The Goralka Law Firm (of Sacramento, CA) writes about Revocable Living Trusts, Wills, Powers of Attorney, Living Wills, Healthcare Power of Attorney, Life Insurance Trusts, Family Limited Partnerships, Limited Liability Companies, Corporations, Charitable Trusts, Medi-Cal Planning, and Other Estate Planning and Tax Planning Strategies.
Over the last two decades, the Internet has become an increasingly important part of our everyday lives. Now that Internet penetration levels are nearing saturation for many demographic groups, many technology experts are speculating about how the Internet will continue to affect our personal and work lives over the next 10 years. Here's a closer look at who's currently using the Internet and where the "Internet of Things" may be headed by 2025.
Commerce Department Delays Privatization of Domain Names
In March 2014, the U.S. Department of Commerce announced plans to complete the privatization of the Internet's domain name system. Originally, the department's contract with an international not-for-profit organization known as Internet Corporation for Assigned Names and Numbers (ICANN) was set to expire on September 30, 2015. However, it has become increasingly apparent over the last few months that more work is needed before the government is willing to hand over the reins to an unspecified group of private international stakeholders as planned.
So, the Commerce Department has extended its contract with ICANN for one year, to September 30, 2016. It also has options to extend the contract for up to three additional years if needed.
How Long Have You Been Surfing the Net?
In October 1995, the Federal Networking Council coined the term "Internet." Over the 20 years that followed, the Internet has exploded, making individuals and businesses more efficient, informed and penny-wise. It shatters many of the geographic boundaries that limited the growth of small businesses. It has enhanced our abilities to communicate via email and social media, access and research data, and buy and distribute products. Unfortunately, opportunistic individuals have also used the Internet to monitor behaviors, infringe privacy rights and even commit fraud.
The widespread use of the Internet wouldn't have been possible without the creation of technology known as the "World Wide Web." Last year, the Web celebrated its 25th birthday. Although many people use the terms "Internet" and "Web" interchangeably, they're technically different. The Internet is an infrastructure that connects networks across the globe. The Web is a way for users to transmit data over the Internet using a uniform resource locator (URL), such as irs.gov or fasb.org. But, for simplicity's sake, we'll use the term "Internet" to refer to both.
Who's Who on the Internet
Increasingly, Americans from all walks of life have made the Internet a part of their daily lives. Earlier this summer, a Pew Research study reported that 84% of adults in the United States use the Internet on a regular basis — up from just 52% in 2000 and 76% in 2010. Here are some characteristics that affect Internet usage, according to Pew Research's study Americans' Internet Access: 2000 - 2015:
Age. Not surprisingly, young people are more likely to use the Internet than seniors. Today, 96% of Americans between the ages of 18 and 29 use the Internet, up from 70% in 2000. By comparison, 58% of people ages 65 or older use the Internet today, up from only 14% in 2000.
Education level. Higher levels of education equate with higher Internet penetration rates. Today, 95% of college graduates use the Internet, compared with 66% of people who haven't completed high school. In 2000, 78% of adults with at least a college degree used the Internet and only 19% of people without a high school diploma used it.
Income level. Similarly, 97% of households earning more than $75,000 use the Internet, up from 81% in 2000. Nearly three-quarters of people in households earning less than $30,000 currently use the Internet, up from one-third in 2000.
Community. Today, 85% of suburban, 85% of urban and 78% of rural residents are Internet users. In 2000, those figures stood at 56%, 53% and 42% respectively.
These characteristics often overlap. For instance, rural communities tend to have a higher proportion of residents who are older, have lower income and have attained lower levels of education.
Integration of the Internet into people's daily lives has grown significantly for all groups. Moreover, the gap in penetration rates for different demographics seems to be closing. The affordability of smartphones has helped people with lower levels of income and education access the Internet. Many of these individuals are "smartphone-dependent" for Internet access.
Wave of the Future
People currently have many options for accessing the Internet, including personal computers, smartphones, tablets and other mobile handheld devices. Tech-savvy people with extra disposable income are already adopting the next wave of online technology: Wearable computing devices, such as Fitbit, Apple Watch and Google Glass. In 2013, 13 billion devices were connected to the Internet. By 2020, the number of Internet-connected devices is expected to grow to 50 billion, according to technology company Cisco.
