
    – Qualifies for the first-time homebuyer exception (maximum $10,000).

Disqualified Rollover – An additional problem arises because the disqualified rollover amount will be treated as an IRA contribution, subject to the normal annual contribution and AGI limitations. Tax law includes a penalty when someone contributes more than is allowed (excess contribution). Thus, an excess contribution (except for on the year of the distribution) would be subject, annually, to a 6% excess contribution penalty.

There are a couple of possible remedies available for a disqualified rollover:

  • Corrective Distribution – The excess contribution and the interest attributable to it can be withdrawn by the extended due date of the return for the year the distribution was made, thus undoing the rollover. The distribution that resulted in a disqualified rollover will be subject to tax, as outlined earlier, depending upon whether it was a traditional or Roth IRA. The earnings attributable to withdrawn funds are taxable. However, the annual 6% excess contribution penalty is avoided.
  • Contributions in Future Years – The excess contribution could be left in the IRA and can be treated as an IRA contribution for a later year. However, until the excess contribution is fully absorbed as eligible future contributions, the annual 6% excess contribution penalty will apply.

Early Withdrawal Penalty – If the disallowed rollover occurs before reaching age 59½, an early distribution penalty of 10% of the taxable amount will apply and is in addition to the normal tax.

Although there are a number of exceptions to the under-age-59½ early distribution penalty, the following might be used to avoid or mitigate an early withdrawal penalty associated with a disqualified rollover:

  • Contributions Returned before the Due Date – If the taxpayer already made an IRA contribution for the tax year, the amount of that contribution can be withdrawn tax-free by the extended due date of the tax return, provided:
1. The taxpayer did not take a deduction for the contributions withdrawn, and
2. The taxpayer also withdraws any interest or other income earned on the contributions, and
3. The taxpayer includes in income, for the year during which the withdrawal was made, any earnings on the contributions withdrawn.
  • Medical Insurance Exception – The amount that is exempt from the penalty is the amount the taxpayer paid during the year for medical insurance for the taxpayer and his or her spouse and dependents. To qualify for this exception, the taxpayer must have:
1. Lost his/her job,
2. Received unemployment compensation for 12 consecutive weeks,
3. Made IRA withdrawals during the year he/she received unemployment or in the following year, and
4. Made the withdrawals no later than 60 days after being reemployed.

  • Higher Education Expense Exception – The part not subject to the penalty is generally the amount that is not more than the qualified higher education expenses for the taxpayer and his or her spouse, children, or grandchildren for the year at an eligible educational institution.

Bottom line, make sure you don’t have more than one IRA rollover in a year. However, if you inadvertently do, please call this office as soon as you realize the error so we can determine what actions can be taken to mitigate the resulting taxes and penalties.

Tax Reform Enables Deferral of Taxable Gains Into Investments in Opportunity Zones

Article Highlights:

  • Tax Cuts and Jobs Act
  • Reinvested Gains
  • Enhanced Basis
  • Qualified Opportunity Funds
  • Partnerships
  • Qualified Opportunity Zones

Those who have a large taxable gain from the sale of a stock, asset, or business and who would like to defer that gain with the possibility of excluding some of it from taxation should investigate a new investment called a qualified opportunity fund (QOF), which was created as part of the recent tax reform.

To help communities that have not recovered from the past decade’s economic downturn, lawmakers included in the Tax Cuts and Jobs Act the new code Sections 1400Z-1 and 1400Z-2, which are intended to promote investments in certain economically distressed communities through QOFs. Investments in QOFs provide unique tax incentives that lawmakers designed to encourage taxpayers to participate in these funds:

Reinvesting Gains – Starting in 2018, a taxpayer who has a gain (short-term, long-term, ordinary, or capital) from selling or exchanging any non-QOF property to an unrelated party may elect to defer that gain if it is reinvested in a QOF within 180 days of the sale or exchange. Only one election may be made with respect to a given sale or exchange. If the taxpayer reinvests less than the full amount of the gain in the QOF, the remainder is taxable in the sale year, as usual. The amount of the gain – not the amount of the sale’s proceeds, as in Sec 1031 deferrals – needs to be reinvested in order to defer the gain.

