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The tax treatment for renting out your vacation home depends on the number of days it’s rented.
If you don’t use your vacation home all the time and are considering renting it out for a portion of the year, you have three possible situations – all with different tax ramifications:
The first situation is the easiest and most straightforward. You own a second home as a vacation property. You do not rent out that property at all during the year. You would be able to deduct the mortgage interest and real estate taxes that you paid during the year as Schedule A itemized deductions.
If you use your vacation home for personal use at least 15 days and rent it out for fewer than 15 days, the IRS considers the primary function of the property to be personal and not a rental. Therefore no rental income or rental expenses should be claimed on Schedule E, Supplemental Income or Loss, of Form 1040.
You are not required to report the rental income and rental expenses from this activity. The expenses that you are able to deduct include mortgage interest and real estate taxes, which would be deducted on Schedule A as itemized deductions.
The third situation is a little more complicated. If you used the vacation home as a home and rented it out 15 days or more during the year, you would be required to include all of your rental income as income on Schedule E. Because you used the home for personal purposes, you must allocate your expenses between business and personal use.
When allocating your expenses, you should follow these two rules:
The numerator for allocation purposes would be the number of days that the vacation home was rented out at a fair market rental price during the year. The denominator would be 365 days.
Crunching these numbers will give you the business-use percentage. You would then multiply all of your various business/rental expenses by this percentage to arrive at the deductible amount of your expenses.
The deductible amount of your expenses is then entered on Schedule E. The IRS provides a worksheet to help you calculate the amount of your deductible business/rental expenses. Unallocated mortgage interest and taxes (the personal part) still goes on Schedule A.
If you follow these simple rules when renting out your vacation home, you can avoid unintended consequences.
©2014 CPAmerica International
The IRS allows taxpayers to use an optional safe harbor method when claiming a home office deduction.
The safe harbor method saves the taxpayer from having to substantiate, calculate and allocate deductible home office expenses, a procedure that is part of the nightmare taxpayers have to go through if they want to use the old actual expense method.
With the optional method, the taxpayer simply calculates the number of square feet used for the office and multiplies that number times $5. The maximum square footage that can be used is 300, so the maximum home office deduction at the present moment is $1,500.
The IRS can adjust the $5 rate as warranted.
The safe harbor deduction may not exceed the gross income from the business. If it does, the excess may not be carried forward.
Taxpayers using the safe harbor method will not be able to depreciate the portion of their home used in the trade or business. But the advantage is the taxpayer may deduct mortgage interest, real estate taxes and any casualty loss as itemized deductions on Schedule A of Form 1040.
The taxpayer would still be allowed to deduct, to the extent allowed by the Internal Revenue Code and regulations, any trade or business expenses unrelated to the qualified business use of the home for that taxable year. Some examples would be advertising and office supplies.
If reimbursed by an employer for the home office expenses, a taxpayer cannot use the safe harbor method.
The taxpayer may elect from taxable year to taxable year whether to use the safe harbor method or to calculate and substantiate actual expenses for the purpose of the home office deduction. A method is elected simply by using the particular method for that tax year. A method once selected for that tax year cannot be changed. ■
©2014 CPAmerica International
Nonemployee compensation received in exchange for services rendered is taxable income, despite tax protester arguments to the contrary.
Stephan Foryan, a resident of the state of Washington and an apparent tax protester, did not file a tax return for 2009. He also did not make any estimated tax payments for the 2009 tax year.
Foryan admits to having received nonemployee compensation for services rendered, but he told the U.S. Tax Court that the compensation was not taxable. He mistakenly relied on a court case from 1920 to support this argument. Unfortunately for him, a 1955 Supreme Court case superseded the 1920 case, making it not applicable to the present matter.
Internal Revenue Code Section 61(a) provides that “gross income means all income from whatever source derived,” including compensation for services.
Using information obtained from third parties, the IRS had calculated Foryan’s income for 2009 to be $137,282. Against this income, Foryan was allowed a self-employment income tax deduction of $8,460, a standard deduction of $5,700 and a personal exemption of $3,650.
Foryan had been involved in a prior court case a few years earlier regarding a tax matter. He lost that case, and the court put him on notice regarding raising tax protester arguments.
The same situation arose in this case. The court rejected Foryan’s arguments as frivolous tax protester arguments. In addition, the court fined him $1,000 because it felt that his position in this case was frivolous or groundless.
Therefore, the court agreed with the IRS in this case, finding that Foryan had received $137,282 in compensation for services performed at various farms during the year and including that amount in his gross income for 2009. He was allowed the deductions calculated by the IRS (Stephan Foryan v. Commissioner, U.S. Tax Court, T.C. Memo 2015-114, June 22, 2015). ■
©2015 CPAmerica International
The IRS has announced that it will issue estate tax closing letters only on request for estate tax returns filed on or after June 1, 2015.
