business issues chapter 6 pp. 177 - 222 2015 national income tax workbook™

Business Issues Chapter 6 pp. 177 - 2222015 National Income

Tax Workbook™

Business IssuesP. 177

1. Net Investment Income Tax & Grouping Considerations.

2. Sale of Section 1250 Property.3. Business Travel Expenses.4. Car and Truck Expenses.5. Form 1099-K Payment Card and Third Party

Network Transactions6. Businesses under Common Control.

Net Investment Income Tax & Grouping Considerations p. 177

Rentals are generally passive activities subject to:▪ Passive Activity Limits (PAL) and ▪ Net Investment Income Tax (NIIT).

Rentals are nonpassive if the taxpayer:▪ Is a real estate professional and ▪ Materially participates in each rental

activity.

Net Investment Income Tax & Grouping Considerations p. 178

Two methods to group activities to meet:▪ Material participation and thus▪ Re-characterize passive rental income to

nonpassive rental income1.Real Estate Professionals can elect to treat all rentals as one activity.

If rental income is nonpassive & from a trade or business it is not subject to NIIT

2.Regs allow grouping of trade or businesses to meet the material participation rules.

Exclusions from Net Investment Rental Income p. 178

Rental income is generally passive.

Rental income can become nonpassive if:▪ The activity is self-rental or▪ The activity qualifies as a trade or

business or▪ The taxpayer elects to group passive

rentals with nonpassive activity and materially participates in the grouped activity.

Exclusions from Net Investment Rental Income p. 178

Self Rental:▪ If gross rental income is from a trade

or business it is considered nonpassive &… ▪ since it is nonpassive…▪ the gross rental income is excluded

from NII if the taxpayer materially participates in the trade or business.

Exclusions from Net Investment Rental Income p. 178, Ex 6.1

Mary owns land she rents to her family owned PS.

Mary’s husband’s farm activities meet the material participation test.

Her husband’s work is attributed to Mary. Mary’s rental income is excluded from NII

under the self rental rule.

Planning Pointer – There is a downside:▪ Losses from self-rentals are still subject to

passive activity loss limitations.

Trade or Business Exception p. 178

Rental real estate in a trade or business of a real estate professional is:▪ Nonpassive and ▪ Not subject to NIIT

Rental real estate NOT in a trade or business of a real estate professional is:▪ Nonpassive BUT ▪ Is NII and subject to NIIT

Trade or Business Exception pp. 178 - 179

To be a real estate professional one must:▪ Spend more than 750 hours

materially participating in real property trade or business AND▪ Spend more than 50% of one’s time

in trades and businesses materially participating in real property trade or business(es).

Trade or Business Exception pp. 178 - 179

Seven Tests for Material Participation:1.TP spends more than 500 hours on activity.2.TP’s participation in activity is substantially all of the time spent on the activity.3.Participation is more than 100 hours and more than any other individual’s time on the activity.4.Participation is more than 100 hours and participation in similar activities is 500 hours.5.Taxpayer materially participated in 5 of 10 preceding years.6.Taxpayer materially participated in 3 years preceding current year in a personal service activity.7.Facts & circumstances show regular continuous activity.

Election to Treat All Rental Real Estate Activities as a Single Activity p. 179

Real Estate Professional must materially participate in each separate rental property to make the rental income nonpassive and exempt from NIIT.

To more easily meet the material participation rules the RE Professional can elect to treat all rentals as one via grouping the rentals.

Grouping Activitiespp. 179 - 180

General Rule – You group once and are stuck with that grouping.

Exceptions:▪ Original grouping was not an appropriate

economic unit.

▪ There’s a material change in facts & circumstances.

▪ You can regroup (one time only) in the first year after 2013 in which the taxpayer meets the threshold for NIIT.

Appropriate Economic Unitp. 180

To group the activities must be an appropriate economic unit.

Five factors used to determine if there is an appropriate economic unit:1. Similarities and differences2. Extent of common control3. Extent of common ownership.4. Geographical location.5. Interdependence between or among the

activities.

Appropriate Economic Unitp. 180

Election to group made by attaching a statement to the return which includes:▪ Names, addresses and employer

identification numbers of all trade or business or rental activities that are being grouped and▪ Declaration that each group is an

appropriate economic group.

Grouping Real Estate with Other Trade or Business Activities

p. 180 Rental activities can be grouped with a trade or

business so that the rental income becomes nonpassive and not NII.

To combine rentals and nonrentals:▪ The activities must form an appropriate

economic unit ▪ and▪ One activity must be insubstantial to the other

or▪ Ownership must be the same

Rental Activity is Insubstantialp. 180, Ex 6.2

Norm & Tom operate a CPA practice. They purchase an office building. They lease 10% of the building to a law

firm. Norm and Tom can group the real

estate rental activity with their CPA practice.

The rental income is not subject to NIIT.

Suspended Passive Losses & Grouping p. 181

Suspended losses of a passive activity are allowed to offset future income of the activity even though the activity became nonpassive as a result of grouping.

Generally suspended losses are allowable in the year the activity is disposed of.▪ Exception: If you have grouped activities

they are one and thus the suspended losses are only deductible when all parts of the grouped activity are disposed of.

Sale of Section 1250 Propertyp. 181

IRC §1250 Property – Depreciable real property other than §1245 property.

IRC §1245 Property – Depreciable personal property & certain real property.


IRC §1250 Property – Depreciable real property includes:

▪ Residential real property, commercial buildings and general-purpose barns unless acquired prior to 1987 and depreciated using regular ACRS.

▪ If acquired prior to 1987 and depreciated using ACRS these are §1245 property.


IRC §1250 Property – Gain from sale taxed as:▪ Ordinary income to the extent allowed or

allowable depreciation exceeds straight line depreciation.▪ At 25% to the extent of allowed or

allowable straight line depreciation.▪ Capital Gain to the extent gain exceeds

allowed or allowable depreciation.

