By Jason Watson, CPA
Posted Monday, December 30, 2024

There are two types of education- one that is open-ended and has no business connection to your trade or profession, and one that helps you improve a current work skill.

Open-Ended Education Assistance

Your LLC or S Corp can pay up to $5,250 (for the 2025 tax year, and has not changed for a while) of an employee’s tuition and education expenses including your children who work for you. But there are some rules for your child. He or she must-

• Be age 21 or older,

• Be a legitimate employee of the LLC or S Corp,

• Not own more than 5% of the LLC or S Corp, and

• Not be your dependent.

The Age 21 rule stems from attribution rules whereby a child under the age of 21 is deemed to own the same percentage as his or her parents. So, if you own 100% and your child is 20, your child is considered to be a 100% owner for this benefit (and many others), which obviously exceeds the 5% rule.

For your amusement, IRC Section 1563(e) Constructive Ownership reads-

(6) Children, grandchildren, parents, and grandparents
(A) Minor children
An individual shall be considered as owning stock owned, directly or indirectly, by or for his children who have not attained the age of 21 years, and, if the individual has not attained the age of 21 years, the stock owned, directly or indirectly, by or for his parents.

And, IRC Section 127(b) Educational Assistance Programs-

(3) Principal shareholders or owners
Not more than 5 percent of the amounts paid or incurred by the employer for educational assistance during the year may be provided for the class of individuals who are shareholders or owners (or their spouses or dependents), each of whom (on any day of the year) owns more than 5 percent of the stock or of the capital or profits interest in the employer.

Therefore, your kids essentially (a) have constructive ownership until 21 year of age, (b) are considered a 5% shareholder and (c) are ineligible for education assistance. And as mentioned through this book, special rules kick in for a 2% shareholder (or 5% shareholder in this case) triggering tax consequences for benefits received. Therefore, the benefit might kick in around senior year in undergraduate school, and certainly for any graduate or post-degree education.

Under IRC Section 127, reimbursable education includes any form of instruction or training that improves or develops the capabilities of an individual, and is not limited to job-related or degree programs. However, qualified expenses do not include meals, lodging and transportation.

A written plan must be drafted, and employees must be notified of the benefit. Therefore we suggest having each employee sign a notice that explains the benefits, and that they have read and understand the benefits. And no other benefits can be offered as an alternative- in other words, you cannot provide additional pay or bonus for employees who do not use the educational assistance program.

Improving Current Work Skills

To be able to deduct education expense as a small business tax deduction, the education must either-

• Maintain or improves skills required in your existing business, or,

• Is required by law or regulation to maintain your professional status through continuing education credits such as attorneys, accountants, real estate agents, mortgage lenders, etc.

So, can you deduct your MBA? Perhaps. In Lori A. Singleton-Clarke v. Commissioner, Tax Court Summary Opinion 2009-182, the court ruled in Lori’s favor. She was an established nurse, and she went back to school to obtain an MBA in Health Care Management. She was already in charge of quality control from a management perspective, and the MBA did not lead to an additional and discernable skill. Additionally, the court stated that the MBA improved her current work skill as a quality control coordinator. Subtle difference.

Here are some more-

Mary Colliver v. Commissioner, Tax Court Summary Opinion 2017-93. Mary held a Bachelor’s degree in speech pathology and was offered a position with a hospital doing similar work. The hospital position required Mary to obtain her Master’s degree in speech pathology, but the hospital allowed her to complete her studies while performing the tasks of the position. Specifically the Master’s degree allowed her to be a medical speech pathologist.

Mary subsequently deducted about $8,500 in qualified education expenses, and upon examination the IRS disallowed the deduction. The Tax Court also agreed and their summary concluded that the tasks and activities before and after the additional education were different enough to qualify as a new trade or business. In other words, Mary could not work in hospitals without the Master’s degree, and her education allowed her to do so. The Court found this convincing enough to deny the qualified education expense deduction.

