TAX TIPS NEWSLINE _____________________
Produced monthly for clients of the Advisory Group Associates
Our Mission: Sharing ideas that make a real difference.
This “TAX TIPS NEWSLINE” is compiled by its founder, Frank Zerjav CPA and team of Professional Tax Associates, and then it is sent by email each month because you need tax and compliance knowledge. It’s a big part of your life and the entities that you operate.
Do not wait to send us your 2014 data. Often Schedules K-1 from partnerships etc. are not issued until April. Best practice is to bring us what you have as soon as possible, even if your forms 1099 and brokerage statements have not yet been received. The goal is to have adequate time to let us process an accurate tax return. If you have any questions, please do not hesitate to contact us. Please notify us promptly of any address, e-mail, and telephone contact changes!
Inside this Month’s Issue
- Top Tax Issues Of 2015
- Recent Tax Developments
- Help If W-2s Are Missing
- Parents: Don’t Miss Out on Tax Savers
- Tax Help for Home Help
- Tax Help if You Get Tipped
- Final “Repair Regulations” Issued On Tangible Property Costs
- Reporting Unrelated Business Taxable Income (UBTI)
- Revised 2014 and 2015 Auto Depreciation Limits
- Wide Range of Solutions & Services Offered
TOP TAX ISSUES OF 2015
The new calendar year is upon us, and there are numerous changes and new regulations expected that companies should be closely monitoring. As you look at your tax-planning activities for 2015, keep your eye on the following issues.
The Affordable Care Act
The Affordable Care Act (ACA) is both a health care law and a tax with far-reaching ramifications. The Obama administration’s release of final guidance on Employer Shared Responsibility and information reporting requirements gave employers little time to ensure their systems are ready to comply. The ACA requires employers to track and report to the IRS a significant amount of employee data. Employers who took a “wait and see” approach to the law, particularly those with calendar-year benefit plans, might need to start gathering required reporting data immediately. This data often resides in multiple functions within the organization (HR, benefits, payroll, operations, etc.) or with vendors.
In addition to system readiness described above, companies must also evaluate excise tax implications that might result from not offering minimum essential coverage to a sufficient percentage of full-time employees on an entity basis. Missing more than 30% of employees that should be covered can result in millions of dollars in excise taxes and penalties. Companies must check and document their internal controls to ensure their systems properly track employee hours and contingent workers.
Tangible Property Regulations
The final tangible property regulations affect all taxpayers that acquire, produce or improve tangible, real or personal property – and their impact transcends industry, geography and ideology. The vast majority of companies are in industries that do not expect industry-specific guidance in the near term and must comply with all the rules in the regulations in their First taxable year beginning on or after Jan. 1, 2014.
The best-prepared companies will begin by determining their objectives (e.g., deduction maximization or reduction of administrative burden) as they begin the journey toward compliance. For many taxpayers, the answer lies somewhere between the most deductions and the least work. Understanding the path to compliance requires a measured approach, including an understanding of current accounting methods and the systems and processes required to capture relevant and necessary information. Proactive companies have the greatest opportunity to achieve their unique objectives, while demonstrating compliance with the regulations.
While some think reform is likely, nothing is certain. What’s clear is that tax reform is dependent on complex political dynamics and will produce winners and losers. Whatever the outcome, companies should become familiar with tax reform proposals and how their provisions might affect operations. It will be important to weigh the tax benefits of lower rates against the detriments of the various base-broadening provisions. Communicating with others who are similarly situated and engaging with policymakers will improve the quality of any potential future legislation.
RECENT TAX DEVELOPMENTS
The following is a summary of the most important tax developments that have occurred in the past three months that may affect you, your family, your investments, and your livelihood. Please call us for more information about any of these developments and what steps you should implement to take advantage of favorable developments and to minimize the impact of those that are unfavorable.
