Home Office Deduction - Exclusive Use

If you use your home for work or business, you may be entitled to the home office deduction. The home office deduction is one of those wonderful tax deductions that allows a taxpayer to turn an otherwise non-deductible personal expense into deductible business expense.

Over a series of posts, I'm going to review some of the rules and nuances of this deduction. You can find more information in IRS Publication 587 or the IRS YouTube video.

The first thing to note are the specific rules you must follow to get this special deduction. If you fail to follow the rules, you will generally lose the deduction.

To qualify to deduct expenses for business use of your home, you must use part of your home:

• Exclusively and regularly as your principal place of business,
• Exclusively and regularly as a place where you meet or deal with patients, clients, or customers in the normal course of your trade or business,
• In the case of a separate structure which is not attached to your home, in connection with your trade or business,
• On a regular basis for certain storage use (Inventory storage or product samples)
• For rental use (See IRS Publication 527)
• As a daycare facility

If you are an employee, you may also qualify for a deduction if you meet the tests noted above plus:

• Your business use must be for the convenience of the employer, and
• You must not rent any part of your home to your employer and use the rented portion to perform service as an employee for the employer.

The IRS notes that if the use of the home office is merely appropriate and helpful for the employer, you cannot deduct expenses for the business use of your home.

The key words that often catch the unwitting taxpayer are exclusive and regular use. Many court cases hinge on the interpretation of these two words. In today's post, I'll review the exclusive use test.

The first thing to note is that you don't have to meet the exclusive use test if you are taking the home office deduction as a daycare facility, or for the storage of inventory or product samples. There are some specific rules you need to meet for these exceptions though I'll refer you to IRS Pub 587 to read those yourself.

Because exclusive use seems to be a very high bar, I'm often asked if there are exceptions to this rule beyond those noted above. In other words, does the IRS really mean "exclusive?"

The law [IRC Sec. 280A(c)(1)] is very clear on this matter - the use must be exclusive. Almost any personal use for the area destroys the deduction.

In Speers v. Commissioner (T.C. Memo 1994-157) the court ruled the exclusive use test is an "all-or-nothing standard." Combining business and personal use precludes the deduction - ANY personal use destroys the deduction.

Despite this clear standard, the courts have carved out de minimis exceptions to the exclusive use test.

In one case, a taxpayer claimed a home office deduction for a walk-in closet in his studio apartment. To get to the bathroom, the taxpayer had to walk through the closet allowing the IRS to challenge the exclusive use test. The court ruled in the taxpayer's favor saying this incidental use to walk to and from the bathroom did not violate the exclusive-use test.

In another case [Culp v Commissioner (TC Memo 1993-270)], a taxpayer stored a lawn mower in the garage he claimed as a home-office deduction. The court again ruled on behalf of the taxpayer claiming the space occupied by the lawn mower amounted to de minimis use and did not alter the deduction.

In an example of how even minor personal use can destroy the deduction, look at Langer v Commissioner [TC Memo 1992-46]. Mrs. Langer ran a piano lesson business from her home and had a special area set aside for this exclusive purpose. However, during the year she had an open house allowing guests to use the room. The court ruled that this use violated the exclusive use test and Mrs. Langer lost her deduction.

We'll continue with this subject in future blog posts.

Same-sex Marriage

The Obama Administration and his Justice Department have stated they can no longer defend the constitutionality of the federal Defense of Marriage Act (DOMA). However, the final say on this subject (whether marriage can be restricted to the legal union between a man and women) is likely to be settled by the Supreme Court, and probably not for a year or more.

In the meantime, legally married same-sex couples can file protective refund claims for all open tax years if they would benefit on their taxes by joint filing. If these protective refund claims are filed and the Supreme Court strikes down DOMA, you'll be entitled to your refunds.

It should be noted that DOMA impacts more than just income taxes. Were DOMA to be held unconstitutional, the following would also be affected:

• Gifts between spouses would get the unlimited gift tax marital deduction;
• Bequests to surviving spouses would not be subject to estate taxes and the survivor would be entitled to any unused estate tax exemption of the decedent;
• Employer provided health care for same-sex spouses would be tax free.

Bush Tax Cuts Set to Expire

Amongst other things, President George W. Bush was famous for cutting taxes, spending money, and running up the deficit.