Another Pew Research study, 2014 Future of the Internet, predicts, "The growth of the Internet of Things and embedded and wearable devices [will] have widespread and beneficial effects by 2025 ... resulting from amplified connectivity [that] will influence nearly everything, nearly everyone, nearly everywhere." To expedite the adoption of these technologies, future smartphones and wearables are expected to be easier to type on and have improved speech and gesture recognition capabilities.
The "Internet of Things" is a catchall phrase for all of the devices, appliances, vehicles, wearables and sensors that connect to each other and feed data back and forth. It will present users with numerous opportunities and challenges as more parts of our environment connect to the Internet. Here are some of predictions for the future of the Internet reported in the Pew Research study:
For individuals, one of the biggest areas of improvement will be health care monitoring. Wearable or small subcutaneous-embedded sensors will help people monitor not just their daily steps, caloric intake and sleep patterns, but also their blood sugar levels, heart rate, pulse and other vitals. This application of the Internet is expected to advance quickly as Baby Boomers age — and their children and grandchildren buy monitoring devices to track seniors' health and report problems to doctors and emergency services.
Individuals and business owners will download apps to monitor and adjust activities remotely, such as pre-heating the oven, gauging utilities usage or tracking speed levels on company vehicles. In addition, parents may track their children and businesses may track their employees, posing complex privacy concerns.
Businesses will have greater access to quality real-time data that can be used to make key decisions, such as when to reorder materials and where bottlenecks occur in the manufacturing process. This information will help management tweak physical flows and logistics within the production process, thereby eliminating waste. Such inventory principles may also be applied on an individual level. For example, smart refrigerator shelves might tell people when to pick up milk or smart cars might tell users when to change the oil, replace tires or redirect to a less crowded route.
The government may even use smart devices to monitor pollution levels or wear-and-tear on roadways, signal when municipal trash cans need to be emptied and distribute moving violations to people who exceed the speed limit.
The Critics Chime In
Skeptical respondents to the Pew Research study doubt how much more the Internet realistically will change the lives of Americans now that penetration levels are nearing saturation. They contend that wearables are merely toys for the wealthy or tools in special purposes environments, such as prisons, hospitals and battlefields. They will be "handy but hardly life-changing."
Others worry that, as the Internet expands, devices and users will be increasingly vulnerable to cyberattacks and fraud scams. Instead of making people smarter, critics argue, Internet-connected devices threaten our abilities to think freely, remember facts and make decisions. In short, the Internet of Things could cause people to "learn less but achieve more." For example, a generation that relies exclusively on their smartphones to get from point A to point B may be getting there faster and more easily than less-smartphone-savvy generations. But what would happen if the grid suddenly went down? Would the smartphone-reliant generation be stranded? Would they know how to read a paper map?
Another problem could be the lack of standardization across online platforms. Without a single global standard to follow, companies are likely to duplicate effort and users will adopt different technologies and devices. This could make it harder to take advantage of the Internet's full benefits.
Are You Ahead of the Curve?
The Internet of Things promises individuals a richer quality of life and presents numerous opportunities for businesses to become more productive and profitable. To reap these benefits, it's important to understand how the latest Internet-connected devices work, as well as identifying and safeguarding against the potential risks.
The rules for required minimum distributions (RMDs) can be bewildering, frustrating and potentially expensive to retirement savers and their beneficiaries.
Avoid the Year-End Crush
Taxpayers subject to required minimum distributions (RMDs) have until December to calculate and schedule RMDs from qualified plans and IRAs. It's not unusual for people to wait until the last moment to take RMDs. So long as the proper RMD is taken prior to the end of the year, you're in compliance with the rules.
However, to minimize the possibility of error by missing the deadline, it may be safer to take your RMDs in advance of December 31. This will give you plenty of time to make any necessary corrections before the end of the year.
And taking — or not taking — RMDs can have a substantial impact on your tax liability. Distributions generally will be taxable at your ordinary-income rate (not your lower long-term capital gains rate) unless they're from a Roth account. And the penalty for not taking your full RMD on time is severe: 50% of the amount you should have withdrawn but didn't.
Here are the answers to 20 common questions to help you navigate the mandatory distribution rules and minimize any negative tax consequences.