New tax-advantaged ABLE accounts. A new law allows states to establish tax-exempt “Achieving a Better Life Experience” (ABLE) accounts, which are tax-free accounts that can be used to save for disability-related expenses. They can be created by individuals to support themselves or by families to support their dependents. Assets can be accumulated, invested, grown and distributed free from federal taxes. Contributions to the accounts are made on an after-tax basis (i.e., contributions aren’t deductible), but assets in the account grow tax free and are protected from tax as long as they are used to pay qualified expenses. Withdrawals are tax-free if the money is used for disability-related expenses including: education; housing; transportation; employment support; health, prevention, and wellness costs; assistive technology and personal support services. A nonqualified distribution is subject to income tax and a 10% penalty on the part of the distribution attributable to earnings. Each disabled person is limited to one ABLE account, and total annual contributions by all individuals to any one ABLE account can be made up to the inflation-adjusted gift tax exclusion amount ($14,000 for 2015).
Health care impacts 2014 income tax returns. The IRS has provided details on how health care reform under the Affordable Care Act (ACA) affects the upcoming income tax return filing season. The most important ACA tax provision for individuals and families is the premium tax credit. Under another key provision, individuals without coverage and those who don’t maintain coverage throughout the year must have an exemption or make an individual shared responsibility payment, as separately detailed in final regulations and a notice issued by the IRS in November. The IRS stresses that most people already have qualifying health care coverage and will only need to check a box to indicate that they satisfy the individual shared responsibility provision when they file their tax returns in early 2015. Individuals and families who get coverage through the Health Insurance Marketplace (Marketplace, also known as an exchange) may be eligible for the premium tax credit. Eligible individuals and families can choose to have advance credit payments paid directly to their insurance company to lower what they pay out-of-pocket for their monthly premiums. Early in 2015, individuals who bought health insurance through the Marketplace will receive Form 1095-A, Health Insurance Marketplace Statement, which includes information about their coverage and any premium assistance received. Form 1095-A will help individuals complete their return. Individuals claiming the premium tax credit, including those who received advance payments of the premium tax credit, must file a federal income tax return for the year and attach Form 8962, Premium Tax Credit.
Supreme Court to decide if premium credit is allowed for health insurance purchased on federal exchange. A controversy has erupted concerning the ACA’s premium credit. The statute makes the credit available for insurance purchased on an exchange established by a state. A federal exchange was established for many states that did not establish their own exchanges. The IRS has issued regulations making the credit available for insurance purchased on a federal exchange. The regulations were challenged in court; one Circuit Court upheld them and another said they were invalid. After these conflicting decisions, the Supreme Court agreed to resolve the issue. The Supreme Court will hear the case in 2015. Its decision could affect about 5 million people getting a credit for insurance purchased on the federal exchange and could affect other key ACA provisions that are intertwined with the credit.
More guidance on toughened IRA rollover rule. A law limits the number of IRA rollovers that can be made in any 1-year period to one. Earlier, the Tax Court held that the limit applies to all of an individual’s IRAs even though the IRS had stated that the limit applies to each separate IRA an individual owns. Shortly after this decision, the IRS announced that it will adopt the more restrictive view for distributions after 2014. Then, in November, the IRS issued more guidance to clarify the start of the new policy. As clarified, an individual receiving an IRA distribution on or after Jan. 1, 2015 cannot roll over any portion of the distribution into an IRA if the individual has received a distribution from any IRA in the preceding 1-year period that was rolled over into an IRA. However, as a transition rule for distributions in 2015, a distribution occurring in 2014 that was rolled over is disregarded for purposes of determining whether a 2015 distribution can be rolled over, provided that the 2015 distribution is from an IRA that neither made nor received the 2014 distribution.
Personal service corporation in group avoids flat tax. Normally, a qualified personal service corporation (e.g., an employee-owned corporation performing legal, health or other professional services) is subject to a flat tax of 35%, unlike other corporations that are subject to graduated rates of 15%, 25% and 34%. In one case, the IRS sought to tax a qualified personal service corporation that was part of an affiliated group of corporations at the flat 35% rate. The Tax Court wouldn’t allow the IRS to do so. Rather, it said that the group’s consolidated income, including the income of the qualified personal service corporation, had to be taxed at the graduated rates.
