Ten forty plus bookkeeping houston

Economic Substance Test

Tax Tip

Economic substance" is a new tax rule

Suppose someone offered you a business opportunity that would let you defer tax on your passive income, then later benefit from lower tax rates by converting ordinary income to capital gain. Would you invest?

In general, structuring business activities in a tax-efficient manner is part of good planning. However, when you enter into a transaction with no bona-fide business motive and that transaction changes nothing but your tax situation, you can run afoul of the economic substance rules.

These rules were not found in the tax code prior to the 2010 health care laws. Instead, they were applied by courts to individual cases. Now, economic substance is defined by a two-part test. When the rules apply, your economic position must change in a meaningful way and you must have a substantial business purpose for choosing a course of action.

What happens if you fail the economic substance test? You lose any tax benefits you claimed and you may be subject to a penalty of up to 40% of the underpayment caused by the loss of the benefits.

Please call before you decide to participate in ventures that purport to save tax dollars. We're here to help you make prudent choices.

Joseph C Becker, CPB, MBA, CQP
Ten Forty plus Quality Tax Preparation & Financial Services
www.tenfortyplus.com
281-397-7777, Fax 281-397-7443
joeb@tenfortyplus.com

LEASED CAR EXPENSES

Tax Tip

Leased Car Deductions

When you lease a car you get deductions for three types of expenses for your leased vehicle:

1.       Advance payments (You likely think of these as down-payments. The law calls them rents-paid-in-advance.)

2.       Lease payments

3.       Operating expenses

Business Use Only

Expenses for leased vehicle is for business use only.  This is simply a reminder. You can deduct a percentage of business use to total use as an expense.  The personal portion is not deductible.

Deduction 1a: Advance Payment

You must amortize the advanced payment over the entire length of the lease. 

In this example, you have a $3,000 advance payment on a 36-month lease. This gives you a deduction of $62.50 per month ($3,000/36 x 75 percent business use).

Deduction 1b: Trade-In Value Advance Payment

What if instead of a cash down payment, you trade in a vehicle that you own?

The trade-in of a vehicle you own on a lease is not a like-kind exchange. For tax purposes, the transaction breaks into two steps as follows:

1.       The value of your trade-in equals the selling price of your vehicle to the dealer. (You use this value to calculate gain or loss on sale.)

2.       The value of the trade-in is your down payment on the lease.

Think of the trade-in on a lease like this: You sold the vehicle to the dealer. The dealer took the cash and applied it as a down payment on the lease.

For tax-deduction purposes, you amortize the trade-in value just as you amortized the cash down payment. If the dealer gives you $3,000 for the trade-in, you amortize the $3,000 over the life of the lease. On a three-year lease with 75 percent business use, your monthly deduction is $62.50.

Deduction 1c: Loss on Trade-In (or Taxable Gain)

Because the trade-in of a vehicle you own is not like kind with the lease of a vehicle, the law treats the trade-in of your old vehicle as a sale to the dealer.

When you sell a business vehicle, you generally have a taxable profit or a deductible loss.

When you sell a personal vehicle, you pay taxes on any profits and get no deductions for any losses.

In the example, you sold a 75 percent business and 25 percent personal vehicle.

Deduction 2: Lease Payments

Your second deduction is for the lease payments. This is almost as straightforward as it sounds. The first step is to add up your lease payments for the year and multiply by your percentage of business use.

But there is a second step, mostly annoying. The IRS makes you reduce your lease payment deductions by a yearly “inclusion amount.”² The inclusion amounts are very low, but they are a pain in the neck to calculate. (The orange box at the end of this article shows you how to do this calculation.)

On May 1, 2013, you leased and placed in service a $30,000 automobile that you use 75 percent for business in 2014. Your 2014 inclusion amount is $12 (see the box at the end of the article).

Your lease payment deduction for 2014 is $2,688 ($300 x 12 x 75 percent - $12).

Inclusion Exemption

You apply the lease inclusion amount only to “luxury passenger vehicles.” You do not apply the lease inclusion amount to the following vehicles, all of which escape the luxury classification:³

1.       Cars with curb weights greater than 6,000 pounds (there are very few of these around)

2.       Sport utility vehicles (SUVs) with gross vehicle weight ratings of 6,001 pounds or more

3.       Pickup trucks and vans with gross vehicle weight ratings of 6,001 pounds or more

Deduction 3: Operating Expenses

You also deduct operating expenses, which include⁴

 · maintenance and repairs,

· tires, · gas,

· oil,

· insurance (including gap insurance),

· parking fees, and · tolls.

Let’s say you have $6,000 of operating expenses. Multiply this by your business percentage of 75 percent, and your deduction for 2014 is $4,500.

Putting It All Together

At tax time, total the three deductions. Using the amounts for 2014 from the example, your vehicle deductions total $7,938 ($62.50 a month x 12 + $2,688 + $4,500).