While his tax cuts reduced taxes on most if not all citizens, they really helped the super-rich with most of the benefits going to them. In fact, it could be argued that his tax cuts facilitated what might be the greatest transfer of wealth in our nation's history. Of course this transfer of wealth went upwards, from the lower- and middle-class to the upper class where we now have one of the highest concentrations of wealth in the world.

While President Bush certainly wanted his tax cuts to be permanent, passing temporary cuts made them appear less costly to the U.S. Treasury, and provided Republicans a future opportunity to make them permanent. That time is now. Most of those temporary tax cuts expire in 2010.

This is going to be a huge battle. The Republican talking points state that allowing the Bush tax cuts to lapse is the same thing as a tax increase while Obama's plan is to let the cuts expire on high income individuals while reducing taxes on average working families.

Who do you believe? How will these tax changes effect you?

The good folks over at the non-partisan Tax Foundation created the website MyTaxBurden where you can enter some tax information and see your tax obligation three ways:

• pre-Bush tax cuts (the system we'll return to if Congress fails to act)
• Bush tax cuts (what will happen if the tax cuts are extended)
• Obama's budget plan (What he ran on and what he's proposed)

I hope you'll check it out and I'd love it if you posted your results here.

Other Green Incentives for Business

In my last blog post I covered IRC Sec. 179D and the deduction for energy efficient commercial buildings.

Today, I'm going to highlight some of the other energy and efficiency related incentives that you might want to know about. Due to the complexity and the narrow applicability of many of these tax incentives, I'm just going to list them out today and I'll decide later whether to delve deeper into any of them.

1. Accelerated Depreciation for Qualified Smart Electric Meter and Qualified Smart Electric Grid System (IRC Sec. 168(e)(3)(D)(iii) and (iv));
2. Qualifying Advanced Energy Project Credit (IRC Sec. 48C);
3. Energy Efficient Appliance Credit (IRC Sec. 45M);
4. Credit for Carbon Dioxide Sequestration (IRC Sec. 45Q);
5. Qualifying Advanced Coal Project Credit (IRC Sec. 48A);
6. Qualifying Gasification Project Credit (IRC Sec. 48B);
7. Alcohol Fuels Credit (IRC Sec. 40);
8. Enhanced Oil Recovery Credit (IRC Sec. 43);
9. Renewable Electricity Production Credit (IRC Sec. 45);
10. Biodiesel Fuels Credit (IRC Sec. 40A);
11. Low Sulfur Diesel Fuel Production Credit (IRC Sec. 45H)
12. Advanced Nuclear Power Facility Production Credit (IRC Sec. 45J); and
13. Nonconventional Source Production Credit (IRC Sec. 45K).

Tax Filing Deadlines at the end of the month

Just a quick reminder that some filing deadlines are looming. From the IRS website, here is what is required to be mailed by February 1st:

Furnish Forms 1099 and W-2. Furnish each employee a completed Form W-2, Wage and Tax Statement. Furnish each other payee a completed Form 1099 (for example, Form 1099-MISC, Miscellaneous Income).

File Form 941 or Form 944. File Form 941, Employer's QUARTERLY Federal Tax Return, for the fourth quarter of the previous calendar year and deposit any undeposited income, social security, and Medicare taxes. You may pay these taxes with Form 941 if your total tax liability for the quarter is less than $2,500. File Form 944, Employer's ANNUAL Federal Tax Return, for the previous calendar year instead of Form 941 if the IRS has notified you in writing to file Form 944 and pay any undeposited income, social security, and Medicare taxes. You may pay these taxes with Form 944 if your total tax liability for the year is less than $2,500. For additional rules on when you can pay your taxes with your return, seePayment with return on page 20. If you timely deposited all taxes when due, you have 10 additional calendar days from the due date above to file the appropriate return.

File Form 940. File Form 940, Employer's Annual Federal Unemployment (FUTA) Tax Return. However, if you deposited all of the FUTA tax when due, you have 10 additional calendar days to file.

File Form 945. File Form 945, Annual Return of Withheld Federal Income Tax, to report any nonpayroll income tax withheld in 2008. If you deposited all taxes when due, you have 10 additional calendar days to file. See Nonpayroll Income Tax Withholding on page 4 for more information.