Standard mileage rates up and down for 2015. The optional mileage allowance for owned or leased autos (including vans, pickups or panel trucks) is 57.5c per each business mile traveled after 2014. That’s 1.5c more than the 56c allowance for business mileage during 2014. But the 2015 rate for using a car to get medical care or in connection with a move that qualifies for the moving expense deduction is 23c per mile, 0.5c less per mile than the 23.5c rate for 2014.
Non-farmer escapes self-employment tax on conservation payments. A recent case addressed a tax issue concerning payments an individual received under a U.S. Department of Agriculture voluntary conservation reserve program. Specifically, an appellate court held that payments received under the program by the taxpayer (who was not a farmer) were not subject to self-employment tax (i.e., social security taxes imposed on self-employed persons). Rather, they were rentals from real estate excludible from self-employment income.
Tenant’s death extinguished tax lien on jointly held property. A district court has held that an IRS lien on a taxpayer’s interest in property was extinguished at his death because the property was owned jointly with a right of survivorship and the other joint tenant survived the taxpayer. Thus, there was no interest left to which the lien could continue to attach.
Tax developments involving West African Ebola outbreak. The IRS has designated the Ebola outbreak occurring in the West African countries of Guinea, Liberia, and Sierra Leone as a qualified disaster for purposes of the income tax exclusion for qualified disaster relief payments. The IRS also made clear that employer-sponsored private foundations can provide disaster relief to employee-victims in areas affected by the outbreak without jeopardizing their exempt status. In addition, the IRS announced that employees won’t be taxed when they forgo vacation, sick, or personal leave in exchange for employer contributions of amounts to charitable organizations providing relief to Ebola victims in Guinea, Liberia and Sierra Leone. Employers may deduct the amounts as business expenses.
HELP IF W-2s ARE MISSING
In most cases you get your W-2 forms by the end of January. Form W-2, Wage and Tax Statement, shows your income and the taxes withheld from your pay for the year. You need your W-2 form to file an accurate tax return.
If you haven’t received your form by mid-February, here’s what you should do:
- Contact your employer. Ask your employer (or former employer) for a copy. Be sure that they have your correct address.
- After Feb. 23. If you can’t get a copy from your employer, call the IRS at 800-829-1040 after Feb. 23. The IRS will send a letter to your employer on your behalf. You’ll need the following when you call:
- Your name, address, Social Security number and phone number;
- Your employer’s name, address and phone number;
- The dates you worked for the employer; and
- An estimate of your wages and federal income tax withheld in 2014. You can use your final pay stub for these amounts.
File on time. Your tax return is normally due on or before April 15, 2015. Use Form 4852, Substitute for Form W-2, Wage and Tax Statement, if you don’t get your W-2 in time to file. Estimate your wages and taxes withheld as best as you can. The IRS may need more time to process your return while it verifies your information. If you can’t finish your tax return by the due date, you can ask for more time to file. Get an extra six months by filing Form 4868, Application for Automatic Extension of Time to File U.S. Individual Income Tax Return. You can also e-file a request for more time. You can do this for free with IRS Free File.
Correct if necessary. You may need to correct your Tax Return if you get your missing W-2 after you file. If the tax information on the W-2 is different from what you originally reported, you may need to file an amended tax return. Use Form 1040X, Amended U.S. Individual Income Tax Return to make the change.
Note: Important New Health Insurance Form. If you bought health insurance through the Health Insurance Marketplace, you should have received a Form 1095-A, Health Insurance Marketplace Statement, by early February. You will need the new form to help you complete an accurate federal tax return. You will use the formation from the Form 1095-A to calculate the amount of your premium tax credit. The form is also used to reconcile advance payments of the premium tax credit made on your behalf with the amount of premium tax credit that you are eligible to claim.
If you did not receive your Form 1095-A, you should contact the Marketplace from which you received coverage to get a copy. You are not required to send in of health care coverage, including Form 1095-A, to the IRS when filing your tax return. However, it’s a good idea to keep these records on hand to verify coverage.
