TAX TIPS AND TRAPS IN by mge41071

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									          S         S
   TAX TIPS AND TRAPS IN

       TODAY S
       TODAY’S ECONOMY




David A. Paddock, CPA

1119 ¼ Hacienda Pl.
West Hollywood, CA 90069
(   )
(310) 622-7090
www.paddockcpa.com
                           1
                                       DISCLAIMER

For purposes of Circular 230 and unless expressly
  t t d th     i       thi         t i d i th l
stated otherwise, nothing contained in the class
materials is intended or written to be used or may be
relied upon or used by any taxpayer for the purpose of
         p              y y         p y          p p
avoiding penalties that may be imposed on the taxpayer
under the Internal Revenue Code of 1986, as
amended This class is a source of general tax
amended.
information. Each client's situation is unique and the tax
results described in this class is no guarantee of the
   t      th t          lt i       ti l    li t' it ti
outcome that may result in a particular client's situation.
Therefore, it is highly recommend that you seek
professional tax advice.

David A. Paddock, CPA (310) 622-7090      www.paddockcpa.com   2
                         HOBBY LOSS RULES
• Who is subject to these rules?

• How do the rules work?

• How will the rules impact my taxable income?

• Tips and Traps




David A. Paddock, CPA (310) 622-7090   www.paddockcpa.com   3
                         HOBBY LOSS RULES
• Who is subject to these rules?
   •Hobbies
   •Individuals, Partnerships, Estates, Trusts, and
    S corporations (not C corporations)
                • applies at partnership level for partnerships
                • applies at corporate level for S corporations
        • Businesses with net operating losses
        • Temporary rental of home prior to sale (not
        applicable to 9th Circuit)
          W2
        • W-2 income with Schedule C, E or F loss

David A. Paddock, CPA (310) 622-7090   www.paddockcpa.com         4
                         HOBBY LOSS RULES
• How do the rules work?
        •Limits deductions from activity not engaged in for
         profit to amount of gross income
        •Three theirs of deductions allowed:
                1. Deductions otherwise allowed (interest, taxes)
                2. Deductions allowable as if activity was engaged in for profit
                   but does not reduce basis of assets
                3. Deductions that reduce basis of assets (e.g., depreciation)
        •Activity not engaged in for profit
        •Presumption (3+ out of 5 years; 2+ out of 7 years for
         breeding, training, showing, or horse racing)
        •Election

David A. Paddock, CPA (310) 622-7090   www.paddockcpa.com                      5
                           HOBBY LOSS RULES
 •How will the rules impact my taxable income?
                               y
                           Hobby                                                      Trade/Business
                              Actual      Allowed

    Gross Income                                     10,000                        Gross Income                    10,000

1. Deductions otherwise allowable                                            1. Deductions otherwise allowable
    Property Tax                           (1,500)    8,500                      Property Tax                      (1,500)

2. Trade/Business deductions (no basis)                                      2. Trade/Business deductions (no basis)
     Auto                      (5,000)     (3,373)                                A to
                                                                                  Auto                              (5,000)
                                                                                                                    (5 000)
     Bank Charges                (500)       (337)
                                                                                  Bank Charges                        (500)
     Internet                  (1,200)       (810)
                                                                                  Internet                          (1,200)
     Postage                     (500)       (337)
                                                                                  Postage                             (500)
     Supplies                  (3,000)     (2,024)
                                                                                  Supplies                          (3,000)
     Telephone                 (2 400)
                               (2,400)     (1,619)
                                           (1 619)   (8 500)
                                                     (8,500)
     Total Expenses           (12,600)                                            Telephone                         (2,400)


3. Basis deductions                                                          3. Basis deductions
    Depreciation               (1,500)        -        -                         Depreciation                      (1,500)

    Net Income (Loss)                                  -                           Net Income (Loss)               (5,600)