The gain income is deferred until the date when the QOF investment is sold or December 31, 2026 – whichever is earlier. At that time, the taxpayer includes the lesser of the following amounts as taxable income:

a. The deferred gain
b. The fair market value of the investment, as determined at the end of the deferral period, reduced by the taxpayer’s basis in the property. (Basis is explained below.)

A taxpayer who holds a QOF investment for 10 years or more before selling it can elect to permanently exclude the gain from the sale that is in excess of the originally deferred gain (i.e., the appreciation).

Qualified Opportunity Fund Basis – The basis of a QOF that is purchased with a deferred gain is $0 unless either of the following increases applies:

(a) If the investment is held for 5 years, the QOF’s basis increases from $0 to 10% of the deferred gain.

(b) If the investment is held for 7 years, the QOF’s basis increases from $0 to 15% of the deferred gain.

If a taxpayer holds a QOF that was purchased with deferred gains on December 31, 2026, the original deferred gain must be included as gross income on that taxpayer’s 2026 return; the basis of the investment will then be increased by the amount of this included gain.

If the QOF investment is held for at least 10 years before being sold, the taxpayer can elect to increase the basis to the property’s fair market value. This adjustment means that the QOF’s appreciation is not taxable when it is sold.

Example 1: On June 30, 2018, Phil sold a rental apartment building for $3 million, resulting in a gain of $1 million. Within the statutory 180-day window, he invested that $1 million into a QOF and elected to take the temporary gain deferral exclusion. On July 1, 2026, he then sold the QOF for $1.5 million. Because Phil held the investment for over 7 years, its basis is enhanced by $150,000 (15% of $1 million). Because the investment’s fair market value is greater than the original deferred gain, he must include a taxable gain of $1.35 million ($1.5 million – $150,000) in his 2026 gross income.

Example 2: The facts here are the same as in Example 1, except Phil waited to sell the QOF until 2030, meaning that he held it for nearly 12 years. Because he had the investment on December 31, 2026, he was required to include $850,000 ($1 million – $150,000) of deferred gain on his 2026 return, and his basis in the QOF was increased from $0 to $850,000. After selling the QOF for $1.5 million, Phil elected to permanently exclude the gain by increasing his basis to $1.5 million (the fair market value on the date of the sale). Thus, he has no gain ($1.5 million – $1.5 million) in 2030.

Mixed Investments – If a taxpayer’s investment in a QOF consists of both deferred gains and additional investment funds, it is treated as two investments; this provides the tax benefits of both types: the temporary gain deferral and the permanent gain exclusion (which applies only to the deferred gain).

Qualified Opportunity Funds – To defer gains-related taxes through the recently enacted opportunity-zone program, taxpayers must invest in a QOF – an investment vehicle that is organized as a corporation or a partnership for the purpose of investing in properties within qualified opportunity zones. These investments cannot be in another QOF, and the properties must have been acquired after December 31, 2017. The fund must hold at least 90% of its assets in the qualified-opportunity-zone property, as determined by averaging the percentage held in the fund on the last days of the two 6-month periods of the fund’s tax year. Taxpayers may not invest directly in qualified opportunity zone property.

Partnerships – Because a QOF that is purchased with deferred capital gains has a basis of zero, taxpayers who invest in QOFs that are organized as partnerships may be limited to deducting the losses that these partnerships generate.

Qualified Opportunity Zones – A low-income census tract can be specifically designated as a qualified opportunity zone after a nomination from the governor of that community’s state or territory. Once the qualified opportunity zone nomination is received in writing, the treasury secretary can certify the community as a qualified opportunity zone. Once certified, zones retain this designation for 10 years.

