Per Diem Method of Substantiating the Amount of Business Travel Costs

A taxpayer may use a per diem method of substantiation in lieu of accounting for and deducting the actual amount of travel costs. The IRS provides the rules regarding the per diem substantiation method and reimbursements. Per diems can be used to substantiate travel cost; the time, place, and business purpose must still be substantiated through adequate documentation.

 

Who can use per diem method of substantiation?

The per diem method is available to (1) employers for use with an employee reimbursement plan, (2) employees not covered by an accountable or other expense allowance arrangement, and (3) self-employed individuals. Self-employed individuals can use the optional per diem method only for deducting meals and incidental expenses.

 

When can an employer use a per diem allowance to reimburse employees for business travel expenses?

An employer can use a per diem allowance to reimburse employees for business travel expenses incurred while away from home. The per diem amount can be at or below the applicable federal per diem rate, a flat rate or stated schedule, or in accordance with an IRS-specified rate or schedule. The amount deemed substantiated for each calendar day (or partial day) is the lesser of the per diem allowance or the amount computed at the federal per diem rate for the locality of travel.

 

Documentation required by IRS for Per Diem Expense Method

Although per diem allowance plans eliminate the need for employees to gather documentation supporting the actual amount spent while traveling on company business, employees must still substantiate the other elements of the travel-related expenses (i.e., time, place, and business purpose) before the allowance can be treated as made under an accountable plan. If the expense allowance arrangement routinely results in payments of excess allowances that are not repaid or treated as wages, the entire plan will be treated as an unaccountable plan, and 100% of the per diems (not just the amount in excess of the federal rate) will be treated as employee compensation subject to employment tax.

 

Receipts are not required to prove the amounts of travel expenses when using the per diem method

While receipts are not required to prove the amounts of travel expenses when using the per diem method, employees may find it convenient to submit lodging receipts (these generally conclusively prove the dates and place of the travel) on which the employee has stated the business purpose for the travel. A lodging receipt can be an easy way for employees to meet the remaining documentation requirements. An airline ticket is another convenient source document that provides most of the needed information.

 

How to Calculate Travel Allowance

A travel allowance that is computed on a basis similar to that used in computing the employee’s compensation (e.g., hours worked, miles traveled, or pieces produced) is not a per diem allowance unless, as of December 12, 1989, (1) the allowance was identified by the payor either by making a separate payment or by specifically identifying the amount of the allowance, or (2) an allowance computed on that basis was commonly used in the industry in which the employee is employed.

Per Diem Business Travel Expenses

A taxpayer may alternate during a tax year between using the per diem method (except for the shortcut high/low method mentioned later in this key issue and except for a special rule for transportation industry workers) of substantiation and substantiation of actual amount of travel costs. A taxpayer may alternate as frequently as daily between methods.

 

Maximum per diem amounts for business travel

The maximum per diem amounts that are deemed substantiated under the IRS guidelines are those that apply to federal employees. There are two separate rates for each locality: a rate for lodging and a rate for meals and incidental expenses (M&IE). The government issues separate tables for the following travel locations: (1) continental U.S. (CONUS) and (2) nonforeign locations outside the continental U.S. (Non-contiguous), which includes Alaska, Hawaii, and U.S. possessions, and foreign locations (OCONUS). The CONUS rates are updated October 1 of each year (although there may be occasional updates during the year) while the Non-contiguous and OCONUS rates are normally updated each month. The rates can be found at the government’s General Services Administration website at www.gsa.gov/perdiem.

 

CONUS lodging and M&IE rates

Because the update cycle for the CONUS rates occurs during the calendar year (October 1), the IRS allows taxpayers to use the old rates for the entire calendar year. Thus, for 2012, taxpayers can use the rates in effect for January through September for the entire year or switch to the updated rates beginning October 1.The CONUS lodging and M&IE rates vary depending on location. (See the previously mentioned website for the per diem amounts for specific locations.) Employers have the option of using a simplified per diem method known as the high/low method, which use only two sets of per diem rates—one for designated high-cost localities and another for all other localities. (This method is not available to self-employed taxpayers or unreimbursed employees.

Differences between an active business and a hobby for IRS Purposes

Determining if an individual is engaged in carrying on a trade or business has implications beyond whether a net loss will be allowed to offset other income, although this income offset is the most obvious benefit for many taxpayers.

 

Hobby or Business in View of IRS

The Internal Revenue Code backs into the rules governing activities not engaged in for profit (commonly referred to as hobbies) by including all activities of the taxpayer other than those for which deductions are allowable under IRC Sec. 162 (expenses of carrying on a trade or business) or 212 (expenses incurred for the production or collection of income or for the management, conservation, or maintenance of property held for the production of income)

 

Items affected by hobby or business determination include:

  1. Self-employment (SE) tax and, ultimately, social security benefits.
  2. IRA, Keogh, SEP, or SIMPLE retirement plan contributions.
  3. Deductions for health insurance premiums and contributions to health savings accounts (HSAs).
  4. Home office deductions.
  5. Section 179 Deduction
  6. Amortization of start-up expenditures.
  7. Character of gain or loss upon disposition of assets
  8. Net operating loss (NOL) carryovers and carrybacks.
  9. AGI-sensitive deductions including rental losses, medical expenses, casualty losses, etc.
  10. AGI-sensitive credits.
  11. Deferral of estate tax and the special-use valuation of assets.

 

Taxpayers need to be careful to ensure that their business is not treated as a hobby.

 

Retirement Plan Form 5500-EZ Return and Filing Form 5500-EZ

What is Form 5500-EZ?

The Form 5500 Series is a disclosure document for plan participants and beneficiaries. The Form 5500 Series is part of ERISA’s overall reporting and disclosure framework, which is intended to assure that employee benefit plans are operated and managed in accordance with certain prescribed standards and that participants and beneficiaries, as well as regulators, are provided or have access to sufficient information to protect the rights and benefits of participants and beneficiaries under employee benefit plans.

 

Who needs to file Form 5500-EZ

A retirement plan sponsor may file a Form 5500-EZ if the plan:

  • covers you or you and your spouse and you and your spouse own the entire business, or
  • covers only one or more partners and their spouses in a business partnership, and
  • doesn’t provide benefits for anyone except you and your spouse or one or more partners and their spouses.

 

Who cannot file Form 5500-Ez?

If you’re eligible to file a Form 5500-EZ, you’re only required to file it if the total assets of all of your one-person plans is $250,000 or more at the end of the plan year, or this is the final year of the plan. Please take care when you complete these returns. There’s much more information on them than 10 years ago, so it’s a lot easier to make a mistake. If you make a mistake on the 5500-EZ return, you increase the chances that IRS will send you a letter

 

What is the IRS Employee Plans Compliance Unit?

For instance, we have an Employee Plans Compliance Unit. They don’t do audits, but they’ll check returns. And if there’s a trend that they see, they will send out compliance letters to you or to your clients and say, “Hey, we saw this on the return. This doesn’t look right. Can you please explain it?” And then you send a letter back saying, “Here’s the answer,” whether “It is wrong, we’ll correct it” or whatever the situation may be, and then they work with you to resolve it. We have a website that lists all the different projects that are ongoing and the ones that have been completed.