Our take is that this is certainly splitting hairs. Mary was a speech pathologist before and after, and she simply improved her current work skills as a speech pathologist to become a better one. It wasn’t like she was a high school counselor who wanted to become a medical speech pathologist. So, be wary that the Tax Court is creating very low thresholds for making the leap of “new trade or business.”

Here’s another, similar crummy deal in our opinion-

Czarnecki v. U.S., 120 AFTR 2d 2017-5372. Jerry Czarnecki was an engineer for most of his adult life and held a Bachelor’s degree in engineering and a Master’s degree in applied mathematics. In 1998 he started a Doctoral program at MIT. Yeah, total nerd, ridiculously smart and probably super rich. Calm down ladies, we’re sure he had a third eye and was married with a gaggle of unruly children who would drive you nuts.

In 2007 he started to work for the U.S. Navy as a Systems Engineer Level 3 ensuring that submarines wouldn’t crumple under water and to study the effects of submarine vibration on batteries. Again, super high-tech stuff. During 2010 he was a licensed professional engineer but was not as a structural engineer. Jerry deducted $8,712 in qualified education expenses on his 2010 amended tax return (first mistake… give an IRS human a reason to say, “yeah right.”).

His second mistake was not demonstrating how his Doctoral studies improved his current work skills. The Court said it was not enough to simply make the assertion as a global argument; the Court wanted very specific links between what Jerry did today and how his education improved his current set of skills.

As a result his deduction was disallowed

Before you drop $50,000 a semester for Wharton or Stanford, be careful. In our experience there is enough case law on either side of the MBA deduction issue to be wary. Having said that, get an MBA because you want the education, degree and ultimately more opportunities. If we can find a way to deduct it, great. If not, you still have improved yourself.

By Jason Watson, CPA
Posted Monday, December 30, 2024

Should you pay Junior to vacuum? Perhaps. While most parents can’t get their children to clean a counter or put away dishes, perhaps putting them to work at the office is a good option.

Tax Advantages

There are some minor tax advantages to paying your children- for example, you can pay your child $14,000 in wages, and since the standard deduction is $15,000 (for the 2025 tax year) the child will not have any taxable income. They can also gift this money back to you, or help pay for groceries.

Kidding aside, for you to give your child $15,000 to save for college or pay for college, it takes probably takes $19,000 or more in parental income because of the income taxes.

However, there are some pitfalls. If you are paying them through an S Corp, you must also pay Social Security and Medicare taxes at 15.3%. Therefore, your marginal tax rate needs to be 22% or higher for this to make sense. Conversely, if you pay yourself this income through a shareholder distribution and you are in the 10% tax bracket, you will unnecessarily pay about $795 in general taxes (since payroll taxes are 15.3% and your tax savings is 10%, 5.3% x $15,000 is $795).

You could also pay your child more money since their tax bracket is probably lower than yours.

For regular LLCs, if your child is under 18, the business does not have to pay employment taxes such as Social Security and Medicare. You can also avoid Unemployment taxes until the child turns 21. But for S Corps and C Corps, Social Security and Medicare taxes are paid regardless of age.

However, you can set up a Family Management LLC (there are other branded or marketing terms for this) where the S Corp pays a fee to an LLC which then turns around and processes payroll for the children. You can read more here-

wcginc.com/6177

Your children are going to take your money anyways- might as well make it tax-advantaged.

Retirement Accounts

Your child can contribute to a retirement account and reduce your taxes. Seriously? Seriously!

For example, a 14-year-old can have an IRA or a Roth IRA and contribute 100% of earned wages up to the maximum contribution. And since the wages to the child are a direct business expense, this reduces your overall taxable income (lower S Corporation income, lower pass-through income, and lower shareholder taxes).