 David A. Paddock, CPA (310) 622-7090                         www.paddockcpa.com                                              6
                         HOBBY LOSS RULES
•How will the rules impact my taxable income? (Continued)
           Hobby                    Trade/Business
    Income
    I                                                                        Income
    Wages                                        $   75,000                  Wages                                 $   75,000
    Interest                                            300                  Interest                                     300
    Dividends                                           100
                                                                             Dividends                                    100
    Schedule C                                          -
                                                                             Schedule C                                (5,600)
    Other Inc - Hobby                                10,000
    AGI                                              85,400                  Other Inc - Hobby                            -
                                                                             AGI                                       69,800
    Deductions
    Income Taxes                                     (25,620)                Deductions
    Property Taxes                                    (1,500)                Income Taxes                              (20,940)
    Interest                                         (15,000)                Property Taxes                                -
    Hobby Expenses            $        (8,500)
                                                                             Interest                                  (15,000)
    Less: 2% AGI                        1,708         (6,792)
                                                                             Hobby Expenses            $     -
    Total Itemized Deductions                        (48,912)
                                                                             Less: 2% AGI                  1,396           -
    Exemptions                                        (7,300)
                                                      (7 300)                Total Itemized Deductions
                                                                               o     e ed educ o s                     (35,9 0)
                                                                                                                       (35,940)

    Taxable Income                               $   29,188                  Exemptions                                 (7,300)

    Net Hobby Income (Itemize)                $   1,708                      Taxable Income                        $   26,560
    Net Hobby Income (
              y        (Std Deduction))            ,
                                                  9,000
    Note: No carryover of disallowed losses, AMT,
                                                                             Net Hobby Income (Itemize)            $       -
    not subject to FICA
                                                                             Net Hobby Income (Std Deduction)           (5,600)
David A. Paddock, CPA (310) 622-7090                          www.paddockcpa.com                                                  7
                         HOBBY LOSS RULES
  Tips and Traps
  Trap-presumption
• Trap presumption (but shifts burden to IRS)
                      Year                                          Year




                                                                                            esumption
                        1         Loss                                5          Profit


                                                    ption




                                                                                          Pre
                                           No Presump
                        2         Profit                              6          Loss

                        3         Loss

                        4         Profit


 Trap-Election could b a trap
•T    El i        ld be
        •Extends presumption test to Year 5
            g                       y           y
        •Flag to IRS that there may be a hobby loss issue
        •Extends statute of limitations for any deficiencies
        •Election made in Year 1 but do not know if future years will be profitable

  Tip-Establish
• Tip Establish a profit motive
David A. Paddock, CPA (310) 622-7090                        www.paddockcpa.com                          8
                          HOBBY LOSS RULES
Establish a profit motive (must have objective to make a
p     ;              p            profit not required)
profit; reasonable expectation of p            q     )
1. Business-like approach (maintain books and records)
2. Consult experts
3. Time and effort (personal and recreational attributes not
    good)
4.
4 Asset appreciation
5. Previous success or prior experience
           year s
6. Prior year’s income
7. Amount of occasional profits and their relation to losses
8. Financial status of taxpayer

 David A. Paddock, CPA (310) 622-7090   www.paddockcpa.com   9
           HOME OFFICE DEDUCTION
• Regularly and Exclusively

• Principal place of business, or

• Place to meet clients in normal course of
business,
business or

  In        ti     ith the business f separate
• I connection with th b i          for     t
structures (e.g., detached garage)


David A. Paddock, CPA (310) 622-7090   www.paddockcpa.com   10
           HOME OFFICE DEDUCTION
• Regularly
        • Occasional use will not qualify (e.g., dentist uses part of home
        exclusively to treat patients on an emergency basis fails regular use
        requirement because use is only occasional)


• Exclusively
        • Use portion of home for only business (e.g., office that is also a
                                  test).
        bedroom fails exclusive test)
        • Exceptions: storage of inventory of product samples and daycare
        • Separately identifiable (separate room or permanent partition not
         equ ed)
        required)
        • Multiple businesses – each business must separately meet the
        requirements (e.g., CPA using home office to prepare tax returns on the
        side as well as perform work for employer fails exclusive test). You can
        have more than one place of business.

