Tuesday, January 10, 2017

Income Averaging for Farmers and Fishermen

Look at your tax situation for the past few years.  Do you notice that your taxable income varies greatly from year to year? If so, it is likely that your applicable tax rate may be varying from 0% to as much as 39.6%. Many people are unaware that income averaging is available to farmers and fishermen. The purpose of the income averaging rules is to alleviate the problem of your paying more tax overall if a substantial portion of your income happens to be bunched in one year.
 
As a farmer (or a fisherman), you can elect to average all or part of your taxable "farming income" or "fishing income" over three years. If you make the election, your farming or fishing income subject to the election is treated as if earned in the three previous years. Thus, the elected farm or fishing income is allocated to the three previous years (base years) in equal amounts.
 
For this purpose, farming (or fishing) income includes income from the trade or business of farming or fishing; but, farming (or fishing) income does not include income, gain, or loss from the sale of development rights, grazing rights, and other similar rights. Although farming (or fishing) income does not generally include compensation received as an employee, a shareholder of an S corporation (or a partner in a partnership) engaged in a farming (or fishing) business may generally treat compensation from the S corporation (or partnership) as income from farming or fishing. It also includes income from certain crop-share arrangements, certain vessel leasing arrangements, the sale or disposition of property (other than land), regularly used for a substantial period in a farming or fishing business. Thus, investment income is not eligible for income averaging. A farming business includes operating a nursery or sod farm and raising or harvesting ornamental trees or trees bearing fruit, nuts, or other crops. A fishing business includes the conduct of commercial fishing (i.e., fishing in which all or part of the fish harvested are intended to enter commerce).
 
Here's a simple example of how averaging works. Assume that F, a single farmer, sold some of his farm machinery and more corn than usual, and all of this happened in 2015. F's 2015 taxable income is $50,000, of which $30,000 is from his farming business. F had no taxable income in 2014, $5,000 of taxable income in 2013, and $10,000 of taxable income in 2012. Since F's income is higher than in previous years, F elects to average $30,000 of his 2015 income over the three base years (2014, 2013, and 2012). F figures his 2015 tax in this manner:
  1. He subtracts the elected portion of his current year's taxable farm income ("elected farm income") from his total taxable income. Thus, in 2015, F subtracts the elected farm income ($30,000) from his taxable income of $50,000. F's remaining 2015 taxable income is $20,000.
  2. He figures the tax on the amount in (1) using the tax tables or tax rate schedules for the current year (in this case, 2015). Under the 2015 tax tables, the tax on $20,000 is $2,543.
  3. For each of the three base years (2014, 2013, and 2012), F adds one-third of the current year's (2015) elected farm income ($10,000 each year) to his taxable income for that year and figures the tax on that amount. Then, in each of the three base years (2014, 2013, and 2012), F subtracts his actual tax from the tax computed for the base year.
  4. Then, F adds the amounts computed for the three base years (2014, 2013, and 2012) to the amount of tax computed for the current year (2015) ($1,050 + $1,305 + $1,500 + $2,543) for a total tax of $6,398. If F had not elected to average his farm income, his 2015 tax (computed under the tax tables) would have been $8,300. Thus, by making the election, F saved $1,902. 
With careful year-end tax planning, we may be able to maximize the benefits of averaging for you. Generally, you will benefit from the election if the income allocated to the three previous years will be subject to a lower tax rate than it would be in the current year. For example, it could be beneficial to accelerate income this year (e.g., sell appreciated farm assets this year). This acceleration would increase this year's farming or fishing income and the increase would receive the benefits of averaging. However, we also need to keep in mind that any amounts allocated to the three previous years as additional income will continue to be allocated to those years should you elect to average your farming or fishing income in future years. Thus, the allocated amounts will increase your taxable income in those years and may reduce any benefits that you might get from an election in later years.
 
Before making an election, we will need to consider all of the tax implications of the election. For example, we would need to determine the appropriate portion of your farm or fishing income that should be subject to the election.  Also keep in mind that this election can be made on an amended return.  So even if you haven’t utilized farm income averaging in the past, a review of your last 6 years of tax returns could identify potential refunds.
 
Please contact us if you have any questions concerning income averaging or if you would like to discuss how income averaging could benefit you.

Friday, December 9, 2016

Avoiding Hobby-Loss Restrictions

Like many of us, you've probably dreamed of turning a hobby or avocation into a regular business. You won't have any unusual tax headaches if your new business is profitable. However, if the new business consistently generates losses (deductions exceed income), the IRS may step in and say it's a hobby (an activity not engaged in for profit) rather than a business.