1. What's an RMD?
An RMD is the amount you're legally required to withdraw from your qualified retirement plans and IRAs after reaching age 70 1/2. Essentially, the tax law requires you to tap into your retirement assets — and begin paying taxes on them — whether you want to or not.
2. Which Plans Do the RMD Rules Apply To?
The RMD rules, also known as the mandatory distribution rules, apply to all employer-sponsored retirement plans, including:
Profit sharing plans, and
Other defined contribution plans.
Slightly different rules may apply to pre-1987 contributions to a 403(b) plan. The rules also cover traditional IRAs and IRA-based plans, such as SEPs, SARSEPs and SIMPLE-IRAs. But there are exceptions in certain, limited circumstances.
3. Do the RMD Rules Apply to Roth Accounts?
The RMD rules also apply to Roth 401(k) accounts. However, they don't apply to Roth IRAs while the original owner is alive. So one way to avoid RMDs on your Roth 401(k)s is to roll over the account assets to a Roth IRA.
After your death, however, beneficiaries of your Roth IRA must take RMDs under the same rules that apply to traditional IRAs. As it is a Roth IRA, the distributions are tax-free, however.
4. When Must I Start Taking RMDs?
The required beginning date for RMDs is generally April 1 of the year after the year in which you turn age 70 1/2. For example, if you turn 70 on June 1, 2015, you must begin taking RMDs no later than April 1, 2016. The first year is the only year you can take an RMD after the close of the year for which it applies.
5. When Must I Take RMDs in Succeeding Years?
The deadline for taking subsequent RMDs is December 31 of the year for which the RMD applies. Therefore, if you turn 70 1/2 in 2015, you must take your RMD for the 2016 tax year by December 31, 2016, in addition to taking your 2015 RMD by April 18, 2016. To reduce overall tax liability, you might take the first RMD in 2015 instead of taking two RMDs in 2016.
6. How Do I Calculate the Annual RMD?
Generally, all you have to do is divide the balance in the plan or IRA on December 31 of the prior year by the appropriate life expectancy factor. The IRS provides three life expectancy tables for taxpayers to use to calculate RMDs:
Joint Life and Last Survivor Expectancy Table. This table applies if the sole beneficiary of the account is your spouse and he or she is more than 10 years younger than you,
Uniform Lifetime Table. This table applies if your spouse isn't your sole beneficiary or your spouse isn't more than 10 years younger than you, and
Single Life Expectancy Table. This table applies if you're the beneficiary of the account.
To illustrate, suppose you're a single 80-year-old with an account balance of $100,000 at the end of the previous year. Using the Uniform Lifetime Table, the distribution period for an unmarried, 80-year-old account owner is 18.7. Thus, you would divide $100,000 by 18.7, resulting in an RMD of $5,347.59.
7. Can I Withdraw More Than the Required Amount?
Yes, there's no restriction against excess distributions. You can take out as much as you want as long as you satisfy the minimum standard.
8. Can I Apply an Excess RMD to a Future Year?
No, an RMD is calculated based on the account balance and life expectancy factor for that particular year.
9. Must I Take RMDs from All Qualified Plans and IRAs?
Although you must calculate the RMD separately for each IRA you own, you can withdraw the total amount from just one IRA or any combination of IRAs that you choose. The same rule applies to 403(b) plans. However, for all other qualified plans, the RMD must be taken separately from each plan account.
10. Will My Plan or IRA Administrator Ensure My RMD Is Made on Time?
Although a plan or IRA administrator may provide the information or do the calculation for you, it's ultimately your responsibility to take the RMD for the applicable tax year.
11. How Do I Estimate the RMD Penalty?
The penalty is equal to 50% of the amount that should have been withdrawn, reduced by any amount you withdrew for the year. For example, if you were required to withdraw $10,000 and took out only $2,500, the penalty is $3,750 (50% of $7,500). In addition, you must still take the RMD. The penalty is in addition to any other tax you owe on the RMD. Penalties are the responsibility of the account owner, not the plan.
12. How Do I Estimate the Income Tax on an RMD?
Generally, distributions are taxed at ordinary income rates. But any amount attributable to a return of basis from a traditional or Roth account or a qualified distribution from a Roth account is tax free.
13. Are There Any Exceptions to the RMD Penalty?
The penalty may be waived if you can show that the shortfall was due to reasonable error and you're taking steps to remedy it. To qualify for this relief, file Form 5329 and attach a letter of explanation. Your tax adviser can help draft this letter to demonstrate why your situation qualifies for an exception.