Sale of Section 1250 Propertyp. 181 Ex. 6.3

1975 Ima bought commercial bldg. $275,000 Allocated to land ( 50,000) Building $225,000

2015 Ima sold commercial bldg. for $575,000 Allocated to land in contract (300,000) Building $275,000 Building was fully depreciated by sale date. What’s her gain and how is it taxed?


Observation:

There is no ordinary income from the sale.

Since the building was fully depreciated the allowed accelerated depreciation does not exceed the allowed straight line depreciation.

Sale of Section 1250 Propertyp. 182 Ex. 6.3, Fig. 6.1

Land BuildingSales Price $300,000 $275,000Cost $ 50,000 $225,000Depreciation ( 0) (225,000)Adjusted Basis $50,000 ( 50,000) 0 ( 0)Gain $250,000 $275,000§1250 Recapture ( 0) ( 0)Unrecaptured §1250 gain (Depre)

( 0)

(225,000)

§1231 Capital Gain $250,000 $ 50,000Pages 182 – 186 show placement on tax Forms & Worksheet.


Practitioner Note: Ima used the building in her trade or

business…..▪ Therefore the gain is not NII and is

not subject to NIIT. If the building had been a passive

investment or rental property it would have been subject to the additional 3.8% NIIT.

Accountable Planp. 187

Reimbursement of business expenses under an “Accountable Plan” are not included in the recipient’s income.

Under an “Accountable Plan”:1. Expenses must be business expenses,2. Employees must account to employer in a

reasonable time period (generally 60-days), &3. Employees must return any excess

reimbursement in a reasonable time period (generally 120-days).

Accountable Planp. 187

An “Accountable Plan” must:1. Expenses must be business expenses,2. Employees must account to employer in a reasonable time period (generally 60-

days), &3. Employees must return any excess reimbursement in a reasonable time period

(generally 120-days).

Failure to comply with all three of the rules for an “Accountable Plans” means:

1. Reimbursements are reported as taxable income to the employee.

2. Employee can deduct the business expenses on Form 2106 and then Sch A.

3. Employee must have records of bus. expenses.

Per Diem Allowancep. 187

Business can pay workers a Per Diem in lieu of actual business expenses.

Per Diem can cover Meals & Incidental Expenses (M&IE) as well as Lodging.▪ Record of expenses are not needed.▪ Records of date, place and business

purpose must be maintained.


Per Diem rate is lesser of employer’s per diem or Federal Gov’t’s rate for location.

Federal Gov’t rates are updated annually in IRS Notices and are on the GSA website (textbook page 188) at www.gsa.gov/perdiem

Practitioner Notep. 187

Incidental Expenses Limited to Some Tips:Per Diem rate includes M&IE.▪ Incidental expenses includes tips.▪ Travel between lodging and places of

business, to get meals, etc., while traveling can be deducted in addition to M&IE.


Per Diem rate can be used by:▪ Employers and employees,▪ Businesses for independent contractors,▪ Partnerships for partners,▪ Entities for volunteers

Related parties and self-employed individuals must use actual lodging costs but can use the Per Diem portion of M&IE.

Per Diempp. 187 - 188

Per Diem is limited to the Federal rate.

Federal employees are limited to 75% of M&IE on the first and last day of travel.

Taxpayers must also adjust the first and last day of M&IE travel but do not have to use the Gov’t 25% reduction and can use any reasonable, consistent method.

Practitioner Notep. 188

Fiscal Year V Calendar Year:Per Diem is limited to the Federal rate.Federal rate is based on Gov’t 9/30 fiscal year.So rate changes on Oct 1st.Taxpayers can choose to use the:▪ Gov’t rate for nine months for the whole

year or▪ Allocate & use the different Gov’t rates.

Per Diem Reimbursementpp. 188 – 189 Ex. 6.4

Mary traveled on Sunday & Thursday. She attended a business conference Monday thru

Wednesday. She spent 4 nights in a hotel. Lunch was included in the conference. Federal per diem for the area is:▪ M&IE $ 71.00▪ Lodging 219.00▪ Total $290.00

What should be her per diem reimbursement?

Per Diem Reimbursementpp. 188 – 189 Ex. 6.4

NightsLodging

Work Days

Travel Days

Per Diem

Lodging 4 X $219 $ 876.00M&IE $71 X 3 213.00

M&IE$71 X 2 X 75% 106.50

Per Diem $1,195.50She can exclude the reimbursement from income.

If she spent less than reimbursed she can keep the savings.If she spent more – Deduction on Sch A subject to 2% AGI limit.

Per Diem p. 189

Practitioner Note:▪ Cohan Rules allows estimation of

expenses.▪ §274, IRC, prohibits estimation (Cohan

Rule) for travel, entertainment and gifts.

Reconstructing Records:▪ For suggestions see the 2014 Text Book,

pages 398 – 402 which is on your CD.

Related Party & Self-Employed Rulesp. 189

Related parties can use per diem rates for M&IE but not for lodging.

For lodging related parties must use actual expenses and have records for the expenses.

Related Parties are defined in §267(b)(1) thru (13)

Substantiation by Related Partyp. 189 Ex. 6.5

Same as Ex. 6.4 but Mary is the sister of company’s owner. Mary traveled on Sunday & Thursday. She attended a business conference Monday thru

Wednesday. She spent 4 nights in a hotel. Lunch was included in the conference. Federal per diem for the area is:▪ M&IE $ 71.00▪ Lodging 219.00▪ Total $290.00What should be her per diem reimbursement?

