Business or a Hobby?

What is the difference between a business and a hobby — and why is it important?

Businesses are motivated by profit, while hobbies are about the joy of the activity not the desire to make a profit. The distinction is important because when you have a business the expenses of the business are deductible and if the expenses exceed the income, the business’s losses are deductible against other income. Hobby expenses are only deductible up to the amount of hobby income and are only deductible for those that itemize as miscellaneous deductions. Hobby losses are never deductible.

While the IRS tends to claim that business activities that don’t make a profit at least 3 out of 5 years are hobby activities and not business activities, the real answer to what is a business as opposed to a hobby according the courts is much more complex and takes into account the following:

  1. Profit motive: Is the activity conducted with the intention to make a profit?
  2. Frequency and continuity: Is the activity operated on a regular and continuous basis?
  3. Expertise: Does the taxpayer have expertise in the field that suggests a business intent?
  4. Investment of time and effort: Does the taxpayer spend a significant amount of time and effort in the activity?
  5. Success in similar endeavors: Does the taxpayer have a history of success in similar business ventures?
  6. Profit and loss history: Does the taxpayer have consistent profitability over time? This may support the claim that the activity is a business, while continuous losses might indicate a hobby.
  7. Changes to improve profitability: Does the taxpayer implement changes or adjustments to enhance the activity’s profitability?
  8. Personal pleasure or recreation: Is the activity primarily pursued for personal enjoyment or recreation? If so, it could be a hobby.
  9. Time and effort spent on other income-producing activities: Does the taxpayer have another source of income and spend more time/effort on that? This might suggest the activity in question is a hobby.

It’s essential to keep thorough records and documentation to support the claim that an activity is a business. Taxpayers should be able to show that they are making a genuine effort to run the activity as a profitable business.

 

1099-K

1099-K Confusion on the Horizon

The American Rescue Plan Act of 2021 lowered the filing threshold for payment processors and credit card companies from 200 transactions or $20,000 to just $600 for 2022 — but the IRS delayed the effective date until 2023.

Because of this taxpayers that use credit card processors PayPal, Venmo and Zelle are going to be receiving a 1099-K for 2023 — even if they only have a few transactions. Worse yet, the IRS is going to be looking to match the income reported on these 1099-Ks to the tax returns filed by these taxpayers.

What can taxpayers do?
Start by letting the payment originators know to mark the payments that are not business related (should not be income and subject to tax) as personal on the chosen platform. If you end up picking up the lunch tab and being reimbursed through Venmo or Zelle be sure to remind your friends to mark the transaction as non-business. This also holds true for gifts, reimbursements, and other non-taxable payments.

At tax time be sure to share these documents, like all tax forms you receive, with your tax professional, so they can see that income reported on 1099-Ks is properly reported on your tax return.

One thing we as tax professionals are sure of is that these 1099-ks are going to generate a lot of confusion for taxpayers in addition to a lot of IRS notices that will need to be delt with long after the 2023 returns are filed.

Hiring People with Disabilities

Employing People with Disabilities

Employing people with disabilities can result in tax benefits for small business.

If your business spends money to accommodate an employee(s) with disabilities it may qualify your business for special tax credits and deductions. Tax credits for making accommodations for disabled employees include the Disabled Access Credit and the Work Opportunity Credit.

What is the Disabled Access Credit and how do you qualify?

Need to remove architectural and transportation barriers to access? You can generally deduct these costs. An eligible small business that incurs an expense to provide access to its premises for employees with disabilities may qualify for the Disabled Access Credit (DAC). An eligible small business is one that earned $1 million and had no more than 30 full-time employees in the previous year. Expenses for barrier removal, that are paid or incurred in connection with any facility first placed in service after November 5, 1990, are not eligible expenses for the DAC.

The DAC is a nonrefundable credit. An eligible small business may claim the credit for each year they incur disabled access expenditures. [See Form 8826, Disabled Access Credit, for information.]

What is the Work Opportunity Tax Credit and how do you qualify?

The Work Opportunity Tax Credit, or WOTC, provides a tax credit for businesses that employ individuals from certain target groups that have faced significant barriers to employment. One of the WOTC’s target groups is workers with disabilities.

The WOTC may be claimed by any employer that hires and pays, or incurs wages for, employees who are certified by a state or local workforce agency as being a member of one of the WOTC’s targeted groups.

Note: to claim the WOTC an employer must obtain certification from the appropriate State Workforce Agency that an individual is a member of a targeted group BEFORE the individual is hired.