 

IRS Audit of Self Employed Retirement Plans

I strongly urge that if you or your clients receive a letter, please answer that letter, because most of the time what happens for people who don’t respond is we do switch it into an examination of a plan. We just had a project from this unit. The plans were marked as a final return and also showed that assets remained in the plan. The final year of the plan means that the plan has been terminated and all the assets should have been distributed, so we sent letters out when we saw those issues. Or maybe you’ve entered the wrong business code or tried to use one of the codes used on the Schedule C; you must use a business code as listed in the 5500-EZ instructions. If not, again, you might get a letter.

 

Common Problems with Form 5500-EZ

One problem area we’ve noticed on examinations of 5500-EZ filers is that you and your spouse must own the entire business to be eligible to file a 5500-EZ. If the plan is a RoBS, and that’s a plan where you transfer or rollover funds to your retirement plan and use that money to buy stock in the company, the plan owns that stock. Since you and your spouse don’t own the entire business, you cannot file the Form 5500-EZ. The 5500-EZ is an IRS form and you must file using a paper copy. Forms 5500 and 5500-SF are Department of Labor forms, and they must be filed electronically. In some cases, a 5500-EZ filer may electronically file using the 5500-SF. On our website, www.irs.gov/retirement, we have a web page called the Form 5500 Corner that helps explain the plan’s filing requirements. If you do a search for “Form 5500 IRS” or “Form 5500 Corner,” it should take you to that page.

 

Problems Filling Out Form 5500

On the Form 5500 Corner, you’ll find links that take you to fillable 5500-EZ forms and instructions. Just download the form, complete it, print it, and mail it to the IRS per the instructions. For Form 5500 and 5500-SF filers, we have links to the instructions and to EFAST 2, which is Department of Labor’s electronic filing system. Over the years, the two reasons I heard most often for not filing their Form 5500-EZ return were, “I didn’t realize the assets had reached $250,000” and “I thought someone else was filing it.” Generally, plan sponsors expect their tax advisor might be filing the return, or maybe the prototype sponsor, the insurance agent, the stock broker. As a tax practitioner, if you notice your client’s taking a deduction for a retirement plan, you should ask to see a copy of their 5500-EZ for that year. If the response is, “Didn’t you file it?” they might have a problem. You all have probably heard that a few times, I’m sure. If you miss filing a Form 5500 series return with the IRS, there’s a penalty of $25 per day up to $15,000 per missed return and it takes, like, 600 days to reach that $15,000. And in the case of a really large corporation, $15,000 may not mean that much to them, but if you’re a one-person plan that didn’t file a Form 5500-EZ for that year, $15,000 could be a huge burden. And if you missed filing the return for three separate years, now you’re up to $45,000. That’s going to be a severe blow to just about any business. Now, IRS may abate penalties for reasonable cause, and I’ll say even on the camera that we often do, but there are no guarantees that you’ll get that.

 

Penalties for Failure to File Form 5500

Also DOL’s penalty for a delinquent 5500 or 5500-SF; that’s up to something, like, $1,100 a day now, so it’s pretty serious when you miss filing these returns. For that Form 5500 or the 5500-SF, those are filed with the Department of Labor. If you missed one of those filings with Department of Labor, you can enter the DOL’s Delinquent Filer Voluntary Correction Program. That’s available to file any missed returns and have those DOL penalties waived. However, to be eligible for relief from IRS penalties, you still need to file a Form 8955-SSA with the IRS. And remember that’s with the Form 5500 and the 5500- SF. And like Mikio said a while ago, you can get more information by going to the Form 5500 Corner on our web page.

 

Form 5500-EZ

Now, Form 5500-EZ is an IRS form that’s filed with the IRS and if you miss filing it, IRS now has a temporary program that’s available to correct that missed filing. Revenue Procedure 2014-32 established the Pilot Penalty Relief Program. It’s a one-year pilot program providing relief for plan administrators and plan sponsors for penalties that are related to failing to file the Form 5500-EZ. This program is only open until June 2, 2015. To be eligible for this program, you must have been eligible to file a Form 5500-EZ and not have received a penalty notice from the IRS for that delinquent 5500-EZ return. You’ll be required to file any late returns along with the required schedules and any attachments for those years. You are not required, however, to pay any penalties or fees under this program. However, in the top margin on that first page of each late Form 5500-EZ, you need to write in red above the title there, “Delinquent Return Submitted under Rev. Proc. 2014-32, Eligible for Penalty Relief.” And if you don’t write that on the return, it’ll be processed as a late return. There’s also a transmittal schedule that you’ll need to attach, and you’ll find all this in the Form 5500 Corner. Again, that’s www.irs.gov. You have until June 2, 2015, to uncover all your clients’ delinquent 5500-EZ returns. It really does appear to be a big problem, and this is our first relief program, I think, we’ve had on the EZs. What we really need is your help to get the word out on this new program. Next time you’re in a restaurant, like tonight, we want you to stand up and tell everybody about this 5500-EZ penalty relief program or you could share it with your peers, because I’m sure they have clients that have failed to file that return and this is a pretty good opportunity to get it straight going forward.

 

 

 

S Corporation Shareholder Stock Basis

What is an S Corp?

An S corporation is a corporation with an election in effect. The impact of the election is that income, loss, and deductions, pass through to the shareholder. The two main reasons for electing S corporation status are to, one, avoid double taxation on distribution. Now this is accomplished by the shareholder reporting pass-through income of the corporation, which increases his basis, which results in a tax redistribution. And then, two, to allow losses to pass through to its owners. Congress, however, did place limits on the amount of pass-through losses that a shareholder is allowed to claim.

S Corp shareholder loss limitations

There are three shareholder loss limitations. They are stock and debt basis limitations, at-risk limitations, passive activity loss limitations. Let’s talk a little about the stock and debt basis limitation. So when a shareholder is allocated a loss pass through on a schedule K-1 the first question to ask is does the shareholder have adequate stock basis. If the answer is, no, the loss is not allowed and must be suspended due to inadequate basis.

Partial Basis in S Corp Stock

If there is partial basis, part of a loss will be allowed and part of the loss will be limited. Now if the answer is, yes, the shareholder does have adequate stock and debt basis, the shareholder still needs to establish whether they are at risk or whether the loss should be limited due to the passive activity loss limitations.

What are At-risk and passive activity loss limitations?

At-risk and passive activity loss limitations apply a little bit differently than basis limitations. Basis limitations are determined at the shareholder level, whereas at-risk and passive activity loss look to the activity generating the loss and whether the shareholder is at risk or non-passive in that specific activity. We are now going to talk in a little bit more detail about stock basis, but before we move on, let’s talk a little bit about at-risk and the passive activity loss limitations.

Avoiding At-risk and passive activity loss in S Corp

So when determining whether a shareholder is at risk in an activity, it’s important to look at the source of the funds that the shareholder contributed or loaned to the S corporation. In addition, you need to look at the specific activities which generated losses and whether the shareholder is at risk in each separate activity. If the S corporation has multiple activities, the Schedule K-1 should provide adequate details the shareholder can appropriately apply the at-risk and passive activity limitations on an activity-by-activity basis.

Deducting S Corp Passive Losses

Generally there are two situations where a shareholder may have adequate stock and debt basis but is not considered at risk. Number one is borrowing money from another shareholder. If the shareholder borrows from another shareholder and contributes or loans that money to the corporation, it will allow him basis, but he will not be considered at risk in the activity. Number two is nonrecourse borrowing. So if a shareholder borrows money on a non-recourse basis and loans or contributes the money to the S corporation, again, it will allow him basis but he will not be at risk in that activity. If the shareholder is not at risk in the activity, the loss is disallowed and must be suspended due to the application of the at-risk limitations. However, if it is found that the shareholder has basis and is at risk, then the shareholder must determine whether the passive activity loss limitations apply. So let’s talk a little bit about the passive activity loss limitations.