Consider this-

IRA Scenario			Roth Scenario
Junior’s Earned Income	22,000		Junior’s Earned Income	15,000
Junior’s Standard Deduction	15,000		Junior’s Standard Deduction	15,000
Junior’s IRA Contribution	7,000		Junior’s Roth IRA Contribution	7,000
Taxable Income	0		Taxable Income	0
Payroll Taxes @15.3%	3,366		Payroll Taxes @15.3%	2,295
Mom/Dad Savings @10%	-1,166		Mom/Dad Savings @10%	-795
Mom/Dad Savings @22%	1,474		Mom/Dad Savings @22%	1,005
Mom/Dad Savings @37%	4,774		Mom/Dad Savings @37%	3,255

The standard deduction and IRA limits are for the 2025 tax year.

There are several things at play here. First, Junior must actually work, and this is the biggest bone of contention with the IRS. Consider a $30 an hour job would need 500 hours or about 10 per week to achieve $15,000 in wages. So, get that squared away.

Second, Junior can still have tax-free income although Mom and Dad are claiming him as a dependent on their individual tax return (Form 1040). This generally preserves certain tax credits.

Another issue to consider is support and claiming Junior as a dependent. If Junior is going to college and Mom and Dad are paying him to work at the family business, for Mom and Dad to claim Junior as a dependent they must provide over half of the Junior’s support. This includes the amounts spent to provide food, lodging, clothing, education, medical and dental care, recreation, transportation, and similar necessities.

This creates an interesting conundrum. If Junior makes $30,000 working for the family business, but socks all the money away into savings while Mom and Dad continue to pay over half of the support such as rent, food and education, they can still claim Junior as a dependent.

Yet another caveat to this is education credits. At times Mom and Dad’s income is too high to be eligible for certain education credits. By paying Junior, and having Junior claim the education credit (and he would have to pay for college too, but gifting can assist), the overall household might win.

So, there might be real savings and, in the example above, Junior is saving for retirement.

A Roth IRA contribution is not deductible while an IRA contribution is, which is why the IRA scenario can have a higher salary. There is not a minimum age for an IRA or Roth IRA- you simply need to have earned income to contribute. And Yes, the money is the child’s so when Junior turns 18 and wants to blow it on a new car, it’s gone plus penalty. You can’t fix everyone.

Company-Sponsored Retirement Plan

A company-sponsored plan could be a SIMPLE, SEP or 401k plan. The usual age for these types of plans is 21, but the plan may be created or adopted to be as low as 14 years of age. Therefore, if you hire your 14-year-old and you also have a 19-year-old working for the business, that 19-year-old suddenly becomes eligible if your company-sponsored plan allows 14-year-olds. There are hours of service thresholds you could implement as well.

But setting up the 401lk plan correctly allows your child to contribute $23,500 (for the 2025 tax year) to a 401k or the maximum limits on SIMPLE’s and SEP’s which can be significant. In turn the business gets an instant deduction, and the kid gets your money, albeit a bit early.

Conceivably, your child could have a $45,500 salary and contribute all kinds of money to his or her 401k plan and IRA. Here is a table-

IRA and 401k Plan Scenario
Junior’s Earned Income	44,600
Junior’s Standard Deduction	14,600
Junior’s 401k Contribution	23,000
Junior’s IRA Contribution	7,000
Taxable Income	0
Payroll Taxes @15.3%	6,824
Mom/Dad Savings @10%	-2,364
Mom/Dad Savings @22%	2,988
Mom/Dad Savings @37%	9,678

The standard deduction, 401k and IRA limits are for the 2025 tax year.

The rule is this- if you are covered by a retirement plan at work (what the IRS calls active participation), and you earn less than $77,000 (for the 2024 tax year) adjusted gross income (which Junior does), you can contribute both to a 401k plan and IRA, and get the IRA deduction.

Here is a link about the various options for small business owners to set up retirement-

wcginc.com/401k

Education Credits

You can also create some tax due to take advantage of the American Opportunity Tax Credit. Huh? Mom and Dad make too much money, and cannot take advantage of the AOTC education credit. But Junior, with a little bit of tax due on their 1040 tax return from a $30,000 salary (for example), can get all the tax back as a credit plus the refundable portion. There are some things to navigate through such as claiming them as a dependent, the work needed for a $30,000 salary, etc. but it is something to consider.

