These days almost everyone seems to work from home, at least occassionally. According to the U.S. Census, about half of all U.S. businesses are based at home, and most professionals work from home at least some of the time, so it’s only right that you should get a tax break for segregating part of your home over to your job. Wishful thinking. The IRS doesn’t think you deserve a write-off for reading your smartphone in the bathroom. For those who legitimately have separate spaces in their homes used under IRC Section 280A “exclusively and regularly” for work (and for employees, the use must also be for the convenience of the employer), the IRS offers some relief, but it’s not easy to claim. IRS Publication 587 for the home office deduction runs 34 pages, and only about a third of eligible taxpayers actually take it, because of the confusing legal history in this area, the recordkeeping requirements, the increased risks of audit by the IRS, and the difficulty determining what portion of the home is actually used for business in a given tax year. The convoluted history of this part of the tax code reveals how, over the years, work escaped from the offices and factories to invade every inch and hour of a person's life, particularly this day in age with the aforementioned smartphones, that allow a person to be plugged in 24-7-365.  A 32 page law review article titled "Simplication is not enough: An Analysis of the Home Office Deduction and the Home Office Simplification Act of 2009" in the 2010 Baltimate Law Review recounts the entire situation in detail.  However, what actually counts as a legitimate home office has been unclear from the start. Before 1976, the tax code had no specific home office provision, but employees who were required to work from home could write off some related costs.  In 1969, in Newi vs. Commissioner, the Tax Court ruled that George Newi, a TV ad salesman who spent three hours a night working from his converted den, could deduct a quarter of his rent, even though he worked after hours by choice when he could have returned to the office. That loose, fuzzy standard invited generous interpretation by people, including one individual who was actually an attorney for the IRS.  In Bodzin vs. Commissioner, Stephen Bodzin tried to write off part of his rent because he did some work at home in the evenings and on weekends. In 1975 (eight years after the tax return in question), Bodzin lost his case against the agency he worked for when an appeals court found that his home wasn’t his place of business. Rather, he sometimes, by choice, did some of his reading and writing at home. The following year, Congress later passed a tax reform law that narrowed the home office definition to prevent taxpayers from abusing the deduction, which caused even more confusion. In another case, Drucker vs. Commissioner, musicians for the Metropolitan Opera who spent 30 hours a week practicing in their homes were initially denied the break because a court ruled that their place of work was Lincoln Center; they won on appeal. In Commissioner vs. Soliman, an anesthesiologist who did paperwork at home because he had no hospital office was denied his write-off by the Supreme Court in 1993. “The facts in each case will vary, making it difficult to develop a bright line test,” the high court said.  This case in particular, set off a firestorm, because it completely denied a home office deduction for legitimate business expenses for numerous professions, including painters, carpenters, landscapers, construction workers, doctors, professors, musicians, artists, and sales professionals, because these types of professions effectively required the business to be conducted at other locations, rather than the home office. However, in 1997, Congress finally decided to correct the problems resulting from the Soliman decision, and passed the Taxpayer Relief Act to explicitly include home offices used for administration in businesses that have no other fixed location, which would give Dr. Soliman the tax break he requested years earlier.  However, as previously noted, the legislative solutions still treat self-employed individuals different from employees, as the latter are required to show additional evidence that the home office is for the convenience of the employer, rather than themselves, which is often difficult to prove. For the past decade, advocates for the home-based workforce have sought to give taxpayers the option to check a box for a standard $1,500 home office write-off. That would save them the difficulty of calculating what percentage of the home is dedicated to business—and therefore what share of rent, insurance, utilities, and maintenance costs can be deducted. Various versions of the proposal have languished in Congress for years to no avail. Unlike employees’ wages, business income and deductions can’t be easily verified by the IRS. In one analysis, 57 percent of sole proprietors misreported income, compared to one percent of employees. So the IRS doesn’t have much of an interest in making it easier to take the home office deduction, for fear that it could be easily abused to short-change Uncle Sam. That leaves a headache for those trying, legitimately, to write off the cost of a workspace that happens to be in the same place that they sleep.  Even the various proposals that have arisen over the years, do not address the primary problems of the disparity in the treatment of self-employed individuals vs. employees and the requirement that the home office be used on a regular basis, without defining what "regular basis" actually means.  A simple solution would be to repeal the "for the convenience of the employer" requirement for employees, which would then put everyone on equal footing and clearly defining "regular use" with some type of minimum use standard.  Unfortunately, the most recent attempt to clear of the legal confusion in this area, the "Home Office Simplification Act of 2009", died in committee, and no new legislation appears to be on the horizon, so the future in this area is still very much unclear.