Deducting a Passive Loss on S Corp

Generally a passive loss may only be claimed up to the amount of the shareholder’s passive income. So what is a passive activity which will generate passive income or loss? If the activity is a rental, it is presumed to be passive, and, of course, there are exceptions to that. Or if the shareholder does not materially participate in the business activity it will also generate passive income. To materially participate, a shareholder is required to substantially participate in the operations of the business activity on a regular and continuous basis. This means the shareholder must meet one of the seven hourly tests that are found in treasury Reg 1. 469-5T(a). So if a shareholder has passive losses in excess of passive income, some or all of the loss will be disallowed and suspended due to the passive activity loss limitations. So, in summary, there are three loss limitations. Again, they are stock and debt basis limitations, at-risk limitations, and the passive activity loss limitations. A shareholder must meet each limitation before they are allowed to claim a pass-through loss from the S corporation. These are shareholder not corporate limitations.

S Corp Shareholders should track suspended losses

Shareholders should track suspended losses due to basis, suspended losses due to the application of at-risk rules, and they should try the suspended losses due to the passive activity loss limitations. The fact that the shareholder gets a schedule K-1 reflecting a loss does not mean that that shareholder is automatically entitled to claim that loss. Today we’re going to focus on the discussion on stock-basis limitations and it’s ordering rules. With that, let’s take a closer look at what goes into the shareholder stock basis. The S Corporation’s income loss and deduction items are generally allocated to the shareholder using the per share/per day method. The shareholder receives a Schedule K-1 reflecting his share of the pass-through income items, the pass-through loss, deduction, and credit items and any non-dividend distributions received for the year. Now the schedule K-1 does not reflect the amount of the loss or deduction items which can be claimed or the taxable amount of the non-dividend distribution.

Allowable loss and deduction items

The amount of the allowable loss and deduction items are dependent on the shareholder having adequate stock and debt basis; whereas the taxability of a non-dividend distribution are dependent on the shareholder having adequate stock basis. So when is it important for the shareholder to know his stock basis? Well it’s important when the S Corporation allocates loss of deduction items to the shareholder, or when the S corporation makes a non-dividend distribution to the shareholder, or when the shareholder disposes of his stock. Tracking and calculating stock and debt basis is the shareholder’s responsibility. It is not a corporate responsibility. Although some corporations may provide this information for their shareholders, it is not the corporation’s responsibility. The shareholder is responsible for determining whether or not they have adequate stock basis to claim the loss and whether their distributions exceed stock basis.

Pass-through loss for deduction item

So if you’re preparing a form 1040 and their schedule K-1 reflects a pass-through loss for deduction item or it has a non-dividend distribution, you need to ascertain whether the shareholder has adequate stock and debt basis to properly prepare the 1040. The requirement to keep adequate records, which includes the records for computing and verifying basis, is contained in treasury reg 1.6001-1(a). And keeping track of S corporation stock basis is really no different than keeping track of the basis of any other asset.

How to compute a shareholder stock basis

How to compute a shareholder stock basis. As with the basis of any asset, we’re generally starting with its cost. So if you purchase the stock, the initial cost will be the amount you pay, which is the same as for a car or any other property. If you acquire the stock by contributing an asset, you know, such as cash, to the corporation, which is covered under IRC Section 351, generally you get a carry over basis, less any liabilities assumed by the corporation. If the stock is received as a gift your initial basis is equal to the donor’s basis in a gift. So when a dad gives stock to one of his kids, the kid’s basis would be dad’s basis at the date of the gift. And if the stock is inherited, generally the initial basis equals a fair market value that the stock at the date of death as recognized by the estate.

Determining Initial S Corp Stock Basis

So in determination of initial stock basis is the same whether the corporation is a C corporation or an S corporation. A shareholder stock basis and his S corporation is unique, as it is a moving target each year. Basis goes up and down based upon the S corporations pass-through allocations of income, loss, and deductions, and the distributions received by the shareholder. Also, stock basis is determined at the end of the year except when the stock is sold or disposed. So if you’ve got a copy of the Schedule K-1 handy, you might want to pull that out right now, as we’re going to be referring to it as we continue our discussion. So as was mentioned earlier, the shareholder stock basis is increased by their pro rata share of their pass-through items, and this includes ordinary income, which is reported on the Schedule K-1, Box 1. It includes separately stated income items reported on schedule K-1, Boxes 2 through 10.

S Corp separately stated income items

Now separately stated income items are required to be separately stated, as they might provide for different tax treatment by some shareholders. Examples include rental activities, which are generally passive, or interest income, which may be needed to establish investment interest expense or the net investment income tax, or even long-term capital gains, which have a different tax rate at the shareholder level.

Other S Corp Basis Stock Increases

Stock basis is also increased for tax exempt income, which is from Schedule K-1 boxes 16 A and B, and this includes interest income from state municipal bonds or life insurance proceeds. And then it will be increased for excess depletion over property basis, which is on schedule K-1 box 5C — sorry, Box 15C. Now let’s look at the items that decrease stock shareholder basis, although it cannot be reduced below zero. So first ordinary losses on schedule K-1, Box 1, separately stated loss and deduction items on Schedule K-1, Box 2 through 12D, and 14L or 14M, which are for foreign taxes paid or accrued, nondeductible expenses, which include things like penalties, non-deductible portions of travel and entertainment, life insurance, and these are on Schedule K-1, Box 16C. Basis is also reduced by non-dividend distributions, which is schedule K-1, Box 16B. And finally, it is decreased for depletion for oil and gas, which is reported to the shareholder on schedule K-1, Box 17R. Now each of these items increase or decrease a shareholder stock basis is reflected on the shareholder’s individual schedule K-1 and represents the shareholder’s pro rata share of income loss and deduction items. With that, I’m going to go and ask Susan to discuss non-dividend and dividend distribution.

Distributions received by the shareholder of an S Corporation

Distributions received by the shareholder, which may or may not be pro rata in any given year equal the fair market value of assets distributed, which can consist of cash or property. Let’s discuss a few items to consider as they relate to distributions. First, as stated on the previous chart, basis is decreased by non-dividend distributions. An S corporation can have both dividend and non-dividend distributions. Generally, an entity that has always been taxed as an S Corp will only have non-dividend distributions, but if the corporation ever operated as a C corporation or if the entity acquired a C corporation with a carryover basis; for example, through a merger, then it can acquire C Corp earnings and profits, which, when distributed, are dividend distributions. The S corporation is responsible for determining the amount of total dividend distributions, the total distributions that are dividend, and the total distributions that are non-dividend. A non-dividend distribution is reflected on the Schedule K-1, Box 16D. They reduce stock basis but not debt basis. But they do not reduce stock basis below zero.

