Thursday, November 17, 2011

Use of Employer-Provided Mobile Phones Is Non-taxable Fringe Benefit

By Marcia Richards Suelzer, Toolkit Staff Writer

If you provide your employees with a cell phone for business use, both their business and personal use of the cell phone is a non-taxable fringe benefit. More importantly, the IRS will not require record keeping of business use in order to receive this tax-free treatment: If your cell phone policies meet the requirements for exclusion from income, then the employee's expenses are considered to be substantiated.

This tax-free treatment is available only if you provide the phone for a non-compensatory business use. This test is met if you have substantial business reasons for providing the employee with a cell phone. Once the non-compensatory business use test is met, all of the employee's use of the phone, whether business or personal, is non-taxable. The following are examples of substantial business reasons for providing a cell phone:

you need to contact the employee at all times for work-related emergencies;
the employee is required to stay in contact with other employees outside of the employee's normal working hours; an employee must contact clients or customers when the employee is away from the office, or the employee needs to speak with clients located in other time zones at times outside of the employee's normal work day. Caution. A cell phone provided to promote the morale or good will of an employee, to attract a prospective employee or as a means of furnishing additional compensation to an employee is not provided primarily for non-compensatory business purposes. In this case, the value of the cell phone must be included in the employee's income as a taxable fringe benefit.

Reimbursement for Phone Use Is Also Non-Taxable

Small businesses often don't provide a cell phone to their employees; instead, a small business owner will provide a cash allowance or reimbursement for the employees' work-related use of their personal cell phones. In recognition of this, the IRS also determined that a similar administrative approach will apply to these arrangements. If you require your employees to use their personal cell phones for business purposes, reimbursements of the employees' expenses for reasonable cell phone coverage will be considered non-taxable. However, the use must be primarily for non-compensatory business reasons; the expenses can not be unusual or excessive expenses and the reimbursements can not be made as a substitute for any part of the employee's regular wages.

Tuesday, November 8, 2011

IRS Makes Voluntary Reclassification of Workers Less Costly

By Marcia Richards Suelzer, Toolkit Staff Writer

The IRS takes a very dim view of the misclassification of employees as independent contractors. In fact, tracking down employers who misclassify workers is a high priority for the IRS, as the recent collaboration with the Department of Labor indicates.

Despite its aggressive enforcement actions, the IRS also seems to be aware of the old bromide: "You can catch more flies with honey, than with vinegar." So the agency has announced a new Voluntary Classification Settlement Program (VCSP).

Why Misclassify?

At first glance, classifying workers as independent contractors seems to be an excellent way of reducing both paperwork hassles and out-of-pocket costs for tax payments. After all, you must withhold income taxes, withhold and pay Social Security and Medicare taxes, and pay unemployment tax on the wages that you pay to your employees. You are spared all of these obligations if the person doing the work is an independent contractor.

In tax law, as in much of life, the easiest option in not necessarily the wisest one. Leaving aside the disruption and unpleasantness associated with an extensive IRS audit, you risk owing more in taxes than you would have had you correctly classified your workers. If you classify an employee as an independent contractor without a reasonable basis for doing so, you may find yourself paying a portion of the employee's Social Security taxes and a portion of the income tax withholding on their wages, as well as your own portion of Social Security taxes.

Tip. If you can control what the worker does and how it will be done, and not simply the result to be accomplished, then it is likely the worker is an employee. Over the years, 20 factors have been developed that help analyze whether the worker is an employee or independent contractor.

Why Voluntarily Re-classify?

One of the biggest benefits of reclassification is peace of mind. Employers who participate in the voluntary reclassification program will not be audited on payroll taxes related to these workers for prior years. In the words of IRS Commissioner Doug Shulman: "This settlement program provides certainty and relief to employers in an important area."

A second important benefit is that you will save a considerable amount of money if you voluntarily reclassify, rather than waiting for the IRS to find you and reclassify your workers following an audit. Under the voluntary program, you will only owe 10 percent of the employment tax liability due on compensation paid to the workers for the most recent tax year, determined under the rules that apply to reclassifications.

Example. You own a construction company. You have been classifying your drywall installers as independent contractors. During an audit, the IRS disagrees and reclassifies them as employees. The workers' total compensation for 2010 was $500,000 and none of the compensation exceeded the Social Security wage base. Even if you qualify for reduced liability, you will owe $53,400 (10.68 percent of $500,000) for 2010 wages. You will owe a similar amount for previous years for which the workers were misclassifed.

