​​You Make the Call

​Please note that the question and answer provided does not take into account all options or circumstances possible.

May 22, 2019

Question: On March 5, 2019, Bluebird, Inc. (an S corporation) requested an extension to file its 2018 Form 1120S, U.S. Income Tax Return for an S Corporation. Bluebird proceeded to file its 2018 Form 1120S on May 1, 2019, without making a SEP contribution for its sole shareholder/employee. Can Bluebird still make a SEP contribution for 2018, and claim the deduction on an amended Form 1120S?

Answer: Yes. The due date for making a deductible SEP contribution is the extended due date of Bluebird’s Form 1120S (Sept. 15, 2019), even though the tax return was filed earlier. As long as the tax return is filed after obtaining a valid extension, taxpayers have until the extended due date to make the contribution regardless of when the return is actually filed (Rev. Rul. 66-144).

May 16, 2019

Question: Can my client Louie, who owns a trust, still take trust investment advisor fees that are above and beyond what an “ordinary” investor needs?

Answer: Yes. Based on Reg. §1.67-4(b)(4), the taxpayer can claim trust investment advisor fees that include advice necessary for the trust above and beyond what an ordinary investor would need for advice. These fees are not subject to the 2% miscellaneous deduction. Louie can no longer claim trust investment advisor fees for advice rendered to an ordinary investor because these fees are subject to the 2% miscellaneous deduction for 2018–2025.

May 9, 2019

Question: The taxpayer purchased a cemetery plot in 1999 for $2,000. In 2019, he discovered the cemetery had used the plot for someone else. As restitution, the cemetery paid the taxpayer $10,000 and the taxpayer acquired a new plot for $8,000. Is any of the involuntary conversion payment taxable?

Answer: Yes. Because the taxpayer did not reinvest the full $10,000 into a new plot, a portion of the restitution payment will be taxable.

The recognized gain is the excess not reinvested. In this case, the recognized gain is $2,000, the amount not reinvested ($10,000 restitution - $8,000 realized gain). The total deferred gain is $6,000 ($8,000 realized or deferred gain - $2,000 recognized gain). The basis of the new plot is $2,000 ($8,000 cost of the new - $6,000 deferred gain).

May 2, 2019

Question: Joe procrastinated filing his 2014 Form 1040 tax return because he knew he was getting a refund. He finally got around to completing it on Sunday April 15, 2018. Joe did not bother to mail it until Monday, April 16, 2018, when the post office was open because he said that the IRS extended the due date for tax returns until Monday because April 15 fell on a Sunday. Will Joe get the refund?

Answer: No. Joe will not receive the tax refund. He is correct that the IRS extends the due dates of tax returns that otherwise land on a Saturday, Sunday or legal holiday. However, that rule does not apply to receiving a tax refund.

The IRS does not extend the deadline used to determine how much of the taxes withheld on his wages may be refunded to him. Under §6513(b)(1), the taxes withheld on his 2014 wages are deemed paid on April 15, 2015. To receive a refund of taxes paid, the claim needs to be filed within three years after filing the return or two years from the date the tax was paid, whichever is later. This was upheld in KHAFRA, ET AL. v. IRS, ET AL., Cite as 122 AFTR 2d 2018-XXXX, (DC MD), 11/06/2018.

April 25, 2019

Question: Prior to her marriage to Elliot, Olivia owned securities. During the marriage, the securities were sold at a loss and a capital loss carryover resulted. The couple filed joint returns during their marriage. In 2017, Olivia died. When filing his 2018 Form 1040, does Elliott continue to use the capital loss carryforward?

Answer: No. Net operating losses (NOLs) and capital losses allocable to the decedent cannot be carried over and used by her estate. Also, those losses cannot be carried over and used in future tax years by a surviving spouse (Ltr. Rul. 8510053). However, they can be used in the decedent's final return, including one filed with a surviving spouse. Carryover losses not used in the decedent's final return expire in the year of death (Rev. Rul. 74-175).

April 18, 2019

Question: Qualified Inc., an S corporation located in Vermont, has several shareholders who are located out of state. Vermont requires estimated income tax payments on behalf of nonresident shareholders. This year, Qualified Inc. made $15,000 in required estimated payments for their nonresident shareholders. The shareholders are not required to reimburse Qualified Inc. for the estimated payments. Can Qualified Inc. deduct the estimated tax payments made for the nonresident shareholders?

Answer: No, Qualified Inc. cannot deduct the Vermont estimated income tax payments made on behalf of the shareholder [TC Memo 2015-73]. Instead, the payments are treated as distributions to the shareholders.