14. Are RMDs Subject to the NIIT?
Distributions from qualified retirement plans aren't included in net investment income for purposes of the 3.8% net investment income tax (NIIT). However, RMDs will drive up your modified adjusted gross income, which could trigger or increase NIIT liability on your net investment income.
15. Can I Still Contribute to a Qualified Employer Plan or IRA if I Take RMDs?
RMDs don't affect your eligibility for retirement plan contributions. So, if an 80-year-old employee is still working and participating in a qualified employer plan, his or her employer must make contributions on the individual's behalf and give the employee the option to continue making salary deferrals if the plan permits them. Otherwise, the employer's plan could lose its qualified status. You can't contribute to a traditional IRA after age 70 1/2 under any circumstances.
16. Do I Have to Take RMDs If I'm Still Working?
Generally, you must take RMDs from all qualified plans and traditional IRAs. However, you don't have to withdraw an RMD from your employer's qualified plan if you still work full-time for the employer and don't own 5% or more of the company. There's no similar exception for IRAs. You must still take RMDs from qualified plans that remain at former employers (that is, the plans that haven't been rolled over to your current employer's plan.)
17. Can I Roll Over an RMD to another IRA or Tax-Deferred Retirement Plan?
No, rollovers are strictly prohibited. Allowing retirees to roll over RMDs to another retirement account would defeat the intention of the mandatory distribution rules.
18. Can I Donate RMDs to Charities?
In the past, you could transfer up to $100,000 directly from an IRA to a charity without paying tax on the distribution. But this tax law provision expired December 31, 2014. Under the current rules, if you wish to donate your RMD to a charity, you're taxed on the distribution at ordinary income tax rates, and then you may deduct it as a charitable contribution.
There's been some discussion in Congress lately about possibly reinstating the rule. If you're interested in donating your RMD to charity, contact your tax adviser about any recent developments later this fall.
19. What Happens If I Die Before RMDs Have Begun?
No distribution is required for the year of death. For subsequent years, RMDs must be taken from inherited accounts. A spousal beneficiary has greater flexibility than a nonspousal beneficiary, including being able to treat the account as his or her own.
Generally, the entire amount of the owner's benefit must be distributed to the beneficiary who is an individual either (1) within five years of the owner's death, or (2) over the life of the beneficiary starting no later than one year following the owner's death.
20. What Happens If I Die After RMDs Have Begun?
The beneficiaries of the accounts must continue to take RMDs under a complex set of rules. Again, spousal beneficiaries have greater flexibility than nonspousal beneficiaries.
Important Note: The beneficiary of a deceased owner of a retirement account can be subject to tax penalties if he or she fails to comply with the post-death distribution rules. If a retirement account owner dies mid-year, the beneficiary may be unaware that the owner has passed away before taking his or her full RMD for the year. Other complex rules may apply if there are multiple non-spousal beneficiaries or if a trust is the beneficiary of a retirement account. Contact your tax professional for guidance if you inherit an IRA or other retirement account assets.
For More Detailed Answers
The mandatory distribution rules for qualified retirement plans and IRAs are complex and may change under Congressional tax reform measures. In the meantime, you can minimize your tax liabilities and preserve more assets for your heirs with careful planning. Contact the Goralka Law Firm to customize the optimal plan based on your individual retirement and estate planning goals.
On the first of each month, our firm votes for Team Member of the Month for the previous month. Each member of the team casts their vote based upon three categories: 1) Contribution to the Team, 2) First Rate Attitude, and 3) Professional Appearance. We are very proud of our team and love to reward them for their hard work and dedication!
Jennifer is our winner for Team Member of The Month for the month of August.
Jennifer is our firm's Business Director. Outside of work she enjoys updating her newly purchased home, cuddling with her two sweet puppies and training for half marathons.
Here is what the team had to say about Jennifer:
She is the glue that holds our office together. She does not hesitate to step in and help anyone in the office with whatever task they need help with as well as handle her own responsibilities. This past month there have been issues in which myself or others in the office have felt stuck on and she was able to step in and help resolve them. She is very poised and professional and a positive driving force in the office and we just wuv her schooooo much!
