You Make the Call
Please note that the question and answer provided does not take into account all options or circumstances possible.
March 14, 2019
Question: Mike is a sole proprietor filing a joint return with taxable income of $150,000 (no capital gains). He reported net income of $54,000 on Schedule C (Form 1040), Profit or Loss From Business (Sole Proprietorship), for 2018. Is Mike’s qualified business income (QBI) deduction based on 20% of $54,000 before the taxable income limitation is taken into consideration?
Answer: Not necessarily. The deduction is 20% of QBI. Mike’s QBI is the net amount of his income, gain, deduction, and loss with respect to his Schedule C business. However, QBI also takes into account other deductions attributable to his trade or business including, but not limited to, above-the-line deductions for self-employed health insurance, one-half the self-employment tax and any contribution to a self-employed retirement plan based on his Schedule C net income [Reg. §1.199A-3(b)(vi)]. Thus, he must reduce his Schedule C net income by other allowable deductions attributable to his business to arrive at QBI, and then multiply the net amount by 20%.
March 7, 2019
Question: My client Albert wants to provide a death benefit to his employee’s spouse or to the employee’s estate. Is there a tax-free employee death benefit available to the employee’s spouse or the employee’s estate from the company?
Answer: Yes, based on Reg §1.101-2(a)(1), the general rule is that amounts up to $5,000 paid to beneficiaries or the estate of an employee, or former employee, from the employer, shall be excluded from income. This does not pertain to income paid to the employee, which must be included as part of compensation and is taxable. The employer will get a deduction for employee death benefits. Any amounts over $5,000 will be included in the beneficiary or estate income.
February 28, 2019
Question: A U.S. taxpayer with a highly appreciated investment portfolio is moving to Puerto Rico for warmer climates. She will retain her U.S. citizenship, but become a resident of Puerto Rico. Additionally, she has heard that she should wait to sell her investments once she moves to Puerto Rico because she would not have to pay tax on any of her capital gain income since the Puerto Rican capital gain tax rate is 0%. Is she correct?
Answer: She is only partially correct.
U.S. taxpayers are taxed on their worldwide income (§61). Therefore, if the taxpayer retains her U.S. citizenship she will continue to pay taxes on her worldwide income to the U.S. However, §933 states that income derived from sources within Puerto Rico by an individual who is a resident of Puerto Rico for the entire taxable year is exempt from U.S. taxation. In other words, the income becomes Puerto Rican sourced income, taxable only in Puerto Rico.
In this case, any appreciation on the investments that occurred prior to her move to Puerto Rico is considered U.S. sourced income and will be taxable in the U.S. and Puerto Rico at the applicable capital gain tax rates. She will be eligible for the foreign tax credit in the U.S. for taxes paid to Puerto Rico.
Any appreciation after her move to Puerto Rico, is considered Puerto Rican sourced income and will be taxed only in Puerto Rico at the applicable capital gain tax rate, which is 0% under Puerto Rico’s Act 22.
February 21, 2019
Question: The taxpayer has a child who started college in the fall of 2014. The American Opportunity Tax Credit (AOTC) wasn’t claimed in 2014. In the spring of 2018, the child completed her senior year in college as an undergraduate, then in the fall of 2018 started her first semester as a graduate student. For AOTC, can the costs of graduate school be included as qualified expenses for purposes of the credit?
Answer: Generally, graduate school expenses may not be included in the AOTC because AOTC is only available for the first four years of undergraduate college education. In this situation, there is an exception for 2018 because the child has not completed four years of college as of the beginning of 2018. In a year that the taxpayer can take the AOTC, the first semester of graduate school may be included as qualified expenses paid during the entire tax year if all other requirements are met. Therefore, in this situation the taxpayer may include both the undergraduate 2018 spring semester qualified expenses and graduate fall semester qualified expenses for the 2018 AOTC because the child didn’t complete four years of undergraduate education prior to 2018. (Publication 970 page 18, example 2.)
February 14, 2019
Question: Sam is the 100% shareholder in Barnes Inc., an S corporation. Sam would like to sell Barnes Inc. and then dissolve the company. A buyer would like to purchase Barnes’ assets on installment. Can Barnes Inc. distribute the installment note to Sam?
Answer: Yes. Different results can occur under the installment sale rules depending on whether the S corporation adopts a plan of liquidation prior to or after the asset sale. The rule requiring corporations to recognize gain or loss upon the distribution of its property in complete liquidation extends to distributions of installment obligations in liquidation. However, an important exception for S corporations allows installment reporting of the gain associated with a liquidation. If an installment obligation is acquired by the S corporation from the sale of its assets during the 12-month period beginning on the date of adoption of a plan of complete liquidation, and this installment obligation is then distributed to the shareholders as part of the liquidation, no gain or loss is recognized by the S corporation upon the distribution of the installment note receivable.
