Author: Jeri Ann

As of this writing on the late afternoon of March 10, 2021, the House and Senate have just passed the American Rescue Plan Act (ARP) and shortly the president is expected to sign it into law. This bill includes many provisions that have major tax impacts for 2020 and 2021 tax returns.

A word of caution is merited as final guidance under IRS regulations does not exist for exactly how to include some items in your filing, but we suggest you start identifying key items that apply to your tax circumstances.

We’ll keep you apprised as things clarify. Below is a bullet-point list of headline items.

• Unemployment benefits: A retroactive tax provisions makes the first $10,200 of unemployment payments nontaxable ($20,400 in the case of a joint return, but only $10,200 per spouse) in 2020 for households earning less than $150,000.
  • Additional provision of a $300 weekly federal unemployment benefit through 6 September 2021
• Economic Impact Payments: Single taxpayers with AGI under $75,000 will receive a $1,400 refundable tax credit, while joint filers with AGI under $150,000 will receive $2,800.
  • In addition, taxpayers will receive $1,400 for each qualifying dependent (including adult dependents).
  • The credit will completely phase out at an income threshold of $80,000 for single filers and $160,000 for joint.
  • The Treasury is directed to issue this credit as an advance payment based on the information on 2019 or 2020 tax returns.
  • It may make sense to delay filing until after payments are disbursed.
• Child Tax Credit: Special rules for 2021 include an expansion of the credit from $2,000 to $3,000 per eligible child under age 18 ($3,600 per child under age 6). Starting in July, the Treasury will issue advance payments of 50% of the child tax credit based on 2019 or 2020 tax return information.
• Earned income credit: For 2021 only, the bill expands the eligibility and the amount of the earned income credit (EIC) for taxpayers with no qualifying children. The maximum credit amount for childless people will increase from $543 to $1,502. For 2021, taxpayers can use their 2019 income if it was higher than 2021.
  • The disqualified investment income limit has increased from $3,650 (2020) to $10,000 and will be adjusted for inflation.
• The act includes other tax changes, such as:
  • Refundability and enhancement of child and dependent care tax credit
  • An individual can receive an advanced premium tax credit (APTC) to lower their monthly health insurance payment (premium).
  • Increase in exclusion for employer-provided dependent care assistance
  • Extension and expansion of the Families First Coronavirus Response Act (FFCRA) paid sick leave and paid family leave credits
  • Extension of employee retention credit
  • Modification of the premium tax credit
  • Change to the tax treatment of targeted economic injury disaster loan (EIDL) advances
  • Exemption of student loan forgiveness from federal taxation through 2026
  • Expanded COBRA continuation coverage premium assistance credit

Many U.S. taxpayers opt to prepare and file their own return.  With the many challenges of 2020, though, you might be thinking of calling a tax preparer to handle your filing this year.  Here are some things to consider:

 

• Make sure the tax preparer has the fulfilled the requirements to prepare and file federal and state returns. At the minimum, all tax preparers should have an IRS Preparer Tax Identification Number (PTIN) for federal returns.  Each state will also have its own qualifications, which are listed in the state’s revenue department.
• Don’t just hire the first person you find. Schedule a phone call or meeting to get to know the preparer before signing an agreement.  Ask questions about critical things like background and experience, but also see how comfortable you feel about the conversation in general.
• Determine what level of tax preparation service you need. Is your return complicated enough to require a tax attorney?  Do you need someone who can represent you on the returns they prepare for you?  The higher the involvement level, the higher the fees you’ll pay — but also the higher your peace of mind in case you need extra support with your filing.
• Get a fee quote before agreeing to work with a tax preparer. Ask if the fee is fixed or a minimum – sometimes a tax preparer will offer a fee that includes a small amount of bookkeeping time, but you’ll have to pay more if it turns out a significant amount of bookkeeping work needs to get done to calculate the return accurately.
• Be careful of “ghost preparers” who will prepare your return but not sign off as preparer. In addition to this being a violation of IRS rules, it is a warning sign that the preparer isn’t properly competent and may be looking to scam you in other ways.
• Finally, DO NOT sign your tax return until you review everything carefully, including your routing and bank account number for direct deposit refunds. If something in the tax return seems off, ask!  Ultimately, you are responsible for the accuracy of your return, even if you pay someone to prepare it.

 

A good starting place on your search is the IRS Directory of Federal Tax Return Preparers with Credentials and Select Qualifications (https://irs.treasury.gov/rpo/rpo.jsf).  But don’t wait too long – the filing deadline is just five weeks away!