PARENTS: DON’T MISS OUT ON THESE TAX SAVERS
Children may help reduce the amount of taxes owed for the year. If you’re a parent, here are several tax benefits you should look for when you file your federal tax return:
- Dependents. In most cases, you can claim your child as a dependent. You can deduct $3,950 for each dependent you are entitled to claim. You must reduce this amount if your income is above certain limits. For more on these rules, see Publication 501, Exemptions, Standard Deduction and Filing Information.
- Child Tax Credit. You may be able to claim the Child Tax Credit for each of your qualifying children under the age of 17. The maximum credit is $1,000 per child. If you get less than the full amount of the credit, you may be eligible for the Additional Child Tax Credit. For more, see Schedule 8812 and Publication 972, both titled Child Tax Credit.
- Child and Dependent Care Credit. You may be able to claim this credit if you paid for the care of one or more qualifying persons. Dependent children under age 13 are among those who qualify. You must have paid for care so that you could work or could look for work. See Publication 503, Child and Dependent Care Expenses, for more on this credit.
- Earned Income Tax Credit. You may qualify for EITC if you worked but earned less than $52,427 last year. You can get up to $6,143 in EITC. You may qualify with or without children. Use the 2014 EITC Assistant tool at IRS.gov to find out if you qualify. See Publication 596, Earned Income Tax Credit, to learn more.
- Adoption Credit. You may be able to claim a tax credit for certain costs you paid to adopt a child. For details see Form 8839, Qualified Adoption Expenses.
- Education tax credits. An education credit can help you with the cost of higher education. There are two credits that are available. The American Opportunity Tax Credit and the Lifetime Learning Credit may reduce the amount of tax you owe. If the credit reduces your tax to less than zero, you may get a refund. Even if you don’t owe any taxes, you still may qualify. You must complete Form 8863, Education Credits, and file a return to claim these credits. Use the Interactive Tax Assistant on IRS.gov to see if you can claim them. Visit the IRS’s Education Credits Web page to learn more. Also see Publication 970, Tax Benefits for Education, for more on this topic.
- Student loan interest. You may be able to deduct interest you paid on a qualified student loan. You can claim this benefit even if you do not itemize your deductions. For more information, see Publication 970.
- Self-employed health insurance deduction. If you were self-employed and paid for health insurance, you may be able to deduct premiums you paid during the year. This may include the cost to cover your children under age 27, even if they are not your dependent. See Publication 535, Business Expenses, for details.
TAX HELP FOR HOME HELP
Household employment is quite different from commercial employment – different forms, processes, deadlines and labor laws. Families with domestic employees struggle with all the state and federal obligations and, as a result, many make inadvertent mistakes that can become very expensive and frustrating. We want to share these helpful tips:
- A domestic worker is considered an employee, not an independent contractor. This is easily the most common mistake seen in the household employment industry. IRS Publication 926 clearly states that nannies, senior caregivers, housekeepers and other domestic workers are employees of the family for whom they work. Unfortunately many families are bombarded with misinformation and believe they can simply provide their household employee with a 1099 at tax time and save themselves the burden of handling employment taxes. Worker misclassification is considered tax evasion and punishes the worker in the form of higher taxes. As a result, it’s being aggressively enforced by the IRS and the Department of Labor.
- During the hiring process, illustrate the difference between gross and net pay. While there is significant momentum building toward household employment tax compliance many domestic workers are still used to being paid under the table in cash. So when they work for a family that wants to pay them legally, it’s important that the worker understands how tax withholdings work – and how much will actually end up in their bank account. It would be wise to run a few payroll scenarios to illustrate the difference between gross wages and net pay – during the compensation discussion at time of hire. This will help prevent any surprises on the first payday.
- Household employees should be paid an hourly rate and overtime. Household employees are classified in the Fair Labor Standards Act as non-exempt workers. This means their payroll should be set up on an hourly rate for every hour worked.