Per Diem Reimbursementp. 189 Ex. 6.5

NightsLodging

Work Days

Travel Days

Per Diem

Lodging 4 X $219 $ 876.00M&IE $71 X 3 213.00

M&IE$71 X 2 X 75% 106.50

Per Diem $1,195.50Unless she is required to report actual to her employer with

substantiation she must include the $876.00 in income and can deduct as an employee business expense if she has substantiation.

Deduction Limitationp. 190

§274(n) limits M&IE deductions to 50%. Sole proprietor applies the 50% to the Sch C

deduction. Employer reimbursing via an accountable plan is

limited to deducting 50% of the M&IE actual or per diem reimbursement.

50% limitation for an independent contractor:▪ Controlled by an agreement between parties.▪ If no agreement – The one who is ultimately

paying the M&IE is limited to deducting 50%.

Deduction Limitationp. 190

Don’t Forget Some Exceptions:▪ Transportation workers subject to

Dept. of Transportation service hours may deduct 80% of meal expenses instead of 50%.▪ They can elect special rates.▪ They do not have to use the Gov’t

local rates.

Car & Truck Expenses p. 190

Deduction Options:A.Standard Mileage Rate (SMR) orB.Actual Costs:

Operating costs – Gas, oil, repairs, etc. plus

Fixed Costs – Depreciation, lease, license, insurance, etc.

Standard Mileage Rate p. 190

SMR can be used for owned & leased vehicles.

SMR must be elected in the 1st year vehicle is placed in service

Later years can use the SMR or actual expenses but depreciation is then limited to SL.

Business Standard Mileage Rate p. 190 Fig 6.5

Year Business SMR

2013 56.5¢2014 56.0¢2015 57.5¢

Don’t forget you have these and other rates in a Chapter at the end of this text book and on your CD.

SMR Eligibility pp. 190 - 191

SMR CanNOT be used if: 5 or more vehicles are used in business at the same time

Depreciation other than SL has been claimed (including §179 deduction)

The vehicle is leased AND actual expenses were claimed on it after 1997.

TP is a rural mail carrier & received qualified rimbursement.

Practitioner Note: Vehicles used for hire (taxis, etc) did not qualify prior to 2011 but qualify now.

Additional Expenses p. 191

Expenses deductible in addition to the SMR:

Ad valorem taxes (PP, etc) on Sch A (as an itemized deduction) but SE taxpayers deduct business % on Sch C Parking fees & Tolls but no Penalties or Fines. Business portion of Interest: Employees -- No Deduction (Personal interest) SE taxpayers – Deductible on Sch C: Ex 6.6 -- 80% bus use x interest on car loan = Sch C Interest Deduction

Depreciation Component pp. 191

SMR includes a depreciation component.

The depreciation component reduces basis but not below zero.

Figure 6.6, page 191 shows the depreciation component in the SMR from 1994 thru 2015…….

Mileage-Based Depreciation Ex 6.7, Fig. 6.7 pp. 191 -

192 Year Miles x SMR Dep. Rate Dep Adj. Basis Gain S/P $15,000 Cost $34,000 Dep 2011 14,000 x 0.22 = $3,080 2012 18,400 x 0.23 = $4,232 2013 19,700 x 0.23 = $4,531 2014 17,500 x 0.22 = $3,850 2015 18,100 x 0.24 = $4,344 Total Depreciation $20,037 ( 20,037) Adj Basis $13,963 (13,963) Section 1245 Gain (Taxed as Ordinary Income) $ 1,037

Depreciation Deduction Limits

p. 193 Automobiles, pick-ups, vans & SUVs are: 5-year MACRS property Eligible for the §179 if used more than 50% in business.

However, §280F limits depreciation (including §179) deductions on passenger automobiles -- But, what is a passenger automobile?

Passenger Automobile p. 193

Passenger automobiles are: 4 wheeled vehicles made for use on the road Cars weighing 6,000 pounds or less –

unloaded. Vans or trucks weighing 6,000 pounds or

less – loaded.

Heavier vehicles are not subject to the depreciation caps of §280F and…..

Passenger Automobile p. 193

Passenger automobile does not include non-personal use vehicles such as–

Ambulances and hearses used in the business.

Vehicles for hire to transport people or property – taxis, delivery vehicles, etc

Qualified non-personal use trucks or vans. ▪ See list on p. 198.

Depreciation Limits p. 194

Figure 6.9 gives the §280F depreciation limits for passenger automobiles.

Recovery period is extended if Dep deduction is limited by caps.

2013 -- $8,000 can be added to the §280F limit if the additional first year depreciation is claimed on the vehicle.

2015 – No Additional First Year Dep.

Depreciation Limits Ex. 6.8, Fig. 6.10 p. 194Sec §280F Depreciation limit:June 2015 Bgt 5,000 pound auto – W/O With100% used for business Limit §280FCost $30,000 $30,000DepreciationMACRS 1st yr 20% x $30,000= ( 6,000)Maximum under §280F= ( 3,160) Adjusted Basis $24,000 $26,840 MARCS 2nd yr 32% x $30,000= ( 9,600) Maximum under §280F= ( 5,100) Adjusted basis at end of 2nd yr $14,400 $21,740

Sec. 179 Deduction p.195

Section 179, IRC, Automobile Expense Deduction : Can deduct all or part of cost of §1245 property in

year placed in service -- Maximum is $25,000. Phased out dollar for dollar if more than $200,000

placed in service in the 2015. Limited to net income from active business. Must be purchased from an unrelated party. Must be used more than 50% in trade or business. Acquisitions for activities for profit (such as rentals, etc) do not qualify Only the business use portion (%) qualifies for

§179 deduction.

Sec. 179 Deduction Limit for SUVs p.195

SUVs have a $25,000 §179 limitation.

However, this has no effect in 2015 since the overall limitation is also $25,000.