David A. Paddock, CPA (310) 622-7090   www.paddockcpa.com                          11
           HOME OFFICE DEDUCTION
• Principal place of business *
        1. Relative importance of activities performed at each location
        2. Time spent at each location
        3. No default rule
                                                                 p p
        Situation 1. Teacher meets students at school. Class preparation p   performed
            at home office is less important than activities at school. Therefore, home
            is not principal place of business.
        Situation 3. Author writes at home office. Research, meetings with publishers,
                                                                             writing.
            and attendance at promotional events are less important than writing
            Therefore, home is the principal place of business.
        Situation 4. Retailer of costume jewelry sells at craft shows and catalog
            orders filled from home office. Substantial income from sales made at
            craft shows. Most important activities of business are performed in more
            than one location so principal place of business cannot be determined
            definitively based on relative importance test. Time spent at each
            business location assumes particular significance. More time is spent at
                                          p          g                          p
            home office. Therefore, home is principal place of business.
* Convenience of the employer required for employees
David A. Paddock, CPA (310) 622-7090     www.paddockcpa.com                          12
            HOME OFFICE DEDUCTION
• Definition of principal place of business expanded
      1. Place used for administrative or management activities (where done; not
         where could be done),
      2. Used regularly and exclusively, and
      3. No other fixed location for the business where substantial administrative
         or management functions are conducted.


     p                 p
Example: Plumber performs services at customer’s homes. The
  administrative activities performed at the home office are less
  important and take less time than service calls. Therefore, home is
  not the principal place of business using the relative importance and
  time tests. However, the plumber has no fixed location for business
  where substantial administrative functions are conducted so the home
  is his principal place of business under this rule.


 David A. Paddock, CPA (310) 622-7090   www.paddockcpa.com                     13
           HOME OFFICE DEDUCTION
• Computing the Home Office Deduction
     1. Direct Expenses (e.g., repairs made to specific room)

     2. Indirect E     (         t     i t    t        t
     2 I di t Expenses (e.g., mortgage interest, property
        taxes)
                                    y
             Allocation ratio: - any reasonable allocation method
                               - office square feet to total home square feet
                               - business rooms to total rooms


     3. Limited to net income from business (carryovers
        allowed)

David A. Paddock, CPA (310) 622-7090   www.paddockcpa.com                       14
           HOME OFFICE DEDUCTION
Tips and Traps
  Tip-change
• Tip change location of
administrative/management activities to qualify
  Tip-see
• Tip see clients/patients at your home office
• Tip-all income from business counts towards
                   (e g
income limitation (e.g., sale of business equipment)
• Trap-letting family members use your office for
non business
non-business activities
• Trap-not deducting home office; allowed (e.g.,
deducted) versus allowable (e.g., allowed per law)

David A. Paddock, CPA (310) 622-7090   www.paddockcpa.com   15
            NET OPERATING LOSSES *
General rule
• Carryback 2 years and forward 20 years
• Election to forgo carryback; failure to elect
Special rule for 2008 and 2009
• Election to carryback up to 5 years
• Applies to 2008 or 2009 but not both
• 50% taxable income limitation in 5th carryback year
Special rule f 2008 and 2009 – Eli ibl Small Business
S     i l l for          d          Eligible S ll B i
• Election to carryback up to 5 years
• Applies to both years if 2008 election made before enactment (11/5/2009)
• 50% taxable income limitation does not apply if 2008 election made before
enactment
• Eligible Small Business = 3-year average annual g
     g                         y            g                  p
                                                    gross receipts =< $15MM

* California does not conform
 David A. Paddock, CPA (310) 622-7090   www.paddockcpa.com           16
            NET OPERATING LOSSES *
Tips and Traps
• Tip Convert IRA to Roth IRA and use NOL to offset
  Tip-Convert
income on conversion

