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Welcome to the Virginia Tech 2014 Tax Seminar

Welcome to the Virginia Tech 2014 Tax Seminar. Team Introductions Schedule, Hours, Supplement & CD Cell Phones to Off or Vibrate No Smoking Please CPE Credit Forms How We’ll Handle Questions. Trade or Business C hapter 4 pp. 109 - 137. 2015 National Income TAX Workbook™.

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Welcome to the Virginia Tech 2014 Tax Seminar

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  1. Welcome to theVirginia Tech 2014 Tax Seminar • Team Introductions • Schedule, Hours, Supplement & CD • Cell Phones to Off or Vibrate • No Smoking Please • CPE Credit Forms • How We’ll Handle Questions

  2. Trade or BusinessChapter 4 pp. 109 - 137 2015 National Income TAX Workbook™

  3. Trade or Business p. 109 • Definition of Trade or Business • Selected Provisions for Trades or Businesses • New Business Models & Non-Traditional Occupations • Trade or Business References

  4. Definition of A Trade or Business p. 110 • Neither the Code nor the Regulations contain a definition of Trade or Business. • Facts and circumstances are definitive. • IRS Rulings and Court cases tend to define a Trade or Business. • Taxpayer must have a profit motive and (for some provisions) be involved.

  5. Factors Indicating a Trade or Business pp. 110 - 111 Trade or Business Considerations by the Courts: • Corp in business due to extensive real estate activities. Flint V Stone, Sup Ct 1911. • Gambler who spent full time gambling & intended to live off winnings in business even though he did not offer services or goods to others. Groetzinger, Sup Ct 1987. • And…….

  6. Factors Indicating a Trade or Business pp. 110 - 111 Trade or Business Considerations by the Courts: • Extent, continuity, varietyand regularity of activity are factors to be considered. Higgins, 312 US 212 (1941). • Temporary cessation of business does not necessarily mean you are no longer in business. It depends on whether cessation is temporary or indefinite. Haft, 40 TC 2 (1963) and Schnelton, TC Memo 1993-264.

  7. Practitioner Note Rev. Rul 67-12, 1967-1 CB 29. p. 112 Cash basis taxpayer who: • Incurs business expenses, • Closes business before paying the expenses and • Later pays the expenses Can deduct the expenses on Sch C in the year of payment via Schedule C even though there is no income and taxpayer is no longer in business.

  8. Part Time Enterprisep. 112 Ex 4.1 • TP worked in oil field until laid off in 2013. • 2014 he bought a house for $25,000. • Spent $14,500 rehabbing the house. • Sold house for $45,000 in November 2014. • December 2014 got a full-time job in oil industry. • Does not plan to rehab any more houses. Questions 1 and 2: • Is Joe in Rehab business in 2014 for SE taxes? • Where should Joe report the income from sale?

  9. Part Time Enterprisep. 112 Ex 4.1 Questions 1 and 2: • Is Joe in Rehab business in 2014 for SE taxes? • No. Not in business of rehabbing and owes no SE tax on profit. Rehabbing one house without any intent to do more rehabbing does not put you into a trade or business. See Batok, TC Memo 1992-727. • Where should Joe report the income from sale? • Form 8949 as a Sale of a Capital Asset. • SP $45,000 – (Basis $25,000 + $14,500) = $5,500 Capital Gain

  10. Sole or Principle Businessp. 112 • Taxpayers can have two or more businesses as well as full time jobs. Achong, (9th CA), 1957. • Full time Federal employee held to also be in real estate business. Schott, TC Memo 1964-272. • Separate businesses require separate Schedules C or F.

  11. Not For Profit Activitiesp. 113 • §183 prevents deduction of losses where an activity is not engage in for profit. • Presumption that taxpayer is in an activity for a profit if there is profit in: • 3 out of 5 years or • 2 out of 7 years for horse activities. • If presumption is met and IRS challenges the issue the burden of proof is on the IRS. • If presumption is not met facts and circumstances in deciding taxpayer’s intent are controlling.

  12. Impact If Not Engaged in Activity For Profit p. 113 • Gross income from activity goes on line 21, Form 1040. • Expenses in excess of income (Losses) are not deductible. • Allowable expenses are deductible as Miscellaneous Itemized Deductions on Schedule A subject to the 2% of AGI limitation…We’ll discuss this on pp. 116-118

  13. Profit Motive Factorspp. 113 - 114 • §183 determination based on taxpayer’s intent. • Intent is determined by considering all of the facts and circumstances. • The Regulations set out 9 factors to be considered. • The Court look to all the facts including the 9 factors. • No one factor is determinative. Having more of the 9 factors does not mean you win.