What are the practical consequences? Under the so-called hobby loss rules, you'll be able to claim certain deductions that are available whether or not the business is engaged in for profit (such as state and local property taxes). However, your deductions for business-type expenses (such as rent or advertising) will be limited to the excess of your gross income from the hobby over those expenses that are deductible whether or not the business is engaged in for profit. Deductible hobby expenses are claimed on Schedule A of Form 1040 as miscellaneous itemized deductions subject to a 2%-of-AGI "floor."

There are two ways to avoid the hobby loss rules. The first way is to show a profit in at least three out of five consecutive years (two out of seven years for breeding, training, showing, or racing horses). The second way is to run the venture in such a way as to show that you intend to turn it into a profit-maker, rather than operate it as a mere hobby. The IRS regs themselves say that the hobby loss rules won't apply if the facts and circumstances show that you have a profit-making objective.

How can you prove that you have a profit-making objective? In general, you can do so by running the new venture in a businesslike manner. More specifically, IRS and the courts will look to the following factors:
  • how you run the activity
  • your expertise in the area (and your advisers' expertise)
  • the time and effort you expend in the enterprise
  • whether there's an expectation that the assets used in the activity will rise in value
  • your success in carrying on other similar or dissimilar activities
  • your history of income or loss in the activity
  • the amount of occasional profits (if any) that are earned
  • your financial status
  • whether the activity involves elements of personal pleasure or recreation

The classic "hobby loss" situation involves a successful businessperson or professional who starts something like a dog-breeding business, or a farm. But IRS's long arm also can reach out to more commonplace situations, such as businesspeople who start what appears to be a bona-fide sideline business.

Please contact our office to get more details on whether a venture of yours may be affected by the hobby loss rules, and what you should do right now to avoid a tax challenge.

Friday, December 2, 2016

ALERT – Deadline Change for Information Returns

A new federal law has moved up the filing date for W-2s and certain 1099 forms.  Under the new law, employers (and paid preparers) must submit copies of these forms to the IRS and SSA by January 31.  This change is effective with the 2016 information forms that will be due on January 31, 2017.  The accelerated deadline is intended to help the IRS spot errors on returns and make it easier for the IRS to verify the legitimacy of tax returns filed.

Previously, a copy of these forms was required to be provided to recipients by January 31, but employers (and paid preparers) had until the end of February (if filing on paper) or March (if filing electronically) to send copies to the Internal Revenue Service (IRS) and the Social Security Administration (SSA).

A 30-day extension is available for IRS submission.  If an extension is necessary, Form 8809 Application for Extension of Time to File Information Returns must be completed as soon as possible, but no later than January 31.

 




Wednesday, November 30, 2016

Handouts for Township Officials

On Wednesday, November 30, 2016, Curtis Root, CPA, gave a presentation on issues related to the upcoming audit cycle for local township officials.  The handouts mentioned in the presentation can be viewed and downloaded here.  Larsson, Woodyard & Henson would be pleased to answer any follow up questions.  Please contact us with any questions you have.

Wednesday, November 23, 2016

ALERT! Proposed Overtime Rule Blocked

ALERT!  The proposed overtime rules will not take effect on December 1, 2016.  A federal court has issued a preliminary injunction blocking implementation at this time.  View more about this at http://www.reuters.com/article/us-usa-employment-overtime-idUSKBN13H2JY.

Thursday, November 10, 2016

New Overtime Rules

The Department of Labor’s “final rule” updating overtime regulations has recently been released.  The effective date of the new regulations is December 1, 2016. 
 
The final rule includes the following changes to overtime:     
  • The salary threshold has increased to $913 per week ($47,476 annually) in order for overtime pay to not be required. 
  • The salary threshold for highly compensated employees has increased to $134,004, which is the current equivalent of the 90th percentile of full time salaried workers nationally.
  • Salary thresholds will now be updated every three years beginning on January 1, 2020.  The Department of Labor will publish the updated rates on the Wage and Hour Division’s website 150 days prior to their effective date.
  • Nondiscretionary bonuses and incentive payments, including commission, may be used toward the salary threshold.  These amounts must be paid at least quarterly to be considered and cannot exceed 10 percent ($4,748) of the new salary basis level.  Discretionary bonuses (such as Christmas or year-end bonuses) cannot be used toward the salary basis level.
The final rule did not change the duties tests for the administrative, executive, professional, or highly compensated employee exemptions.  An exempt employee must also still be paid a salary to be considered for overtime exemption.
 