April 11, 2019

Question: Taxpayer has a Schedule K-1 (Form 1120S), Shareholder’s Share of Income, Deductions, Credits, etc., from her S corporation that does not list any information about qualified business income (QBI). Box 1 of the K-1 reports ordinary income and the taxpayer received a Form W-2, Wage and Tax Statement, from the S corporation. Is this enough information to calculate the 20% deduction under §199A?

Answer: No, the S corporation must supply QBI information to the shareholder on Schedule K-1 in Box 17 with codes V-Z. If the K-1 fails to report this information, it is presumed that the shareholder’s share of QBI items is zero.

A relevant pass-through entity or RPE must separately identify and report the following items on the Schedule K-1 issued to its owners for any trade or business engaged in directly by the RPE:

• Each owner’s allocable share of QBI, W-2 wages and unadjusted basis immediately after acquisition (UBIA) of qualified property attributable to each trade or business.
• Whether any of the trades or businesses are an SSTB.

If an RPE fails to separately identify or report the required items, the owner’s share of those items will be presumed to be zero [ Reg. §1.199A-6(b)(3)(iii)].

April 4, 2019

Question: In 2017, John filed a joint return reporting wages of $355,000 and was subject to the additional Medicare tax on Form 8959. On John’s 2018 joint return, his wages dropped to $215,000 and your software program did not generate Form 8959. Why is John not subject to the additional Medicare tax on Form 8959 in 2018?

Answer: The threshold for filing Form 8959 for a MFJ return is when wages exceed $250,000. Since John’s wages did not exceed $250,000 in 2018, he is not subject to the additional Medicare tax on Form 8959 and, therefore, your program did not prepare the form.

March 28, 2019

Question: John owned a rental property for 10 years. In 2018, he moved into the property to use as his primary residence in hopes of excluding gain under §121 when he sells it in the future. Will John recognize gain on the conversion of the rental property to his residence in 2018?

Answer: No, there is no recognition for income tax purposes for the retirement of a depreciated asset by converting it to personal use, assuming assets were not expensed under §179. No gain or loss is recognized at the time of conversion. However, when a business asset is converted to personal use and later sold, §§165(c)(1) and 165(c)(2) do not permit deduction of a loss on a sale or other disposition. This is true even if the decline in the property's value occurred while it was used in the taxpayer's business and would have been deductible had the property been sold when it was converted.

March 21, 2019

Question: You have many clients who own rental activities.

• Robert works full time as a car salesman and owns one rental property that generates income.
• George is sole proprietor who owns a handyman business and owns seven rentals.
• Bill is a farmer who rents out 120 acres of farmland that he doesn’t use in his farming business.
• Chuck is the CEO of a major corporation and personally owns a commercial rental building.

Is the income from these activities qualified business income (QBI) for the purposes of claiming the qualified business income deduction (QBID)?

Answer: It depends. It may be frustrating to hear, but there is no one-size-fits-all answer to any of these scenarios and the dozens of others that tax professionals are wrestling with this year.

Fact: Only §162 trade or business income can generate QBI [Reg. §1.199A-1(b)(14)]. Generally, a rental does not rise to the level of a trade or business, which is why rental activities are passive, reported on Schedule E, and not subject to SE tax. However, it has always been possible for a taxpayer’s rental activities to rise to the level of a trade or business, but the IRC has never offered a clear definition for this, which has historically made this determination highly subjective. It is nearly impossible to glean a precedent from Tax Court rulings, and they have swung either way with similar fact sets. With this is mind, when Congress enacted this new §199A/QBID at the end of 2017, tax professionals had nothing to hang their hat on, and the community has been flooded with opinions as to whether rental activities are a trade or business for §199A purposes. No matter how eloquent or convincing the arguments are one way or the other, there simply isn’t a statute to rely on for anyone.

That said, the IRS issued Notice 2019-07 in January 2019, which includes a proposed revenue procedure that provides a safe harbor for treating a rental activity as a trade or business solely for purposes of §199A. The proposed regulations indicate that a rental activity that meets certain criteria is a rental real estate enterprise (RREE), and deemed to be a trade or business for §199A purposes only.

In sum, taxpayers and tax professionals are free to argue any rental activity is a “trade or business” under §162, if they have an argument. But only those owners of rental real estate that meet the safe harbor in Notice 2019-07 are considered a trade or business in the eyes of IRS without argument.

The safe harbor is not part of this answer, but members can access a summary of the safe harbor that is included in the summary of §199A regulations published late January at the following link.

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.

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