• Tip-file when 12 months of year-end to expedite refund

• Trap-failure to make election to forgo NOL carryback

• Trap-make loss some of carryback benefits due to AMT


* California does not conform
 David A. Paddock, CPA (310) 622-7090   www.paddockcpa.com   17
                                    FORECLOSURE *
Federal
          p y
1. Bankruptcy
2. COD income excluded for qualified principal
   residence indebtedness discharged before
   1/1/2013
3. Insolvency
4. Basis in principal residence reduced if ownership
   continues
   $2MM principal residence acquisition indebtedness
5. $
6. Ordering rules: portion of loan not qualified is
   treated as discharged first
* Same rules apply to short sales and load modifications
  David A. Paddock, CPA (310) 622-7090        www.paddockcpa.com   18
                                             FORECLOSURE
                             Recourse Debt                                        Nonrecourse Debt
               Scenario                           A                B                     A                B

               Assumptions                                                         Assumptions
                ili S
               Filing Status                     MFJ             MFJ                   MFJ              MFJ
               §121 Exclusion                    Yes             No                    Yes              No
               Loan, 1st TD (qualified) $        900,000         900,000           $   900,000          900,000
               FMV at Foreclosure                600,000         900,000               600,000          900,000
               Cost                              900,000         800,000               900,000          800,000
Federal




               COD Income                                                          COD Income
               Loan, 1st TD                       900,000         900,000              900,000           900,000
               Payoff                            (600,000)       (900,000)            (900,000)         (900,000)
               COD Income                    $    300,000    $        -            $       -        $        -
F




               Gain (Loss) Sale of Home                                            Gain (Loss) Sale of Home
               Proceeds               $           600,000    $    900,000          $     900,000     $    900,000
               Cost                              (900,000)       (800,000)             (900,000)         (800,000)
               Gain (Loss)            $          (300 000)
                                                 (300,000)   $    100 000
                                                                  100,000          $         -       $    100 000
                                                                                                          100,000


               Taxable Income                                                      Taxable Income
               COD                           $        -      $        -             $        -      $        -
               Gain                                   -           100,000                    -           100,000
               Total                         $        -      $    100,000           $        -      $    100,000



      David A. Paddock, CPA (310) 622-7090                   www.paddockcpa.com                                      19
                                             FORECLOSURE
                             Recourse Debt                                        Nonrecourse Debt
           Scenario                               A                  B                    A               B

           Assumptions                                                             Assumptions
           Filing Status                         MFJ                MFJ                  MFJ             MFJ
           §121 Exclusion                        Yes                 No                  Yes             No
           Loan, 1st TD (qualified)     $   900,000                  900,000        $     900,000         900,000
           Loan, 2nd TD (N/Q, recourse)     300,000                  300,000              300,000         300,000
           FMV at 12/31/2007              1,200,000                1,200,000            1,200,000       1,200,000
           FMV at Foreclosure               600,000
                                               ,                     900,000
                                                                        ,                    ,
                                                                                          600,000            ,
                                                                                                          900,000
Federal




           Cost                             900,000                  800,000              900,000         800,000

           COD Income                                                              COD Income
           Loan, 1st TD                           900,000            900,000           900,000           900,000
           Payoff                                (600,000)          (900,000)         (900,000)         (900,000)
F




           COD Income                        $    300,000
                                                  300 000      $         -         $       -        $        -


           Gain (Loss) Sale of Home                                                Gain (Loss) Sale of Home
           Proceeds                          $    600,000      $     900,000       $     900,000     $    900,000
           Cost                                  (900,000)          (800,000)          (900,000)         (800,000)
           Gain (Loss)                       $   (300,000)
                                                 (300 000)     $     100 000
                                                                     100,000       $         -       $    100 000
                                                                                                          100,000