  14. Profit Motive Factorspp. 113 - 114 • The 9 Reg factors used in §183 determinations: • Manner in which activity is carried on. • Expertise of taxpayer or advisors. • Time and effort taxpayer spend on activity. • Expectation activity assets will increase in value. • Success of taxpayer in other activities. • Activity’s history of profit and loss. • Amount of occasional profits from activity. • Financial status of taxpayer. • Elements of personal pleasure.

  15. Hobby Activity Determinationpp. 114 – 115 Ex. 4.2 • Lois always wanted a horse. • As a successful businesswoman she bought a ranch and began buying horses to be sold to disabled people for therapy. • She employees people to care for and train the horses, goes there as often as she can and rides when she is there. • She has had no sales for 6-years and has had substantial losses. • She attributes losses to the time its taken to learn the type of horse to buy and train.

  16. Hobby Activity Determinationpp. 114 – 115 Ex. 4.2 • Lois does not qualify for the presumption so we consider the factors in determining her real intent. • Lois spends as much time as possible at the ranch but spends little time trying to sell the horses. She devotes most of her time to her marketing company. • Lois is successful and wealthy and does not need any income from the sale of horses. • There have been losses and no sales of horses. • We do not know if she has researched the activity or her experience other than wanting horses.

  17. Hobby Activity Determinationpp. 114 – 115 Ex. 4.2 • Lois did build a successful marketing company. • The ranch is increasing in value but the horses may or may not be. • Lois loves horses and riding. • Which factors weigh in her favor? • Which factors weigh against her? • What would you tell this new client?

  18. Hobby Activity Determinationpp. 114 – 115 Ex. 4.2 • Which factors weigh in her favor? Against her? • What would you tell this new client? • Develop a plan, get involved, market horses, run ads in magazines, learn or hire someone knowledgeable in the activity, maintain business records. • Be prepared to settle the issue….Each year stands on it’s own.

  19. Election to Postpone Determination p. 115 • File Form 5213 to postpone an IRS determination until the close of the 4th year of beginning the activity. • 6th year for horse activities. • Deadline for filing is 3 years from due date of return for the year the activity started or 60 days after IRS issues notice to disallow losses. • Filing Form 5213 extends the statute of limitations until 2 years after the due date of the return for the last year in the presumption.

  20. Election to Postpone Determination p. 115, Ex 4.3 • BB is a bowler who decided to go professional. • His entry fees and travel exceeded the prizes he received the first two years of competitions. • BB had no sponsors and deducted substantial losses in 2012, 2013 and 2014. • BB has not (yet) been contacted by the IRS. • Con’t

  21. Election to Postpone Determination p. 115, Ex 4.3 • BB is a bowler who decided to go professional. • His entry fees and travel exceeded the prizes he received the first two years of competitions. • BB had no sponsors and deducted substantial losses in 2012, 2013 and 2014. • BB has not (yet) been contacted by the IRS. • What is his deadline for filing Form 5213? • If he timely files what is the statute of limitations? • Is filing the same as asking for an IRS audit? • What happens if the IRS audits the 2012 return in 2018 and finds non-bowling adjustments?

  22. Election to Postpone Determination p. 115, Ex 4.3 • What is his deadline for filing Form 5213? • Activity started in 2012. • That return is due 4/15/2013 • His 3-year period ends on 4/15/2016 if the IRS has not issued a report disallowing losses. • If IRS has proposed to disallow losses he must file within 60-days of the notice and before 4/15/2016.

  23. Election to Postpone Determination p. 115, Ex 4.3 2. What is the statute of limitations if BB files the Form 5213? • Activity started in 2012. • So the presumption period goes thru 2016. • Due date for the 2016 return is 4/15/2017. • Two years later is 4/15/2019. • The statute of limitation for the 2012, 2013 and 2014 (and 2015) returns will be 4/15/2019.