 

If you operate your business from your home, chances are high that you’ve been considering how to deduct the use of your home space on your taxes.  The good news: The Internal Revenue Service offers home office deductions for business owners who don’t own or rent space for business operations.  The bad news: Those deductions are subject to specific definitions of what qualifies as a “home office”.

 

I’m very lucky to own a house with more bedrooms than people.  We bought a larger-than-necessary-for-three-people house so we could have space for our visiting friends and family.  But I claimed one room as mine when we moved in.  I installed a closet organization system, bought some bookshelves and a comfy couch, and enjoyed exercising, crocheting, sewing, and relaxing in “my room”.

 

Then I started Sunstone Bookkeeping, and the most logical move was to change “my room” to “the office”.  I bought office furniture and equipment, moved my craft supplies to another room, and set up operations.  I have signs to put on the closed door to warn my family in case I’m on a call or video meeting or working on a deadline (though the signs don’t seem to work on the dogs, as they still feel compelled to loudly let me know there’s a squirrel in the back yard).  I continue to use the space for exercise three mornings a week as well as to read or crochet with the door closed when I need a little decompression time to myself, but most of the time it’s where I conduct business activities.

 

It’s that “most of the time” phrase that prevents me from claiming the space as a home office deduction.  The IRS rules are very clear:  the space (FYI, “space” can mean a room or a specific section of a room) must be used exclusively for business in order to qualify as a deductible expense.  By using my office for any personal activities, the space is no longer exclusively used for business.

 

The most comprehensive source for information on all the specific qualifications and calculations is IRS Publication 587, Business Use of Your Home.  You’ll also find worksheets, information on recordkeeping, and even specific situations for daycare facilities.

 

One more thing to keep in mind: The home office deduction is reported as an audit trigger by several financial sites:

 

https://www.personalcapital.com/blog/taxes-insurance/10-irs-audit-triggers/

https://www.thebalance.com/top-audit-triggers-that-catch-irs-attention-4153034

https://www.hrblock.com/tax-center/irs/audits-and-tax-notices/irs-audit-triggers/

 

That’s not to say you shouldn’t claim the deduction, but you need to make sure that you’ve carefully followed the IRS rules (including – and you know I’m always going to say this – keeping detailed records) in case you are audited.

This week’s tax tip is less technical and more mindful:  I’m going to talk about the positive side of tax season.

What?!!

You heard (or read) me.  “Positive side.” I know – it sounds bizarre, but stay with me:

Every year, when the excitement of the holidays is over and we realize we should probably take down the holiday decorations, the stress and dread of tax season begins for U.S. business owners.

“Ugh,” we moan. “I have to gather all that paperwork and the calculator and the tax software and fill out all these forms and send them in.”

Of course, we do it – because we’re required to by U.S. law.

But in our complaining, we’re overlooking the fact that this annual obligation provides us with something all business owners should have:

A record of the business’s financial performance for the year.

Think about it:  We’re obligated to submit a document that outlines our business’s revenue, expenses, and profit – a document all business owners need to review to run their business!

So, this year, why not try changing your perspective?  Instead of looking at tax preparation as a chore required by law, look at it as a way of reviewing your business’s performance.  You have to do it anyway – might as well do it with a positive mindset!

“OK, you’ve already said that all these business receipts/canceled checks/bills/invoices/register tapes are important to hold on to.  Really, are they THAT important?”

 

Yes.  They are THAT important.  And I mean totally, completely, and unequivocally IMPORTANT.

 

(Yes, bold caps was necessary.)

 

There are many reasons why they are IMPORTANT (yes, that needed to be in bold caps again), but I’ll start with the more timely since I’m writing this in February:  TAXES.

 

You should always prepare your tax filing as if an auditor from the Internal Revenue Service is going to appear at your door the second the paperwork is processed, ready to demand proof of your calculations.  (In fact, your tax preparer has a duty to calculate your taxes as if this exact scenario were to happen.)

 

In other words, if you can’t defend the expenses you claimed, you could be in for a lot of frustration, headaches, and probably some fines and penalties.

 

Therefore … fewer receipts on hand at tax time means less proof of deductible expenses, which means fewer expenses you can deduct, which could mean more taxes that you owe.

 

The IRS Publication 583 “Starting a Business and Keeping Records” may not have the most riveting plotline, but it’s a great reference for all things related to supporting documents.

 

Make your tax filing season less stressful … and save those receipts!

Late in 2020, the Internal Revenue Service (IRS) announced a plan to increase audits of small businesses and their investors by 50% in 2021 and, in a sign that they are serious, put hiring plans in motion to add the capacity.