IRS and State Concerns

You must be mindful of child labor laws, and as far as the IRS is concerned there are some rules too.

First, the child must actually perform work. Some argue that cleaning bathrooms and stuffing envelopes are different since cleaning bathrooms is non-essential to the business operations and therefore not qualifying. The counter argument is that having your child clean bathrooms replaces your third-party janitorial expense. Our advice is to be as legitimate as possible- create a job description, list of expectations, etc. Ensure that the work they do has a business connection.

Also, the pay must be consistent, and the pay must be reasonable relative to what you pay others for similar work. Basically, you need to treat them like any other employee to avoid troubles. Lastly, you need to keep detailed records such as timecards and job descriptions (of course you do!). This must be perceived as an arms-length relationship.

Many states have labor laws that dictate the age your child can work, even for Mom and Dad. For example, Indiana allows a 14-year-old to work with a permit. Minors under 14 may work as newspaper carrier, golf caddy, domestic service worker in a private residence (sounds like chores) or farm laborer. Minors under 12 in Indiana can only be farm laborers. Again, in Indiana, there is no need for a work permit if the work is outside school hours of 7:30AM to 3:30PM. We bring these examples to light so you understand to check your state or local laws about hiring your kids.

WCG CPAs & Advisors will not process payroll for any child under the age of 12 unless there are special circumstances. For example, we have a client who has twin 9-year-old daughters who do quite well recording Tik Tok videos. We continue to be amazed at how people make money, and what the public is willing to pay for the efforts.

Mom and Dad (your parents)

The concepts above could also be applied to supporting your Mom and Dad. Aside from possibly making them minority owners and providing them with shareholder distributions, there could be some scenarios where a salary could make sense as well. Other sources of income and tax brackets of course all need to be considered.

By Jason Watson, CPA
Posted Monday, December 30, 2024

This might be the best option, especially if Section 179 depreciation is not going to benefit you much and/or you use the automobile personally more than you use it professionally. As the owner of the automobile, you would submit expense reports in the form of mileage logs. If you are a smart automobile owner, you would also use a smartphone app to keep track of your miles for you. Keep in mind that the IRS wants corroborating evidence to support your mileage logs, so keep those Jiffy Lube receipts or other service records showing odometer readings near the beginning and end of the year (so extrapolation can occur). Just whippin’ out a pretty color-coded spreadsheet during an IRS examination is not enough.

The business would reimburse you according to your mileage log submission. This can be a great option for a lot of reasons. First, you are reducing the net income of your business, and if you are an S Corp the lower business income could decrease the amount of reasonable salary you must take as a shareholder. Second, most automobiles generally operate for less than the federal mileage rate.

Let’s look at some numbers-

Business Miles	12,000
Miles Per Gallon (MPG)	25
Gallon of Gas	$4.50
Cost of Gas	2,160
Maintenance, Biz Portion	3,000
Total Cost	5,160
Reimbursement at $0.70 / Mile (for the 2025 tax year)	8,400
Difference	3,240

As such, you just took home $3,240 tax-free. All legit. All legal. AAA might consider these operating costs to be too low, but then again this would be representative of an older or thrifty automobile. Why is that?

For the 2025 tax year, the IRS designated $0.33 of the $0.70 standard mileage rate to be depreciation of your automobile (almost half) according to IRS Notice 2025-05. Therefore, if you have a $5,000 POS which will be worth $5,000 ten years from now, you are getting reimbursed for depreciation that never happens. Cool! 10,000 miles would be $3,300 in your pocket (but you will reduce your basis in the automobile from $5,000 to $1,700).

Let’s not forget that you took money out of the business tax-free, and you reduced your business’s overall taxable income through legitimate small business tax deductions. Therefore, if we are using net business income after expenses as one of the proxies for determining a reasonable S corporation salary, that salary starts off at a lower number and subsequently reduces Social Security and Medicare taxes (among others). Win win!