Jennifer is the super-glue that keeps it all together and rolling along smoothly at the office! We can focus on what we need to do because Jennifer takes care of everything else. Thank you, Jennifer!
My vote for team member of the month goes to Jennifer. She keeps our business running smoothly and holds us together. She's a very hard worker and a problem solver. I don't think there's anything that's thrown at Jennifer that she cannot take on.
Congrats to Jennifer as our Team Member of the Month!
The Federal Trade Commission estimates as many as 9 million Americans have their identities stolen every year. Although the security of personal data is a top priority of all types of entities, the IRS is especially vigilant, because tax-related identity theft is the most common form of reported identity theft.
Are Identity Protection Services Taxable?
Under federal tax law, gross income generally includes "all income from whatever source derived, and in whatever form realized, whether in money, property or services." However, the IRS recently announced that, when a taxpayer receives identity protection services from an organization at no cost following a data security breach, the taxpayer isn't required to include the value of those services in gross income.
Examples of such services include credit reporting and monitoring, an identity theft insurance policy, and identity restoration. The breached organization also isn't required to report these amounts on information returns filed with respect to the recipient of these services.
However, taxpayers are required to report in gross income 1) any cash received in lieu of identity protection services or 2) the value of identity protection services received for reasons other than a data breach, such as identity protection services received in connection with an employee benefits package. Existing tax rules also continue to apply to any proceeds a taxpayer receives under an identity theft insurance policy.
The number of identity theft victims is expected to grow as perpetrators become increasingly sophisticated. Many are now clever enough to hack through passwords and other security measures to gain access to personal accounts and data. Case in point: The IRS recently announced that the May 2015 security breach of its online "Get Transcript" service affected nearly three times more taxpayers than the agency originally estimated.
Expanded IRS Data Breach
In August the IRS announced that fraudsters had hacked into 334,000 taxpayers' accounts — up from the agency's original estimate of 114,000 accounts. They used stolen Social Security numbers, addresses and other personal data acquired from social media and other sources to breach the system's multistep verification process.
In response to the breach, the IRS will offer free credit monitoring services and other protections — such as identity protection personal identification numbers (PINs) — to taxpayers whose information was compromised. The IRS will also mail letters to another 170,000 households, notifying them that their personal information could be at risk even though the fraudsters failed to access the IRS system with their information. (This is in addition to the 334,000 taxpayers whose accounts were breached.)
Future Cutbacks on W-2 Extensions
In another effort to combat taxpayer identity theft scams, the IRS has curtailed the W-2 filing extension available to employers. Under existing tax law, the automatic extension for filing W-2 forms is 30 days from the original due date. Employers may request an additional extension of up to 30 days by submitting a second Form 8809.
For the 2016 tax season, the current automatic extension will still be available. Starting in the 2017 tax season, however, the IRS will allow only one 30-day, nonautomatic extension for filing W-2 forms.
Identity thieves often file fraudulent tax returns early in the tax season, before W-2s have been sent. Early filing leaves the agency unable to verify wage and other information. By limiting the availability of extensions, the IRS hopes to catch fraudulent refund scams earlier in the tax season and reduce the opportunity for thieves to steal data.
IRS Reminder about Tax Scams
In August, the IRS reiterated its warning for taxpayers to be on "high alert" for aggressive tax scams. Often these frauds start with access to personal information (names, addresses and Social Security numbers) obtained through social media or possibly illegal means. Then the fraudster contacts the individuals using this information via a phone call, email or letter, requesting payment or additional personal information to use in other frauds.
These tax scams — which originally targeted older people and immigrants — have become bolder and more authentic-looking. For example, fraudsters may cite fake IRS badge numbers, alter what shows up on the victim's caller ID and copy IRS letterhead. To sound legitimate, a fraudster may provide directions to the nearest bank so the victim can make a payment and an actual IRS address where the victim can mail the receipt from the bank for the payment (though the payment actually goes to the fraudster, not the IRS).
The IRS warns, "Scammers try to scare people into reacting immediately without taking a moment to think through what is actually happening."
How to Protect Yourself
The Treasury Inspector General for Tax Administration estimates that nearly 4,000 victims have collectively reported more than $20 million in financial losses as a result of tax-related scams. Don't allow yourself to become the next identity theft or fraud victim. If you receive a suspicious call, email or letter from someone posing as an IRS agent, contact your tax adviser immediately. He or she can help determine whether the alleged IRS inquiry is legitimate or, if not, help you report the suspicious activity to protect others from identity theft and other tax scams.