S Corp Shareholder Dividend Distribution

If a shareholder receives a dividend distribution it should be reported on the 1099-DIV. The dividend distribution does not increase or decrease a shareholder’s stock basis. Another item I’d like to mention regarding distributions is that distributions can be disproportionate in a given year. But keep in mind, an S Corp can only have one class of stock, so if I am a 20% shareholder, I’m entitled to 20% of the distribution and liquidation rights of the company. I can receive more or less in a given year but over the life of the company it should balance out. Finally, payments to a shareholder for services rendered by the shareholder should be wages, subject to employment taxes. They’re not distributions. So back to the stock basis computation. It was discussed that basis is increased by ordinary and separately-stated income items, but stock basis is not increased if a shareholder fails to report pass-through income. This is an exception to the rule. There is an exception to the rule if the shareholder’s not required to file. For example, we’ve got grandma who owns 5% of an S Corp. and is allocated $1,000 worth of income. Grandma only has — only other income she has is social security income. So grandma is not required to file a tax return, but she is allowed to increase her stock basis by the $1,000 allocated S Corp. income.

S Corp Stock Basis Loss

On the flip side, basis is reduced by losses, even when a shareholder fails to claim the losses. When a shareholder receives no tax benefit from the loss; for example, assume a shareholder has allocated a charitable contribution expense from the S corporation. The shareholder claims standard deduction, so he doesn’t itemize his deductions. As a result, the shareholder receives no benefit for the allocated charitable contribution. In this case, stock and/or debt basis must be reduced by the allocated charitable contribution, even though the shareholder received no benefit from that deduction. Also, basis is reduced even when the shareholder must defer the loss under either the at-risk or the passive activity loss limitations. For example, let’s assume a shareholder has an ordinary loss of $5,000, which the shareholder has adequate stock basis to claim. However, the shareholder does not materially participate in the business and has no other passive income. Stock basis is reduced by the $5,000 despite the fact the shareholder is not allowed to claim the loss due to the passive activity rules, which results in the shareholder having a suspended passive activity loss carry forward. The shareholder will be allowed to carry over that suspended passive loss indefinitely or until he has passive income or the activity is completely disposed of, which will trigger the suspended loss. Now let’s look at the ordering rule. Allowable loss and deduction items are limited to stock and debt basis.

S Corp Non-dividend distributions

Non-dividend distributions are tax free up to the extent of stock basis. As both items of loss and deductions and distributions reduce stock basis, there must been an ordering rule for items that increased and decrease stock basis in order to apply the stock and debt basis limitations. As such, for stock basis, stock basis will be adjusted in the following order, number one, it will first be increased for income items and excess depletion, then it will be decreased for non-dividend distributions, but not below zero. Any non-dividend distribution in excess of stock basis will result in capital gains. Remember that a distribution will not look to debt basis, only stock basis. Next, stock basis is decreased for non-deductible items but not below zero. Nondeductible items in excess of stock basis and debt basis will generally evaporate at the end of the year, meaning they’re not carried forward to offset basis in future years. And finally, stock basis is decreased for items of loss and deduction, but not below zero. The loss and deduction items in excess of stock basis are generally suspended and carried forward. If you missed it, basis cannot go below zero.

Suspended loss and deduction items

Suspended loss and deduction items due to basis retain their character and are carried over indefinitely or until all of the shareholder stock is disposed of. Suspended loss and deduction items are treated as loss and deduction items incurred in the subsequent year. The loss in deduction items are not netted against that year’s income items of the same character. Suspended losses due to basis in the year of disposition are lost forever. So a common error made by a shareholder is when suspended losses are treated as triggered in a complete disposition. A shareholder cannot claim losses in excess of basis, even if they dispose of their stock. So remember, a shareholder can have suspended losses due to a basis limitation, due to an at-risk limitation, and due to passive activity loss limitations. Each of these pools must be separately maintained because they have different rules. So, for example, upon disposition, suspended losses due to basis are lost. However, if a loss is suspended due to passive activity loss limitation, the disposition will trigger the previously suspended loss in deduction items, and this is because basis was already reduced by the suspended passive loss in deduction items. And shareholders often confuse these two rules and they incorrectly claim losses suspended by basis when they dispose of their stock. So a shareholder can make an election to change the normal stock basis ordering rules. If an election is made under Treasury Reg 1.1367-1(g), it allows a shareholder to claim loss and deduction items before non-deductible expenses. So under the normal stock basis ordering rules, if the non-deductible expenses exceed the stock and debt basis, the excess goes away, as there’s no provision requiring that they are carried forward. So on the other hand, the cost of making the election under the regulation, is there any unused nondeductible expenses are carried forward until they are used to reduce stock or debt basis.

Suspended Loss Election

Now once the election is made the shareholder must continue to use that ordering rule unless the IRS approves a change back to the current law ordering rule. I have seen it done but rarely, usually if the shareholder makes a selection when the corporation is in its final year of operation. Now although debt basis is beyond the scope of today’s forum, there are a few items we did want to cover, such as losses in deductions which exceed a shareholder stock basis are allowable to the extent of the shareholder basis and loans, and that debt basis is computed similar to stock basis, but there are some differences. So when considering stock basis versus debt basis, it’s important to remember that they are not the same thing and they must be tracked separately. And a couple of examples, include distributions look to stock basis only; loan repayments, look to debt basis only; and reduced basis debt is restored by current year net increases.

Now in order for a shareholder to obtain debt basis the debt must be bonafide indebtedness from the shareholder to the corporation. So in other words, the shareholder personally loaned the money to the corporation. So therefore, corporate debt does not give it shareholder debt basis. A corporation is a legal entity and is separate from its owners. A loan guarantee or a co-made loan is not sufficient to allow shareholder debt basis. So with corporate debt, loan guarantees or co-made loans the debt is between the corporation and the third party or the corporation and the shareholder jointly and the third party, and it’s not between the corporation and the shareholder. So, again, a shareholder is only allowed debt basis to the extent that he or she has a bonafide indebtedness between them and the corporation. So losses and deductions claimed against a shareholder’s debt basis reduce the shareholder’s basis in the debt. And if an S corporation repays reduced basis debt to the shareholder, part or all of that repayment is taxable to the shareholder.

Tracking and calculating the basis is the shareholder’s responsibility, not the S corporation’s.

Tracking and calculating the basis is the shareholder’s responsibility, not the S corporation’s. Basis generally starts with costs, and basis goes up and down based on the schedule K-1 pass-through income, loss, and deduction items. You’ll also recall that the S corporation stock basis is adjusted at year end in the following order: Increased for income items and excess depletion, then decreased for non-dividend distributions, then decreased for non-deductible items, and finally, decreased for items of loss and deductions. And losses and deductions which exceed a shareholder’s stock basis are allowable to the extent that the shareholder’s basis in loans, and losses and deductions in excess of stock and debt basis are suspended and carried over to future years.

Form 1099-MISC Miscellaneous Filing Requirement

Let’s spend a little time talking about Form 1099-MISC miscellaneous filing requirements, backup withholding and the recent increases to information return penalties. Even though businesses use the form 1099-MISC to report their payments to nonemployees to the IRS, the issue is so closely related to employment tax, that it bears discussion today. The Internal Revenue Code requires a business to report payments to the IRS for services rendered by non-employees if the business paid the non-employee $600 or more during the calendar year.

 

Reportable Payments in Box 7, Nonemployee Compensation, on Form 1099-MISC

Businesses that make reportable payments to non-employees in the course of their business must report those payments in Box 7, Nonemployee Compensation, on Form 1099-MISC. Also, the payer must remember to furnish a copy of the Form 1099-MISC to the recipient or payee, and to file a copy of the 1099-MISC with the IRS. That is an important point to remember. A business should always secure the Taxpayer Identification Number, or TIN, for the workers it makes reportable payments to, so the business can properly report those payments on the Form 1099.