  24. Election to Postpone Determination p. 115, Ex 4.3 3. Is filing the same as asking for an IRS audit? • Maybe….Maybe not. • Not filing could mean you lose the opportunity to postpone an IRS determination to see if you qualify for the presumption

  25. Election to Postpone Determination p. 115, Ex 4.3 4. What happens if the IRS audits the 2012 return in 2018 and finds non-bowling adjustments? • The normal statue has expired and so the IRS cannot make adjustments to the return except for those related to or effected by the activity if the Form 5213 had been filed.

  26. Restriction on Deductionsp. 116 - 117 No deductions are allowed if there is no income from an activity not engaged in for profit. §183 does not apply to C Corps but does apply to: • Individuals • S Corporations at the corporate level. • Partnerships at the partnership level. • Trusts • Estates

  27. Three Tiers for Expenses Under §183,IRC p. 117 Tier / Category 1 Expenses that are otherwise deductible such as property taxes, mortgage interest, casualties, etc. These reduce the income of the activity and then are deductible as itemized deductions. Tier / Category 2 Activity expenses that do not affect basis such as utilities, advertising, insurance, etc. These are only deductible as itemized deductions limited by 2% of AGI & limited to the income from the activity after Tier 1 expenses are allowed. Tier / Category 3 Activity expenses that impact basis like depreciation. Limited to income after Tier 1 & 2 expenses – Item Ded – 2%

  28. Three Tiers for Expenses Under §183,IRC p. 117 Question 1 Ex 4.4 Same facts as Example 4.2 - Lois’ horse activity. Can she deduct the losses since she in the 7th year? No. For the presumption she needs a profit in 2 of 7 years and she has had losses in 6 years. Even with a profit in the 7th year she canNOT meet the presumption. Under facts she was not in the activity for profit.

  29. Three Tiers for Expenses Under §183,IRC p. 117 Question 2 Ex 4.4 Same facts as Example 4.2 - Lois’ horse activity. In 2014 Lois sold horses & grossed $27,000 She paid ranch real estate taxes of $24,000 She paid ranch wages of $48,000 She has additional feed & other expenses. How do you report the activity on the return?

  30. Three Tiers for Expenses Under §183, IRC p. 117 Question 2 Ex 4.4 Wages and other expenses over $7,000 limit are lost.

  31. Three Tiers for Expenses Under §183,IRC p. 117 Question 3 Ex 4.4 What should you do about Lois’ prior tax returns?

  32. Three Tiers for Expenses Under §183,IRC p. 117 Question 3 Ex 4.4 What should you do about Lois’ prior tax returns? Warn of potential IRS audit. Offer to prepare amended returns. Nothing if Lois so directs.

  33. Three Tiers for Expenses Under §183,IRC p. 118 Question 4 Ex 4.4 What if Lois had incorporated the ranch 6-years earlier and not made an S corp election?

  34. Three Tiers for Expenses Under §183,IRC p. 118 Question 4 Ex 4.4 What if Lois had incorporated the ranch 6-years earlier and not made an S corp election? §183 would not be applicable. Losses would be trapped in C Corp and only off set any income it had.

  35. Three Tiers for Expenses Under §183,IRC p. 118 Question 5 Ex 4.4 What if Lois’ ranch operation begins to have profits in the future?

  36. Three Tiers for Expenses Under §183,IRC p. 118 Question 5 Ex 4.4 What if Lois’ ranch operation begins to have profits in the future? The 7-year presumption shifts each year so she could show profits in 2 of 7 years in the future and get the presumption. In addition, each year stands on its own facts.

  37. Selected Provisions for Trades and Businesses p. 118 • Self-Employment Taxes • Travel Expenses Away from Home • Start-up Expenses

  38. Self-Employment (SE) Tax p. 118 • SE tax applies to all individuals in a trade or business as a sole proprietorship or by partner in a partnership. • §1402, IRC, imposes the SE tax. • Practitioner Note – The SE tax applies to US persons and not to non-resident aliens. • SE tax is due on foreign earnings even if foreign earned income is excludible from income taxation (unless a treaty excludes).

  39. Income Items Excluded from Self Employment (SE) Tax pp. 119 - 120 See lists on Pages 118 – 119 that include: • Most income not taken into account in gross income for income tax purposes. • Rents from real estate and from personal property leased with real estate unless: • The rents are received in the course of a trade or business as a real estate dealer or • The land is used for certain conditions which are discussed later. • Dividends and interest unless received in the course of a trade or business as a dealer in stocks or securities. • Capital gains and losses and certain other gains such as sales of business assets.