Time to pump the brakes a bit. There is some confusion out there about getting reimbursed for actual expenses. For example, a business owner will own the automobile personally but also wants to get reimbursed for actual expenses. This same business owner will use the business credit card for gas and oil changes. This is bad. If you want to get reimbursed for actual expenses, it must be a pro-rated amount. If you drive 18,000 miles and 12,000 are business miles, then the business should only reimburse 75% of all actual expenses.

If you have leased your automobile and you use the standard mileage rate for reimbursement, you must continue with that method for the entire lease term.

Your business must have an Accountable Plan to take advantage of the You Own the Automobile, Get Reimbursed scenario. As a general rule, any payment of an allowance or reimbursement of business expenses for which the employee does not provide an adequate accounting (i.e., substantiation with receipts or other records) is considered to have been provided under a non-Accountable Plan and is required to be treated as taxable wages for purposes of federal, state, and local (if applicable) income tax withholding, Social Security and Medicare taxes, and Federal and state unemployment taxes. Yuck!

As a reminder, please please please use your personal funds at the gas station and service center. If you want to be reimbursed for mileage, the business will absolutely pay for nothing except the reimbursement itself. You can certainly have the business pay for all automobile expenses, but then that becomes a business owned vehicle situation described above.

By Jason Watson, CPA
Posted Monday, December 30, 2024

Is there a way to have the business reimburse, compensate, or otherwise pay for my home office? Can I still take a home office deduction with an S corporation? Yes, there is a way to claim a home office deduction with an S Corp.

Prior to the IRS making a recommendation to use the Accountable Plan and subsequent reimbursements to the employee (or shareholders), taxpayers would charge their corporation rent and declare the rent as income on Schedule E. Ok, but not elegant.

In the garden variety LLC world, the beauty of this was to take money out of the business as passive income. Since you were changing the color of money from earned income to passive income you were also sidestepping self-employment taxes. In the S corporation world, the beauty of this was to reduce the S Corp’s overall income, and therefore reduce the reasonable salary heuristics or thresholds for shareholders while still taking money out of the business as passive income (again reducing self-employment taxes).

The IRS got sick of this (among other things of course).

The new school way is to use an Accountable Plan and reimburse the employee (you) for expenses associated with the home office. Remember, if you are an S Corp owner, you are both shareholder and employee. Imagine yourself as an employee of Google- the relationship would be arms-length, and you would submit expenses to Google just like you should with your own S corporation. Maintaining an arms-length perspective in your dealings as an employee of your S Corp will help you in the long run.

Your business must have an Accountable Plan to take advantage of this scenario and the basic housekeeping must be satisfied.

Section 280A of the Internal Revenue Code reads in part, “Except as otherwise provided in this section, in the case of a taxpayer who is an individual or an S corporation, no deduction otherwise allowable under this chapter shall be allowed with respect to the use of a dwelling unit which is used by the taxpayer during the taxable year as a residence.”

So, what are the exceptions?

• Certain business use (typical home office, and discussed more here)

• Certain storage use

• Rental use (tax free… 14-day “Master’s” rule or “Augusta” rule)

• Providing day care services

Section 280A continues by reading-

Subsection (a) shall not apply to any item to the extent such item is allocable to a portion of the dwelling unit which is exclusively used on a regular basis-

(A) as the principal place of business for any trade or business of the taxpayer, or

(B) as a place of business which is used by patients, clients, or customers in … the normal course of trade or business,

(C) in the case of a separate structure which is not attached to the dwelling unit, in connection with … trade or business.”

We highlighted the buzzwords intentionally. Let’s define these more carefully-

• Exclusive means the identifiable space or room is used only for business purposes (so let’s not have a bed in your home office).

• Regular is a squishier since it is a facts and circumstances evaluation. Spending 4 hours a month selling Etsy stuff online probably won’t win too many arguments.