Four wheeled vehicles, weighing less than 14,000 pounds and not a bus,

pickup, van, etc.

Adjustment for Business UseEx 6.9 p. 195

2015 bought & put in service SUV. Weight = 6,500 pounds Cost = $40,000. Business use = 60%. Not subject to §280F limit since weighs more

than 6,000 pounds. Depreciable basis = 40,000 X 60% = $24,000 The entire $24,000 can be deducted using

§179.

Related Party Transactions

p.195Sec 179 Automobile Deduction Expense.

Purchase must be from an unrelated party:

Acquisitions via gift or inheritance, etc do not qualify. Must be bought.

Cannot be bought from a member of a controlled group.

Cannot be bought from family…BUT.. for this purpose family means only spouse, ancestors and lineal descendants so purchase from brother or sister is ok.

Related Party Disqualification Ex. 6.10 p. 195

▪ Pick-up bought from corporation.

▪ TP and spouse own 51% of corporate stock.

▪ Bought from “related party”.

▪ No §179 deduction.

Use in Lodging BusinessEx. 6.11 p.196

Vehicles used primarily in lodging rentalactivity do not qualify under §179 unless:

▪ Rental is a hotel or motel renting to transients OR

▪ It is available on same basis to people using and not using the lodging facility (Ex. Taxis, tours vans, etc)

Ex. 6.11 – 7,100 pound SUV bought and used in B&B business. Average rentals less than 7-days. Not a rental. Can expense entire $25,000 cost under §179.

Variable Business Use p. 196

Vehicle has business and personal usage which varies from year to year.

Cost basis is adjusted for change in bus. use before depreciation is computed.

If business % is less in a later year there maybe no depreciation deduction in that particular later year.

But, no recapture of §179 unless bus % drops to 50% or less, or vehicle is sold.

Fluctuating Depreciable BasisEx. 6.12, Fig 6.11 p. 196

Year Cost Basis

BusUse

Bus.Basis

§179Adjust

SL Dep

Basis

SLDep

TotalDeduction

2010 40,000 90% 36,000 25,000 11,000 1,100 26,100


Year Cost Basis

BusUse

Bus.Basis

§179Adjust

SL Dep

Basis

SLDep

TotalDeduction

2010 40,000 90% 36,000 25,000 11,000 1,100 26,1002011 40,000 80% 32,000 25,000 7,000 1,400 1,400


Year Cost Basis

BusUse

Bus.Basis

§179Adjust

SL Dep

Basis

SLDep

TotalDeduction

2010 40,000 90% 36,000 25,000 11,000 1,100 26,100

2011 40,000 80% 32,000 25,000 7,000 1,400 1,400

2012 40,000 60% 24,000 25,000 -0- -0- -0-

No depreciation deduction in 2012 because Business basis is less than depreciation (including §179) already deducted.

§179 Deduction does not reduce depreciable basis below 0.


Year Cost Basis

BusUse

Bus.Basis

§179Adjust

SL Dep

Basis

SLDep

TotalDeduction

2010 40,000 90% 36,000 25,000 11,000 1,100 26,1002011 40,000 80% 32,000 25,000 7,000 1,400 1,400

2012 40,000 60% 24,000 25,000 -0- -0- -0-2013 40,000 70% 28,000 25,000 3,000 600 600

2014 40,000 90% 36,000 25,000 11,000 2,200 2,2002015 40,000 80% 32,000 25,000 7,000 700 700

$ 31,000

§179 Recapture Upon Sale p. 197

§179 deductions are depreciation.

So when there is gain on sale or exchange there can be:▪ §1245 property recapture

resulting in ordinary income.

§179 Recapture Upon Disposition Ex 6.13 p. 197

2013 John bought truck. Weight = 6,900 Cost = $36,000 Business use = 100% §179 Deduction claimed = $20,000 2015 John sold truck for $17,500 Depreciation and gain are….

§179 Recapture Upon Disposition Ex 6.13, Fig 6.12 p. 197100% Business Use:

Dep.Basis

Rate Cost Recovery

AdjustedBasis

Gain

SP $ 17,500Cost $36,0002013 §179 $36,000 $20,0002013 AFYD $16,000 50% $ 8,0002013 MACRS $ 8,000 20% $ 1,6002014 MACRS $ 8,000 32% $ 2,5602015 MACRS $ 8,000 9.6% $ 768Cost Recovery $32,928 ( 32,968)Adj. Basis $ 3,072 ( 3,072)§1231 Gain Ord Inc Form 4797 $ 14,428

Listed Property p. 197

All vehicles are “Listed Property” Bus use is 50% or less:▪ SL Dep and no §179 deduction

Bus use is more than 50%:▪ MACRS Dep & §179 deduction allowed.

Above test uses only trade or business use. For dep. deduction use trade or business %

and / or profit activities (rentals, etc) %.

Substantiation of Business Use pp. 197 - 198

Must substantiate business use for listed property: ▪ Amount of expense; ▪ Date and place of expense or use of vehicle;▪ Business or investment purpose of expense.

Exception to substantiation rules for Qualified Non-Personal Use Vehicles. ▪ Such as ambulances, hearses, cement mixers,

etc ▪ List on page 198

Aggregation & Sample Use Exs. 6.14 & 6.15 pp. 198 - 199 Single record for uninterrupted

business trips is acceptable.▪ Ex. 6.14, Page 198

Record for part of year can be used as a sample to prove entire year.▪Reg. 1.274-5T(c)(3)(iii).▪ Ex. 6.15, Page 199

Other Car & Truck Expense Issues p. 190

§179 deduction must be recaptured if bus use of listed property falls to 50% or less.

Recapture amount due to change in business use is subject to both income and SE tax.

Recapture from a sale is treated as sale of §1245 property and not subject to SE tax.