  40. Income Items Included for Self Employment (SE) Tax p. 120 - 121 See list on pages 120 -121 that include: • Director’s Fees • Recaptures of 179 and 280F deductions when bus use drops to 50% or less. • Gains and Losses from options and commodities dealers from §1256 from contracts or from property related to those contracts. • Distributive share of PS income or loss whether or not distributed. • Compensation & housing allowance of clergy who have not elected out of SS. • Wages paid by an international organization to US citizen.

  41. SE Income from Farming p. 121 Individuals operating farming business are subject to SE Tax. See list on page 121 but some specific items include: • Patronage dividends from farm co-ops even if the taxpayer was not farming when the payments were made. • Value added payments from a co-op even if the farmer bought the grain rather than grew it. • Conservation reserve program payments. • Storage fees paid by the Commodity Credit Corp under a reseal agreement. • National Tobacco Settlement Trust payments to a farmer who raises and sells tobacco. • Payments for pasturing, feed & caring for another’s cattle.

  42. SE Income from Rental Property p. 121 • Rentals of real estate and personal property leased with real estate are exempt from SE income. • But, if significant services are provided with the real estate the activity is not rentals and is subject to SE Tax. • Hotels, Motels, B&Bs subject to SE Tax. • BoBo court decision held owner of mobile home operation was subject to SE Tax due to services provided.

  43. Renting Personal Property p. 122 • Rental of personal property (machinery, vehicles) is subject to SE Tax and goes on Sch C if not related to rental of real property. • If personal property rentals are for profit but sporadic: • Income goes on Line 21, Form 1040 • Expenses go on Line 36, Form 1040 • Write-in entry is PPR.

  44. Real Estate Dealers p. 122 • SE Tax exclusion for rents does not apply to real estate dealers. • Real Estate Dealers: • “Engaged in the business of selling real estate to customers with a view to the gains and profits that may be derived from such sales.” • Does not include an investor who sells a piece of real estate.

  45. Rent from Land Used in Agricultural Production pp. 122 - 123 • Generally land rentals excluded from SE tax. • Exception subject to SE tax: • Land is leased for agricultural purposes and lessor will materially participate in production, management and • There is material participation which includes a level of pay, furnishing of assets, providing advice or consultation or inspecting activities.

  46. Rent from Land Used in Agricultural Production p. 123 • “Material Participation” for a lessor of land if he / she meets any one of four tests: • Pays > ½ of direct crop production, furnishes > ½ tools, equip or livestock, advises or consults with tenant or inspects production activity. • Regularly or frequently is involved in managing operations. • Works > 100 in the activity. • Involvement is material and substantial.

  47. Summary of Rulings and Cases p. 124 • Accountantwas employee of his closely held accounting firm (S Corp). • Citrus Grove Owners were employees due to agreement to pick and market produce. • Contractors who did home repairs were not employees of homeowners but in trade or business. • Drug Dealer is in a trade or business subject to SE tax but dealer’s son who stole cash from father is subject to income tax but not subject to SE tax.

  48. Summary of Rulings and Cases p. 124 • Honoraria – Acceptance of pay for an occasional speech, presentation is not subject to SE BUT doing so on a regular or continuing basis is SE Inc • Hospital Owner – Doc owned hospital but turned operation over to a management company. Doc is subject to SE Tax since operation is a business. • Incompetent Person – Business operated by guardian is SE income for incompetent person who owned trade or business. • Inventor – Not subject to SE tax since did not develop or design invention regularly.

  49. Summary of Rulings and Cases p. 125 • Investor in cattle operation not subject to SE tax where involvement was minimal. • Law Practice – Gov’t employee who operated part-time law practice not subject to SE tax where fees were low, kept no records & meant to gain legal experience. Business deductions not allowed. • Leasing of crab pots and nets to fishermen for several years & expected to continue was subject to SE tax. • Oil & Gas Working Interests are SE Income subject to SE tax.

  50. Summary of Rulings and Cases p. 125 • Real Estate Agents and Direct sellers are statutory non-employees and thus subject to SE tax. • Seminar Speaker – Professor who worked for University and also gave seminars is subject to SE tax on seminar income even though fees paid to him thru the University. • Tree Cutter paid hourly by a timber mill was subject to SE tax as a skilled, independent contractor. • Window Installer who did the work for one month not subject to SE tax since work not continuous.

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