• Principal place of business was once a hot topic but has been tightened up with this language right out of the tax code- “For purposes of subparagraph (A), the term “principal place of business” includes a place of business which is used by the taxpayer for the administrative or management activities of any trade or business of the taxpayer if there is no other fixed location of such trade or business where the taxpayer conducts substantial administrative or management activities of such trade or business.”

• Trade or business has been defined in Commissioner v. Groetzinger, 480 U.S. 23, and reads in part, “to be engaged in a trade or business, the taxpayer must be involved in the activity with continuity and regularity and that the taxpayer’s primary purpose for engaging in the activity must be for income or profit. A sporadic activity, a hobby, or an amusement does not qualify.”

Administrative or management activities include a nice list from IRS Publication 587 such as billing customers, clients, or patients, keeping books and records, ordering supplies, setting up appointments, forwarding orders or writing reports (we list more below).

Multiple Work Locations

You can have multiple work locations. The IRS states that if you use a home office as your primary location for substantial administrative activities you are allowed to essentially have two work locations. For example, you own a landscaping business and you have an office in your shop. You perform all your administrative activities such as hiring and firing employees, accounting, balancing your checkbook, talking to your attorney, chatting it up with your Colorado Springs CPAs at WCG etc. in your home office, that office counts as a work location in addition to your office in your shop. Here is the play-by play-blurb from the IRS-

You can have more than one business location, including your home, for a single trade or business. To qualify to deduct the expenses for the business use of your home under the principal place of business test, your home must be your principal place of business for that trade or business. To determine whether your home is your principal place of business, you must consider:

1. The relative importance of the activities performed at each place where you conduct business, and

2. The amount of time spent at each place where you conduct business.

Your home office will qualify as your principal place of business if you meet the following requirements.

1. You use it exclusively and regularly for administrative or management activities of your trade or business.

2. You have no other fixed location where you conduct substantial administrative or management activities of your trade or business.

This also works well for the consultant who works out of his or her home office, but also spends a ton of time on site with the client.

Don’t forget that commuting miles between your residence and your office are not deductible, but if you have a home office suddenly these miles become business miles and therefore deductible. Boom! The use of Boom! is apparently out of fashion. Whatever.

You can read the full IRS Publication 587 (Business Use of your Home) by using the link below-

wcginc.com/5322

We will discuss the question, “What is my tax home?” in a few pages.

Get Reimbursed for the Home Office

The expense report should detail the space used as a home office or storage of business items (inventory, supplies, etc.) as a percentage of overall square footage of the home. This percentage is then applied against rent, mortgage interest, property tax, utilities, HOA dues, insurance and repairs to determine the expense amount to be reimbursed. The reimbursement can be monthly or quarterly or annually- your choice.

Keep in mind that two major expenses associated with a home office are mortgage interest and property taxes. These expenses are already 100% deductible on Schedule A (assuming your state and local taxes (SALT) do not exceed $10,000), so for most taxpayers the home office deduction or reimbursement is relatively small. And you must reduce your mortgage interest and property taxes being deducted on Schedule A by the amounts reimbursed by your business. No double dipping.

Here is quick table on what we mean-

Total Home Size	2,500
Home Office Size	150
Home Office %	6.00%
Expense	Amount	Reimbursed	Schedule A
Mortgage Interest	15,000	900	14,100
Property Taxes	2,500	150	2,350
Hazard Insurance	1,100	66	NA
Utilities	3,600	216	NA
HOA Dues	600	36	NA
Depreciation ($400,000 building)	10,256	615	NA
Totals	33,056	1,983
Total Non Sched A	15,556	933
Savings @ 22%		205
Savings @ 37%		345

What are we showing here? Good question! The $933 number above represents a reimbursement to you and a deduction to the business that would otherwise not have been deductible except through an Accountable Plan reimbursement. In essence with a home office you are deducting portions of Hazard Insurance, Utilities, HOA Dues and Depreciation.