Business Uses Decreases to 40%Ex. 6.16 p.199 - 200

2013 Marcia bought truck. Cost = $30,000 Weight = More than 6,000 pounds. Not subject to §280F 2013 and 2014 = Business Use = 100% Claimed §179 deduction = $10,000 2015 Business use dropped to 40%

What is the recapture income amount?What is the basis in the truck?

What is the depreciation in 2015?

Business Uses Decreases to 40%Ex. 6.16, Figs 6.13, 6.14 & 6.15 p.199 - 200

Basis Rate Dep Total Dep Cost $30,000 2013 §179 $10,000 2013 MACRS $20,000 20% 4,000 2014 MACRS $20,000 32% 6,400 Total actual depreciation claimed $20,400 $20,400In 2015 bus use dropped to 40% Allowable Depreciation: Total §179 -0- 2013 SL $30,000 10% $ 3,000 2014 SL $30,000 20% $ 6,000 Total allowable depreciation $ 9,000 ( 9,000) §280F Recapture (Ord. Income & subject to SE Tax) $11,400

2015 Adj. Basis in truck is $21,000 (30,000 – 20,400 + 11,400)2015 Dep = $30,000 x 40% Bus Use x 20% Rate = $2,400.

Leasing an Automobile p. 200

Listed Property Rules Apply to Leased Vehicles Section §280F Inclusion – Lease amount is reduced

by an inclusion amount for rentals over 30-days for: Passenger cars with a FMV over $17,500 Trucks and Vans with a FMV over $18,000

“Inclusion amounts” are in Rev Proc 2015-19 and Text Chapter “Tax Rates & Useful Tables”.

100% Business use – Use table amounts Bus & Personal use – Use table & Adjust.

Trade-In (Like Kind Exchanges) p. 201 §1031 – No gain or loss recognized on

exchange of qualifying property.

Usually, basis of new asset is the adjusted basis of traded-in property plus / minus any boot.

If there is an exchange the §1245 recapture from the exchanged vehicle carries over to the replacement vehicle.

Employer-Provided Vehicle p. 201

Employee excludes from income the business portion of usage.

Use of Qualified Non-Personal Use vehicle is excludable.

FMV of personal usage is taxable and should be on W-2.

Employee needs to keep record of use.

Employer deducts 100% of expense.

Form 1099-K Payment Card and Third Party Network Transactions p. 201

Form 1099-K Payment Card and Third Party Network Transactions is an informational filing that reports income that was generated through:▪ Payment card transactions and ▪ Third-party network transactions.

Effective in 2012.

Who Must File A 1099-K pp. 201 - 202

Payment Settlement Entity (PSE)is responsible for:▪ Filing the 1099-K and ▪ Providing a “participating payee”

a statement of filing. A PSE is obligated to make

payments (or provide instructions) to a “participating payee” of a reportable payment transaction.

Bank and Credit Cardsp. 202 Ex. 6.17

Rob paid his grocery bill with a credit card. The grocery store’s bank has an obligation

to pay the funds from the sale to the grocery store.

That transaction is reported on a 1099-K. Rob also got a cash advance on his credit

card. The credit card company does NOT have to

issue a 1099-K since the money went to the card holder.

Online Providersp. 202 Ex. 6.18

Sam started an antique business in his home.

He contracted with an online provider to help sales through auctions.

Sam’s customers buy antiques through the online provider.

The online provider then transfers the sale proceeds to Sam.

The online provider must file a Form 1099-K.

Avoiding DuplicationWho is a “Participating Payee?”

p. 202 To avoid duplicate issuing of Forms 1099-K the

PSE that submits instructions to transfer funds is responsible for the 1099-K. Unless the PSE has contracted otherwise.

“Participating Payee” is any person who accepts:▪ Payment card transactions or ▪ Payment from a third party settlement

organization.

Income on 1099-K is taxed to the Participating Payee

When Form 1099-K Is Requiredp. 202

▪ Payments by payment card – • Regardless of amount or number

of transactions.

▪ Payments through a third party payment network – • When gross amount exceeds $20,000 AND • Total number of transactions exceeds 200.

When Form 1099-K Is Requiredpp. 202 – 203 Ex. 6.19

▪ John used a credit card to purchase an antique chair for $15,000.▪ This was the only sale made by the

antique shop this year.▪ The antique shop’s bank must report

the sale on 1099-K.▪ Number of sales or dollars does not

matter.

When Form 1099-K Is Requiredp. 203 Ex. 6.20

▪ Will contracted with an online provider to sell antique figurines.▪ Will sold 199 figurines through the site in

different transactions.▪ Will grossed $35,000 in sales.▪ The online provider does NOT need to

complete Form 1099-K.▪ Will’s number of sales did not exceed 200.▪ Note: Will stills needs to report his sales.

Content Requirements of Form 1099-Kp. 203

Form 1099-K is similar to Form 1099 reporting information on the Filer, Payee and Transactions.

Practitioner’s Note: A TIN verification system allows PSEs to verify TINs.

Starting in 2015 the Form 1099-K provides the amount of sales where the “Card not present.”

Participating payees should received 1099-K by January 31st.

Confused?Pp. 203 - 204

Instructions for the 1099-K and

1099-MISC try to explain which form is used for reporting which transactions.

Now….. p. 204

Let’s talk about….Businesses Under Common

Control……

Businesses Under Common Control p. 204

Shared ownership (direct or indirect)of disparate businesses can present

unexpected tax issues.

For Example…….

Businesses Under Common Controlp. 204

When can consolidated tax returns be filed or when are they required to be filed?

When do corporations of a controlled group share one graduated tax rate?

When are corporations aggregated for computing AMT?

Are there limits on deductions, losses, etc when transactions involve related parties?

How are the §179 limits applied to business with common control?

And there are more issue too!