February 7, 2019
Question: Tonya and Trey, a married couple, both have full-time jobs. In 2008, they started to dabble in investment property. They hold one property that is rented on a full-time basis. They do not have a separate checking account for the rental activity, nor do they spend more than 250 hours on the rental activity per year. The couple asks if they qualify for the 20% QBI deduction for 2018. What do you tell them?
Answer: No. The rental activity does not meet the safe harbor provided in proposed IRS Notice 2019-7. To meet the safe harbor requirements, the clients must:
- Maintain separate books and records for the rental property.
- Provide 250 or more hours of rental services for each rental real estate enterprise for tax years beginning prior to Jan. 1, 2023. For tax years after Dec. 21, 2022, the requirement is met if the clients provide 250 or more hours of rental services for three out of five consecutive taxable years that end with the current taxable year.
Tonya and Trey do not meet the safe harbor requirements and the activity does not rise to the level of a trade or business under §162.
January 31, 2019
Question: Harry, a hobby farmer, often hires his nephew during the summer months to work on the farm. Harry reports his income from the hobby farm activity on Form 1040, Schedule 1, Line 21. Under the Tax Cuts and Jobs Act 2017 (TCJA), Schedule A, miscellaneous 2% itemized deductions have been suspended for tax years 2018–2025, which means he no longer can deduct hobby activity expenses. Because Harry wants to claim the least amount of hobby income possible, he is wondering if issuing a Form 1099-MISC to his nephew will offset the hobby income reported on Schedule 1. Can Harry issue a 1099-MISC to his nephew?
Answer: No. Harry is not required to issue Form 1099-MISC and should not issue this form because he is not in the trade or business of farming; the activity is a hobby. Even if he did issue a 1099-MISC, it will not offset hobby income. The code defines what is considered an activity not engaged for profit (hobbies) by stating all activities other than those allowed deductions under §162 or §212, both of which deal with expenses of carrying on a trade or business and expenses for the production or collection of income for property held for investment.
Law Change Alert: The deduction for expenses under §212 as a miscellaneous itemized deduction is also suspended from 2018–2025 by the TCJA [IRC Sec. 67(g), as added by the TCJA].
January 24, 2019
Question: Jennifer is single and made a large charitable contribution to her church in 2017, creating a charitable contribution carryover into 2018. However, with the new standard deduction being $12,000 for a single taxpayer, she does not have enough itemized deductions to file a Schedule A in 2018. Can Jennifer claim the charitable contribution carryover in a year that she is claiming a standard deduction?
Answer: No, Jennifer will not be able to claim the carryover amount as part of her standard deduction. Reg §1.170A-10(a)(2) disallows the carryover to be claimed in a year the taxpayer is not able to itemize, but it can be carried over for five years even though the taxpayer cannot itemize. The excess is carried over, but is reduced by any amount she would have been able to claim had she itemized her deductions in the current year.
January 17, 2019
Question: Martha’s daughter Rosie is 12-years-old. Martha is self-employed and files a Schedule C. Martha wants to employ her daughter and not pay FICA and Medicare tax on the wages. Can she do this?
Answer: Yes. The mother can pay Rosie a reasonable wage. A family business may be operated as a sole proprietorship (when income and expenses are reported by the sole proprietor on Schedule C of Form 1040). Another family member's employee service for the family's sole proprietorship may be considered exempt employment for FICA and/or FUTA purposes. Service performed by a child under 18 employed by a parent is exempt for FICA purposes [IRC Sec. 3121(b)(3)(A)]. A similar rule applies for FUTA purposes except that the age limit is increased to under 21 [IRC Sec. 3306(c)(5)].
January 10, 2019
Question: Your client comes to you with questions regarding the new §199A deduction or pass-through deduction. He is a shareholder in an S corporation who files on a fiscal year that ends on May 31 each year.
The S corporation filed its 2017 Form 1120S timely and issued a Schedule K-1 for the fiscal year ending on May 31, 2018, which he must include on his 2018 individual return. The business operates a trade or business that generates qualified business income (QBI) for purposes of the new qualified business income deduction (QBID).
This new code section, however, went into effect for tax years beginning on Jan. 1, 2018. Your client is anxious to understand whether a shareholder who receives a 2017 Schedule K-1 for a tax year ending after the effective date for the QBID is able to claim the QBID, assuming he otherwise qualifies to claim the deduction in terms of income limitations, and so on. What do you tell him?
Answer: The fact that the tax year for the S corporation began in 2017 does not prevent the shareholder filing his 2018 individual tax return from claiming the QBID. The QBI is not prorated either to include only QBI that occurred in 2018. According to Prop. Reg. §1.199A-1(f)(2), a taxpayer is permitted to take a full §199A deduction related to a fiscal-year qualified business whose tax year includes Jan. 1, 2018.
Therefore, on the client’s 2018 individual return, he can claim the §199A deduction for the QBI earned by the S corporation for its tax year beginning June 1, 2017, and ending May 31, 2018.