           Taxable Income                                                          Taxable Income
           COD                               $   300,000       $    300,000         $   300,000     $    300,000
           Gain                                      -              100,000                  -           100,000
           Total                             $   300,000
                                                 300 000       $    400,000
                                                                    400 000         $   300 000
                                                                                        300,000     $    400 000
                                                                                                         400,000




      David A. Paddock, CPA (310) 622-7090                   www.paddockcpa.com                                      20
                                        FORECLOSURE
California – Partial Conformity (4/13/2010)
1. Retroactive to 1/1/2009
2. COD income excluded for qualified principal residence
    indebtedness discharged before 1/1/2013
3.
3 Qualified principal residence indebtedness limited to
    $800,000 ($400,000 for married filing a separate return)
    instead of the federal $2 million ($1 million for married
    filing a separate return)
4. The maximum cancellation of debt income exclusion is
               $500,000 ($250,000
    limited to $500 000 ($250 000 for taxpayers married filing
    a separate return)



 David A. Paddock, CPA (310) 622-7090      www.paddockcpa.com   21
                                                FORECLOSURE
                           Recourse Debt                                              Nonrecourse Debt
                Scenario                         A               B                           A                B

                Assumptions                                                            Assumptions
                Filing Status                   MFJ             MFJ                        MFJ              MFJ
                §121 Exclusion                  Yes             No                          Yes              No
                Loan, 1st TD (qualified) $      900,000         900,000                 $   900,000          900,000
                FMV at Foreclosure              600,000         900,000                     600,000          900,000
 alifornia
         a




                Cost                            900,000
                                                900 000         800 000
                                                                800,000                     900 000
                                                                                            900,000          800,000
                                                                                                             800 000

                COD Income                                                             COD Income
                Loan, 1st TD                     900,000         900,000                   900,000           900,000
                Payoff                          (600,000)       (900,000)                 (900,000)         (900,000)
Ca




                COD Income                  $    300 000
                                                 300,000    $        -                 $       -        $        -


                Gain (Loss) Sale of Home                                               Gain (Loss) Sale of Home
                Proceeds               $         600,000    $    900,000               $ 900,000         $ 900,000
                Cost                            (900,000)       (800,000)                  (900,000)         (800,000)
                Gain (Loss)            $        (300,000)   $    100,000               $         -       $ 100,000


                Taxable Income                                                         Taxable Income
                COD                         $    33,333     $       -                   $        -      $        -
                Gain                                -           100,000                          -           100,000
                Total                       $    33,333     $   100,000                 $        -      $    100,000

         David A. Paddock, CPA (310) 622-7090                    www.paddockcpa.com                                      22
                                                FORECLOSURE
                          Recourse Debt                                           Nonrecourse Debt
                      Scenario                        A                B                  A                B

                      Assumptions                                                   Assumptions
                      Filing St t
                      Fili Status                    MFJ              MFJ               MFJ               MFJ
                      §121 Exclusion                 Yes              No                Yes               No
                      Loan, 1st TD (qualified)     $ 900,000           900,000      $     900,000          900,000
                      Loan, 2nd TD (N/Q, recourse)    300,000          300,000            300,000          300,000
                      FMV at 12/31/2007             1,200,000        1,200,000          1,200,000        1,200,000
         a
 alifornia




                      FMV at Foreclosure              600,000          900,000            600,000          900,000
                      Cost                            900,000          800,000            900,000          800,000

                      COD Income                                                    COD Income
                      Loan, 1st TD                    900,000         900,000           900,000           900,000
Ca




                      Payoff
                      Pa off                         (600 000)
                                                     (600,000)       (900,000)
                                                                     (900 000)         (900 000)
                                                                                       (900,000)         (900 000)
                                                                                                         (900,000)
                      COD Income                 $    300,000    $        -         $       -        $        -