Because household employees are non-exempt workers, they also must be paid overtime if they work more than 40 hours in a seven-day workweek. Overtime should be paid at least 1.5 times the regular hourly rate and should be spelled out in the employment contract. The Domestic Worker Bill of Rights laws passed in California, Hawaii, Massachusetts and New York over the past few years have heightened awareness of overtime rights, making it more important than ever to stay compliant and prevent any potential wage disputes.
Note: Federal law exempts household employers from paying overtime to live-in employees, but they must be paid for every hour they work. Additionally, several states have laws on the books to extend overtime to live-in employees or have daily overtime requirements, so it’s important your clients understand the specific requirements in their state.
- Think about paid time off, holidays and sick time for the employee. While federal law does not require you to provide paid time off for vacations, holidays or sick time to a household employee, it’s an important benefit to provide if you want to attract and retain a high-quality employee. Additionally, several states and municipalities have paid time off or sick time requirements, so it’s crucial to build these details into their employment contract.
- Don’t procrastinate! To families, the “nanny tax” obligations seem like “tax stuff’ that can wait until “tax time.” However, most states have wage reporting obligations throughout the year. Additionally, employers must withhold FICA taxes from the employee or they become liable for them. Waiting until tax season to address these issues – as well as all the labor law issues – usually results in mistakes and added expense. It’s much cheaper and easier to handle all this at the time of hire.
The Domestic Worker Bill of Rights has brought attention to legal pay among workers across the country. Additionally, many domestic workers qualify for the federal health insurance subsidy, but they must have documented wages in order to realize that benefit. In addition, many caregivers will be approaching their family about these issues – and families will then turn to their trusted advisors to help them handle things correctly and eliminate risk.
TAX HELP IF YOU GET TIPPED
If you get tips on the job, you should know some things about tips and taxes. Here are a few tips from the IRS to help you file and report your tip income correctly:
- Show all tips on your return. You must report all tips you receive on your federal tax return. This includes the value of tips that are not in cash. Examples include items such as tickets, passes or other items.
- All tips are taxable. You must pay tax on all tips you received during the year. This includes tips directly from customers and tips added to credit cards. It also includes your share of tips received under a tip-splitting agreement with other employees.
- Report tips to your employer. If you receive $20 or more in tips in any one month, you must report your tips for that month to your employer. You should only include cash, check and credit card tips you received. Do not report the value of any noncash tips on this report. Your employer must withhold federal income, Social Security and Medicare taxes on the reported tips.
- Keep a daily log of tips. Use Publication 1244, Employee’s Daily Record of Tips and Report to Employer, to record your tips. This will help you report the correct amount of tips on your tax return.
For more on this topic, see Publication 531, Reporting Tip Income. You can get it on IRS.gov.
FINAL “REPAIR REGULATIONS” ISSUED ON
TANGIBLE PROPERTY COSTS
(May Require 2014 Form 3115 Filings)
The IRS has issued long-awaited final regulations during mid-January, 2015 on the treatment of costs to acquire, produce or improve tangible property. Taxpayers must apply these Repair Regulations on their 2014 tax return to determine whether they can immediately deduct costs as repairs and maintenance or capitalize and depreciate these costs over a sometimes lengthy depreciation period. These new regulations cover all tangible property (that which you can see and touch), that is used in or associated with any type of business or rental property.
The final Repair Regulations retain the basic requirements and the structure of the temporary and proposed regulations issued in December 2011 (the 2011 regulations). The Repair Regulations are complex. At the same time, they made changes that can benefit taxpayers. These new regulations also contain new and revised safe harbors, which if adopted and adhered to will make them safe from Internal Revenue Service audit. The Safe Harbors cover repairs, routine maintenance, materials and supplies.
As expected, the regulations “take effect” January 1, 2014. However, they can be applied to prior years retroactively by adopting the changes which would require filing Form 3115, Application for Change in Accounting Method.