Green Tax Incentives for Travel (Part I)

I covered federal tax incentives for going green in the home here and here. Now I'm going to cover green tax incentives associated with travel.

For individuals, the following credits are available:

• New Qualified Plug-in Electric Drive Motor Vehicles Credit (IRC Sec. 30D)
• Certain Plug-in Electric Vehicles Credit (IRC Sec. 30)
• Alternative Motor Vehicle Credit (IRC Sec. 30B)
• New Qualified Fuel Cell Motor Vehicle Credit (IRC Sec. 30B)
• New Qualified Advanced Lean burn Technology Motor Vehicle Credit (IRC Sec. 30B)
• New Qualified Hybrid Motor Vehicle Credit (IRC Sec. 30B)
• New Qualified Alternative Fuel Motor Vehicle Credit (IRC Sec. 30B)
• Plug-in Conversion Credit (IRC Sec. 30B)

The first three items on the list are also available for businesses that purchase energy efficient vehicles.

The rules for each of these credits is too detailed to blog about but you can find out more by reviewing the code sections or looking at the required forms where the various credits are calculated - Form 8936 (Qualified Plug-in Electric Drive Motor Vehicle Credit), Form 8834 (Qualified Plug-in Electric and Electric Vehicle Credit), and Form 8910 (Alternative Motor Vehicle Credit).

Going Green using the Tax Law

I'm often asked about tax and other governmental incentives for going green, so thought I'd give a high level overview. It would probably take a book to cover all the federal, state and local incentives that might be available so I'll just be covering the federal tax incentives.

I've worked with clients who got part of their funding to "go green" through federal programs like USDA REAP Grants, which are available for rural development. I do not know where one would find a comprehensive list of all the available programs that might fund your green project.

On a local level however, you should always check the Database for State Incentives for Renewables & Efficiency to see what local incentives are available.

For the CPAs and attorneys who might be interested, there are three main federal Acts which provide tax incentives for businesses and individuals:

1. The American Recovery and Reinvestment Act of 2009 (ARRA)
2. Emergency Economic Stabilization Act of 2008 (EESA)
3. The Energy Policy Act of 2005

Check back and I'll cover the incentives in the next few posts.

Corporate taxes in Oregon

The Oregon legislature passed a bill this last session increasing the minimum corporate tax from $10 to $150. The $10 minimum fee hasn't changed since 1931! Faced with massive budget deficits, the legislature enacted a combination of spending cuts and increased taxes to address the problem.

The bill was challenged through the referendum process so the issue will be voted on by Oregon voters in January. A "Yes" vote will keep the tax increases and the services these funds provide, a "No" vote will stop the tax increase forcing a deep cut in human services.

The legislative spending cuts were deep and real. I've talked to teachers who now have 3-5 more kids in every class increasing their workload. My teenage daughter has mentioned both the increased class size and the decreased school district support for athletics, music and other extra curricula activities like debate, dance, and more.

The tax increases were responsible and targeted. The tax increase on individuals only hits those earning $125,000 ($250,000 for married couples) or more, and then, the tax increase only hits their income ABOVE $125,000 ($250,000 for married couples). For corporations, they increased the minimum tax as noted above, and, also added a gross receipts tax of .0015 for corporations with $500,000 or more in Oregon sales. Both of these groups (corporations and wealthy people) can afford these very modest increases. Without the increases, the service cuts would be even deeper.

I had an "In My Opinion" piece in the morning's Oregonian. Check it our if you'd like to read more.

Small Business Incentives in the Recovery Act

The $787 billion American Recovery and Reinvestment Act of 2009 provides nearly $300 billion in tax relief.  As a stimulus package, over $280 billion in tax relief is targeted for 2009 and 2010.  Keeping with the Obama administration view that small business is the principal engine for job growth, the act has some nice benefits for small to medium size businesses.  Please note that this is a high-level overview and you should probably see a CPA or qualified tax accountant for more information about your specific situation.

CAPITAL  EXPENDITURES

One benefit for small business is the ability to immediately expense major capital purchases through the use of Code Sec. 179 and bonus depreciation (Code Sec. 168(k)).  Code Sec. 179 is limited to small business as it begins to phase out when a company spends more than $800,000 on eligible purchases.