Remember that overtime is not based on the number of hours worked on any given day during the week but rather on the number of hours worked in a seven-day work week.  There are some exceptions to this (such as prevailing wage work).  Hours worked does not include time where the employee was not performing work such as holiday and vacation time.
 
There are several actions that can be taken to comply with the new overtime rules.  We can assist you with determining what actions, if any, you should consider for your employees.
  • Increase your employees’ salaries to comply with the new levels if they meet the duties test.
  • Consider hiring additional employees to cover the workload and limited non-exempt employees to 40 hour work weeks to reduce overtime premiums.
  • Reduce any salaries that previously included overtime and pay the appropriate overtime premiums instead.
  • Consider limiting employee travel time to business hours.
If you have a new employee start during the year, they must earn at least $913 per week to be considered for the exemption.  Overtime is based on a seven-day work week – not an annual amount.  The minimum weekly amount may be translated into equivalent amounts for periods longer than one week up to one month.
 
You are not required to exempt your employees from overtime if they meet both the salary and duties tests.  You may still pay them overtime if you wish.  These rules simply state the requirements and exceptions to overtime regulations.
 
Please contact us if you need any assistance interpreting or complying with these new rules.

Friday, October 7, 2016

Converting a home into rental property


You have decided to move to another residence, but find it difficult to sell your present home. One way to weather a soft residential selling market is to rent out your present home until the market improves. If you are thinking of taking this step, you no doubt are fully aware of the economic risks and rewards. However, you also should be aware that renting out your personal residence carries potential tax benefits and pitfalls.

You generally are treated like a regular real estate landlord once you begin renting your home to others. That means you must report rental income on your return, but also are entitled to offsetting landlord-type deductions for the money you spend on utilities, operating expenses, and incidental repairs and maintenance (e.g., fixing a leak in the roof). Additionally, you can claim depreciation deductions for your home. You can fully offset your rental income with otherwise allowable landlord-type deductions. However, under the tax law passive activity loss (PAL) rules, you may not be able to currently deduct the rent-related deductions that exceed your rental income unless an exception applies. Under the most widely applicable exception, the PAL rules won't affect your converted property for a tax year in which your adjusted gross income doesn't exceed $100,000, you actively participate in running the home-rental business, and your losses from all rental real estate activities in which you actively participate don't exceed $25,000.

You should also be aware that potential tax pitfalls may arise from the rental of your residence. Unless your rentals are strictly temporary and are made necessary by adverse market conditions, you could forfeit an important tax break for home sellers if you finally sell the home at a profit. In general, you can escape taxation on up to $250,000 ($500,000 for certain married couples filing joint returns) of gain on the sale of your home. However, this tax-free treatment is conditioned on your having used the residence as your principal residence for at least two of the five years preceding the sale. So renting your home out for an extended time could jeopardize a big tax break. Even if you don't rent out your home so long as to jeopardize your principal residence exclusion, the tax break you would have gotten on the sale (i.e., exclusion of gain up to the $250,000/$500,000 limits) will not apply to the extent of any depreciation allowable with respect to the rental or business use of the home for periods after May 6, 1997, or to any gain allocable to a period of nonqualified use (i.e., any period during which the property is not used as the principal residence of the taxpayer or the taxpayer's spouse or a former spouse, such as a rental) after Dec. 31, 2008. A maximum tax rate of 25% applies to this gain (attributable to depreciation deductions).

Some homeowners who bought at the height of a market may ultimately sell at a loss. In such situations, the loss is available for tax purposes only if the owner can establish that the home was in fact converted permanently into income-producing property, and isn't merely renting it temporarily until he can sell. Here, a longer lease period helps an owner. However, if you are in this situation, you should be aware that you probably won't wind up with much of a loss for tax purposes. That's because basis (cost for tax purposes) is equal to the lesser of actual cost or the property's fair market value when it's converted to rental property. So if a home was bought for $300,000, converted to rental property when it's worth $250,000, and ultimately sold for $225,000, the loss would be only $25,000.


The question of whether to turn a principal residence into rental property isn't easy to resolve. We can review your situation in detail and guide you to an answer that makes the most sense for you.  Contact us at http://www.lwhcpa.com/contactus.