For expenditures that were capitalized and depreciated in prior years that could have been expensed under the new Repair Regulations, taxpayers can make an accounting method change and file Form 3115 to stop depreciating the capitalized amounts and claim an immediate deduction on the remaining undepreciated amount. Conversely, amounts expensed in a prior year that should have been capitalized under the new Repair Regulations standards, the expensed amounts (less depreciation that could have been claimed) are reported as income. Depending upon your particular situation, the net effect may generate additional deductions or an additional income for 2014. Often the adjustments are taxpayer favorable.
Complying with the final regulations requires significant time and effort, despite several taxpayer-friendly changes. Every business and real property owner, especially those with significant fixed assets, must develop an understanding of the regulations and their requirements.
The regulations will provide simplification and reduce controversy to the extent they allow taxpayers to follow their financial accounting (“book”) policies for certain expenditures. For example, de minimis safe harbor rules provide a $500 per item safe harbor deduction for taxpayers that have a policy in effect at the beginning of the tax year to deduct items within the safe harbor deduction limit. The $500 per item limit is increased to $5,000 if you have an Applicable Financial Statement (AFS), which usually means audited financial statements.
Other Significant Provisions In The Final Regulations Relate To The Following:
Materials and Supplies. The deduction threshold for materials and supplies has increased from $100 to $200. Materials and supplies also include items that are expected to be consumed within 12 months or less, or that have an economically useful life of 12 months or less. Materials and supplies can be immediately deducted when purchased, or if the taxpayer tracks such items, deducted when used.
Unit of Property. “Unit” of property rules apply the rules for real property to building systems, as well as to the overall structure.
Routine Maintenance. A routine maintenance safe harbor is expanded to include real property. In the context of buildings, a taxpayer that expects to perform an activity more than once within a 10 year period, such as replacing the handrail to an escalator, may immediately deduct such costs. There are similar rules for personal property. The routine maintenance safe harbor ensures the current deductibility of certain recurring maintenance.
Capitalization Election. The final regulations allow taxpayers to capitalize repair and maintenance costs if they are capitalized for financial (book) accounting purposes. This is a significant simplification over earlier proposed guidance. It is an annual election and does not require filing Form 3115.
DE MINIMIS SAFE HARBOR IN FINAL REPAIR REGULATIONS
The goal of the final Repair Regulations is to bring some certainty to the treatment of costs to acquire, produce or improve tangible property. Overall, both the proposed and final regulations generally require a taxpayer to capitalize amounts paid to acquire or produce a unit of real or personal property including the related transaction costs. However, taxpayers can take advantage of a de minimis safe harbor. The safe harbor in the final regulations is much more expansive and generous than in the proposed regulations.
A taxpayer with an Applicable Financial Statement (generally, an audited financial statement) may rely on the de minimis safe harbor only if the amount paid for property does not exceed $5,000 per invoice, or per item, as substantiated by the invoice.
For taxpayers without an Applicable Financial Statement, under this approach, a taxpayer may rely on the de minimis safe harbor only if the amount paid for property does not exceed $500 per invoice, or per item, as substantiated by the invoice.
The final regulations authorize the IRS to increase the $5,000/$500 de minimis amounts in future years. Our firm will keep you posted of developments.
The de minimis safe harbor is an election that is made annually on the tax return. An election statement must be included with the return. Moreover, you must have a “Capitalization Policy” in place at the beginning of the tax year to expense for both tax and financial (book) accounting purposes items costing less than the de minimis limitation ($500 or $5,000, as applicable).
As you can see, the new Repair Regulations are extensive and complex. Determining whether particular costs should be deducted or capitalized will be challenging. This firm stands ready to help taxpayers digest and understand the regulations, determine what accounting and record-keeping policies are needed, and make appropriate elections to comply with the regulations. Please contact our firm so that we can help you address these rules.
REPORTING UNRELATED BUSINESS TAXABLE INCOME (UBTI)
Even though your Retirement Plan is generally recognized as tax exempt before making distributions, it still may be liable for tax on its Unrelated Business Income, which is income from a trade or business. If your retirement plan has $1,000.00 or more of Unrelated Business Income, either the Custodian, Trustee or you must file Form 990-T, Exempt Organization Business Income Tax Return.