First-year expensing was once limited to $25,000 per year and then increased to $100,000.  In 2008, the limit was increased to $250,000, and the act extended this limit through 2009.    Businesses that qualify should take advantage of this opportunity because the limit reverts to around $125,000 in 2010 with a $500,000 phase-out and could go even lower in 2011.

NOL CARRYBACKS

The act allows corporations, partnerships and sole proprietors to carryback 2008 losses for five years rather than the two years allowed in the previous law.  NOLs can provide an immediate and significant cash infusion for a cash-starved business running at a current loss if they had income in any of the previous five years.

I was consulting with a business last week who was struggling with cash flow in this current economic environment and was able to identify over $40,000 of cash sitting in his 2008 loss.  His current CPA firm had been sitting on their S-Corp return for over 6 weeks (crappy service but that is a blog entry for another day).  I recommended he light a fire under them or bring it to TriLibrium to tap into this tax refund ASAP.

The five year carryback only applies to companies with average sales of less than  $15 million over a three year period.  It should also be noted that if a business has already filed their 2008 return and elected to forgo the carryback, there is a provision in the act that allows taxpayers to revoke that election by making a new election before April 18, 2009.

QUALIFIED SMALL BUSINESS STOCK

Owners of qualified small-business stock could previously exclude 50 percent of the realized gain on the stock if the stock was acquired when issued and held for five years.  The act increased the exclusion to 75 percent of the gain, for stock issued after February 17, 2009 through the end of 2010. 

I should also point out that start-ups should consider the benefits of Code Sec. 1244.  I see far too many lay people choose the LLC model without understanding the options and benefits of other forms of business.

S CORPS

I don’t want to go into all the details but will say that the act has some special rules that would apply to C corporations that converted to an S corporation in 2001 or 2002 and are facing downsizing and need to unload assets.

ESTIMATED TAXES

The safe harbor for estimated taxes was reduced from 100 percent to 90 percent of prior year’s tax, or 90 percent of the current year’s tax.  This safe harbor is limited to taxpayers with less than $500,000 of adjusted gross income, where more than 50 percent of income is derived from a business with an average of less than 500 employees in 2008.  This benefit applies only to 2009 but should lower estimated tax payments for many people.

Taxes, AIG bailout and more

I was going to blog about taxes so I started researching the federal budget and looking for an image to post.  

I really wanted to discuss the residential energy-efficient property credit, which was extended through 2016 and which generally covers solar electric, solar water heating, fuel cell property, small wind energy and geothermal heat pump property.  I also wanted to discuss the non-business energy property credit for insulation, exterior windows, exterior doors, furnaces, water heaters and other energy-saving improvements to a main home which was not available in 2008 but returns in 2009.

However, the AIG bonus hysteria got in the way of a deeper discussion on taxes. 

First, I don’t believe anyone is worthy of a multi-million dollar income and lifestyle while we have needy children in our midst.  That is one of my beliefs and values.  I think billionaires are evidence of a flawed system.

While I’m opposed to the whole Wall Street bailout and the more than $9 TRILLION spent on this fiasco to date, what gets me is the missing perspective on the AIG bonuses.

AIG Bonuses = $165,000,000 ($165 million)

Missing Cash in Iraq = $12,000,000,000 ($12 billion – 73x more)

Official cost of Iraq war to date = $656,100,000,000 ($656.1 billion – 3,977x more)

Wall Street bailout to date = $9,400,000,000,000 ($9.4 TRILLION – 56,970x more)

The AIG bonuses amount to 2/1000^th’s of the cost of the bailout!

FYI:  Missing from the "official" cost of the bailout is government guarantee and insurance programs like the FDIC ($1.5 trillion), FHA ($.3 trillion) and the Federal Reserve ($7 trillion).

Form 1099-Misc due February 2

This is a reminder that 1099s, with a few exceptions, need to be mailed by Monday, February 2nd. Fines for late filing start at $15 per return (if filed within 30 days of the due date) and go up to $50 per return if filed after August 1 or not at all.

Businesses (and non-profits) need to send them to any individual or partnership if you paid them more than $600 during 2008. Professional fees to attorneys, doctors and other professionals are included. Payments to corporations are included only if they are for medical, legal or fishing activities.

You also need to send one if you paid someone more than $10 in royalties.

You can read the more detailed general instructions here or the more abbreviated 1099-Misc instruction here.