Assume the same facts as above, but you apply to participate in the Voluntary Classification Settlement Program. Under this program, the maximum amount you will owe is $5,340: 10 percent of the most recent year's applicable employment taxes.

If a 90 percent savings isn't enough to pique your interest, you also will be spared any interest and penalties on the liability.

Warning. Your tax issues could be even worse if you are considered a person who is responsible for withholding and paying over taxes (and nearly every small business owner is going to be a responsible party). You could be held personally liable for the amount of tax that should have been paid over to the IRS, in addition to owing the worker's portion of employment taxes and income tax withholding.

There is one downside to participation--but the benefits are likely to outweigh it. In order to participate in the VCSP, you must agree to extend the employment tax limitations period from three to six years for the first three years after you enter into the agreement. This means that the IRS has longer to determine if you are honoring the terms of the agreement or surface other issues with your employment taxes.

Who Can Participate?
  • You can participate in the program if you meet these three requirements:
  • You must have consistently treated your workers as nonemployees;
  • You must have filed all required Forms 1099 for these workers for the past three years; and
  • You currently are not under audit by the IRS, the Department of Labor or a state agency concerning the classification of these workers.
You apply by filing Form 8952, Application for Voluntary Classification Settlement Program . You can file the form at any time, but you must file at least 60 days before you want to begin treating the workers as employees. This means that you must file by November 2, 2011, if you want to start treating a group of workers as employees beginning with the New Year.

Tuesday, November 1, 2011

Take a Moment to Fine-tune Your Withholding

By Marcia Richards Suelzer, Toolkit Staff Writer

As summer winds down, this is an excellent time to make sure you are on track to have the correct amount withheld from your wages this year. This is especially true if you got married or divorced, added or lost a dependent, purchased a home, changed jobs or retired. In addition, you should also check your withholding if you are going to have a significant amount of income that is not subject to withholding (such as capital gains) or if you start or stop a second job.

Use the IRS Withholding Calculator

The IRS has made it easier than ever to verify that your withholding is correct by creating an interactive calculator. The Withholding Calculator at can help you figure the correct amount of federal withholding and provide information you can use to complete a new Form W-4, Employee’s Withholding Allowance Certificate.

You will need to have your most recent pay stubs and your most recent federal income tax return to use the calculator effectively. In order to get the most accurate result, the IRS advises that you:
  • Fill in all the information that applies to your situation.
  • Avoid estimating or guessing at amounts. While you can estimate if it's necessary, the results are only as accurate as the information you provide.
  • Take advantage of the information links that are built into the calculator to help you answer the questions correctly.
  • Print out the final screen that summarizes your entries and the results. Use it to complete a new Form W-4 (if necessary) and give the completed W-4 to your employer.
Make sure to keep a copy of your new W-4 with your tax records.

Use Publication 919 for Complex Situations
For many people, the withholding calculator is a great tool that can simplify the process of determining your withholding. However, some tax situations are more complex. You are likely to fall into this category if:
  • you are subject to the alternative minimum tax or self-employment tax;
  • your current job will end before the end of the year;
  • you are going to be able to claim significant tax credits (other than the child and dependent care credit or the child tax credit);
  • you expect to have a net capital gain;
  • you expect to have qualified dividends;
  • you will be able to exclude foreign earned income; or
  • you can deduct or exclude foreign housing allowances.
If you have one or more of these tax complications, then you will probably achieve more accurate withholding by following the instructions in Publication 919, How Do I Adjust My Tax Withholding, which is available at or by calling 1-800-TAX-FORM (1-800-829-3676). This publication has worksheets that enable you to accurately determine withholding regardless of the complexity of your tax picture.

Thursday, September 1, 2011

In-home Care Services Provided to Dementia Patient Qualify As Medical Expenses

Personal care services provided by a live-in housekeeper qualified as "long-term care" expenses, according to the Tax Court. It was clear that the services were not for medical treatment, but solely to assist an elderly individual who suffered from dementia with the activities of daily living and to keep her safe.

The definition of deductible medical expenses includes "long-term care services." Unpacking this definition, the court determined that it was not necessary that the service providers be licensed health professionals as long as their services were provided under a plan of care that was established by a health professional. In addition, the services did not need to treat the illness. Assistance with basic living activities, such as feeding, bathing, or toileting, and actions designed to keep the individual safe and healthy qualified as medical expenses because she was "chronically ill" as a result of her dementia.