Generally, the WOTC is equal to 40% of up to $6,000 of wages ($2,400) paid or incurred for a qualified individual who:

  1. is in their first year of employment;
  2. is certified as being a member of a targeted group; AND
  3. performs at least 400 hours of services for that employer.

A 25% rate applies to wages for individuals who perform fewer than 400 but at least 120 hours of service for the employer.

For more information about the Work Opportunity Tax Credit, call RMS Accounting at 954-563-1269.

IRS Knocking At Your Door?

Unannounced IRS Visits

If someone knocks at your door claiming to be the IRS don’t believe them.

The IRS has ended unannounced visits of revenue agents and other personnel to taxpayers’ homes and places of business.  If you think this is to protect taxpayers, you would be mistaken. According to the IRS this measure is designed to protect IRS employees.

The IRS has announced that it will send an appointment letter, formally known as a 725-B, to taxpayers and schedule a follow-up meeting when a matter needs to be discussed.

However, the IRS will still make unannounced visits in limited cases where the agency needs to serve a summons or subpoena, or when there’s an enforcement action like the seizure of assets at risk of being removed from the U.S. Those instances typically only occur a few hundred times a year, as opposed to the tens of thousands of unannounced visits that IRS’s revenue officers have made in the past years. IRS Criminal Investigation employees, can also still make unannounced visits.

What should you do if someone shows up at your door claiming to be with the IRS? Keep your door closed. Ask them for ID and give them the name and contact information for your tax professional or attorney, do NOT open the door and let them in and do NOT provide them with any other information or answer any questions. They may not be with the IRS or worse yet, they are and anything you say can’t be unsaid.

Selling Appreciated Property?

Delay the Tax With An Installment Sale

When selling property like land, rentals or business property an installment sale may delay the tax and even lower the tax bracket on some of the sales proceeds. An installment sale is when the seller provides part, or all, of the financing for the purchaser and allows the purchaser to make payments over time.

For example, let’s look at a client selling some land and a hunting lodge that was in his family for a number of years and which would be subject to a large capital gain for tax. They sold the land for $600,000 but agreed to take $300,000 down at sale and to take back a mortgage for the balance of $300,000 to be paid at 6% over 10 years.

His tax basis in the in the property was $200,000 making 1/3 of the sales proceeds taxable as it was collected in the year of the sale. $200,000 of the $300,000 down payment was subject to capital gains taxes. In the subsequent years the seller will receive monthly payments of $3,330.39; an annual total of $39,964.68 of which $22,600 will be principal with 2/3 of that $15,066 subject to capital gains taxes and interest income of $1,736.40 subject to ordinary income taxes.

Over the life of the transaction the total amount collected, including the down payment, will be $699,646. Our client was looking at putting the after-tax proceeds in the bank and would have only received 4% interest. Here they get 6% plus get to earn interest on the amount on which the tax is delayed.

Section 1244 Stock

When things go bad on a startup investment in a C Corporation. Section 1244 of the Internal Revenue code allows you to treat certain losses as ordinary on up to $50,000 ($100,000 married filing jointly) in a year instead of a capital loss, which is limited to $3,000 in excess of capital gains.

To qualify the stock / investment must meet the following requirements:

  1. As of the time the stock was issued, the aggregate amount that was received by the issuing corporation for stock, as contributions to capital and as paid-in surplus, must not have exceeded $1 million.
  2. The stock must have been issued for money or property (other than stock or securities). Thus, the stock can’t be issued as compensation for services.
  3. For the five years before the year the loss was sustained, the corporation must not have received 50% or more of its receipts from certain passive sources.
  4. The taxpayer claiming the special treatment must be an individual (including, if certain conditions are satisfied, individuals who claim the loss through holding an interest in a partnership that is selling the stock). The special treatment isn’t available to corporations, trusts or estates.
  5. The stock must have been issued to the individual claiming the special treatment, or to the partnership through which the individual is claiming the special treatment and held continuously by that individual (or partnership) to the time of sale.

Tax Jail Does Exist

Yes, you can end up in jail for hiding income from the IRS.

U.S. citizens and residents are required to report all income received from all sources both inside and outside the U.S. Apart from income specifically excluded for tax under the IRS code, all income is taxable.

The consequences of failure to report taxable income on your tax return can range from the assessment of tax, interest, and penalties to federal prison time.

While we have no debtors prison in the U.S. so the inability to pay your taxes is not a jailable offence, you are required to sign your tax return under penalty of perjury and signing a return that  does not include all income can be considered fraud, depending on the amount of underreporting.

Here are some names you may know that found out just what can happen if you lie on a U.S. tax return.