A recent U.S. Tax Court decision drives home the important point that current deductions aren't allowed for most expenses incurred while a new business is still in the start-up phase. Other decisions have dealt with the same issue in recent years. So, the proper federal income tax treatment of start-up expenses remains an ongoing source of confusion for taxpayers.
Here's what you need to know about deducting start-up costs, along with a real-life example of how the Tax Court applied the rules.
Deduct Section 162 Expenses Now
Internal Revenue Code Section 162 allows current deductions for "ordinary and necessary" business expenses. Section 162 expenses are basically routine expenses incurred in operating an up-and-running business. Examples include employee wages, rent, utilities and advertising. Section 162 expenses can generally be deducted in the year when they're paid or incurred.
Many taxpayers are unaware that Section 162-type expenses incurred by a start-up can't necessarily be deducted right away. That's because these expenses are classified as Section 195 start-up expenses until the "active conduct" of business begins.
Once a taxpayer meets the active-conduct standard, Section 162-type expenses become Section 162 expenses, and the taxpayer can deduct them currently. (This assumes that other provisions — such as the passive activity loss or at-risk basis rules — don't come into play and prevent current deductibility.)
Deduct or Amortize Section 195 Expenses When Business Commences
Section 195 start-up expenses are Section 162-type expenses that are incurred before the business actively commences operations. Start-up expenses can include costs incurred:
To investigate the creation or acquisition of a business,
To create a new business, or
To engage in any for-profit activity before the active conduct of business begins, in anticipation of such an activity becoming an active business.
Common examples of Section 195 start-up expenses include employee training, rent, utilities and marketing expenses incurred prior to opening a business.
In the tax year when active conduct of business commences, the Section 195 rules allow taxpayers to elect to amortize start-up expenses. The election potentially allows an immediate deduction for up to $5,000 of start-up expenses. However, the $5,000 deduction allowance is reduced dollar-for-dollar by the amount of cumulative start-up expenses in excess of $50,000. Any start-up expenses that can't be deducted in the tax year the election is made are amortized over 180 months on a straight-line basis. Amortization starts in the month in which the active conduct of business begins.
A taxpayer is deemed to have made this election in the tax year when active conduct of business commences unless, on a timely filed tax return for the year, the taxpayer elects instead to capitalize start-up expenses.
Important Note: Section 195 start-up expenses don't include interest expense, taxes or research and development costs. Those expenses are subject to specific rules that determine the timing of the deductions. Section 195 start-up expenses also don't include corporate organizational costs or partnership or LLC organizational costs — although the tax treatment of those expenses is similar to the treatment of start-up expenses.
Recent Tax Court Decision
A recent Tax Court case demonstrates potential pitfalls that taxpayers should avoid when claiming deductions for start-up expenses. In this case, the taxpayer was a civil engineer with 25 years of experience as a highway designer and construction engineer.
In 2008, while still employed in a full-time job, he decided to start his own business. He selected the name Civil Engineering Services (CES), printed business cards, designed stationery and set up a website. He also purchased a computer, a desk and other office supplies and set up an office in the basement of his home.
By mid-2008, the taxpayer's employer dramatically reduced his salary, and he decided to devote more time to developing CES. From his years of work experience, the taxpayer knew many contractors and project engineers who worked in the state. He regularly visited construction sites after his regular work to distribute business cards and speak with managers and others performing construction on local highways.
In addition to promoting his business, the taxpayer used these visits to stay abreast of developments in the highway construction engineering industry. He continued these trips throughout 2009, 2010 and 2011. In late 2010, he became unemployed and began focusing all of his attention on CES.
On his 2009 and 2010 federal income tax returns, the taxpayer claimed Schedule C business deductions totaling $46,629 and $45,618, respectively, for expenses purportedly incurred in the new business. After an audit, the IRS disallowed the deductions on the grounds that:
They weren't properly substantiated, and
CES hadn't yet commenced business because it didn't have any clients, wasn't hired to perform any services, didn't bid on any highway engineering jobs and earned no income.