 

Form W-9, Request for Taxpayer Identification Number and Certification

You can use Form W-9, Request for Taxpayer Identification Number and Certification, to obtain the payee or recipient’s TIN. There are exceptions to the Form 1099-Miscellaneous filing requirements. For example, currently, payments to corporations, including limited liability companies that are treated as a C or S corporation, generally aren’t required to be reported on Form 1099-Miscellaneous unless the payments were for legal services and medical or health-care services. Does a business have to withhold reportable payments it makes no nonemployees?

 

Backup withholding for reportable payments to certain individual

Yes, there are situations that call for businesses to make what we call backup withholding for reportable payments to certain individuals. In 1983, the backup withholding provisions of Internal Revenue Code Section 3406 set forth the requirements for withholding from certain reportable payments. Presently, the backup withholding rate is 28%; however, although the rate has generally remained at 28%, the rate could change, so make sure you consult the IRS website to ensure that you’re using the appropriate withholding rate for your specific year.

 

Payers of reportable payments

Payers of reportable payments must withhold federal income tax from such payments, if the payee fails to provide the payer with a taxpayer identification number or provides one that is obviously incorrect; for example, a TIN with the wrong number of digits or a TIN that includes an alpha character, or the payee is notified by the IRS that the TIN provided by the payee is incorrect.

 

When do businesses have to start backup withholding for these workers?

When do businesses have to start backup withholding for these workers? Generally the payer must begin backup withholding on all reportable payments immediately at the time of the first payment if the payer never received the payee’s taxpayer identification number or discovers that the TIN provided is incorrect. In essence, as soon as the payer knows that there is a problem, they should start backup withholding. If the payer has been notified by the IRS that the payee’s TIN is incorrect, the payer should follow the instructions on the notice the IRS sends to the payer with respect to starting and stopping backup withholding. And how long should the business make backup withholding?

 

Where does the payer report these backup withholdings?

The payer should continue with backup withholding until the payee provides the payer with a valid taxpayer identification number. Where does the payer report these backup withholdings? Backup withholding withheld from non-employee compensation must be reported in Box 4 of Form 1099-Miscellaneous.

 

Form 1099-Miscellaneous

Payers must furnish a copy of Form 1099-Miscellaneous to the non-employee by January 31st and file a copy with the IRS by February 28th of the year following the year of the payment. I think we should note here that generally the payer may be liable for the tax required to be withheld, whether or not the payer made the proper withholding from the payee’s compensation. Also, the payer reports and remits the backup withholding to the IRS on Form 945, Annual Return of Withheld Income Taxes.

 

Are there any other consequences related to Form 1099, Reporting Compliance and Backup Withholding?

The IRS has compliance programs in place to review information returns, including Forms 1099 and to identify those with possible noncompliance related to backup withholding. There are potential penalties for such noncompliance, some of which have recently increased. The information return penalties are related to Code Sections 6721 and 6722. Section 6721 pertains to the failure to file correct information return, and Section 6722 pertains to the failure to furnish correct payee statements. The penalties per information return depend on when they were correctly filed, and the penalties have a maximum penalty per year.

Penalties for forgetting backup withholding

The revised penalty rates per information return for Code Section 6721 and 6722 are $50, $100, or $250 per information return, with maximum penalties of $500,000, $1.5 million, and $3 million per year. The recent increase in penalties applies to the returns in statements required to be filed after December 31st, 2015. There are also lower maximum penalties for small businesses, which are defined as taxpayers with gross receipts of not more than $5 million.

Increased penalty for forgetting backup withholding

As mentioned earlier, failure to backup withhold from reportable payments may result in penalties asserted using Internal Revenue Code Section 6672, Trust Fund Recovery Penalties. This is the penalty imposed on the responsible person we talked about earlier.

Officer Compensation for IRS Purposes and Taxable Income

is an important topic to cover because many business owners do not realize that corporate officers are employees by statute. For example, corporate officers are employees for FICA purposes under Internal Revenue Code Section 3121(d)(1). Corporate officers are employees for federal income tax withholding purposes under Internal Revenue Code Section 3401(c). Corporate officers are employees for FUTA purposes under the Internal Revenue Code Section 3306(i).

 

Payments for services as wages

Although the statutes are clear, many offices of S corporations or closely-held C corporations fail to treat payments for services as wages. Instead, they improperly treat the payments as corporate distributions, loans, and payments of personal expenses. I’ll go over some examples of an officer’s compensation being wages.

 

 

Officer Compensations, Wages, and Employment Tax

If a corporate officer performs services, their compensation is wages and subject to employment tax. Performance of services is a key factor in determining if these payments are subject to employment tax. The courts have recognized that the president of a corporation generally performs more than minor services and is therefore an employee. Because a corporate officer is an employee by statute, the courts have found, in case after case, that the corporate taxpayer had no reasonable basis for treating a corporate officer as anything other than an employee. When does Section 530 comes into play with respect to officer’s compensation?

 

Section 530 Relief

The courts have consistently rejected the argument that the corporation is entitled to relief under Section 530 of the Revenue Act of 1978. This is not because Section 530 cannot apply, but because it is not reasonable to treat an officer as a non-employee when the statute clearly states that the officer is an employee. Over the past 25 years, courts in five different circuits, plus the Tax Court, have issued opinions that an officer of a corporation was an employee and that payments to the officer were wages, subject to employment taxes.

 

Other Officer Compensation Issues

In these cases, where Section 530 was addressed, the court found that the taxpayer was not entitled to relief under that provision. Some case names are on the screen in case you want to refer to them in the future. Marvina, now that we have clearly explained why officer compensation is considered wages, can you tell us how to determine a reasonable salary for officers

 

Determination of a reasonable salary for Officer

Is there a standard formula?  No, there’s no magic formula. The determination of a reasonable salary will be different in each case, because it must be based on each specific situation. So the facts and circumstances of each officer and company should be addressed. Some of the key factors will include: position held by each officer, duties performed by each officer, hours worked by each officer, and compensation paid, including bonuses.

 

What is Reasonable Compensation for a Corporate Officer?

As I said, there is no magic formula for determining reasonable compensation for an officer; however, I understand that there are some websites that can be useful for providing ranges of comparable salaries for many types of businesses in various geographic areas. So where can a corporation find a little help in establishing what reasonable compensation should be? There are several websites that businesses can use as resources to help determine compensation in their fields or geographic locations.

The U.S. Department of Labor, Bureau of Labor Statistics website publishes occupational employment statistics, which include an alphabetical list of occupation from accountants to zoologists. There are also many other useful sites on the internet to help determine reasonable compensation.

 

Which of the following are factors in determining a reasonable salary for corporate officers?

Please remember that more than one answer may be correct. A, the officer’s lifestyle; B, the scope and extent of the duties the officer performs; C, the Internal Revenue Code provides pay scales for corporate officer compensation; D, the hours the officer works? As has been our practice, please take a few moments to think about your answer.

Factors in Determining Officer Compensation

The correct answers are B and D. A is incorrect because an officer’s lifestyle has no bearing on a reasonable compensation. Reasonable compensation is determined within the framework of the officer’s relationship to the corporation, not how the officer lives a personal lifestyle. B is correct. The actual scope and duties an officer performs are a key factor in determining the reasonable compensation for that officer. The officer’s reasonable compensation should reflect what duties the officer performs. Answer C is incorrect, because, as we have stated, there is no one set way of determining reasonable officer compensation, and the tax code does not provide such guidance. And finally, D is correct. It makes sense that the hours an officer actually spends performing their duties for the corporation are a key factor in determining reasonable officer compensation.