Why You Should Skip the Mileage Method

If you don’t operate your business as a corporation, the IRS gives you an easy alternative to the deductions listed above. You can use the IRS standard mileage rate (currently 56 cents per mile) for each business mile you travel.⁵

If you pick this method, you have to

1.       Give up deductions for your down-payment amortization, lease payments, and operating expenses, and

2.       Use the mileage rate method for the entire term of your lease (including renewals).

The mileage rate method is not a good choice for most leases. But it can work to your benefit if you lease a low-cost car that gets lots of miles to a gallon of gas and you drive a huge number of business miles.

Suppose in 2014 you drive your vehicle 12,000 miles for the year. The 56 cents a mile gives you a deduction of only $5,040 (12,000 x 75 percent x 0.56). When you compare the $5,040 with the $7,938 in actual expenses calculated above, you gain $2,898 of deductions by using actual expenses.

Takeaways

1.       The trade-in of a business or personal vehicle on the lease of a business vehicle produces first an amortizable down payment and second either taxable gain or deductible loss on the vehicle that you traded in.

2.       If your newly leased vehicle qualifies as a “luxury vehicle” (6,000 pounds or less as explained above), you generally need to calculate an “inclusion amount” from the IRS table to find your deductible lease payments for the year.

3.       You may not use IRS mileage rates on a corporate-owned vehicle.

4.       You deduct the business part of the vehicle only.

Calculating the Inclusion Amount

With the exception of non-luxury passenger vehicles discussed above, the IRS makes you reduce the amount of your lease payment deductions by an “inclusion amount.” Rates are currently very low, but you still have to make the calculation.

Here are the steps:

1.       Determine the fair market value of the vehicle on the day you begin the lease. 2.       Look at IRS Publication 463 for the year your lease began, and then find the “Inclusion Amount” tables in the appendices near the end of the publication. 3.       Determine the type of vehicle you have. 4.       Find the table that begins in the first year of your lease. As of the date of this article, the IRS publication is up-to-date only to 2013. You can find 2014 numbers at Rev. Proc. 2014-21 in Section 4.6 5.       Scan the table to find the dollar amounts for each year of the lease. 6.       Multiply the listed amount for each year by a.        The number of days of the year your lease is in effect (e.g., 244/365) and b.        The percentage of business use of your vehicle.       7.    Round to the nearest dollar amount. Example. Let’s say your lease begins May 1, 2013, and on that date your leased car had a fair market value of $30,000. You use the vehicle 75 percent for business in both 2013 and 2014. Your inclusion amounts are: · 2013 = $5 ($7 x 244/365 x 0.75 = $5) · 2014 = $12 ($16 x 0.75 = $12)

Joseph C Becker, CPB, MBA, CQP
Ten Forty plus Quality Tax Preparation & Financial Services
www.tenfortyplus.com
281-397-7777, Fax 281-397-7443
joeb@tenfortyplus.com

Foreign Bank Accounts

Tax Tip

Foreign Banks Forced to Report US Account Owners’ Tax Information to IRS.  The Foreign Account Tax Compliance Act (FATCA) is a United States law that requires United States persons, including individuals who live outside of the US, to report their financial accounts held outside of the United States to the Treasury Department. This is done by completing and attaching IRS Form 8938, Statement of Foreign Financial Assets, to the individual’s income tax return, and is generally required if the value of the foreign accounts exceeds $50,000 (this threshold is higher for US persons residing abroad). In addition, FATCA requires foreign financial institutions to report about their US clients to the IRS. Congress enacted FATCA in order to make it more difficult for US taxpayers to conceal assets held in offshore accounts and shell corporations and thus, recoup federal tax revenues on unreported foreign-source income. The penalties for not reporting the accounts are draconian.

Under FATCA, foreign financial institutions that refuse to share information with the IRS face penalties when doing business in the US. FATCA requires US banks to withhold 30% of certain payments to foreign banks that have refused to comply with the information-sharing program. That is a heavy price to pay for access to the world’s largest economy, and it has forced many reluctant countries to comply with the reporting requirement.

As a result, nearly 70 countries, including Switzerland, the Cayman Islands, and the Bahamas—all places where Americans have traditionally hid assets in the past—have agreed to share information from their banks.

Beginning in March 2015, more than 77,000 foreign banks, investment funds, and other financial institutions have agreed to supply the IRS with names, account numbers, and balances for accounts controlled by US taxpayers. Some foreign banks are refusing to accept US citizens as clients because they don’t want the paperwork headaches imposed by FATCA and the additional compliance costs. As a result, US persons living abroad may find their banking options curtailed.

Oh, and did I mention that the FATCA filings are in addition to the long-standing Foreign Bank Account Report (FBAR) that US persons must file with the U.S. Treasury when the aggregate value of foreign accounts exceeds $10,000 in a calendar year? This report must now be e-filed using FinCEN Form 114 and is due by June 30 for the prior calendar year—no extensions are available. Heavy penalties apply if a FBAR isn’t filed when one is required.

If you have foreign accounts and have not been reporting, there is an amnesty filing that is still availbable.

If you have questions related to the individual FATCA or FBAR reporting requirements, please give this office a call.

Joseph C Becker, CPB, MBA, CQP
Ten Forty plus Quality Tax Preparation & Financial Services
www.tenfortyplus.com
281-397-7777, Fax 281-397-7443
joeb@tenfortyplus.com