The IRS also disallowed some itemized deductions claimed on the taxpayer's 2009 and 2010 returns. The disallowed deductions resulted in a delinquent tax bill of about $30,000. The IRS also imposed a 20% substantial understatement penalty on the additional tax due. The Tax Court upheld both the IRS deficiency and the understatement penalty (Tarighi v. Commissioner, T.C. Summary Opinion 2015-28).
Factors to Consider
The Tax Court has historically focused on these three factors to determine if a taxpayer has commenced the active conduct of a business:
Did the taxpayer undertake the activity intending to earn a profit?
Was the taxpayer regularly and actively involved in the activity?
Has the activity actually commenced?
In Tarighi, the Tax Court concluded the taxpayer wasn't engaged in a business during 2009 and 2010, because CES didn't have any income or clients and didn't bid on any jobs during those years. Though the taxpayer did engage in promotional activities, he didn't intend to earn a profit in those years, because he didn't pursue contracts or bid on jobs.
Therefore, the court ruled that the IRS was correct in denying the deductions reported on the taxpayer's 2009 and 2010 returns, because they were amortizable Section 195 start-up expenses rather than currently deductible Section 162 expenses. However, if the taxpayer could properly substantiate the expenses, the opinion notes that the taxpayer could begin amortizing them in the year when his business activity started.
Finally, the court ruled that the IRS was correct in imposing the 20% substantial understatement penalty, because the taxpayer had failed to establish that there was any reasonable cause for the tax underpayment or that the taxpayer had acted in good faith.
Important Reminders about Start-Up Costs
When you incur business start-up expenses, it's important to remember two key points. First, start-up expenses can't always be deducted in the year when they are paid or incurred. Second, no deductions or amortization write-offs are allowed until the year when active conduct of your new business commences. That usually means the year when the business has all the pieces in place to begin earning revenue.
Time may be of the essence if you have start-up expenses that could be deducted in the current year. Contact your tax adviser to explain your plans. Failing to give your tax adviser a heads-up is often a recipe for unfavorable tax consequences. Call the Goralka Law Firm if you have any questions.
If the government is thinking of closing a planning opportunity, that typically means it is an effective strategy. In this case, the Obama Administration is proposing to close the so-called "Backdoor Roth IRA."
A Roth IRA can be a particularly attractive device because, unlike a traditional IRA, neither the funds nor the growth thereon are taxed upon withdrawal. Also, there are no required minimum distributions during the lifetime of the contributor. After death, the distributions are based on the beneficiary's life expectancy as with traditional IRAs. In order to contribute to a Roth IRA, a taxpayer may not have modified adjusted gross income above a certain level. For a single taxpayer, the ability to contribute to a Roth IRA is phased out beginning at $116,000 until it is gone entirely at $131,000 ($183,000 and $193,000 if married filing a joint return). The limits on Roth IRAs have been in the law, adjusted for inflation, from the inception. However, since 2010 the income limits for converting traditional IRA to a Roth IRA have been removed. Thus, a taxpayer who wants a Roth IRA but earns over the limit can now make a contribution to an IRA and then convert the IRA to a Roth IRA.
If your income is too high to make a Roth IRA contribution and you are covered by a retirement plan at work, you cannot make a deductible IRA contribution. But, you could still make a contribution to a non-deductible IRA and then convert the non-deductible traditional IRA to a Roth IRA. Normally, when you are converting a traditional IRA to a Roth IRA, you must pay tax on the balance of the IRA because you took a deduction when you made the original contribution. However, there is no such downside when you've made a contribution to a non-deductible IRA because you never got a deduction. Thus, this is a great way to get money into a Roth IRA for those earning too much to make the contribution directly to a Roth IRA.
This can be a powerful vehicle for savings and investing since it is never income taxed. However, your time to take advantage of this strategy may be running short.
If you have any questions about this topic, please contact the Goralka Law Firm at (916) 440-8036.
A business owner's 20-year experience with a competent attorney.
This documentary explores the 20-year experience that Ed and Georgette Stormo had growing from a small entity to over a 30 Million Dollar corporation with over 225 employees. It demonstrates the critical role a competent attorney plays through a business owner's life-cycle from start to sale including protecting the wealth with asset protection and solving the "unsolvable" problems that often cause businesses to fail along the way. The Stormo family had a multi-generation business and lived in both California and Nevada during the time-frame that this film covers. This film contains interviews from the family as well as our own, John Goralka of The Goralka Law Firm.