  Most people are familiar with the Federal Income Tax (regular) system, but most are not that familiar with the Alternative Minimum Tax (AMT) system.  AMT does not apply to partnerships or S-corporations, but does apply to C-corporations, Estates, Individuals and Trusts.  AMT is a tax system separate from the regular tax system.  Under AMT, separate rates (26% or 28%) are applied to AMT income (regular income after certain “add backs” of various regular tax benefits) to determine the AMT tax liability.  The Taxpayer pays the larger of regular tax or AMT tax liability. The intent of AMT is to force taxpayers with high income and lots of certain types of deductions to pay tax to the Federal government.  An exemption amount is provided to prevent taxpayers with lower income from being included in the AMT system.   This exemption is phased-out (eliminated) for higher income earners.  Unfortunately, this exemption amount and phase-out are not indexed for inflation.  As a result, more middle class taxpayers become included in the AMT system each year.  This forces Congress to pass AMT legislation each year to “patch” this problem.  Congress has not always addressed this issue effectively. For individuals, the major “add backs” are: The personal exemption.  Taxpayers with many exemptions may end up paying AMT tax for this reason alone. The Standard Deduction. Real Estate taxes and State taxes deducted as itemized deductions. Miscellaneous Itemized deductions. Medical Expense deductions. Incentive Stock Options (ISOs).  The unrecognized gain on the exercise of the options is recognized for AMT. C-corporations whose average annual gross receipts for the prior three year period don’t exceed $7.5 million are exempt from AMT. Depreciation on tangible property is calculated differently for AMT than regular tax.  This adjustment affects everyone under AMT. There are other adjustments and preferences that can also apply.  Urish Popeck tax professionals can assist with the complexities of AMT. Please contact us if you need assistance.

The Pennsylvania House has approved a corporate tax reform bill designed to eliminate the "Delaware Loophole," which will “create a more competitive and fair business climate in Pennsylvania”, according to bill sponsor Rep. Dave Reed (R-Indiana). The loophole allows businesses headquartered in other states to avoid paying the state Corporate Net Income (CNI) Tax on their operations in PA. According to the PICPA, House Bill 2150 attempts to eliminate the loophole by requiring companies to “add-back” intangible expenses such as royalties and patent payments that do not have a “valid business purpose” as defined in the legislation. An amendment adopted by members of the House Finance Committee added interest income from a loan made to a related company which must meet the valid business purpose to qualify for a deduction. The bill also lowers the corporate net income tax rate from 9.99 percent to 6.99 percent over a six-year period, gradually uncaps net operating loss carry-forward over an eight-year period, and moves to a single sales factor apportionment for tax years beginning after Dec. 31, 2012.

  In February, the IRS issued the 2012 Exempt Organizations (EO) work plan. For those who work with EOs, the plan “provides an opportunity to understand where the IRS enforcement initiatives will be as the IRS must try to allocate its limited resources efficiently.” Historically, the IRS EO Division has focused its enforcement efforts on particular categories of tax-exempt organizations or particular issues. The 2012 work plan exempt organizations list includes: Legislative Implementation Compliance: Using the Form 990 Collaborative Efforts General Work Detailed information regarding focus topics within each of these areas is included in the March 2012 issue of Nonprofit Standard. In addition to the 2012 Exempt Organizations Work Plan, the newsletter contains articles on cost allocations for nonprofits, best practices for travel and expense reimbursements, bonuses and incentives for tax-exempt organizations, and more.

    The IRS is proposing that taxpayers that have an employer identification number (EIN) will be required to update their information with the IRS. At issue is that EINs - which are issued to employers, sole proprietors, corporations, partnerships, nonprofit associations, trusts, estates, government agencies, certain individuals, and other business entities for tax filing and reporting purposes – are commonly issued to representatives acting on behalf of an applicant.  However, that representative may subsequently lose its authorization to represent them. To address this, a proposed revision to Form SS-4 (Application for Employer Identification Number) would require the disclosure of the applicant’s “responsible party” and that person’s SSN, individual taxpayer identification number, or EIN. Note – it is proposed that this change would apply retroactively to all persons possessing an EIN, as well as to new applicants. To read more see the Federal Register, Volume 77, No. 50.    