With in-home caregiving services running into the tens of thousands of dollars, the court's ruling that these expenses are deductible medical expenses could provide significant tax relief to many families coping with a loved one's dementia. For additional insights into why the caregiving services qualified as deductible medical expenses, read our story, Payments to Live-in Caregiver for Dementia Patient Were Medical Expenses.

Tax Tips

Ordinary and Necessary Business Expenses
To be a deductible business expenses, you must be prepared to demonstrate that it was both "ordinary" and "necessary." Learn how the IRS applies these terms by consulting our discussion, Ordinary and Necessary Business Expenses.

Medical and Dental Expenses
As our lead story indicates, knowing the rules for medical and dental expenses can reduce your taxes—perhaps significantly if you have a large amount of unreimbursed expenses in a year in which you don't have much income. Our discussion Medical and Dental Expenses provides you with the information you need about this deduction.

Payroll Taxes and Household Employees
If you have hired household help, you have the responsibility for ensuring the payroll taxes (e.g., social security and unemployment taxes) are properly calculated and paid. Learn the rules at Payroll Taxes and Household Employees.

Home Office Deduction
Working from home can provide flexibility and increase your productivity. Does your home workspace qualify as a home office? What tax benefits do you gain from having a home office? And, are there any downsides? Find out by reading the Home Office Deduction.

Tax News

Standard Mileage Rate Increased to 55.5 Cents per Mile Beginning July 1
The IRS increased the standard mileage rate from 51 cents per mile to 55.5 cents per mile, effective for miles driven after June 30 of this year. The rate for moving and medical driving expenses increased to 33.5 cents per mile, up from 19 cents per mile. (There is no change for charitable driving because that's set by law at 14 cents per mile.) The increase is obviously important for self-employed individuals. However, it also will affect most employees because employers generally use the standard mileage rate to calculate expense reimbursements. Standard Mileage Rate Increased to 55.5 Cents per Mile Beginning July 1.

Federal Unemployment Tax Rate Decreased on July 1
The federal unemployment tax rate dropped 0.2 percent on July 1, 2011 when a thirty-five year old "temporary" surtax expired. Because of a credit against FUTA for state unemployment taxes paid, the effective federal tax rate will be 0.6 percent for amounts paid starting July 1. Prior to July 1, the effective tax rate was 0.8 percent. Federal Unemployment Tax Rate Decreased on July 1.

Verify Tax Exempt Status before Making a Donation
While it is always wise to verify that an organization that claims to be tax-exempt actually is tax-exempt, it may be more important this year. More than 275,000 tax-exempt statuses had their exemption revoked for filing to file annual reports with the IRS. You can not claim a charitable deduction for any donation made to an organization after the date on which its exemption was revoked. Verify Tax Exempt Status before Making a Donation.

Required Booster Club Fundraising Payments May Be Deductible Contributions
The IRS has opened the "deductibility door" a crack with regards to fundraising amounts required by an amateur athletic clubs as a condition of participation. Although the application of the law breaks no new ground, it does clarify that if you do not receive full value for your contribution, a portion of it may be a tax-deductible contribution. However, the burden of establishing you didn't receive full value will be significant. Required Booster Club Fundraising Payments May Be Deductible Contributions.

Monday, May 2, 2011

Consider Incorporating to Leverage Capital Gain Exclusion

By Marcia Richards Suelzer, Toolkit Staff Writer

Incorporating your business now may yield a surprising result when you sell it in the future: You won't have to pay tax on gain from the sale!

Back in September 2010, Congress passed a "small business jobs act." In that law, tucked deep in the recesses of the Internal Revenue Code, is a provision designed to spur business growth by providing a tax break for those who invest in small business stock. Right now, an individual can exclude 100 percent of the gain realized from the sale of certain small business stock.

Incorporating your business can help you to avoid capital gains.
Example. You invest $1,000 in Big-Multinational-Corporation (BMC). Five years later you sell your stock for $101,000, which is a gain of $100,000. Assuming a long-term capital gains tax rate of 25 percent, you will owe $25,000 in tax on the sale. However, if you purchase $1,000 worth of shares in Mom-n-Pop, Inc. (a very small business), and you sell the stock for $101,000 in five years, you will not owe any tax on the gain from the sale of the shares. You can pocket the $25,000 instead of paying it to Uncle Sam.

This creates an extraordinary opportunity for you to incorporate your business, hold onto the stock for the required period of time and then sell the stock without paying any tax on the gain you realize. Also, while you must acquire the stock at its original issuance, your tax break is preserved if the stock is transferred by gift or upon your death. Your holding period carries over to the transferee.