Taxation of Employer Fringe Benefits and IRS Treatment

A fringe benefit is a form of payment for the performance of services. Employers provide fringe benefits to workers of all types, including employees, independent contractors, partners, and directors. Any fringe benefit a business provides to a worker in connection with the performance of services is taxable and must be included in the worker’s income unless the law specifically excludes it or the recipient pays for the benefit.

 

 

Reporting Fringe Benefits on Form 941

Fringe benefits provided to employees that the law does not specifically exclude from income, are subject to employment taxes, and the employer must report the benefits on the employee’s Form W-2, wage and tax statement, and Form 941. If the fringe benefit is provided in connection with the performance of services by a worker who is not an employee, the provider may have to report the benefit on Form 1099 Miscellaneous for independent contractors, or on Schedule K-1, Form 1065 for partners.

 

How to determine the amount or value of fringe benefits?

How to determine the amount or value of fringe benefits that must be included as wages for employment tax purposes. A business must generally report the fair market value of the benefit provided to a worker, less any amount paid for the benefit by the worker as income and wages on the worker’s form W-2. However, there are some special valuation rules for fringe benefits that a business may elect to use if they meet the requirements for use of those specific rules.

What is the Fair Market Value of Fringe Benefits?

The fair market value of a fringe benefit is the amount an employee would have to pay a third party in an arm’s length transaction to buy or lease the benefit. This amount is based on all the related facts and circumstances. Note that neither the amount the employee considers to be the value of the fringe benefit nor the cost the employer incurs to provide the benefit determines the fair market value. There are special rules for determining the value of some benefits. Those benefits are meals provided at the employer-operated eating facility, use of aircraft, use of automobiles. More information about these benefits is in Publication 15B, Employer’s Tax Guide to Fringe Benefits.

 

When should an employer withhold on these fringe benefits?

Generally an employer must determine the actual value of non-cash fringe benefits no later than January 31st of the year after the year in which the benefit was received. Before January 31st, the business may reasonably estimate the value of the fringe benefits for purposes of withholding and depositing on time. That is the general rule, but this can get complicated, so please check out the valuations and special timing rules in Publication 15B.

 

Valuation of Fringe Benefits

Let’s complete this discussion on valuation and withholding by pointing out that if an employer chooses to pay an employee’s social security and Medicare taxes on taxable fringe benefits without deducting them from his or her pay, the employer must include the amount of those tax payments in the employee’s income. Also, if the employee terminates his employment and the employer has unpaid and uncollected taxes for non-cash benefits, the employer is still liable for those taxes. Finally, an employer must determine the actual value of fringe benefits provided during a calendar year by January 31st of the following year. The employer must report the actual value on Form 941 or Form 944, Employers Annual Federal Tax Return, and Form W-2.

 

Fringe benefits and cafeteria plans.

We cannot examine cafeteria plans in depth, but I can provide an overview. A cafeteria plan including a flexible spending arrangement, is a written plan that allows employees to choose between receiving cash or taxable benefits instead of certain qualified benefits for which the law provides an exclusion from wages. If an employee chooses to receive a qualified benefit under a cafeteria plan, the fact that the employee could have received cash or taxable benefits instead will not make the qualified benefit taxable. However, if a cafeteria plan favors highly-compensated or key employees, a business must include in their wages the value of the taxable benefit they could have selected. Definitions of highly-compensated and key employees are in the cafeteria plan section of Publication 15B. Instances where benefits can be includable in an income and subject to employment taxes.

 

Benefits excludable from income

Can you talk a little bit about benefits excludable from income? Fringe benefit exclusion rules exclude all or part of the value of certain benefits from the recipient’s pay. These excluded benefits are not subject to federal income tax withholding. Also, in most cases, they are not subject to social security, Medicare, or federal unemployment tax and are not reported on Form W-2. Exclusion rules apply to a host of benefits under various code sections. Some of these benefits include accident and health benefits, adoption assistance, dependent care assistance, group term life insurance, no-additional-cost services, transportation benefits, bus pass, metro card, subject to specific limitations.

 

Common excludable fringe benefits

A few other common excludable benefits are employee discounts, health savings accounts, HSAs, working condition benefits. There is more information about these and other fringe benefits in Publication 15B, Employer’s Tax Guide to Fringe Benefits. There are several exemptions, so make sure to check Publication 15B and the IRS website for more information. A and B are not correct, because some benefits will be includable in income and some exempt for both employees and independent contractors. And I think it is pretty obvious that D is not a correct choice, since we’ve already explained that the benefits are includable in income unless exempted by law. That concludes our discussion on fringe benefits.

Businesses that improperly classify workers as independent contractors instead of employees

What can happen if a business misclassifies some of its workers?

Businesses that improperly classify workers as independent contractors instead of employees can incur substantial amounts in additional taxes and penalties as a result of that misclassification. The Trust Fund recovery penalty may apply if federal income tax, social security tax, and Medicare tax that must be withheld are not withheld, or are either not deposited or paid. This penalty may apply to the responsible person if these unpaid taxes cannot be immediately collected from the employer or business. Furthermore, the Trust Fund Recovery penalty may be imposed on all persons who are determined by the IRS to be responsible for collecting, accounting for, and paying over these taxes and who act willfully in not doing so.

 

Who a responsible person is, and what we mean with the word “willfully?

A responsible person can be an officer or employee of a corporation, a partner or employee of a partnership, an accountant, a volunteer director or trustee, or an employee of a sole proprietorship. A responsible person also may include someone who signs checks for the business or otherwise has authority to cause suspending of business funds. Willfully means voluntarily, consciously, and intentionally. A responsible person acts willfully if the person knows the required actions are not taking place. More information regarding the trust fund recovery penalty can be found in Publication 15 Circular E, Employer’s Tax Guide.

 

Section 530 Relief

There is relief available for some taxpayers. First, Section 530 provides businesses with relief from federal employment tax obligations if certain requirements are met. If you have a reasonable basis for not treating a worker as an employee, you may be relieved from having to pay employment taxes for that worker.

 

Do You Qualify for Relief Under Section 530

To get this relief you must file all required federal tax returns, including information returns on a basis consistent with your treatment of the worker. IRS publication 1976, Do You Qualify for Relief Under Section 530, provides additional information on this issue. Next we will discuss Section 3509 rates. If you treated an employee as a nonemployee, Section 3509 provides reduced rates for the employee’s share of FICA taxes and the federal income tax that should have been withheld. Section 3509 does not provide relief for the employer’s share of FICA taxes. The applicable rates depend on whether you filed required forms 1099. See Publication 15, Circular E for additional information.

 

The IRS classification settlement program, or CSP

The IRS classification settlement program, or CSP, establishes procedures that will allow businesses and the IRS to resolve worker classification cases as early in the course of an exam as possible, thereby reducing taxpayer burden. CSP agreements are closing agreements that bind the service and the taxpayer to prospective tax treatment for future tax periods. If the business meets the CSP qualification, it may be entitled to a reduced amount of tax. Note that the classification settlement program, CSP, is available in an audit setting. For taxpayers that are not under audit, there’s a different program available. It’s called the voluntary classification settlement program or VCSP.