So, a home office reimbursement as a business deduction might put $200 to $350 in your pocket. Might be worth it based on that alone, but where the home office has a ton of weight is now your commute is from the bedroom to the basement or den, and all travel from your home office is business travel.

Here is another consideration. For those taxpayers who are seeing Schedule A deductions being phased out due to high income, SALT limitations and / or Alternative Minimum Tax (AMT), using the home office reimbursement is a way to ensure these deductions are not reduced.

This can be a huge swing in taxes. This is one of the largest compelling reasons to have WCG (formerly Watson CPA Group) prepare both your corporate and individual tax returns- we can move things around to ensure the maximum deduction is obtained.

There are other examples. A quick example would be where you own an office building 100% through an LLC and the business is operating as a separate LLC or S Corp. The rent must be market rent- we suggest using Zillow or a realtor to periodically update your comparables for market rent analysis. This is outside the home office world (see our chapter on self-rentals).

Home Office Safe Harbor

There is a safe harbor provision for home office deductions where you can deduct $5 per square foot. This would be on Form 8829 for LLCs without an S Corp election. However, for S Corps where you choose to reimburse yourself for the use of the home office, you cannot use the safe harbor method.

According to IRS Revenue Procedure 2013-13 which reads in part-

.02 Reimbursement or other expense allowance arrangement. The safe harbor method provided by this revenue procedure does not apply to an employee with a home office if the employee receives advances, allowances, or reimbursements for expenses related to the qualified business use of the employee’s home under a reimbursement or other expense allowance arrangement (as defined in § 1.62-2) with his or her employer.

An expense allowance arrangement is synonymous with an Accountable Plan which we discuss in detail in Chapter 10 (Accountable Plan Expense Reimbursements, page 277). Therefore, you must use actual expenses! This is in stark contrast to the mileage reimbursement since the IRS simply gives you a rate per mile regardless of what you spend.

For disregarded LLCs and sole proprietors, there are some real advantages for using the safe harbor method such as being able to use all mortgage interest on Schedule A instead of a proration. But there are also some limitations that need to be considered. We typically optimize for both methods in these situations.

Home Office Issues with Multiple Owners

We broached this concern in Chapter 2 (Multi-Member LLC That Issues Invoices, page 48) but we’ll tackle it again here. Let’s say you and another person own a business together, and you elect to have the entity taxed as an S Corp. You also create an Accountable Plan to reimburse home office expenses among other things.

As you have learned, you cannot use the simplified method and therefore only actual expenses are reimbursed. No biggie right? Well, perhaps. However, what happens if your home office is smaller as a percentage of your overall home size? In other words, your room is 150 square feet and your house is 3,000 square feet… this is 5%. But your business partner has 180 square feet within a 2,500 square foot house… or about 7.2%.

Perhaps we are splitting hairs… but wait… there’s more! What if your property taxes are substantially lower than your business partner’s? HOA dues? Insurance? Housekeeper? We could go on and on.

You could limit your Accountable Plan expense reimbursements to a certain dollar amount, but doesn’t that hose the other guy? You could reimburse without regard to limits or amounts, but doesn’t that hose the guy with a smaller reimbursement? We’ll find a new word for hose.

Yes, all those things are true except finding a synonym for getting hosed. One solution is to split up into a multi-entity arrangement as shown in Chapter 2 (Multi-Member LLC That Issues Invoices, page 45). Talk to us and we can help!

Home Office With Partnerships

If you are a partner in partnership (member of a multi-member LLC) that is not being taxed as an S corporation, you might be able to reduce partnership income through a tax mechanism called Unreimbursed Partnership Expenses, or UPE for short. UPE is a slamma-jamma version of old school Form 2106 unreimbursed employee expenses, and is a singular line on Schedule E Page 2 reducing partner income.

Here is the blurb from the IRS website on completing Schedule E if you can’t get enough-

You can deduct unreimbursed ordinary and necessary partnership expenses you paid on behalf of the partnership on Schedule E if you were required to pay these expenses under the partnership agreement. You only can deduct unreimbursed expenses on Schedule E that are trade or business expenses under section 162. Don’t report unreimbursed partnership expenses separately if the expenses are from a passive activity and you are required to file Form 8582.