To be clear, the rate of audits of small businesses has been quite low in recent years, so the increase, while meaningful, doesn’t mean you are assured of being audited. However, your business could be chosen for audit solely by statistical algorithms, or could be flagged because of doing business with someone who is under audit (including an investor/partner/member).

The targeted taxpayers are mostly “pass through entities” including LLCs, LLPs, Subchapter S corporations, and partnerships. It should be noted as well that 2015 legislation made it possible for the IRS to collect underpaid taxes from such entities themselves rather than only chase the partners/members, meaning the business entity itself is at risk now if an audit finds underpaid taxes.

Now, you’re probably thinking, “Well, that’s just dandy.  So what do I do now?”

The last few years have seen a bewildering array of changes in tax laws, so what might be a “red flag” that draws attention today versus yesteryear is probably unknowable.  Our suggestion: Focus on what you can do be prepared if that audit algorithm picks you at random.

The law requires you keep all records relating to tax returns for three years and the IRS usually only audits returns filed in the last three year (more often within the last two years) but if the IRS auditor identifies substantial errors, you might have to provide earlier records.. The auditor may request records such as receipts, bills, cancelled checks, legal papers, loan agreements, logs/diaries, tickets, medical/dental records, theft/loss documents, employment documents (including employee policies), K-1s, and whatever else is relevant to your tax return.

What we strongly suggest is to use your tax preparation as a chance to organize your business records so that you know if you are missing any vital substantiation of expenses or inadvertently underreported income. If you start with the proverbial shoe box of receipts, don’t just dump them back in there after you file your return.  Instead, file them physically in an organized manner that cross-references your return (e.g. keep inventory records together and separate from your auto expenses) or, better yet, enter everything into bookkeeping software with scans of the records attached.

If the worst-case scenario happens and that audit letter hits your mailbox, you’ll be ready to deal with it rather than scrambling in a panic. The side benefit is that you will know how your business really performed, have a clearer view of how to manage going forward, and have the basis for ongoing record keeping that will make next tax season easy and your return able to withstand scrutiny.

Tax Day 2021 in the U.S. is, as usual, April 15 – 74 days away.  Seems like a long time, right?

But for many business owners, because you’re so busy running a business, the annual gathering of the paperwork/receipts/statements/information/all things financial ends up happening waaaaay too close to that filing deadline.

Which means stress, and hurrying, and a higher chance of deductions getting missed or mistakes being made.

So … how about we make 2021 a little different?

Join me on Facebook for a second FREE Five-Day Prepping for Tax Prep Challenge!

We’ll meet for five days in the group, where we’ll guide you on how to locate the relevant information for the different sections of the Schedule C.

The best parts?

1.  No calculator or bookkeeping knowledge required.  We’ll be showing you where to find the information needed to file the taxes, NOT filling out any of the forms.

2. The challenge runs from February 8 to February 12.  There will be a pre-recorded video available each day, plus a live Q&A session each night at 7:00 pm via Zoom.

So, if you want a tax filing season that’s less stressful than usual, click on over to the Facebook group and join us!

The evolving complications of food, meal, and entertainment deductibility are really a sore point for many small business owners. We are not going to blame the IRS for this one – rather, some people in Congress seem to suffer from an unbearable fear that somewhere, someone is having fun, and fun can’t be deductible.

However, with the passing of the Consolidated Appropriations Act of 2021 (the ‘CAA’), it seems as though Congress was willing to allow a bit more “fun” (specifically in the form of conducting business during a shared meal) to be deductible over the next two tax years.  In this post, we’ll review the rules that apply to your taxes for the 2020, then outline the changes for tax years 2021 and 2022.

(Quick clarification: While we speak herein of dining with a “client”, in reality the rules apply to anyone you “reasonably expect to do business with” which can include a customer/client, supplier, employee or potential employee, partner, or advisor.)

General rules:

• Always keep receipts (The IRS says receipts are required for meals over $75, but this bookkeeper is telling you to keep ‘em all!).
• On the receipt, write the name and title of the client and how the meal relates to your business.
• Entertainment – defined as “any activity generally considered to provide entertainment, amusement, or recreation”– is not deductible (see aforementioned unbearable fear of someone having fun). If you do take your client to an event, get a separate receipt for the food to keep the records clear; if the food is lumped in with the “fun” on one bill, none of the expense is deductible.  NOTE:  There are specific rules for things like the buffet in a skybox, so be sure to review those rules carefully.
• The meal cannot be “extravagant”.
• You or your employee must be present at the meal (sending your client take-out is not deductible).
• The meal must be provided to the taxpayer and/or client (if a spouse is at the meal, you must not include the spouse’s costs as a deductible expense).