Prior to this change, CPAs and clients anxiously awaited the closing letter for filed estate tax returns. A very large portion of returns are audited. Receiving the closing letter meant that the IRS had accepted the return (Form 706, United States Estate Tax Return) as filed and it would not be audited.
The IRS recommends waiting at least four months after filing your Form 706 return before requesting a closing letter.
If you filed your estate tax return before June 1, 2015, the IRS will continue its policy of issuing closing letters provided the return is accepted as filed and has no other errors or special circumstances. Expect to wait four to six months to receive the letter.
Not all returns filed before June 1, 2015, will receive a closing letter. The IRS will not issue a closing letter for any return that was filed after Jan. 1, 2015, but before June 1, 2015, that did not meet the filing threshold for an estate tax return and whose taxpayer portability election was rejected by the IRS.
The filing threshold simply means the gross value of the estate. Those numbers are indexed for inflation and are as follows:
2015 – $5,430,000
2014 – $5,340,000
2013 – $5,250,000
A portability election allows a deceased spouse to transfer the estate’s unused exclusion amount to the surviving spouse.
The IRS gives a great deal of attention to the estate tax return when a portability election is made, so the election must be made properly.
For returns filed after Jan.1, 2015, and before June 1, 2015, the IRS will still issue a closing letter if the estate met the filing threshold. In addition, if the filing threshold was not met, but no portability election was made, you will still receive a closing letter.
If you have any questions about estate tax closing letters, please contact your CPA. ■
As I get ready to head off on vacation, I ran across a couple of articles on CFOs taking more working vacations. Robert Half Management Resources performed a study as to how often CFOs check in with the office during summer vacation. The percentage of time is increasing from their responses in 2012. It’s so easy now with everyone being so plugged in. Only 32% don’t anticipate checking in at all.
Robert Half Management Resources offers suggestions for allowing yourself to get away:
I’m a bit of an “all in or all out” person. When I’m in town I’m tied to my work. Some call me a workaholic. However, when I’m gone, I’m usually “gone.” Why? Because I do trust my team to take care of things. Our firm involves other staff in client relationships so that they can handle matters when the key contact person is out. I don’t worry when I’m gone.
We promote work-life balance because it’s meaningful to the Millennials, but we all need an opportunity to take some time to recharge. Sure, we may pay for it by putting in extra time before we leave and then on our return. 
But I do believe it is important to recharge. Your perspective is much better when you’ve had a chance to clear your mind and enjoy some personal relationship time.
I’m heading off to spend some quality travel time with my future daughter-in-law. One to one time. How often will that opportunity happen?
So, even as I feel guilty about taking off, it won’t last long. Until I return.
A recent Tax Court case shows that keeping good auto mileage records – as well as a little persistence – pays off when it comes to dealing with the IRS.
In 2010, Ricky Ray Ressen was employed as a construction manager at Innovative Construction Solutions, Inc. (ICS).
For most of 2010, he lived away from home to carry out his job responsibilities. He would return home on weekends.
Ressen owned two different trucks that he used for commuting and for traveling between various jobsites. One of the vehicles was a 2008 Chevrolet Silverado 2500 and the other a 2007 Chevrolet Silverado. He put 11,585 business miles on the 2008 Silverado and 45,422 business miles on the 2007 Silverado.
Ressen’s employer, ICS, did not and would not reimburse him for the use of the 2007 or 2008 Silverado.
Ressen maintained both a logbook and a calendar to record his business activities and the business use of the two Silverados. He maintained, in general terms, a summary of his business activities and weekly travel in a logbook.
He recorded the beginning and ending odometer readings for the two Silverados in the logbook. He kept track of his mileage on a weekly basis on a calendar.
On Form 2106, Employee Business Expenses, Ressen claimed 100 percent of the 45,422 miles for the 2007 Silverado and 100 percent of the 11,585 miles for the 2008 Silverado as business miles. After multiplying the total miles driven times the standard mileage rate, Ressen claimed unreimbursed vehicle expenses of $28,504. He also reported additional unreimbursed employee business expense of $7,597.
Unfortunately, communication broke down between Ressen and the Internal Revenue Service, with the IRS ultimately disallowing all of the unreimbursed employee business expenses and issuing a notice of deficiency. The deficiency notice disallowed the deductions because of insufficient substantiation of the claimed miles.
Generally, the taxpayer bears the burden of proof for any claimed deduction. There is an income tax regulation that says if a taxpayer produces credible evidence about any factual issue relevant to determining the taxpayer’s tax liability for any year, the burden of proof shifts to the IRS.