The Department of the Treasury and the Internal Revenue Service will provide further details regarding this new incentive in the near future, including additional legal guidance and an outline of the procedure for electing to defer a gain. If you have questions, please give this office a call.

Hardship Exemption Rules for Not Having Health Insurance Eased

Article Highlights:

  • Shared Responsibility Payment
  • Executive Order
  • Hardship Exemption
  • Exemption Certification Number

The Affordable Care Act (Obamacare) included a “shared responsibility payment,” which in reality is a penalty for not having health insurance. Along with this penalty came a whole slew of exemptions from the penalty, including some that were designated as “hardship” exemptions. However, the hardship relief from the penalty required pre-approval from the government health insurance marketplace, which required the applicant to provide documentary evidence of the hardship. Once approved, the applicant was issued an exemption certificate number (ECN) that needed to be included on the individual’s tax return to avoid the penalty.

Hours after being sworn in, President Trump signed an executive order aimed at reversing the Affordable Care Act. The executive order states that the Trump administration will “seek prompt repeal” of the law. To minimize the “economic burden” of Obamacare, the order instructs the secretary of the Department of Health and Human Services and other agency heads to “waive, defer, grant exemptions from, or delay the implementation” of any part of the law that places a fiscal burden on the government, businesses or individuals.

As a result of President Trump’s executive order, the Centers for Medicare & Medicaid Services (CMS) announced on September 12, 2018, that consumers can claim a hardship exemption for not purchasing insurance and avoid the penalty for not being insured for 2018, either by:

  • Obtaining an ECN through the existing application process or
  • Simply entering the hardship code on their federal income tax return (a form of self-certification).

However, the CMS cautioned that consumers should keep any documentation that demonstrates qualification for the hardship exemption with their other tax records.

The following are the more common hardship exemptions affected by this change. For a complete list and additional details related to qualifying for these hardships, visit the CMS website.

  • Homelessness
  • Being evicted or facing eviction or foreclosure
  • Receiving a shut-off notice from a utility company
  • Experiencing domestic violence
  • Death of family member
  • Fire, flood or other disaster that caused substantial damage
  • Bankruptcy
  • Medical expenses that can’t be paid, resulting in substantial debt
  • Increased medical expenses to care for a member of the family
  • Claiming a child who has been denied Medicaid or CHIP coverage
  • Ineligibility for coverage because the state didn’t expand Medicaid

The shared responsibility payment and exemptions are determined on a monthly basis, and a person is eligible for a hardship exemption for at least the month before, the month(s) during and the month after the specific event or circumstance that creates the hardship.

There are a variety of other exemptions in addition to the hardship exemptions, and 2018 is the final year the shared responsibility payment will be assessed. The Tax Cuts and Jobs Act (tax reform) has eliminated the penalty beginning in 2019.

If you have questions related to the penalty for not having health insurance and the exemptions from being penalized, please call.

Mitigating the Effects of Employee Burnout: What You Need to Know

Make absolutely no mistake about it: Not only is employee burnout very real, it’s probably costing your business a lot more money than you realize. It’s also not a problem that you’re necessarily going to be able to buy your way out of, either.

According to one recent study, a massive 70 percent of the workforce in the United States is not engaged with their current jobs in any type of meaningful way ― and employee burnout is a major contributing factor to this. As stated, if you think that this is because people don’t feel like they’re making enough money, the chances are very high that you’re wrong. The same study revealed that 89 percent of employers THINK that people leave jobs to get more money elsewhere, but in reality, that’s only actually true about 12 percent of the time. But perhaps the most damning statistic of all is the following: Collectively, disengaged employees cost organizations in the United States between $450 and $550 billion every year in terms of lost productivity alone.

So, once you’ve come to the realization that this is, in fact, a problem, you must then turn your attention toward taking advantage of any possible solution in front of you. The good news is that it is possible to mitigate the effects of employee burnout ― you just need to keep a few key things in mind.

