Experience is the Difference®

Dice with the letters L O S S stacked on piles of coins which are decreasing.  Delaware Business CPA

If your business is a limited liability company (LLC) or a limited liability partnership (LLP), you know that these structures offer liability protection and flexibility as well as tax advantages. But they once also had a significant tax disadvantage: The IRS used to treat all LLC and LLP owners as limited partners for purposes of the passive activity loss (PAL) rules, which can result in negative tax consequences. Fortunately, these days LLC and LLP owners can be treated as general partners, which means they can meet any one of seven “material participation” tests to avoid passive treatment. 

The PAL rules

The PAL rules prohibit taxpayers from offsetting losses from passive business activities (such as limited partnerships or rental properties) against nonpassive income (such as wages, interest, dividends and capital gains). Disallowed losses may be carried forward to future years and deducted from passive income or recovered when the passive business interest is sold.

There are two types of passive activities: 1) trade or business activities in which you don’t materially participate during the year, and 2) rental activities, even if you do materially participate (unless you qualify as a “real estate professional” for federal tax purposes).

The 7 tests

Material participation in this context means participation on a “regular, continuous and substantial” basis. Unless you’re a limited partner, you’re deemed to materially participate in a business activity if you meet just one of seven tests:

  1. You participate in the activity at least 500 hours during the year.
  2. Your participation constitutes substantially all of the participation for the year by anyone, including nonowners.
  3. You participate more than 100 hours and as much or more than any other person.
  4. The activity is a “significant participation activity” — that is, you participate more than 100 hours — but you participate less than one or more other people yet your participation in all of your significant participation activities for the year totals more than 500 hours.
  5. You materially participated in the activity for any five of the preceding 10 tax years.
  6. The activity is a personal service activity in which you materially participated in any three previous tax years.
  7. Regardless of the number of hours, based on all the facts and circumstances, you participate in the activity on a regular, continuous and substantial basis.

The rules are more restrictive for limited partners, who can establish material participation only by satisfying tests 1, 5 or 6.

In many cases, meeting one of the material participation tests will require diligently tracking every hour spent on your activities associated with that business. Questions about the material participation tests? Contact us.

 

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Proft and Loss bindersIf you reported losses from one or more of your business activities, we would like to remind you that the IRS has rules that limit the deductibility of expenses and losses from a hobby or activity not engaged in for profit. If the IRS determines that an activity is not profit-driven, deductions from the activity are limited to the amount of income the activity generates. Losses from such activities cannot be used to offset other income, such as salary or investments.

You must be prepared to show that an activity that generates deductions is a business from which you intend to profit. It is not necessary that the activity actually earns a profit, so long as a profit is one of the motives for participating in the activity.

The IRS assumes that an activity is carried on for profit if it makes a profit during at least three of the last five tax years, including the current year, or at least two of the last seven years for activities that consist primarily of breeding, showing, training or racing horses. Otherwise, the IRS applies non-exclusive tests and factors to the surrounding facts to judge whether activities are more like a business with a profit motive, or are for personal satisfaction.

To make sure you are properly claiming all of the deductions available to you, and to strengthen your position in the event of an IRS audit, it is important to consider all the facts and circumstances surrounding activities the IRS is likely to challenge. If you would like assistance in documenting the for-profit characteristics of your activity, please call our office at your earliest convenience to arrange an appointment.

 

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In its final session of the year, Congress extended a long list of tax breaks that had expired, retroactive to the beginning of 2014. But the reprieve is only temporary. The extensions granted in the Tax Increase Prevention Act of 2014 remain in effect through December 31, 2014. For these tax breaks to survive beyond that point, they must be renewed by Congress in 2015.

Although certain extended tax breaks are industry-specific, others will appeal to a wide cross-section of individuals and businesses. Here are some of the most popular items.

* The new law retains an optional deduction for state and local sales taxes in lieu of deducting state and local income taxes. This is especially beneficial for residents of states with no income tax.

*  The maximum $500,000 Section 179 deduction for qualified business property, which had dropped to $25,000, is reinstated for 2014. The deduction is phased out above a $2 million threshold.

*  A 50% bonus depreciation for qualified business property is revived. The deduction may be claimed in conjunction with Section 179.

*  Parents may be able to claim a tuition-and-fees deduction for qualified expenses. The amount of the deduction is linked to adjusted gross income.

*  An individual age 70½ and over could transfer up to $100,000 tax-free from an IRA to a charity in 2014. The transfer counts as a required minimum distribution (RMD).

*  Homeowners can exclude tax on mortgage debt cancellation or forgiveness of up to $2 million. This tax break is only available for a principal residence.

*  The new law preserves bigger tax benefits for mass transit passes. Employees may receive up to $250 per month tax-free as opposed to only $130 per month.

*  A taxpayer is generally entitled to credit of 10% of the cost of energy-saving improvements installed in the home, subject to a $500 lifetime limit.

*  Educators can deduct up to $250 of their out-of-pocket expenses. This deduction is claimed "above the line" so it is available to nonitemizers.

The remaining extenders range from enhanced deductions for donating land for conservation purposes to business tax credits for research expenses and hiring veterans.

Finally, the new law authorizes tax-free accounts for disabled individuals who use the money for qualified expenses like housing and transportation. Another provision in the law provides greater investment flexibility for Section 529 accounts used to pay for college.

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Check your records to be sure you have the paperwork you need for charitable contributions you want to deduct on your 2013 tax return. Cash, check, and other monetary donations of any amount can be deducted only if substantiated by a bank record or written documentation from the charity. The rules require you to obtain the necessary records before you file your 2013 return.

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Experience is the Difference®

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