The IRS allows these expenses to be deducted at 100% of cost for 2020:

• Meals for employees working outside normal business hours due to necessity.
• Food and beverages given out free to the public.
• Food and beverages for events you host for your employees (i.e., holiday parties).

The IRS allows these expenses to be deducted at 50% of cost for 2020:

• Business meals with clients.
• Office snacks (Note: you do not have to include these purchases as income for your employees).
• Meals consumed during business travel.
• Meals out with less than half of company employees.

Now the good news:  For tax years 2021 and 2022, the CAA allows for 100% deductibility of business-related food and beverage incurred at restaurants (including on business travel).  This new rule is a lovely little bread crumb recognizing the devastating impact on the restaurant business due to COVID-19.

Detailed regulations on the new deductibility breakdown have not been released yet, so be cautious. In particular, there is some confusion as to the IRS definition of “restaurant” for this purpose – for example, it’s unclear how the IRS would view the deductibility of the purchase of take-out snacks from a coffee shop for the employee break room.  Stay tuned!

 

Our buddy, Peter, likes to collect comic books, comic-related paraphernalia, and card-based games. He makes a point to get special editions, plays with some packs but keeps other in original packaging. He buys and sells these items routinely.

 

Question:  Is Peter running a business?

Answer:  A solid “maybe”.

 

The Internal Revenue Service has rules about what is and isn’t a business and it’s important.  If your endeavor as a “side-hustle” is deemed a hobby, you cannot deduct what would normally be business expenses and could be taxed on proceeds arising from the activity, after the Tax Cuts and Jobs Act of 2017 suspended deductions for hobby expenses until 2025.

An underlying presumption is that people run businesses to make a profit. If you find yourself thinking “I really enjoy this activity and I just want it to pay for itself” or “If I don’t make a profit in any given year, then I won’t have to pay taxes” then you might have a problem.

There are three things to keep in mind that we’ll discuss in brief here: the safe-harbor provision, deferring determination of business or hobby, and the nine factors the IRS looks at. For further detail, you should consult the IRS (Publication 535, Business Expense is a good start) or your tax-preparer.

The “safe-harbor” for most businesses is that if you make a profit in at least three of the prior five tax years, you are assumed to make a profit. Why do we say “most businesses”? Because if you breed, train, show, or race horses, the time frame is at least two of the prior seven tax years.

(We here at Sunstone Bookkeeping love trivia … )

If you are a new business, you can file Form 5213 to postpone determination “ … Whether the Presumption Applies That an Activity is Engaged in for Profit” within three years of the due date of the return for the first year you start your activity.

The IRS looks at nine factors to determine if your activity is a business if you don’t meet the safe harbor requirements; no one factor alone is determinative. As the deductibility of the expenses are at jeopardy here, we are phrasing the factors in the form of a question:

• Do you carry on the activity in a businesslike manner? Have you registered the business as an entity or DBA? Do you have a written business plan?  Do you maintain financial records?  Peter should be keeping an inventory, tracking prices for items, finding venues frequented by buyers, etc.
• Are you putting in time and effort to make the business profitable? Spending material time on the activity (particularly if it does not have a “fun” aspect) and taking time away from another occupation are supportive of this factor. Also, hiring competent people to run the activity even if you do not personally spend a lot of time shows profit motive. Peter needs to do more than just buy comics and read them!
• Do you depend on the activity for your livelihood? If you are trying to pay the bills in part or in whole with this activity, then it is more likely to be a business in the eyes of the IRS than a hobby. Is Peter trying to make enough money here for more than buying another graphic novel?
• Did you lose money because of things you cannot control (or are normal at your stage of start-up)? This is pretty much self-explanatory but see the next question …
• Do you change your operating methods to improve profitability? If the business is not making money, you should do something about it if you want to be considered a business seeking to make a profit. Is Peter consistently buying niche items that he likes but aren’t popular for re-sale? If so, he needs to change his business practices.
• Do you have the expertise necessary to be successful? Remember, the relevant definition of successful here is “profitable”. You don’t necessarily have to know the industry in-and-out, but you should be able to show that you’re taking steps to improve your industry knowledge and apply standard business practices.
• Have you demonstrated an ability to be profitable in similar activities before? If you’re starting your first business, then obviously you’re not able to prove or disprove this ability. However, if you’ve tried and not succeeded multiple times, you might have a harder time defending your venture as a business.
• Has the activity made money in some years? See the above regarding safe harbor.
• Can you expect to make money from the appreciation of assets used in the activity? In Peter’s case, can he reasonably expect to make more money from the sales of his inventory if he holds on to it? Or will the value of the inventory decrease over time to the point where sales on eBay would create a loss as if he marketed them in a yard sale?