Understand What Employee Burnout Looks Like

Not every employee is necessarily burned out ― even if they’re pulling long hours or giving everything to help you achieve your goals. But in an effort to avoid the major downsides of burnout on your business, you need to know more about how to spot it in its nascent stages. If an employee is burned out, they’re probably exhibiting one or even all of the following signs:

  • They’re exhausted, either physically or emotionally. The resources needed to cope with their work environment in these two areas are totally spent, and they tend to act accordingly. We’ve all been here, so you should know what it looks like.
  • They’re increasingly cynical. They know what they’re supposed to do and why it matters, but they’re less convinced that it really matters to THEM in the long run.
  • They’re growing more inefficient as time goes on. Burned-out employees tend to give up “trying” pretty quickly as a result of the cynical attitude outlined above, and the quality of the work they offer suffers as a result.

Put a Premium on the Mental Health of Your Employees

If you truly want to mitigate the effects of employee burnout, you need to focus not on correcting the problem but on trying to prevent it from happening in the first place.

This means placing a high priority on the mental health and wellness of all of your workers, something you can do in a few different ways.

Some experts recommend that you should hold walking meetings, for example. Instead of holding yet another meeting with your team in a stuffy boardroom with absolutely no natural lighting, get outside and take a walk around the block. You can still discuss all the same things (and thanks to cloud technology, you can likely refer to all of the same files on devices like smartphones and tablets), but the change of scenery will really make a big difference.

Along the same lines, don’t be afraid to encourage people to take mental health days ― especially during busy periods or the holiday season. Remember that a burned-out employee ultimately isn’t doing you any good anyway, so if they need to leave early one day or not come in at all, they’ll be at far more of an advantage than you are at a disadvantage in terms of lost productivity. Just knowing that you support their health and wellness like this will really go a long way toward mitigating this type of risk.

Likewise, you should always maintain an open door policy with your employees. If they feel like they need to come in and talk to you for any reason, good or bad, they should feel comfortable with their ability to do so. If they need something to thrive in their job every day, they shouldn’t be afraid to come ask for it because they should know you’ll work hard to get it. If they have a problem, they should feel willing to come talk to you to look for a solution. Again, the importance of this level of managerial support is something that you absolutely cannot overstate.

Everyone feels burned out every now and again ― this is not something you can avoid. But if you truly want to avoid letting employee burnout have a long-term negative effect on everything that you’ve already worked so hard to build, you need to recognize the problem and take steps now to do something about it. Oftentimes, success to that end is less the product of one big move and more about a series of smaller ones. Provided you follow tips like these every day, you’ll soon realize that a large portion of the hard work has already been done for you.

Three Common Family Tax Mistakes

Article Highlights

  • Family Member Transactions
  • Renting to a Relative
  • Below-Market Loans
  • Transferring Home Titles
  • Gifts
  • Basis
  • Life Estate

When it comes to transactions between family members, the tax laws are frequently overlooked, if not outright trampled upon. The following are three commonly encountered situations and the tax ramifications associated with each.

Renting to a Relative – When a taxpayer rents a home to a relative for long-term use as a principal residence, the rental’s tax treatment depends upon whether the property is rented at fair rental value (the rental value of comparable properties in the area) or at less than the fair rental value.

Rented at Fair Rental Value – If the home is rented to the relative at a fair rental value, it is treated as an ordinary rental reported on Schedule E, and losses are allowed, subject to the normal passive loss limitations.

Rented at Less Than Fair Rental Value – When a home is rented at less than the fair rental value, it is treated as being used personally by the owner; the expenses associated with the home are not deductible, and no depreciation is allowed. The result is that all of the rental income is fully taxable and reported as “other income” on the 1040. If the taxpayer were able to itemize their deductions, the property taxes on the home would be deductible, subject to the $10,000 cap on state and local taxes effective starting with 2018. The taxpayer might also be able to deduct the interest on the rental home by treating the home as their second home, up to the debt limits on a first and second home.