Finally, you should have a policy to require your non-corporate vendors to complete a Form W-9 prior to disbursing any payments to them. This will insure you have the required information you need at year end to properly prepare your 1099s. Don't wait until January to start gathering this data.

US tax system not perceived as fair according to report

Yesterday I provided some information from The Tax Institute at H&R Block’s annual survey of taxpayers. The study found that most Americans weren’t very knowledgeable about the tax laws that impact their pocketbook and should inform their financial decisions.

What I didn’t report, and what I found more interesting, was the finding that a whopping 92 percent of those taxpayers surveyed could not describe the U.S. tax system as "very fair." While “very fair” may be a high threshold, it shows me there is a lot of room for improvement since the best tax systems are perceived as fair.

To me, the fairest system is a progressive system with increasing marginal tax rates. Increasing marginal tax rates means that tax rates increase as income increases, but only at the margin. For example, if marginal rates increased every $50,000, then the first $50,000 everyone earns would be taxed the same regardless of total income, while those who made between $50,001 and $100,000 would pay slightly more on that income than on their first $50,000. In this example, the marginal rate would go up until it reaches the maximum rate.

The theory behind this is based on the utility of money. The less money you earn, the more valuable and vital each dollar is to you, while the more you earn decreases the utility of the subsequent dollar. A $1,000 to me and a $1,000 to Bill Gates are two very different amounts.

I’ll continue with this discussion the next time I blog.

Would you pass the tax quiz?

An annual survey conducted by The Tax Institute at H&R Block finds a majority of taxpayers can’t answer even the most basic tax questions correctly according to their press release. Accordingly to Amy McAnarney, Executive Director of the institute, “Americans are failing Taxes 101.” The annual survey asks 1,000 people tax related questions.

Some of the findings:

70 percent said they were not aware of recent legislative changes that could affect their return despite the fact that changes could affect parents, first-time home buyers, long-time homeowners, military personnel, retirees, taxpayers impacted by Alternative Minimum Tax and more.

Nearly 60 percent didn’t know whether a deduction or tax credit trimmed more off the bottom line. (The correct answer is a tax credit.)

78 percent didn’t know what tax bracket they were in. (Knowing your marginal tax rate, including state and local taxes, can be very important when making financial decisions).

You can click through to their press release if you want more of their findings.

I think my key take away is that most Americans need help. Yes, you can do it yourself but are you really prepared to sort through and understand all the complexities?

It is my belief that having a CPA prepare your taxes and assist you with planning is a bit like using a slugger in baseball - They may not get a hit every time but occasionally, they hit it out of the park and that's why you pay them.

Tax breaks for the green community

The latest tax bill has some nice benefits for the sustainability community to help us green our economy. For instance, starting in 2009, employers can give bicycle commuters a tax free fringe benefit of up to $20 per month to cover the cost of pedaling to work including repairs, storage, accessories and even the cost of a bike. Employers and employees should act now to put this in place starting January 1st.

Also, the credit for residential energy saving improvements will return in 2009. The 10% tax credit has been expanded to include biomass fuel stoves as well. You may want to delay the installation of skylights, windows, outside doors and high-efficiency furnaces, water heaters and central a/c units until next year in order to claim the credit. This credit will be on the books through 2017 so you can use it in 2010 and beyond if you don’t get your project done next year.

One of the challenges for the alternative energy market is financing, and tax policies can make or break projects. Trying to determine long-term cash flows with unpredictable tax policies makes the challenge even harder so it is good news that many existing energy tax breaks have been extended:

• Coal and wind energy credits as well as the biodiesel credit have been extended through 2009.
• Energy credits for biomass and landfills lapse after 2010, as will a new credit for energy from waves and tides.
• The 30% solar energy and fuel cell credits however get a long-term extension through 2016. 
• The residential solar credit also lasts through 2016, and the $2,000 cap is repealed. 
• The law that allows commercial realty to expense energy saving improvements will run through 2013.

Why I don't trust corporate media

Last night CBS Evening news did a story that purported to compare the impact of Obama’s and McCain’s tax plans on three separate Ohio families.

If I recall, all three families had three children. The story discussed some of the details of each candidate’s plan (special credits, deductions, rate changes, etc.), then used an Ohio CPA to crunch the actual numbers of these three families.