 

The voluntary classification settlement program or VCSP

As the name indicates, the VCSP is a voluntary program that allows taxpayers to reclassify their workers as employees for future tax periods for federal employment tax purposes and obtain partial relief from federal employment taxes. This is important, because one of the biggest tax issues facing companies today is determining whether their workers are employees or independent contractors. This decision has ramifications to the businesses well beyond the initial determination. The VCSP process is simple.

 

Participate in the VCSP

To participate in the VCSP, the taxpayer must meet certain eligibility requirements, apply to participate in the VCSP program using Form 8952, Application for Voluntary Classification Settlement Program, and if accepted, enter into a closing agreement with the IRS. Rebecca, what else can you tell us about the VCSP? It should also be noted that exempt organizations and government entities may participate in VCSP as long as they meet all of the eligibility requirements. Lastly, a taxpayer that was previously audited by the IRS or the Department of Labor concerning the classification of the workers, will only be eligible if the taxpayer has complied with the results of that audit, and is not currently contesting the worker classification in court.

 

Form 8952, Application for Voluntary Classification Settlement Program

First, the application Form 8952, Application for Voluntary Classification Settlement Program, should be filed at least 60 days before the date the taxpayer wants to begin treating their workers as employees. There are also new requirements mandating that the taxpayer include a list of names and social security numbers for the workers identified for the worker classification. The IRS will review the application and verify the taxpayer’s eligibility. As part of the agreement, taxpayers receive audit protection from the IRS employment tax audits concerning the class of workers covered by the VCSP agreement for the past years. However, the audit protection does not extend to other issues, if present.

In return, taxpayers agree to prospectively treat a class or classes of workers as employees and pay 10% of the employment tax liability that may have been due on compensation paid to the workers for the most recent tax year determined under the reduced rates of Section 3509(a) of the Internal Revenue Code. The payment works out to just over 1% of the amount paid to these workers for the most recently completed tax year. In addition, businesses will not be liable for any interest and penalties on the amount due. We believe this is very attractive. For additional guidance, please refer to IRS announcement 2012-45 and the IRS website. Those are the highlights of the voluntary classification settlement program.

 

 

Eligibility for Voluntary Classification Settlement Program

To be eligible for the VCSP, one of the criteria is that the taxpayer; A, must have consistently treated the workers as nonemployees and must have filed all required forms 1099 for the workers to be reclassified for the previous five years; B, is currently under audit concerning the classification of workers by the Department of Labor or by a state government agency; C, is not currently under employment tax audit by the IRS; D, is not an exempt organization.

IRS Worker classification and Employment Taxes

Worker classification does seem to be a recurring employment tax issue. We’ll provide an overview of the issue. Workers may be classified as either independent contractors or employees. An independent contractor is different from an employee, both in definition and tax responsibility. If a worker is an employee, the business will have to meet all of the withholding requirements, file the proper employment tax returns, and furnish a W-2 wage and earnings statement to the employee. Generally, if the worker is an independent contractor and the business pays $600 or more to the worker during a calendar year, the business must issue a Form 1099-Miscellaneous to the worker.

 

Backup Withholding Responsibilities

The business should also be aware that they may have backup withholding responsibilities if they fail to secure a valid taxpayer identification number, or TIN, from the worker. On the next two slides are copies of Forms W-2 issued to employees and 1099-Miscellaneous issued to independent contractors. Form W-2, which is used to report wages to employees, Form 1099- Miscellaneous is used to report income to independent contractors.

 

How to make a determination as to who is an employee and who is an independent contractor?

Contractors and subcontractors, for example, who follow an independent trade, business, or profession in which they offer their services to the public are generally not employees. However, whether such people are employees or independent contractors depends on the facts and circumstances of each case. The right to direct and control the workers really is key in determining the proper worker classification, and evidence falls into three categories: Behavioral control: does the company control or have the right to control what the worker does and how the worker does his or her job? Financial control: are the business aspects of the worker’s job controlled by the payer? This would include criteria like how the worker is paid, whether the expenses are reimbursed, and who provides tools and supplies. Relationship of the parties: are there written contracts or employee benefits, including for example fringe benefits, insurance, or vacation pay? Will the relationship continue, and is the work performed a key aspect of the business?

 

Factors to Determine Employee of Independent Contractor

There is quite a lot we can say about behavioral control. The key issues for behavioral control are instructions and training. Types of instructions includes things like how, when, where to do the work, what tools or equipment to use, what workers to hire or to assist with the work, where to purchase supplies and services, what work must be performed by a specified individual, what order or sequence to follow when performing the work. Degree of instruction means that the more detailed the instruction, the more control the business exercises over the worker. More detailed instructions indicate that the worker is an employee. Less detailed instructions reflect less control, indicating that the worker is more likely an independent contractor.

 

What are some of the other factors in determining whether the worker is an employee versus independent contractor?

The next factor is training. Training means explaining detailed methods and procedures to be used in performing a task. If the business provides the worker with training on how to do the job, this indicates that the business wants the job done in a particular way. This is solid evidence that the worker is an employee. Periodic or ongoing training about procedures and methods is even stronger evidence of an employee/employee relationship. However, if a former employee who had terminated employment is rehired by the company to perform substantially similar duties, training would not typically be required. Therefore, training or the lack of training in this circumstance is not indicative of the worker being an independent contractor.

 

Controlling Independent Contractors

When looking at behavioral control, the key fact to consider is whether the business retains the right to control the worker and the details of how the services are performed, regardless of whether the business actually exercises that right. Here’s an example. An electrician agrees to install wiring in a new warehouse under construction. Upon arriving at the warehouse, the electrician is given the building plans showing where the wiring is to be installed and advised that the wiring must be completed within five days. In this example, the directives concern what is to be done rather than how it is to be done, and is consistent with independent contractor status. Here’s another example, which points more to the worker being an employee. An electrician works for a general contractor. The warehouse owner hires the general contractor and the general contractor tells the electrician what wiring has to be done, gives specific instructions on installation regarding the wiring, provides the tools to use, and dictates the order in which the wiring is to be installed. In this example, these are specific instructions on how the work is to be performed. This is consistent with employee status.

Financial Control of Employees

The second category is financial control. Financial control refers to whether the business has the right to control the financial aspects of the worker’s job. Let’s talk about several different ways a business exercises financial control. First, there’s investment. An independent contractor often has a significant investment in the equipment he or she uses in working for someone else. However, in many occupational industries, such as construction, workers spend hundreds of dollars on the tools and equipment they use and are still considered to be employees. There are no precise dollar limits that must be met in order to have a significant investment. Furthermore, a significant investment is not necessary for independent contractor status, as some types of work simply do not require large expenditures. Next are expenses. Employers are more likely to reimburse employees for their job expenses, while businesses usually do not reimburse independent contractors for expenses. However, employees may also incur expenses that are not reimbursed.

A school teacher is an employee. She buys erasers, posters, and other minor supplies throughout the year, and she is not reimbursed for these expenses. Minor expenses incurred by an employee are not indicative of an independent contractor relationship. The opportunity to make a profit or loss is another important factor. If a worker has a significant investment in the tools and equipment used, and if the worker has unreimbursed expenses, the worker has a greater opportunity to lose money; that is to say, their expenses will exceed their income from the work. For example, the electrician we mentioned a moment ago, might agree to wire a warehouse for a set price. That electrician stands to make a profit or bear a loss depending on the electrician’s skill in bidding the job. Having the possibility of incurring a loss or turning a profit indicates that the worker is an independent contractor. Another indication of financial control would be who provides the insurance coverage, including workers compensation insurance.