The IRS has strict substantiation requirements regarding the use of trucks and automobiles. The taxpayer must substantiate by adequate records or sufficient evidence corroborating the taxpayer’s own statement:
➜ The amount of the expense
➜ The time and place of travel, entertainment or use of the property
➜ The business purpose of the expense of other items
➜ The business relationship of the taxpayer to the persons entertained or using the property
The taxpayer must also be able to establish the amount of business use and the amount of total use of the property.
Ressen provided his calendar and logbook and backed those items up in court with corroborating testimony. The burden of proof shifted from him to the IRS concerning the standard mileage deduction amount.
The court ruled in Ressen’s favor on the standard mileage deduction amount of $28,504 subject to the 2 percent miscellaneous deduction limitation.
Ressen was unable to provide any evidence regarding the other $7,597 in deductions. The burden of proof was on him to substantiate the deductions. Because he was unable to do so, the court disallowed these deductions and ruled in favor of the IRS (Ricky Ray Ressen and Rosalind Ressen v. Commissioner, U.S. Tax Court, T.C. Summary Opinion 2015-32, April 21, 2015). ■
©2015 CPAmerica International
It might seem like driving expenses to some, but to the IRS, it’s commuting.
Lonnie Bartley, a construction supervisor for Far West Contractors Corp. in California, was denied a deduction for nearly $25,000 in business expenses because the Tax Court said they were actually nondeductible commuting expenses.
Bartley’s job required him to travel to various job sites in the metropolitan Los Angeles area, mainly Redondo Beach and El Segundo.
Far West did not provide Bartley with a vehicle, nor did it reimburse him for mileage.
On his 2010 Form 1040 return, Bartley claimed $24,448 in auto-related expenses on Form 2106 EZ, Unreimbursed Employee Business Expenses. He also had $2,482 in other unreimbursed expenses.
The IRS sent Bartley a deficiency letter regarding the 2010 return. It was challenging the large amount of deductions on the Form 2106. In this situation, the taxpayer bears the burden of proof and must substantiate the deductions.
When expenses involve passenger automobiles and traveling while away from home, deductions are not allowed unless the taxpayer substantiates by adequate records or sufficient evidence the following three items:
1. The amount of the expenditure or use
2. The time and place of the expenditure or use
3. The business purpose of the expenditure or use
The business purpose test is usually not met if commuting is involved. There are two exceptions to this general rule.
The first exception permits a taxpayer to deduct transportation expenses incurred in going between a taxpayer’s residence and a temporary work location outside the metropolitan area where the taxpayer normally lives and works.
The second exception permits a taxpayer to deduct commuting expenses between the taxpayer’s residence and a temporary work location, regardless of distance, if the taxpayer also has one or more regular work locations away from the taxpayer’s residence.
Bartley did not meet the first exception to the commuting rule because he both lived and worked in the metropolitan Los Angeles area. He did not meet the second exception because the two job sites where he worked were determined by the court not to be temporary work locations because he already had worked at both the Redondo Beach and El Segundo locations for well over a year. Temporary work locations are usually job sites worked at for less than a year.
Bartley did not meet one of the exceptions to the commuting rule. Therefore, he did not meet the business purpose part of the three-part test that must be met to deduct automobile expenses.
The court ruled the $24,448 in auto-related expenses was nondeductible (Lonnie J. Bartley and Kimberly A. Bartley v. Commissioner, U.S. Tax Court, T.C. Summary Opinion 2015-23, March 31, 2015). ■
©2015 CPAmerica International
A Lockheed Martin employee who participated in the company’s retirement plan was ordered to pay tax on distributions because he couldn’t provide documentation that he had rolled over the account in time.
Balvin A. McKnight was required to include in income two early distributions from his qualified retirement plan because he could not prove to the Tax Court that he had actually rolled that money over into another account within 60 days of the distributions.
McKnight was a participant in the Lockheed Martin Salaried Savings Plan, a qualified retirement plan. State Street Retiree Services was the custodian of McKnight’s account.
During 2011, State Street Retiree Services issued to McKnight two Forms 1099-R, Distributions from Pensions, Annuities, Retirement or Profit-Sharing Plans, IRAs, Insurance Contracts, etc.
The first Form 1099-R reported a gross distribution of $4,984, which was also the taxable amount. There was no federal withholding on this amount. The distribution was classified as an early distribution, with no known exception.
The second Form 1099-R reported a gross distribution of $206,515, which was also the taxable amount. Federal income tax of $48,303 was withheld. The distribution was classified as an early distribution, with no known exception.
When McKnight filed his 2011 Form 1040 return, he listed retirement distributions of $206,516 and $48,304 as the taxable amounts.
The IRS examined his return and determined that the first distribution amount of $4,984 was not picked up as income on his return. They also determined that the entire amount of both distributions, which equaled $211,499, was taxable.