The first family had an income of $32,000, the second family had an income of $64,000 and the third family had an income of $213,000.

The CPA determined that the first family would see no change in their taxes under McCain’s plan but would get a refund of $2,200 under Obama’s. The second family would save $225 under McCain’s plan and $500 under Obama’s.

Unfortunately, we never found out how the plan would impact the third family. Instead, rather than provide a specific answer as they did with the first two people, the story focused in on Obama’s plan to raise the top two marginal rates from 33% to 36% and from 35% to 39.6%, respectively. Due to deductions and exemptions, these top rates would only apply to people with income of $225,000 or more. It should also be noted that these are marginal rates and not effective tax rates, meaning the higher rate only applies to the income earned above the $225,000 threshold. All the income below that threshold would be taxed just as it is now.

Rather than give us the actual numbers, the CBS Evening News story pointed out that the third family was nearing the line where the new marginal rates on Obama would kick in. “If this business owner were to make more next year, they could find themselves in the 33% bracket which under Obama will become the 36% brackets” said the reporter. They then cut to the taxpayer who says he’d be hurt if his taxes went up 8% (from 28% to 36%).

This is dishonest and deceitful reporting for a couple reasons. First, why didn’t they compare apples to apples and just tell us how the plans would effect the three families? Additionally, as I pointed out above, the rate increase Obama support is at the margin, so the third family’s taxes wouldn’t be going up by 8% even if they got that $12,000 bump in income.

I believe CBS Evening News has enough resources to get this story right and that this was a blatant attempt to distort the information and change the impression on viewers. There can be no other explanation other than media bias.

I’m not a member of the Democratic Party or an Obama partisan, but I believe we need accurate and truthful information to make good decisions. I was particularly interested in this story so I could learn something relevant to my profession, unfortunately, CBS let me and the rest of America down.

Domestic Partner Tax Filing in Oregon

The Oregon Dept. of Revenue (ODR) is preparing forms and special instructions to accommodate domestic partners in 2008 due to the new law finally recognizing these relationships.

Two new “statuses” have been added: Registered domestic partner filing jointly and Registered domestic partner filing separately. For ODR tax purposes, if domestic partners register in an Oregon county, they will be able to file as registered domestic partners. If the domestic partners are registered outside of Oregon, they will need to register in an Oregon county.

Because the federal government does not recognize domestic partners, it gets a little convoluted going from federal Form 1040 to the state return.

The partners will need to file their single federal returns and then prepare another federal return “As-if” a combined federal return were allowed for domestic partners. This “As-if” return will drive the amounts on the state return except for one major difference. The federal tax subtraction shown on the Oregon return will be the amount of the actual federal tax liabilities, less any economic stimulus rebates received.

While this solution isn't perfect, it should help many couples save money by filing together.

Wouldn't it be nice if the federal government would move into the 21st century and allow consenting adults to marry and/or partner up in anyway they so choose?

Residential Energy Tax Credits Set to Expire

Hurry!! At the end of 2008, without Congressional action, the only remaining federal residential energy tax incentives available for homeowners will expire. You must act soon if you want to take advantage of the following tax credits:

FUEL CELL POWER PLANT – A credit of 30 percent, to a maximum of $500 per ½ kilowatts of electricity generated by electrochemical means from a qualified fuel cell plant installed in the taxpayer’s primary home located in the United States.

SOLAR ELECTRIC AND/OR SOLAR WATER HEATING SYSTEMS - The credit is 30 percent of the cost, with a maximum cap of $2000, for the installation of a qualified system in the taxpayer’s primary or secondary home located in the United States.

These credits are nonrefundable and can only be used to offset your income tax in the current year. Any unused credit can be carried forward to future years. No credit is allowed for expenditures related to hot tubs or swimming pools. You may lose part or all of the credit if you are taxed by the alternative minimum tax.

The House passed H.R. 5351 (Renewable Energy and Energy Conservation Tax Act of 2008) back in February 2008, which would have extended these credits as well as others to 2009 and beyond. Unfortunately, the bill is stuck in the Senate and faces a threatened veto so it looks unlikely to pass this year. The cost of the extended credits would have been funded by reducing subsidies to the oil and gas industry. Hmmm, I wonder if that has anything to do with the hangup?