The Form 990-T may need to be filed for an employee’s 401(k) Trustee, an IRA (including SEPs and SIMPLEs), a ROTH IRA, a Coverdell ESA, or an Archer MSA by the 15th day of the 4th month after the end of its tax year. Failure to file when due (including extensions of time for filing) is subject to a penalty of 5% of the unpaid tax for each month the return is late, up to a maximum of 25% of the unpaid tax.
For many years investors with qualified retirement plans have looked to reduce overall portfolio volatility and improve returns on their investments. This has led to an increased interest in the area of “Alternative Investments,” which include Direct Participation Programs (“DPP”) in oil and gas, hedge funds, real estate, private equity and venture capital funds. These investors have embraced the pros and cons of Unrelated Business Taxable Income (“UBTI”) generated by Alternative Investments for more attractive risk adjusted returns.
Oil and gas drilling funds structured through a limited partnership that holds working interests in oil and gas properties create UBTI when placed inside an IRA or other qualified retirement plan. So, do oil and gas investments belong in IRAs and qualified plans? This is not a black and white issue and the usual answer is no, but there may be exceptions. The nature of certain types of oil and gas DPP investments may have benefits created by the investment that more than offset the potential negatives, or exposure to UBTI. If the exposure to UBTI is insignificant or inconsequential to the total benefits from the investment’s non-UBTI returns, there may be a level of acceptability.
Other energy DPP investments, such as leasebank investments, may be more suitable to an IRA than a drilling fund. Typically, the majority of the returns to a leasebank fund come from capital gains created by the sale of lease assets and passive income from royalty interests. It is our belief that capital gains and passive income are exempt from UBTI, however, we encourage investors to consult their tax advisors for specific advice and guidance.
What is UBTI?
Unrelated Business Taxable Income in the U.S. Internal Revenue Code is the income that comes from an activity engaged in by a tax exempt entity or organization that is unrelated to the tax-exempt purpose of that entity or organization.
UBTI is a tax imposed by Congress on tax-qualified entities that produce profits through business activity instead of passive investments. Examples of passive investments include interest from loans, dividends and gains from private stock holdings, and returns from the purchase/sale of precious metals.
UBTI in an IRA or Qualified Retirement Plan
If an investor holds an Individual Retirement Account (IRA), and the Alternative Investment generates income that qualifies as UBTI, the Plan may be subject to taxation. When it comes to self-directed IRA investing, account holders often find out about prohibited transactions and disqualified persons before making investments; but fewer investors learn about (or even come across) UBTI before acquiring their DPP in a limited partnership or purchasing rental real property in their self-directed IRA or 401(k).
There are two scenarios that trigger UBTI for Retirement Plans:
- Profits generated from a business/trade. When an IRA or 401(k) derives profit from an operating business that has not paid business tax on those profits before distributing them to the retirement account, those profits trigger UBTI and are taxed at trust rates. This includes net taxable income from working interests in oil and gas properties. Taxable deductions from oil and gas properties can be used in computing net taxable income. (Generally Mineral Royalties are excluded from UBIT whether measured by production or by gross or taxable income from the Mineral Property).
- Leveraged Real Estate Investments. When an IRA purchases real estate using a non-recourse mortgage loan, the Debt-Financed portion of the property’s profits is subject to UBTI. Similarly, if an IRA-owned property is sold while a percentage of ownership is still debt financed, the profit derived from the debt financed percentage is subject to UBTI. (Generally rental income and Capital Gain are excluded in computing UBTI-property that is NOT Debt-Financed).
What is the tax rate for UBTI? How is UBTI Calculated?
UBTI rates for retirement account investments follow a schedule of “Trust Rates” provided by the IRS on an annual basis. Contact your Professional Tax Advisor about filing form 990-T as soon as you consider investing in an asset that may be subject to UBTI. Keep in mind that losses in some years may offset profits in subsequent years. Trust rates change from year to year, but slide from 15% to 39.6%.