Al Capone: The infamous American gangster, Al Capone, was not ultimately convicted for his criminal activities but for tax evasion. In 1931, he was sentenced to 11 years in federal prison for failing to pay income taxes on his illicit earnings.

Leona Helmsley: The Queen of Mean, a New York City real estate businesswoman, was convicted of tax evasion in 1989. She was accused of fraudulently billing personal expenses as business expenses. Helmsley served 18 months in federal prison.

Richard Pryor: A well-known comedian was convicted of tax evasion in 1974. He failed to report a substantial amount of income and was sentenced to three years in prison, although he served only 10 months.

Wesley Snipes: The actor was convicted of tax evasion in 2008. He was found guilty of failing to file tax returns and pay federal income taxes for several years. Snipes was sentenced to three years in federal prison and served approximately two and a half years.

Mike Sorrentino: A cast member of MTV’s “Jersey Shore,” pleaded guilty to tax evasion in 2018. He was sentenced to eight months in federal prison for concealing income and submitting false tax returns.

Remember, you don’t have to be famous to end up in prison. The IRS has a criminal investigation division that investigates tax fraud cases referred by tax auditors and others, most of which are ordinary individuals who felt the tax laws did not apply to them.

Reasonable Compensation

What is reasonable compensation for corporate officers and why is it important?

The tax laws require officers of corporations to receive “reasonable compensation, as corporate officers such as presidents, treasurers, CEOs and COO as by law employees of the corporation.”

As employees they must receive wages as payroll with the appropriate taxes withheld and employer payroll taxes paid. S-Corporation shareholders lose the IRS Code Section 199A deduction on passthrough income which could reduce passthrough taxable income by up to 20% (if they do not have reasonable compensation of officer shareholders). The IRS can also reallocate distributions and other items to wages should they determine the reasonable compensation rules are not met, thereby making the corporation liable for additional payroll taxes as well as penalties for late payment of these taxes.

The important question is just how much compensation is necessary for reasonable compensation to be archived. “Reasonable Compensation” is the amount a company would have to pay an unaffiliated third party to fill the position and perform the same or similar duties.

If it seems a little subjective that is because it is. Use too high a number for reasonable compensation and you end up paying more payroll taxes than might be otherwise required. Pay too little and if you are audited you may find the IRS requiring you to make adjustments and pay additional taxes and penalties.  The only thing we are certain about is that ZERO is never a reasonable amount for officers’ payroll and that the minimum should not be less than minimum wage based on the hours worked. The rest depends on the skills and experience necessary, the kind of business and the amount of profits realized by that business.

If you are a corporate officer of a company where you control your own compensation our best advice is to review your compensation amounts at least annually with your tax advisor.

Overtime?

Can employers refuse to pay employees for unauthorized overtime?

I was recently asked by a client if he had to pay overtime to hourly employees who had ignored the company policy that all overtime must be approved in advance. He explained that he had told two of his employees time and time again that they had to punch out each day for lunch and leave their desks and not return for one hour. However, the employees would just ignore this and remained at their desks through lunch. His question “Do we have to pay them for the unauthorized overtime?”

 

The answer is yes; they must be paid for all hours worked regardless of approval.

The Fair Labor Standards Act, clearly states that regardless of whether an employer authorizes overtime, “Work not requested but suffered or permitted is work time.” This includes if the employee violated an employer’s policy of obtaining approval prior to overtime being worked.

What can an employer do? While an employer must compensate an employee for overtime worked, an employer is permitted to establish a policy against unauthorized overtime. Employers can inform all workers that approval is required before overtime is worked and provide disciplinary consequences, including termination of employment, for when that policy is violated. However, a policy is not enough. Employers must actively enforce that policy to ensure that employees comply.

Employees have a legal right to be paid, including overtime payment. Not understanding the rights of employees when it comes to compensation rights can result in fines, penalties and awards of back pay for amounts deemed by state or federal authorities to be due to employees. It’s therefore important for employers to understand their responsibilities and to keep all supporting records and documentation so that they can prove, if called upon, that they have met their legal obligations.

Minimum Wage Update

Do you know the minimum wage for your state?

The current Florida Minimum wage is $11.00 per hour and it increases to $12.00 per hour on September 30,2023. The Federal minimum wage is currently $7.25 and employers must pay the greater of either the state or federal minimum wage in most cases.

Other states have minimum wages that range from $5.15 in Georgia (which is only applicable to a vary small number of businesses that are not subject to the federal minimum wage) to as much as $19.08 for certain California cities.

For a detailed list of minimum wages for 2023 see 2023 Minimum Wage by State – RMS Accounting on our web site.