Under IRS code, any amount distributed from an employee’s trust account is taxable to the person who receives the distribution. The facts establish that $211,499 was actually distributed to McKnight in 2011 by State Street Retiree Services, the custodian for Lockheed Martin’s employee retirement trust account. This amount is taxable unless an exclusion applies.
An IRS code section provides a “rollover” exception to the general rule. It excludes from gross income any portion of a distribution that is transferred to an eligible retirement plan made within 60 days of the distribution.
McKnight claims that he rolled over $95,000 of the distribution but was unable to provide the IRS or the court with any documentation of this rollover. Because McKnight didn’t offer the court any proof of the rollover, the entire distribution of $211,499 was determined to be taxable income (Balvin Anthony McKnight v. Commissioner, U.S. Tax Court, T.C. Memo 2015-47, 109 T.C.M. 1224, March 16, 2015). ■
©2015 CPAmerica International
A New York couple who had received an enterprise zone credit for property taxes were required to pay taxes on the amount because of the tax benefit rule.
Yigal and Bonnie Elbaz were required to include in income $54,507 received in 2008 from a refund of New York state income taxes as a result of the tax benefit rule. The entities receiving the benefits were actually flow-through entities.
The Elbazes owned three different companies organized as flow-through entities – in which income passes on to the owners or investors.
They had a 50 percent interest in all three of the entities. Superflex Management, LLC, was treated as a partnership for federal income tax purposes. Superflex Realty, LLC, was treated as an LLC for federal income tax purposes.
The state of New York provides tax benefits to businesses that invest in certain designated areas of the state. One of these benefits is the Qualified Empire Zone Enterprise credit for real property taxes.
In calculating this credit, the amount of property taxes paid or incurred by a business is a major factor. All three of the businesses owned by the Elbazes qualified for this credit.
The Elbazes’ three businesses deducted the share of property taxes that they had paid or incurred during 2007. These expenses decreased the amount of income allocated to them on their respective K-1 schedules. This is where the tax benefit comes in.
The taxpayers report less income on their 1040 return as a result of the businesses having deducted the property taxes paid or incurred.
The $54,507 refund received in 2008 by the taxpayers was a direct result of the Qualified Empire Zone Enterprise credit. The credit was calculated using the property taxes paid or incurred by the three flow-through entities owned by the taxpayers.
Therefore, the $54,507 was the receipt of a refund of a previously deducted tax and was fundamentally inconsistent with the previous treatment to the extent that the Elbazes benefited from the decreased pass-through income. Thus, the $54,507 is considered to be taxable income (Yigal Elbaz and Bonnie Elbaz v. Commissioner, U.S. Tax Court, T.C. Memo 2015-49, March 17, 2015). ■
To deduct your elderly parent as a dependent on your income tax return, you must first meet four tests.
The tests are:
1. “Not a qualifying child” test
2. Member-of-household or relationship test
3. Gross income test
4. Support test
The first test is the easiest to meet. By definition, a qualifying child is a son, daughter, stepchild, foster child, brother, sister, stepbrother, stepsister, half brother, half sister or descendant of any one of them.
As you can see from this definition, your mother and father do not fit this defined terminology. So your parents cannot be your qualifying child.
To meet the member-of-household or relationship test, the person must have lived with you the entire year or be part of a group of persons not required to live with you.
The IRS publishes a list of persons who are not required to live with you. Your father and mother are on that list, so you can meet this test without having either one or both of your parents live with you at any time during the year. Your parents must be citizens, nationals or residents of the United States or residents of Canada or Mexico.
This rule is very helpful to you if you want to deduct your elderly parents as dependents on your tax return despite the fact that your parents are in a nursing home or some other type of care facility.
The gross income test is met if a person’s gross income for the year is less than the personal exemption amount – $3,950 in 2014 and $4,000 in 2015. Gross income is all income in the form of money, property and services that is not exempt from tax.
The gross income test works out well in a situation where the elderly parent has only Social Security income or minimal sources of other income in addition to Social Security. In this situation, all of the Social Security income is generally nontaxable income, allowing the elderly parent to meet the gross income test.
The support test is met if you provide more than half of your elderly parent’s support. Total support includes amount spent to provide food, lodging, clothing, education, medical and dental care, recreation, transportation and similar necessities. The IRS provides taxpayers with a worksheet to help in making this calculation.
If you make a lump-sum advance payment to a nursing home to take care of your elderly parent for life, and the payment amount is based on the parent’s life expectancy, the amount of support provided each year is the lump-sum payment divided by the parent’s life expectancy.
If you are making monthly payments to the nursing home facility, this monthly amount times 12 months would be considered part of the support you provided.
If you are helping to support an elderly parent who is in a nursing home or some other type of care facility, take the time to look into the gross income and support tests. You might discover you are entitled to a dependency exemption deduction that you have never before realized.
©2015 CPAmerica International