If your IRA generates UBTI, it does not disqualify the IRA (like prohibited transactions would). It does, however, require your IRA to file an income tax return, which is unusual since an IRA is supposed to be tax-exempt. Since UBTI is generated, income tax will be owed on the income if it reaches certain levels.
Just like individual tax returns, if the IRA generates gross income of $1,000 or more during the tax year, the Retirement Plan must file Form 990-T. Issues that arise with this filing include:
- The IRA must have a federal tax ID (EIN).
- The custodian is considered responsible for filing Form 990-T, but most self-directed IRA custodians transfer this responsibility to the account owner.
- The IRA custodian may not have all of the information required to file the return, since much of the information in these privately-held investments is given directly to the account owner.
- The account owner ultimately has the final responsibility to file the Form 990-T, and a lack of an understanding of the rules can cause major issues for the account owner.
- The account owner will also be required to file quarterly estimated tax payments as long as the investment is in place. Every three months, a tax payment must be made to the IRS if the total tax for the year is expected to be greater than $500.
Note: UBTI may create one of those cases where income within an IRA is actually destined to be double-taxed. Even though you pay tax on the tax as it is earned within the IRA (at trust rates, not individual rates, which are more compressed), when you take the money out of the IRA, you will be taxed again. Paying tax on the UBTI doesn’t create non-taxable basis in the IRA.
Depending upon the nature of the IRA or qualified plan investment, UBTI may be:
Good – with limited exposure, the overall net investment benefits may be worthwhile using assets from this source.
Bad – the tax shelter on some or all investment earnings may be lost and some of the IRA/plan may wind up being double taxed.
Ugly – there are tax reporting and tax estimates that may come into play. Failure to take care of all of these duties could lead to adverse consequences.
Account Owners should not run away when they hear UBTI, but care and proper evaluation are definitely in order. When debating the pros and cons of UBTI in an IRA, the question shouldn’t be “How do I avoid UBTI?” but rather “What is the resulting net rate of return from the investment within my IRA that will generate UBTI”
Dismissing an investment because of the potential payment of taxes should never be a deal killer.
PLEASE CONSULT YOUR PROFESSIONAL TAX ADVISOR REGARDING THE POTENTIAL IMPACT OF UBTI ON AN IRA OR OTHER QUALIFIED PLAN.
REVISED 2014 AND 2015 AUTOMOBILE DEPRECIATION LIMITS
IRS just recently issued revised numbers for the amount of depreciation taxpayers can take for the first year they use a passenger automobile (including a truck or van) for business in 2014 and the figures for 2015 (Rev. Proc. 2015-19, amplifying and modifying Rev. Proc. 2014-21).
The revised numbers for 2014 were necessary because the Tax Increase Prevention Act of 2014, P.L. 113-295, extended bonus depreciation retroactively to the beginning of 2014, but it did not extend it for 2015.
Under the new law, the amount of the first year depreciation limitation for 2014 for passenger automobiles to which bonus depreciation applies is increased by $8,000. For passenger automobiles (other than trucks or vans) placed in service during calendar year 2014 to which 50% first-year bonus depreciation applies, the depreciation limit under Sec. 280F(d)(7) is $11,160 for the first tax year. Trucks and vans to which bonus depreciation applies have a slightly higher limit: $11,460 for the first tax year.
For 2015, for passenger automobiles (other than trucks or vans) placed in service during that calendar year, the depreciation limit under Sec. 280F(d)(7) is $3,160 for the first tax year. For trucks and vans, the limit is $3,460 for the first tax year.
For passenger automobiles for 2015, the limits are $5,100 for the second tax year; $3,050 for the third tax year; and $1,875 for each successive tax year.
For trucks and vans, the limits are $5,600 for the second tax year; $3,350 for the third tax year; and $1,975 for each successive tax year.
Sec. 280F(c) limits deductions for the cost of leasing automobiles, expressed as an income inclusion amount according to a formula and tables prescribed under Regs. Sec. I.280F-7. The revenue procedure provides an updated table of the amounts to be included in income by lessees of passenger automobiles and another for trucks and vans, in both cases with lease terms that begin in calendar year 2015.
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