Possible Gift Tax Issue – There also could be a gift tax issue, depending if the difference between the fair rental value and the rent actually charged to the tenant-relative exceeds the annual gift tax exemption, which is $15,000 for 2018. If the home has more than one occupant, the amount of the difference would be prorated to each occupant, so unless there was a large difference ($15,000 per occupant, in 2018) between the fair rental value and actual rent, or other gifting was also involved, a gift tax return probably wouldn’t be needed in most cases.

Below-Market Loans – It is not uncommon to encounter situations where there are loans between family members, with no interest being charged or the interest rate being below market rates.

A below-market loan is generally a gift or demand loan where the interest rate is less than the applicable federal rate (AFR). The tax code defines the term “gift loan” as any below-market loan where the forgoing of interest is in the nature of a gift, while a “demand loan” is any loan that is payable in full at any time, at the lender’s demand. The AFR is established by the Treasury Department and posted monthly. As an example, the AFR rates for October 2018 were:

TermAFR (Annual) Oct. 2018
3 years or less2.55%
Over 3 years but not over 9 years2.83%
Over 9 years2.99%

Generally, for income tax purposes:

Borrower – Is treated as paying interest at the AFR rate in effect when the loan was made. The interest is deductible for tax purposes if it otherwise qualifies. However, if the loan amount is $100,000 or less, the amount of the forgone interest deduction cannot exceed the borrower’s net investment income for the year.

Lender – Is treated as gifting to the borrower the amount of the interest between the interest actually paid, if any, and the AFR rate. Both the interest actually paid and the forgone interest are treated as investment interest income.

Exception – The below-market loan rules do not apply to gift loans directly between individuals if the loan amount is $10,000 or less. This exception does not apply to any gift loan directly attributable to the purchase or carrying of income-producing property.

Parent Transferring a Home’s Title to a Child – When an individual passes away, the fair market value (FMV) of all their assets is tallied up. If the value exceeds the lifetime estate tax exemption ($11,180,000 in 2018; about half that amount in 2017), then an estate tax return must be filed, which is rarely the case, given the generous amount of the exclusion. Because the FMV is used in determining the estate’s value, that same FMV, rather than the decedent’s basis, is the basis assigned to the decedent’s property that is inherited by the beneficiaries. The basis is the value from which gain or loss is measured, and if the date-of-death value is higher than the decedent’s basis was, this is often referred to as a step-up in basis.

If an individual gifts an asset to another person, the recipient generally receives it at the donor’s basis (no step-up in basis).

So, it is generally better for tax purposes to inherit an asset than to receive it as a gift.

Example: A parent owns a home worth (FMV) $350,000 that was originally purchased for $75,000. If the parent gifts the home to the child and the child sells the home for $350,000, the child will have a taxable gain of $275,000 ($350,000 − $75,000). However, if the child inherits the home, the child’s basis is the FMV at the date of the parent’s death. So in this case, if the date-of-death FMV is $350,000 and if the home is sold for $350,000, there will be no taxable gain.

This brings us to the issue at hand. A frequently encountered problem is when an elderly parent signs the title of his or her home over to a child or other beneficiary and continues to reside in the home. Tax law specifies that an individual who transfers a title and retains the right to live in a home for their lifetime has established a de facto life estate. As such, when the individual dies, the home’s value is included in the decedent’s estate, and no gift tax return is applicable. As a result, the beneficiary’s basis would be the FMV at the date of the decedent’s death.

On the other hand, if the elderly parent does not continue to reside in the home after transferring the title, no life estate has been established, and as discussed earlier, the transfer becomes a gift, and the child’s (gift recipient’s) basis would be the parent’s basis in the home at the date of the gift. In addition, if the child were to sell the home, the home gain exclusion would not apply unless the child moves into the home and meets the two-out-of-five-years use and ownership tests.