Note: The facts in this question strictly center around what happens when a pass-through entity operates on a fiscal year that straddles the effective date of the new QBID. It is not intended to focus on the qualifications to claim the QBID. The assumption is that the client qualifies to claim the QBID.
January 4, 2019
Question: Paul and Liz bought a home in California in 2011 for $750,000 and used it as their principal residence through June 30, 2016. They moved from California to South Carolina, so they decided to convert the property to a residential rental when it was worth $700,000. After renting it out for two years, they sold it in October 2018 for $650,000. They claimed $40,000 of depreciation while it was a rental. Can they claim a loss on the sale of this property? If so, how much can they deduct?
Answer: Paul and Liz can claim a loss attributable to the period it was rented out. In general, the basis of a converted personal residence for purposes of reporting a loss on sale is the lesser of: the original cost basis, or the FMV at the time it was converted to a rental, reduced by depreciation allowed or allowable [Reg. §1.165-9(b)(2)]. Thus, the basis for computing Paul and Liz’s loss on sale is $660,000 (lower of $750,000 or $700,000 less $40,000 depreciation). They can claim a loss of $10,000 ($650,000 sales price - $660,000 adjusted basis). The $50,000 decline in value while it was used as a personal residence is not deductible.
December 27, 2018
Question: The taxpayer gifted his daughter an apartment building. However, he is going to continue receiving the income from the property for the balance of his life. Is this a completed gift requiring the taxpayer to file Form 709,
United States Gift (and Generation-Skipping Transfer) Tax Return.
Answer: Yes. Because the taxpayer will continue to receive income from the property, he has created a life estate in the property. It is a completed gift of a remainder interest in the property to the daughter.
The father will file Form 709 for the value of the remainder interest in the property only. At the father’s passing, because he retained the right to the income from the apartment building for life, the fair market value of the entire property, as of the date of death, is included in his gross estate. The value of the building is reported on Schedule G, item B [§2036].
December 20, 2018
Question: Mom passed away and after dealing with probate and other legal issues, her husband David decided he would simplify the situation for their children when he passes away. David decided to add his daughter, Bonnie, to his bank account so that it becomes a joint bank account. When David needs something, Bonnie will purchase it for him and pay for it from the joint bank account or withdraw money to reimburse herself.
Unfortunately, Bonnie is having some financial challenges and David told her she could take $20,000 from the joint account. No bona fide loan is made and the plan is for Bonnie to settle up with her siblings when David passes away. She never added any contributions to the joint bank account and there is no intent to add any in the future. Do any of these transactions have any tax reporting consequences either before or after David passes away?
Answer: Before David passes away, none of the transactions from the joint bank account for David’s benefit are reportable to the IRS. The $20,000 that Bonnie withdrew from the joint bank account for her own personal benefit prior to David’s passing is a reportable gift on Form 709, United
States Gift (and Generation-Skipping Transfer) Tax Return.
A gift to Bonnie from David did not occur when the joint bank account was created because David could revoke it at any time. However, when Bonnie makes a withdrawal for her personal benefit then that amount becomes a gift from David because Bonnie did not contribute anything to the account and there was no consideration given for receiving the $20,000. When David passes away, the remaining balance in the joint bank account must be included in his gross estate.
December 12, 2018
Question: During 2018, Andrew filed his 2015 Form 1040 and mailed in a partial payment with the return. In the memo section of the check, Andrew wrote his social security number and labeled the payment “2015 Form 1040.” Andrew has an IRS payment plan in place for prior years and was making payments under the payment plan agreement. The IRS applied the 2015 payment to the prior year’s liability, not the 2015 liability. Can the IRS do this?
Answer: Yes, there is no code section that specifically states the remittance is a payment of tax for the year specified on the check. However, the taxpayer's intent in making a remittance is a crucial factor in determining whether the remittance is a payment of tax or a deposit.
The Code specifically provides that the following types of remittances are always payments of tax:
- Taxes withheld from wages,
- Estimated tax payments, and
- Taxes withheld at the source on a foreign taxpayer's income.
For all other remittances, the Code provides no rules, so the courts have come up with their own rules. The courts have often looked to the following three factors in determining whether a remittance was a payment: (1) the taxpayer's intent in making the remittance; (2) how the IRS treated the remittance and (3) when the IRS assessed the tax to which the remittance relates.
December 6, 2018
Question: Maria and Jose have three children: Alex, age 10, Gabriella, age 12, and Juan, age 17. Both Maria and Jose have full time jobs. They understand that they are eligible for the child tax credit for both Alex and Gabriella; however, they don’t know if they will receive a tax benefit for Juan. What would you tell the couple?
Answer: Jose and Maria can claim the other dependent credit for Juan. Taxpayers are allowed a $500 credit for dependents who are not eligible for the child tax credit [§24(h)(4)(A)].
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