Commonly Controlled Corporations p. 205 Ex. 6.21 TPH owns C Corp repairing cars. Taxable income of $50,000 to $75,000 annually. TPW owns dental practice which is a PSC. PSC pays out all profits to avoid 35% PSC tax rate.Are there problems due to relationship? Maybe: TPH’s C Corp may be entitled to only ½ of each corporate

tax rate bracket. If TPW adopts a qualified pension or profit sharing plan

then TPH may have to cover his employees so TPW can avoid non-discrimination tests.

One IRC § 179 deduction is allocated to the 2 businesses. Combined gross receipts might require accrual method.

Controlled Group Relationship p. 205 Ex. 6.22, Fig. 6.16Five individuals have ownership of three corporations as:

Shareholder Hiway Maxcar Walla Villa Ownership Hauling Motors George 30% 50% 5%Vicki 10% 20% 10%Andy 40% 10% 5%Kathy 20% 20% 80%Totals 100% 100% 100%

George and Vicki are cousins.Who is related to who under IRC § 267(b)?

Controlled Group Relationship p. 205 Ex. 6.22, Fig. 6.16

Shareholder Hiway Maxcar Walla Villa George 30% 50% 5% Vicki 10% 20% 10% Andy 40% 10% 5% Kathy 20% 20% 80% Totals 100% 100% 100% None of the individuals are related. Attribution does not make

cousins related parties. George is not related to Maxcar – Must have >50%. Kathy is related to Walla since she owns over 50%. Corporations not related under §267 – No >50% mutual SH. But rules on controlled groups of corporations might bring

some of the corporations under related party rules.

Related Parties Defined§267(b), IRC

Most Common Related Parties under §267(b):1.Family members – brothers, sisters, etc.2.Individual and Corp where individual owns more than 50% of Corp.3.Two corps in a controlled group.4.Grantor & fiduciary of a trust.5.Fiduciaries of trusts with same grantor.6.Fiduciary and beneficiary of trust. 7.Fiduciary and beneficiary of trusts with same grantor.8 thru 13 There are 6 more – See §267(b), IRC.

Affiliated Groups and Controlled Corporations pp. 205 - 206 An affiliated group of corporations may

file a consolidated tax return. One C Corp must own 80% of another C

Corp’s stock. Attribution rules do not apply.▪ But, Corps’ ownership interests can

be combined to meet the requirement.

Direct Ownershipp. 206 Ex. 6.23, Fig. 6.17

Corp # 1 Corp # 2 Corp # 3Corp # 1 0 90% 79%Allan 100% 0 21%Unrelated Mr. X 0 10% 0%Totals 100% 100% 100%

Ownership of Corps #1, #2 and #3 are as follows:

Which Corps are an affiliated group?

Direct Ownershipp. 206 Ex. 6.23, Fig. 6.17

Corp # 1 Corp # 2 Corp # 3Corp # 1 0 90% 79%Allan 100% 0 21%Unrelated Mr. X 0 10% 0%Totals 100% 100% 100%


Corps #1 and #2 are affiliated – 80% common controlCorp 3 is not affiliated.

Combined Ownershipp. 206 Ex. 6.24, Fig. 6.18

Corp # 1 Corp # 2 Corp # 3Corp # 1 0 90% 79%Allan 100% 0% 0%Corp # 2 0% 0% 21%Unrelated Mr. X 0% 10% 0%Totals 100% 100% 100%


Which Corps are an affiliated group?

Combined Ownershipp. 206 Ex. 6.24, Fig. 6.18

Corp # 1 Corp # 2 Corp # 3Corp # 1 0 90% 79%Allan 100% 0% 0%Corp # 2 0% 0% 21%Unrelated Mr. X 0% 10% 0%Totals 100% 100% 100%


All three of the Corps are an affiliated group.

An Affiliated Groups of Corporations p. 206

An affiliated group of corporations may file a consolidated tax return.

Election to file consolidated is made by filing Form 1122 with the tax return by the due date + extensions.

An election applies to all future years and can only be revoked with IRS permission.

Benefits & Disadvantages of Consolidated Returns p. 207 Benefits:▪ Gains and losses of group members can

offset one another.▪ Property sale gains from one member to

another are deferred until property leaves the group.▪ Only one return needs to be filed.

Disadvantage – Complexity, especially if a member leaves or enters the group.

Controlled Groups – IRC Sec 1563 p. 207 Constructive ownership rules apply. Many Code Sections must be aggregated…

including:▪ §11 graduated tax rate structure.▪ §55 AMT exemption.▪ §535 accumulated earnings credit. ▪ §179 expense election.▪ §38 general business credit $25,000 limit▪ Etc….See page 207

Controlled Groups – IRC Sec 1563 p. 208 A controlled group includes:▪ Parent-subsidiary corporations and ▪ Brother-sister corporations.

Component members are treated as single taxpayer for many tax benefits.

S corporations are excluded for some purposes. Constructive ownership rules apply. Only $50,000 of entire group’s income can be

taxed at 15% lowest rate.

Constructive Ownership Rules pp. 208 - 209 Constructive ownership rules apply to

determining whether there is a controlled group.

Examples of Constructive Ownership rules:▪ Stock is owned if there is an option to buy

the stock.▪ Stock owned by a PS is attributed to the

Partners. See pages 208 – 209 for all details.

Controlled Group Definedp. 208 - 210

Parent-Subsidiary: ▪ One corporation owns controlling interest

(at least 80% by vote or value) of the other.

Brother-Sister: ▪ Five or fewer individuals own at least 80%

of two or more corporations and minimum common ownership is more than 50%

Direct and Indirect Ownershipp. 209 Ex. 6.25

Littleco SmallcoBigco 90% 45%

Bigco owns 90% of the stock in Littleco so they are members of a controlled group.Bigco owns less than 80% of the stock of Smallco so they are NOT members of a controlled group…….But suppose Littleco owns at least 35% of Smallco….then….