 

If you’ve taken this venture seriously, putting in time and effort (and legitimate funding) into making the venture profitable to pay your bills, you’re not likely to run afoul with the IRS.  However, if your venture is no more than a money-losing “side hustle”, you’ll have a hard time defending your expenses as deductible and will potentially have extra earnings on which you owe taxes.

For Tax Year 2020 (i.e. for tax forms you’ll file in 2021) what used to be on one form, the Form 1099-MISC, is now split between a slimmed down 1099-MISC and a “new” 1099-NEC. I say “new” because it last existed in 1982, so it is new to most of us.

Before getting into what you must report on each, let us first go over what DOESN’T get reported on either of the two forms:

• Payments to a corporation (C or S) or an LLC treated as a corporation (there’s an important exception regarding lawyers);
• Payments for merchandise, telegrams, telephone, freight, storage, and similar items,
• Rents paid to an agent or property manager (the agent or manager must report on 1099-MISC payments to the property owner);
• Employee wages;
• Group term-life insurance costs;
• Military differential wage payments;
• Business travel allowances;
• Payments made through a third-party network transaction (credit cards and other payment processors);
• And a few specialty cases.

What is this Form 1099-NEC?

Way back in 2015, Congress passed an act they called the Protecting Americans from Tax Hikes (PATH) Act which resurrected the Form 1099-NEC for reporting Non-Employee Compensation (see, “NEC”). If you run a trade or business (nonprofits and some special cases are included as well), what you reported on Line 7 of the 1099-MISC last year now has its own full form. Your deadline for the 1099-NEC is February 1, 2021.

In general, you will report on Form 1099-NEC any amounts in excess of $600 for: services performed by someone not your employee, payments to an attorney, or (yes, I’m serious here) cash purchases for fish from a fishmonger.

The most common items to report on your Form 1099-NEC include:

• Service fees and payments to independent contractors (examples include consultants, plumbers, bookkeepers, graphic designers, etc. who are not your employees);
• Fee-splitting or referral fees;
• Non-employee commissions;
• Payments to entertainers;
• Exchanges of services (yes, “barter” arrangements for services are captured here).

A very special case is that Attorney’s Fees paid in cash over $600 are reportable on your 1099-NEC even if paid to a corporate entity.

What about the old 1099-MISC?

Now, your old friend the 1099-MISC is still around with a fresh new slimmed-down look. You will need to file that by March 1, 2021, if you are filing on paper or March 31, 2021, if filing electronically.

The most common items you will report on your Form 1099-MISC include:

• Royalty payment in excess of $10;
• Rents paid to a property owner;
• Prizes and awards;
• Amounts of federal income tax under backup withholding rules (even if the person in question is not an employee);
• And some special cases, including deceased employee wages, payments made on behalf of another person, state or local sales taxes imposed on the seller of services but paid by you, fishing boat proceeds, payments in lieu of dividends or interest, crop insurance proceeds, and nonqualified deferred compensation.
• There is a “check the box” requirement if you made sales of $5,000 or more to a person on a buy-sell/deposit-commission/or other commission basis anywhere outside an established store (network marketers: take note).

And of course, payments to an attorney make an appearance for special treatment here: gross proceeds in excess of $600; that are paid in connection with legal services but not FOR the attorney’s services (for example an amount paid to a law firm as part of a settlement agreement); and are otherwise not reportable on the 1099 NEC are reportable on the 1099-MISC.

Another special case are payments of $600 or more to a physician or other provider of medical/healthcare services in the course of your trade or business, including corporations. But note the key words and ask yourself: Was this “in the course of my business” and not incidental?

Some questions to ask when determining if you need to file either of the 1099s:

First, ask yourself:  Is this payment to a living employee? If yes, then more likely than not, you’ll not report it on these forms. If you work through the W-2s you’ve filed and find there’s some payment to an individual that doesn’t belong there, then you might need to revisit the 1099s.

Second:  Did you pay by credit card? Then you can move on.

Third:  Was this payment in the course of operation of my trade or business? Personal payments are not reported here.

Fourth:  Did you pay a lot of cash out in any way related to purchasing fish or hiring attorneys?

Fifth:  Anything else a bit weird?

Those five questions will likely sort out most of your concerns and lead you to the right form. But as always, consult your tax preparer or tax attorney for specific questions or issues.