If a worker covers their own insurance, the relationship is probably that of an independent contractor. If the business provides the insurance coverage, the relationship would more likely be an employee relationship. A final point here concerning profit and loss is that you should consider who is responsible for correcting a mistake on the job. If the business is responsible for correcting and paying for the mistake, the relationship is probably an employee relationship. If the worker is responsible for correcting and paying for the costs to rectify an error or mistake, the worker is more likely to be an independent contractor. While we’re talking about the category of financial control, we also want to consider the availability of the services. Are the workers’ services available to the general public?

Who is an Independent Contractor?

Independent contractors often advertise, maintain a visible business location or presence, and are available to the relevant market. Also, an independent contractor is generally free to seek out other business opportunities. Finally, the method of payment must be considered. What method of payment does the worker receive? Are they paid by the job or by the hour? Hourly, weekly, or similar basis for payment in return for services or labor generally is evidence of an employer/employee relationship. A flat fee is generally evidence of an independent contractor, especially if the worker incurs the expenses of performing the services. Again, just as with behavior control factors, in the financial control category, there is no one factor that takes precedence over the others. It is a matter of looking at the whole relationship and seeing where the preponderance of evidence lies.

Let’s start by taking a look at some of the elements which may be present in the relationship between the two parties. Is there a written contract? Although a contract may state that the worker is an employee or an independent contractor, this is not sufficient to determine a worker’s status. The IRS is not required to follow contracts stating that the worker is an independent contractor responsible for paying his or her own self-employment tax. How the parties work together determines whether the worker is an employee or an independent contractor.

 

Businesses should consider whether there are employee-type benefits provided

Businesses should consider whether there are employee-type benefits provided. Employee benefits could include things like insurance, pension plans, paid vacations, and sick days and disability insurance. Businesses generally do not grant these fringe benefits to independent contractors. However, the lack of these type of benefits does not necessarily mean the worker is an independent contractor. Other questions are how permanent is the relationship? If you hire a worker with the expectation that the relationship will continue indefinitely rather than for a specific project or period, this is generally considered evidence that the intent was to create an employer/employee relationship.

Are the services provided a crucial activity of the business? If a worker provides services that are a key aspect of your regular business activity, it is more likely that you will have the right to direct and control his or her activities. For example, if a law firm hires an attorney it is likely that it will present the attorney’s work as their own and would have the right to control or direct that work. This would indicate an employer/employee relationship.

 

How to treat seasonal or part-time workers?

We often get questions from business owners about how to treat seasonal or part-time workers. For each worker you will need to look at all of the factors we have just discussed and see whether they indicate an employee or an independent contractor status. The length of time the worker performs services for you is not a standalone factor in determining his or her status. A worker can be an employee even if he or she only performs a few hours of services. It is important to remember that businesses must weigh the factors under all three categories of evidence when determining whether a worker is an employee or independent contractor. Some factors may indicate that the worker is an employee while other factors may indicate that the worker is an independent contractor. There is no set number of criteria that makes the worker an employee or an independent contractor. No one factor stands alone in making this determination. Also, factors which are relevant in one situation, may not be relevant in another. The key is to review the entire relationship, consider the degree or extent of all the factors in the right to direct and control, and finally, to document each of the factors used in coming up with the determination.

 

IRS Publication 1779, Independent Contractor or Employee

There is a host of useful information about worker classification available. There is the IRS Publication 1779, Independent Contractor or Employee; Publication 15A, Employer’s Supplemental Tax Guide; and IRS podcast and training materials available on the IRS website, www.irs.gov. As we end the worker classification part of the presentation we would like to pose our first question for the audience. Which of these are important factors in determining proper worker status?

When making a worker classification determination, the business should consider all aspects of the work relationship and make the decision based on all the factors. The business should not simply rely on one or two factors that may indicate the worker is an employee or an independent contractor. And finally, answer D is incorrect. It does not matter whether a worker is permanent or seasonal. The right to direct and control the worker is a key factor while considering the overall relationship.

 

Form SS-8, Determination of Worker Status for Purposes of Federal Employment Taxes and Income Tax

A worker or firm may file Form SS-8, Determination of Worker Status for Purposes of Federal Employment Taxes and Income Tax. The Form SS-8 is filed to request a determination of the status of a worker under the common law rules for purposes of federal employment taxes and income tax withholding. Additionally, the IRS developed Form 8919, Uncollected Social Security and Medicare Tax on Wages, to simplify the process for employees to report their share of uncollected social security and Medicare taxes due on their compensation when their employers have misclassified them as independent contractors. Additional information can be found in the instructions for Form 8919.

Deduct repairs and maintenance expenses tangible property regulations

Under the Final Tangible Property Regulations, generally a taxpayer can deduct repairs and maintenance expenses to tangible property when the amounts are not for an improvement. The Final Regulations, under 263a do not eliminate the requirements of Section 263A, which generally provides that a taxpayer must capitalize the direct and allocable indirect costs of producing real or tangible personal property and acquiring property for resale.

Whether a cost is deductible as a repair and maintenance expense of must be treated as a capitalized improvement has always required an evaluation of the taxpayer’s facts and circumstances, also referred to as the Facts and Circumstances Analysis. The Final Regulations has not changed the need to perform a factual analysis in certain cases.

 

Deduct repairs and maintenance expenses tangible property regulations

The Final Regulations provide several safe harbors and simplifying elections as alternatives to the application of this Facts and Circumstances Analysis. They are: safe harbor elections for small taxpayers, the safe harbor for routine maintenance, and the election to capitalize repair and maintenance costs. The determination of whether an expense must be capitalized under the Internal Revenue Code Section 263(a) depends on the answer to two questions. First, what is the unit of property to be analyzed for determining whether there is an improvement. Second, does work performed constitute an improvement to the relevant unit of property? Question number two will be referred to as the Improvement Analysis. Again, the first question is, what is the unit of property to be analyzed for determining whether there is an improvement? There are two main categories of property addressed in the Final Regulations. These are, first, buildings, including condominiums, cooperatives and leased buildings or leased parts of buildings. And two, property other than buildings, including leased property other than buildings, plant, property, and network assets.

Network assets, for example, are railroad tracks, and electric transmission, and distribution line or pipeline, are subject to special industry-specific rules and will not be covered during this webinar. The building and its structural components is the unit of property. Under the Final Regulations, and for these purposes only, an Improvement Analysis is applied to the building structure and each of the key building systems. The key building systems are the HVAC system, fire protection and alarm, plumbing, electrical, escalators, elevators, security, gas distribution, and other systems identified in future IRS guidance. Lessees of portions of buildings apply the Improvement Analysis to the portion of the building structure, and portion of each building system, subject to the lease. Lessors of an entire building apply the Improvement Analysis to the entire building structure and each of the key building systems.

 

What can be deducted?

The general rule for non-buildings is that all components that are functionally interdependent are a single unit of property. Components are functionally interdependent if the placing in service of one component of a taxpayer is dependent on the placing in service of the other component by the taxpayer. Property other than buildings include non-building real property, for example land, and tangible personal property. Plant property is defined as machinery or equipment used to perform an industrial process such as manufacturing, generation, warehousing, distribution, automated materials handling and service industries or other similar activities. An exception to the general rule of functional interdependence for plant property is that the unit of property for the plant is comprised of each component or group of components within the plant that performs a discreet and major function or operation within the functionally interdependent machinery or equipment.