Direct and Indirect Ownershipp. 209 Ex. 6.25

Littleco SmallcoBigco 90% 45%Littleco 35%All three corps are members of a controlled group because: Bigco owns more than 80% of the stock in Littleco AND Bigco owns 45% of the stock of Smallco and is also considered to own Littleco’s 35% of Smallco so there is 80% common control of Smallco.

Brother Sister Controlled Groupp. 210

Brother-Sister: Five or fewer individuals own at least

80% of two or more corporations and minimum common ownership is more than 50%

So, let’s look at an example where 4 people own stock in 3 Corporations…..

Brother Sister Testing p. 210 Ex. 6.26, Fig 6.19 1st test met: Same 4 people own more than 80%

of stock of each corporation.Shareholder Hiway Maxcar Walla VillaGeorge 30% 50% 5%Vicki 10% 20% 10%Andy 40% 10% 5%Kathy 20% 20% 20%Total 100% 100% 100%

Brother Sister Testing p. 210 Ex. 6.26, Fig 6.19

1st test met:▪ Same 4 people own more than 80% of

stock of each corporation.

BUT now must look at 2nd test:▪ Minimum common ownership must be

more than 50%.▪ This requires looking at ownership of 2

corporations at a time.


2nd test met: Same 4 people own more than 50%

of stock of these two corporations.Shareholder Hiway Maxcar Lowest

George 30% 50% 30%

Vicki 10% 20% 10%

Andy 40% 10% 10%

Kathy 20% 20% 20%

Total 100% 100% 70%


2nd test not met: Same 4 people do not own more than 50%

of stock of these two corporationsShareholder Hiway Walla Lowest

George 30% 5% 5%

Vicki 10% 10% 10%

Andy 40% 5% 5%

Kathy 20% 80% 20%

Total 100% 100% 40%


2nd test not met: Same 4 people do not own more than

50% of stock of these two corporationsShareholder Walla Maxcar Lowest

George 5% 50% 5%

Vicki 10% 20% 10%

Andy 5% 10% 5%

Kathy 80% 20% 20%

Total 100% 100% 40%

Brother Sister Testing p. 210 Ex. 6.26, Figs. 6.19, 6.20, 6.21 and 6.22

All 3 corporations met the 1st test. Hiway and Maxcar met the 2nd test

and so are members of a controlled group.

Walla did not meet the 2nd test and so is not part of the controlled group.

Brother Sister Testing p. 211 Ex. 6.27, Fig. 6.23 What happens if 2 of the individuals in

the prior example are married and the other two are brother & sister?

Well, just for fun let’s say:▪ George and Kathy are married and▪ Vicki and Andy are brother and

sister.

Brother Sister Testing with Family Attribution

p. 211, Ex 6.27, Fig 6.23 Spouses with direct ownership in multiple

corporations are treated as one shareholder. Siblings are not treated as one SH. All 3 corps end up in a controlled group.

Shareholder Hiway Maxcar Walla Villa Lowest

George and Kathy 50% 70% 85% 50%

Vicki 10% 20% 10% 10%

Andy 40% 10% 5% 5%

Total 100% 100% 100% 65%

Special Rules for Spousal Attribution p. 211

Escape hatch for spouses owning separate businesses…….

No spousal attribution for stock if the spouse has in other spouse’s corp:1. No direct ownership and 2. Is not an employee or director and3. 50% or less of corp’s income is from

investment income and 4. No required consent for sale of stock.

Example 6.28: No common control

Practitioner Note and Ex. 6.29pp. 211 & 212

Minor child treated as owning shares in both parents’ corporations.

Separate corporations become a controlled group. Example 6.29: Baby complicates tax situation.▪ TPH and TPW own stock in their respective

corps which are not related because…▪ They meet the 4 tests for non-attribution.▪ But, they have a child.▪ Child indirectly owns 100% of parents’ stock.▪ Corps are now related.

Applying Tax Benefit Limitsp. 212

Corporate benefits are divided evenly by the group unless group agrees on allocation formula.

▪ Benefits include right to apportion the graduated tax rate brackets between corps.

▪ If elect to allocate benefits Schedule O (Form 1120) is filed with each member’s tax return.

▪ Best option - Empty the lower tax brackets.

Equal sharing of benefits is not beneficial if income is unequal or one corp is a PSC.

Application of Limitsp. 212 Ex. 6.30, Fig. 6.24 Hiway and Maxcar are related corps. Taxable incomes: $20,000 for Hiway & $180,000 for Maxcar. Maxcar’s share of tax rates and tax are as follows:

Brackets DefaultAllocation

MaxcarShare

Tax Rate

Tax

0 - $50,000 50% $25,000 15% $3,750$50,000-$75,000 50% 12,500 25% 3,125$75,000-$100,000 50% 12,500 34% 4,250$100,000-335,000 130,000 39% 50,700Totals $180,000 100% $61,825

Impact of using the default allocation & not allocating is....

Application of Limitsp. 212 Ex. 6.30, Fig. 6.24

Equal allocation means that the corps lose the 15% tax rate on $5,000 & Maxcar pays 39% on that $5,000 because

The $20,000 taxable income of Hiway did not use the full $25,000 taxable at 15%.

Brackets DefaultAllocation

MaxcarShare

Tax Rate

MaxcarTax

0 - $50,000 50% $25,000 15% $3,750$50,000-$75,000 50% 12,500 25% 3,125$75,000-$100,000 50% 12,500 34% 4,250$100,000-335,000 130,000 39% 50,700Totals $180,000 100% $61,825

Alternative Minimum Tax Rulespp. 213 - 214

Controlled group must share: One $40,000 corporate AMT exemption. One $2M environmental tax exemption.