Another frequently encountered situation is when the parent simply adds the child’s name to the title, while retaining a partial interest. If the home is subsequently sold, the parent, provided they met the two-out-of-five-years use and ownership rules, would be able to exclude $250,000 ($500,000 if the parent is married and filing a joint return) of his, her or their portion of the gain. A gift tax return would be required for the year the child’s name was included on the title, and the child’s basis would be the portion of the parent’s adjusted basis transferred to the child. As mentioned previously, the child would not be able to use the home gain exclusion unless the child occupied and owned the home for two of the five years preceding the sale.

These are only three examples of the tax complications that can occur in family transactions. I highly recommended that you contact this office before completing any family financial transaction. It is better to structure a transaction within the parameters of tax law in the first place than have to suffer unexpected consequences afterwards.

Rejoice – Business Meals Are Still Deductible

Article Highlights:

  • Ban on Deducting Entertainment Expenses
  • Business Meals
  • Mixed Entertainment and Meals
  • Substantiation Requirements
  • Disallowed Employee Business Expenses

If you are a business owner who is accustomed to treating clients to sporting events, golf getaways, concerts and the like, you were no doubt saddened by the part of the tax reform that passed last December that did away with the business-related deductions for entertainment, amusement or recreation expenses, beginning in 2018. You can still entertain your clients; you just can’t deduct the costs of doing so as a business expense.

While the ban on deducting business entertainment was quite clear in the revised law, a lingering question among tax experts has been whether the tax reform’s definition of entertainment also applied to business meals, such as when you take a customer or business contact to lunch. Some were saying yes, and others no. Either way, both sides recommended keeping the required receipts and documentation until the issue was clarified.

The IRS recently issued some very business-friendly guidance, pending the release of more detailed regulations. In a notice, the IRS has announced that taxpayers generally may continue to deduct 50 percent of the food and beverage expenses associated with operating their trade or business, including business meals, provided:

  1. The expense is an ordinary and necessary expense paid or incurred during the taxable year in carrying out any trade or business;
  2. The expense is not lavish or extravagant under the circumstances;
  3. The taxpayer, or an employee of the taxpayer, is present at the furnishing of the food or beverages;
  4. The food and beverages are provided to a current or potential business customer, client, consultant or similar business contact; and
  5. Food and beverages provided during or at an entertainment activity are purchased separately from the entertainment, or the cost of the food and beverages is stated separately from the cost of the entertainment on one or more bills, invoices or receipts.

The IRS notice also included the following interesting examples related to #5: The taxpayer invites a business contact to a baseball game. The tickets to the game are entertainment and not deductible. However, the taxpayer also purchased hot dogs and a beverage for himself and the business contact. Because the food and drinks were purchased separately, they are not disallowed as entertainment and are deductible if they otherwise qualify as an ordinary and necessary business expense. Had the ticket price included the hot dogs and beverages, they would be treated as non-deductible entertainment. If the ticket price separately stated the ticket price and the food and beverage price, then the food and beverage portion would not be disallowed as entertainment.

Of course, the substantiation requirements still apply. You must be able to establish the amount spent, the time and place, the business purpose and the business relationship and names of the individuals involved. You should keep a diary, an account book, digital files or similar records with this information and record the details within a short time of incurring the expenses. If the meal expense is $75 or more, documentary proof (receipts, etc.) is also required.

If you are an employee, starting in tax year 2018, you will not be able to deduct your unreimbursed employee business expenses, including the cost of client meals. These expenses have been deductible as miscellaneous itemized deductions when you itemized deductions and when your total deductions in that category exceeded 2% of your adjusted gross income. Under the tax reform, this category of deductions is not deductible for years 2018 through 2025. So, unfortunately, the IRS’s expansive definition of meal expenses will not benefit you.

If you have questions related to business meals, substantiation or the ban on entertainment expenses, please give this office a call.