                      Gain (Loss) Sale of Home                                      Gain (Loss) Sale of Home
                      Proceeds                   $    600,000    $    900,000       $ 900,000         $ 900,000
                      Cost                           (900,000)       (800,000)          (900,000)         (800,000)
                      Gain (Loss)                $   (300,000)   $    100,000       $         -       $ 100,000


                      Taxable Income                                                Taxable Income
                      COD                        $   333 333
                                                     333,333     $    300 000
                                                                      300,000            300,000
                                                                                     $ 300 000       $    300,000
                                                                                                          300 000
                      Gain                               -            100,000                 -           100,000
                      Total                      $   333,333     $    400,000        $ 300,000       $    400,000

         David A. Paddock, CPA (310) 622-7090                www.paddockcpa.com                                       23
                                       FORECLOSURE
 Tips and Traps
 • Tip-short-sale to reduce potential COD income

     p                             y     (if you
 • Tip-live in home for at least 2 years ( y can))
 to qualify for §121 exclusion

   Tip-amend C lif i tax return
 • Ti      d California

   Tip-request
 • Tip request offer in compromise

   Trap phantom
 • Trap-phantom income

David A. Paddock, CPA (310) 622-7090      www.paddockcpa.com   24
      ALTERNATIVE MINIMUM TAX
• What is Alternative Minimum Tax (AMT)?

• How can I reduce my AMT?
    • Form 6251
    • Taxes, Miscellaneous Itemized Deductions, Mortgage Interest,
    Depreciation
    • Bunch expenses in one year
    • Ask employer for reimbursement of EE business expenses with offset
    to salary (reduces FICA to ER)

• How does it impact me?
    • Increases your overall tax rate
                                                         Tax Rate Effective Rate
            Taxable Income             $     950,000
            AMTI                           1,200,000
            Income Tax                       294,000        31%        31%
            Minimum Tax                      329,000        27%        35%
            AMT                               35,000
David A. Paddock, CPA (310) 622-7090          www.paddockcpa.com                   25
                       TAX BREAKS IN 2010
Change Provisions
•AMT exemption decreases to $45,000 MFJ and $33,750 Single (2009 $70,950 MFJ and $46,700
Single) – See report
 $500       lt   d theft loss fl
•$500 casualty and th ft l          decreases t $100
                              floor d         to
•Standard mileage rate reduced to $0.50/mile from $0.55/mile
•Personal exemption and itemized deduction phaseouts are schedule to resume in 2011

Expiring Provisions
   p g
•5-year net operating loss carryback
•RMD waiver
•$2,400 exclusion for unemployment compensation
•Up to $100,000 exclusion for donations to charity from IRA (70 ½)
•Educator expenses for AGI
•Tuition and related expenses for AGI
•Increased standard deduction for real estate taxes
•Itemized deduction or increased standard deduction for sales tax on purchase of new motor
vehicle

Continuing Provisions
•Cancellation of debt principal residence
•First-time homebuyer credit (before May 1, 2010)




David A. Paddock, CPA (310) 622-7090       www.paddockcpa.com                                26
               AMT WILL AFFECT MORE
                    TAXPAYERS
In a 2/1/10 report, the Congressional Research Service noted that the
lack of indexation of the Alternative Minimum Tax (AMT) coupled with
      t d ti       in the      l income t h greatly expanded th
recent reductions i th regular i          tax has      tl     d d the
potential impact of the AMT. If Congress does not extend the 2009
increases in the AMT exemptions, the number of taxpayers subject to
                                                                2010.
the AMT will rise from about 4 million in 2009 to 27 million in 2010
Taxpayers in every state would be affected, regardless of whether
taxpayers in that state deduct their state/local taxes and/or
                                               returns.
miscellaneous deductions on their federal tax returns




David A. Paddock, CPA (310) 622-7090   www.paddockcpa.com          27
                                       THE END

                     g
“In this world nothing can
be said to be certain,
except death and taxes.”
  B j i Franklin
–Benjamin F kli


David A. Paddock, CPA (310) 622-7090    www.paddockcpa.com   28

								
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