Controlled group may be required to aggregate:

Gross receipts with those entities for the $7.5M or $5M small corporation exception from AMT

Plan and Consent Formatp. 214, Fig 6.25

Text Figure 6.25 gives a suggested format for adopting a plan for uneven allocation of:▪ Tax Rates▪AMT Exemption▪General Business Credit Limit▪ §179 Expensing

Limits on Losses & Deductionsp. 215

§267 disallows certain losses and deductions on transactions between related parties.

Related seller cannot recognize loss. Related buyer starts with cost basis,

but can reduce a later gain by first seller’s loss.

Sales Between Related Partiesp. 215 Ex. 6.33

TPH’s corp sells asset to TPW for $ 45,000 $ 45,000Corp’s Adjusted basis ( 75,000)Since they are related the Corp cannot recognize loss of ( $ 30,000) ( -0-)TPW’s basis is her cost $ 45,000

If TPW later sells to unrelated party she can increase her basis up to $30,000 for the loss

the related party could not deduct.

Disallowed Loss – Controlled Group Ex. 6.34 p. 215

If buyer and seller are in controlled group, seller’s loss deduction is deferred until later sale outside of group.

Ex. 6.34:▪ Since same 4 people own 2 corporations they

are a controlled group for related party sales.▪ If one corp sells an asset to another corporation

in the controlled group it cannot deduct any resulting loss.

▪ If the buying corp later sells to unrelated party it can then claim the loss.

§1239 – Related Party Sale of Depreciable Assets

pp. 215 - 216 Ex. 6.35 §1239 - Sale of depreciable property between corps in a

controlled group resulting in a gain is taxed as ordinary income.

Ex. 6.35:Maxcar sells bldg. to Hiway for FMV $400,000Basis $340,000 – Dep $190,000 = ( 150,000)Gain $250,000

Gain taxed as capital if sold to unrelated party. Gain taxed as ordinary if sold to related corp.

Accruals to Related Cash Method Taxpayers p. 216 Ex. 6.36

§267(a)(2) – Accural method taxpayer cannot deduct an amount owed to a related cash basis taxpayer until the recipient reports the item in income.

Ex. 6.36: C Corp owes rent to S Corp owned by one man. All events have passed and C Corp on accrual

method could normally deduct year end rent. But, S Corp on cash method did not receive and so

did not report the rent in the year. C Corp cannot deduct rent until S Corp reports it.

Employee Benefit Rules §414 pp. 216- 217

Businesses operating through multiple entities are treated as single employer for non-discrimination rules.

Common control embraces all business structures including Schedule Cs, P/Ss, Trusts, Estates, C Corps & S Corps.

Determination uses capital and profits interests for ownership.

Example 6.37……..

Employee Benefit Rules §414C Corporation & S Corporation

p. 217 Ex 6.37 C Corp and an S Corp are members of a

controlled group. The corporations are related for purposes of non-

discrimination rules. Employees of both corporations are combined in

applying qualified retirement plan rules, fringe benefit rules and Affordable Care Act coverage rules.

Same result if one of the businesses was a P/S and other was a corporation.

Affiliated Service Groupp. 217

Employees of an “Affiliated Service Group” are treated as if employed by one employer for employee benefit aggregation rules.

“Affiliated Service Group”:▪ Organizations with principal business of

providing services (accounting, law, etc), plus▪ Organizations that are shareholders or partners

in the service provider, plus▪ Organizations that regularly provide services to

the service organization.

Affiliated Service GroupEx. 6.38 p. 217

3 unrelated doctors practice together. Each doctor works for his own corporation. The 3 corporations are partners in a medical P/S. All employees of the corporations and the

partnership must be aggregated in applying non-discrimination tests for qualified plans and fringe benefits.

Rules embrace all forms of business….S Corp, C Corp, sole proprietors, LLCs.

§179 Deduction p. 217

Members of a controlled group (other than excluded members (defined on text page 208)) must allocate one §179 deduction.

The IRS does not say how the allocation is to be made.

No member can deduct more of the 179 deduction than it actually incurred.

§38 General Business Credit p. 218

Members of a controlled group (other than excluded members (defined on text page 208)) must allocate the §38 credits.

IRS is charged with writing Regulations on how to allocate the credits but has not yet done so.

§51 and §52 Work Opportunity Credit p. 218

All commonly controlled businesses are treated as a single employer for computing the credit.

If a worker works for more than one of the businesses the credit is allocated proportionately.

See Examples 6.26 and 6.27, text page 218.

Accounting Methods p. 219 - 220

Accrual method required of most businesses including:▪ C Corporations ▪ Partnerships with C Corp partner(s).▪ Tax shelters

Exempt from accrual method:▪ C Corps and Partnerships with less than $5M in average

gross receipts in most recent 3-year period.▪ Taxpayers with less than $1M in gross receipts.▪ Certain businesses with less than $10M in gross

receipts.

Affordable Care Act Aggregations Businesses with Common Control

p. 221

If two or more companies have a common owner or are related under 414(b),(c),(m), or (o) they are treated as a single employer for determining whether they have at least 50 full time employees for the Affordable Care Act rules to apply.

Common Paymaster Electionpp. 221 - 222

Controlled group of corporations with shared employees can use a paymaster to aggregate wages for FICA and FUTA tax purposes.▪ Could eliminate overpayment of FICA that employee

could get back but employers cannot recoup. One corporation must be designated as paymaster and pay

employees of all corporations.▪ Employees must be employees of the paymaster.▪ Ineligible if separate employers issue pay checks to

employees. Only Corporations qualify -- Other business forms are

excluded.

That’s All for NOLs

business issues chapter 6 pp. 177 - 222 2015 national income tax workbook™

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