  In order to help struggling tax payers, the IRS announced a major expansion of its “Fresh Start” initiative. This will provide new penalty relief to the unemployed and make installment agreements available to more people.   Under the expansion, certain tax payers who have been unemployed for 30 days or longer will be able to avoid failure-to-pay penalties. The dollar threshold for taxpayers eligible for installment agreements would be doubled, increasing the number of people who would qualify for the program.   One of the biggest factors a financially distressed taxpayer faces on a tax bill is the failure-to-pay penalties. A six-month grace period will be made available for certain tax payers. However, even with the new penalty relief available, the IRS continues to encourage taxpayers to file on time, or request an extension.   Expanding the installment agreements will allow more tax payers the ability to catch up on back taxes. The agreement will allow those who owe up to $50,000 in back taxes to enter into a streamlined agreement that stretches the payment out over a series of months or years, which will reduce the tax payer’s burden.   To read more about the changes in the “Fresh Start” initiative and the specific changes to the failure-to-pay penalties and installment agreements, see the full article on the IRS’ website.

  Late in 2011, the Internal Revenue Service released new regulations on the treatment of certain costs incurred relating to tangible property. The new regulations provide guidance on issues such as materials and supplies expenses and safe harbor for routine maintenance expenses on tangible property. These temporary deductions will affect some of the regulations that have been in place since 2008 regarding tangible property. The new rules provide clarity on the following –      What constitutes an improvement to a unit of property      Whether an expense is attributable to a building improvement      Disposition of property      The definition of a unit of property      Revisions to loss recognition rules There is an opportunity for taxpayers to take advantage of these temporary regulations. Costs that would have otherwise been capitalized may qualify as deductible costs under this new regulation. In some cases, a ‘catch – up’ deduction will help taxpayers capture missed deductions in the year of their method change.   

  FASB is listening to its constituents. In response to feedback from respondents, FASB has put forth a proposal intended to reduce costs and simplify the guidance for testing indefinite-lived intangible assets, other than goodwill for impairment. Currently under Topic 350, Intangibles-Goodwill and Other, indefinite-lived intangible assets are required to be tested for impairment annually, or more frequently. In addition to these frequent tests, guidance for evaluating impairment indicators for long-lived tangible assets included in Topic 360, Property, Plant, and Equipment must not be ignored. However, responding to feedback, FASB decided to simplify the guidance testing. There were many concerns about the recurring cost and complexity of calculating the fair value of indefinite-lived intangible assets when the risk of impairment is unlikely. Therefore, it was suggested that the Board consider a qualitative approach or other alternative approaches for assessing indefinite-lived intangible assets for impairment. Under the proposal, Topic 350, Testing Indefinite-Lived Intangible Assets for Impairment, an organization can assess qualitative factors to determine whether performing the quantitative impairment test is necessary. This would save the organization from having to calculate the fair value of an asset unless the qualitative assessment shows that it is “more likely than not” that the asset’s fair value is less than it carrying amount. The amendments would be effective for annual and interim impairment tests performed for fiscal years beginning after June 15, 2012, and early adoption would be permitted. For more information, see FASB’s website.

  The IRS recently announced that it has reopened the Offshore Voluntary Disclosure Program (OVDP), which will continue for an indefinite period of time.  The OVDP allows for reduced penalties for taxpayers who voluntarily disclose their offshore bank accounts or other assets that have not been properly taxed in the US. It is similar but not identical to the disclosure programs that were available in 2011 and 2009. So far, collections in back taxes and penalties under those programs total $4.4 billion. Participants in the program file all original and amended tax returns for up to eight years, and pay the associated back taxes, interest, and penalties. Participants generally pay a penalty of 27.5% of the highest aggregate balance in foreign accounts during the eight years prior to disclosure. However, accounts not exceeding $75,000 are subject to a 12.5% penalty, and taxpayers in certain situations may qualify for a 5% penalty. If a taxpayer shows reasonable cause for noncompliance, no penalty is imposed. Taxpayers who believe the penalty is unwarranted in their case may choose to opt out of the program and submit to an IRS examination. The IRS is becoming more adept at discovering hidden assets overseas. For those who willfully fail to report their foreign accounts or assets and do not participate in the OVDP, the law allows for a penalty of $100,000 or 50% of the balance of the undisclosed account each year. It is suggested that taxpayers who own unreported foreign accounts or assets consult an attorney and carefully weigh the financial consequences of participating in the program or opting out.  

A recent U.S. Tax Court case (Estate of Liljestrand) reminds us that proper planning is essential when forming a Family Limited Partnerhship (FLP).  The Court included the FLP assets in the estate and hit the taxpayer for an additional $2.5 million in estate taxes.  The Court stated a number of structural problems in their opinion such as failure to keep proper books and records, commingling of personal and FLP funds, and lack of a proper valuation. You can find more detail on Estate of Liljestrand in Trusts & Estates. This case is just one more demonstration of the importance of careful planning  and due diligence when your family's succession plan is at stake.  Be sure to choose proven valuation and tax professionals that are well qualified to assist with the critical task of transferring wealth to the next generation.