A few of my clients have had investments in local businesses. They typically start off as silent partners but then if the business starts failing they get more involved. This can have a tremendous positive effect on their tax bill. Losses that could not be taken in the prior years suddenly can be allowed. Below is the general explanation of how this works.

IRC Sec. 469 prevents taxpayers from using passive losses to offset nonpassive income. Generally, passive activity losses are limited to passive activity income. The unallowed losses are carried forward to later tax years. A trade or business activity in which the taxpayer does not materially participate is passive, and includes most rental activities and limited partnership interests. Generally, taxpayers materially participate if they are involved in the trade or businesses’ operations on a regular, continuous, and substantial basis.

Individuals can meet the material participation requirements by satisfying one of the following seven tests

(Temp. Reg. 1.469-5T):

1. The individual spends more than 500 hours participating in the activity during the year.

2. The individual is the only one who substantially participates in the activity.

3. The individual spends more than 100 hours participating and no one else spends more hours.

4. The activity qualifies as a significant participation activity (greater than 100 hours), and the individual’s aggregate participation for all significant participation activities exceeds 500 hours for the year.

5. The individual met material participation requirements for any five of the 10 prior tax years.

6. The activity is a personal service activity and the individual materially participated for any three prior taxable years (consecutive or not). A personal service activity is the performance of personal services in health, law, engineering, architecture, accounting, actuarial science, performing arts, consulting or any other trade or business where capital is not an income-producing factor.

7. Facts and circumstances determine that the individual participates in the activity on a regular, continuous, and substantial basis during the year, and he or she participates more than 100 hours.

Certain management activities do not qualify for this test.

Taxpayers may group activities into a single activity if, based on relevant facts and circumstances, the grouped activities are an appropriate economic unit. Activities that are not grouped are treated as single activities.

Certain activities are not considered participation:

· Work of a type not customarily performed by the owners done in an attempt to avoid passive activity rules.

· Investor participation, unless the individual is directly involved in the day-to-day management or operations.

Call us for your tax prep or bookkeeping needs.

Abacoa CPA’s

Jupiter, FL

Jupiter is home to many small business owners who also work at home or operate entirely from their home. A recent court case came up that would be beneficial for most business owners to know about.

Under IRC Sec.162(a), a deduction is allowed for ordinary and necessary expenses paid or incurred during the tax year in carrying on any trade or business. However, a deduction normally is not available for personal, living, or family expenses [IRC Sec. 262(a)]. The facts must be considered in determining whether an expenditure is deductible under IRC Sec.162.

Facts. The taxpayer, a self-employed financial advisor, begins each workday morning from home watching television programs devoted to financial news and making phone calls to business associated on the East Coast. He then either commutes to an office near Santa Clarita, California or drives to meet with clients around Southern California. He paid Time Warner approximate monthly fees for telephone service ($14), Internet service ($53) and cable television ($43) for his residence. On his Schedule C(tax return for business) for the year at issue, the taxpayer deducted “other” expenses of $1,371 for telephone, cable television, and Internet charges.

Taxpayer and IRS Position. The taxpayer maintained that he used the: (1) telephone line exclusively to send and receive facsimile transmissions related to his business and (2) Internet service approximately 75% of the time for his business (for example, to send and receive emails). He argued that he should be able to deduct a portion of the total charge. He conceded that he was not entitled to a deduction for the cable television service. The IRS disallowed all the Time Warner deductions as nondeductible personal expense.

Court Decision. IRC Sec. 262(b) provides that the first telephone line in any residence shall be treated as a personal expense. The taxpayer did not show that the telephone charge was for anything other than basic service, so the Tax Court did not allow a deduction. However, the Tax Court allowed the taxpayer to deduct

$477 ($53 per month × 12 × 75%) of the amount paid for Internet services. The Tax Court characterized the Internet access expenses as utility expenses to which the strict substantiation under IRC Sec. 274(d) does not apply and allowed the taxpayer’s estimate of the deductible expenses based on reasonable evidence.

This is something to think about for all of those who have businesses at home or even work from home.

Call us for your tax prep or bookkeeping needs.

Abacoa CPA’s

Jupiter, FL

Silent Partners who become active can have incredible tax benefits

Deducting Home Internet Expenses as Employee Expenses