Yet another reason to go green and be proactive

Fines and penalties paid to the government for legal violations are not deductible for taxes. This applies to fines for environmental damage as well. The public policy doctrine and IRC Section 162(f) provide the basis to disallow tax benefits inconsistent with articulated public policy.

Over the years, many companies have had fines reduced by agreeing to perform a Supplemental Environmental Project (SEP) or similar project to settle a matter with the state or federal government. As a general rule, violators pay a smaller fine when they agree to a SEP or other remedial project.

In a recently released IRS Coordinated Issue Directive (http://preview.tinyurl.com/6m9z6l), the IRS says it will deny deductions for these projects because in their view, the cost is a nondeductible fine if the work is done to settle government charges of pollution. This includes wildlife habitat restoration and wetlands purchases.

Hopefully, this position won’t discourage the government and polluters from agreeing to mutually beneficial SEPs. Ideally, this provides yet another incentive to be proactive, go green and avoid the expensive and now non-deductible cost of remediation.

The value of a CPA

I may have saved a friend well over $50,000 in taxes this weekend.

I don’t want this to be a tax column and I haven’t researched this specific issue to speak with authority but I want to point out the value of professional advice, especially when you are going through life’s transitions (marriage, death, children, divorce, starting or closing a business, etc.) and dealing with non-routine transactions.

During a casual conversation, my friend mentioned that her elderly father wanted to leave his California home to her when he died. The house has over $500,000 of potential gain in it (Market price less tax basis). Dad had or was going to simply add her name to the title with right of survivorship.

While this would get the house to her upon death, my concern here is that dad has made an Inter vivos transfer as opposed to a testamentary transfer. This difference can have significant tax implications since the beneficiary of a testamentary transfer gets a step up in basis while the recipient of an Inter vivos transfer doesn’t.

My advice to her was to talk with an attorney and her CPA to make sure they were doing this transaction correctly from both a legal and tax perspective. While it will cost some money for the professional services, I think it is better to be safe then sorry when engaged in transactions with significant financial implications.

As a CPA, I really, really like it when my clients call me for advice BEFORE these situations arise since it provides us the best opportunity to accomplish their goals and to avoid nasty surprises.

Business deductions

I was meeting with a prospective client yesterday and they were talking about deductions. This person owned an upscale retail clothing store and a friend of theirs had told them they could write off almost everything as a small business owner.


Drive to work - write it off.
Laptop computer - write it off.
Cell phone - write it off.
Daily lunch with his business partner - write it off.
Fancy clothes - write it off.
Haircut - write if off.


The list was actually longer but I think you get the picture.


While all of these have some connection to the business activity, that doesn't necessarily make them deductible. While there are many specific rules regarding business deductions, the items noted above generally have a high degree of personal benefit, i.e. non-business, to them. Everyone has to eat, wear clothes, get their haircut and drive to work. These are generally personal expenses and therefore not deductible as business expenses.


Haircuts and clothing are almost never deductible. As a general rule, clothing is deductible only if it is a requirement of the job AND, cannot be worn as street clothes. My friend and his employees who dress nicely in their upscale clothing store cannot deduct their clothing as a business expense. It may be a requirement of the job but the clothes can also be worn outside of work and therefore can't be deducted. If it is any consolation, I can't deduct my suits, shoes and ties either.


Cell phones and laptops are considered listed property and an allocation between business and personal use is required. The business use portion is deductible while the personal portion isn't.


There are a number of ways to handle cell phone accounting and I recommend you do it right with professional help to review the tax implications of your plan. I see too many companies who don't handle this correctly and expose themselves to potential liabilities. The biggest mistake I see is where a company simply provides cell phones to employees and pays the monthly bill without any accounting by the cell phone user. This type of arrangement is allowed but the payment is considered W-2 compensation and should be handled accordingly.


Business meals have a their own set of specific rules but generally, the meal must be ordinary and necessary for your business and directly related to or associated with it as well. Having lunch with a co-worker will not pass the necessary test and is therefore not deductible. Most meals are considered personal unless, you are meeting with a client or perspective client AND discussing business.


The IRS has strict rules for substantiating meal and entertainment expenses. For each expense, you must show the date, place, amount, business purpose of the expense, and the business relationship of the person you entertained. Receipts are required for expenses of $75 or more.