Act Now. While there are many tax and non-tax ramifications to consider before incorporating your business to take advantage of the exclusion of gain upon the sale of the stock, here are some circumstances when it merits serious investigation:

  • Your business is thriving and you see great growth potential--this is a great way to ensure the appreciation in value is tax free when you exit the business;
  • You want to make it easy to transfer your business to your children or other family members--the exclusion from income applies to gifts of stock; or
  • You have key employees that you want to compensate--by making them shareholders you can foster the relationship while providing them with an opportunity for tax-free income.

If any of these apply to you, it's time to talk over your options with a business advisor.

Certain Conditions Apply

Of course, it's tax law that provides this benefit, and that means there are conditions that must be met in order to take advantage of the exclusion. The major requirements are as follows:

Type of business. The business:

  • must be a regular C corporation;
  • must have $50 million or less in capital;
  • must use 80 percent of the value of the corporate assets in the active conduct of business; and
  • must not be a personal services business, banking or finance business, leasing business, hospitality business, farming or mining business

Acquisition of stock. You must acquire the stock: before January 1, 2012; at its original issue;
and using money or contributed property (not other stock) or as compensation for services to the corporation.

Holding Period. You must hold the stock for more than five years. With planning, most small business owners will be able to meet these conditions.

While the exclusion on gain is generous, it is not unlimited. For any tax year, you are able to exclude the greater of 10 times your adjusted basis in the stock or $10 million (reduced by any amounts previously excluded). However, dispositions of stock can be structured to maximize the exclusion.

Even with conditions and limitations, this is a planning opportunity that does not happen often. And, it is one definitely worth your time to investigate.

Posted May 2, 2010.

Thursday, March 24, 2011

Child's Unearned Income Can Trigger 'Kiddie Tax'

By Marcia Richards Suelzer, Toolkit Staff Writer

If your son or daughter has more than $1,900 of investment (not earned) income, that income might be taxed at your tax rate, rather than at your child's tax rate, as a result of the "kiddie tax" rules.

The "kiddie tax" was enacted back in 1986 to prevent high-income parents from shifting income to lower-income children, thereby reducing the family's overall tax liability. Initially, the provision's nickname, "kiddie tax," seemed to fit: it applied only to children who were under age 14 at the end of a calendar year. But, law changes have expanded its reach to teenagers and young adults, making it an issue for more high-income families.

Example. Frank Burns transfers all of his shares of several biotechnology stocks to his 16-year-old son, Frank Jr. During the year, Frank Jr. receives $5,000 in dividends. Frank Jr. has no earned income. Without the kiddie tax, the $5,000 in unearned income would be taxed at Frank Jr.'s tax rate of 10 percent, rather than his father's 35 percent tax rate. However, as a result of the kiddie tax, the $5,000 is taxed at Frank Sr.'s tax rate.

Income and Age Requirements

The kiddie tax applies only to unearned income, such as interest, dividends and capital gains. Distributions from trusts are generally considered unearned income. It never applies to the child's earned income. The tax on the child's unearned income must be calculated using the parents' tax rate if the child meets any one of these three tests as of the end of the year:

  • The child was under age 18 at the end of the year,
  • the child was 18 and did not have earned income that was more than half of his or her support, or
  • the child was:
  • a full-time student;
  • over age 18 and under age 24; and
  • did not have earned income that was more than half of his or her support.

Electing to Claim the Income on Your Return

Whether your child reports the income on his or her return, or you report it on your return, it is going to be taxed at your tax rate. In recognition of this, the IRS allows the parent to elect to report the child's unearned income provided:

  • the child is under 19 (24 if a full-time student) as of December 31;
  • the child's only income is from interest or dividends; and
  • the child's gross income was $9,500 or less.

Assuming that you can do so, should you elect to report it on your return and avoid the aggravation of filing a return for your child? The answer depends upon your overall tax picture. Adding the child's income to your own will have an impact on any deductions or credits that have limitations based upon adjusted gross income, such as miscellaneous itemized deductions, casualty losses or education credits. If the child's income is substantial and you are close to those limitations, then you will want to calculate the impact both ways.

If the numbers work out, you make the election by filing Form 8814, Parents' Election To Report Child's Interest and Dividends, with your tax return. Otherwise, you would complete Form 8615, Tax for Certain Children Who Have Investment Income of More Than $1,900, and attach it to your child's federal income tax return.
From simple to complex returns, our online tax program makes it easy to prepare and file your taxes quickly — and with confidence that you're getting the biggest refund!