If your partnership agreement or operating agreement allows for it, partners can deduct UPE. However, an Accountable Plan-esque method must be used to create the workpapers and math behind the calculation since it is one big fat number without supporting statements or supplemental forms on your individual tax return (Form 1040).

Home Office Depreciation

Similar to rental properties (among other things), depreciation on a home office is required by the IRS. Here is a Q&A from their website under Sale or Trade of Business, Depreciation, Rentals > Depreciation & Recapture.

Question- I have a home office. Can I deduct expenses like mortgage, utilities, etc., but not deduct depreciation so that when I sell this house the basis won’t be affected?

Answer- No. All allowed or allowable depreciation must be considered at the time of sale. You can generally figure depreciation on the business use portion of your home up to the gross income limitation, over a 39-year recovery period and using the mid-month convention. As long as you determine actual expenses and the correct amount of allowed or allowable depreciation, the depreciation reduces the basis of your home accordingly, whether or not you actually claim it on your tax return.

Note that last phrase, “whether or not you actually claim it on your tax return.” That is the kicker. Truth be known, when a client sells their primary residence most tax professionals do not ask if it was ever used as a home office. Right, wrong or indifferent, it is often overlooked.

Additionally, home office depreciation is tough to track within a tax return. Sure, if you are a disregarded LLC or sole proprietor and reporting your business activities on Schedule C, you will use Form 8829 to generate the home office deduction and that form helps track home office depreciation. Easy.

If you use the simplified method for the home office deduction, you do not have a depreciation recapture problem since you do not have to depreciate your home office. Easy again. But as you know, using an Accountable Plan for reimbursing the S Corp shareholders (recall the two hats- employee and investor) requires actual expenses for home office reimbursement including depreciation.

What makes matters worse is that the depreciation deduction for home office reimbursement is truly done at the business entity level (Form 1120S or 1120). The individual tax return (Form 1040) is not affected, but when the home is sold, depreciation recapture is picked up as income by the individual who was reimbursed.

The tax theory goes like this- if you are reimbursed for depreciation then the cost basis of the asset is reduced by the amount of depreciation. When the asset is sold your reduced cost basis could increase your taxable capital gain (for houses, Yes, for automobiles and other things, probably No).

Sidebar: Having your S corporation reimburse you for business mileage also reduces the cost basis of your automobile by 33 cents per mile (for the 2025 tax year). If you think home office depreciation is often overlooked, the reduction in cost basis for your automobile because of reimbursed mileage is flat-out ignored by most.

WCG CPAs & Advisors tracks home office depreciation within an individual tax return (Form 1040) by creating an out-of-service asset, and updating the historical depreciation each year. Not ideal, but at least it is contained within the owner’s individual tax return for tracking, eventual sale and recapture.

By Jason Watson, CPA
Posted Sunday, December 29, 2024

Let’s talk about the Hummer Loophole since that is where most taxpayer confusion comes from. Yes, at some point, long ago, in a galaxy far far away, businesses could buy heavy trucks and deduct them 100%. Was this a loophole of sorts? Yes. Does Congress and the IRS like loopholes? Not really, unless it benefits them. Did Congress change the Hummer Loophole? Yes. What is the current state of affairs?

The following trucks and business automobiles qualify for 100% deduction in Year 1-

• Automobiles that can seat nine-plus passengers behind the driver’s seat (i.e.: Hotel / Airport shuttle vans, etc.).

• Automobiles with: (1) a fully-enclosed driver’s compartment / cargo area, (2) no seating at all behind the driver’s seat, and (3) no body section protruding more than 30 inches ahead of the leading edge of the windshield. In other words, a classic cargo van.

• Heavy construction equipment will qualify for the Section 179 deduction, as will forklifts and similar.

• Typical “over-the-road” Tractor Trailers will qualify.

This is straight from the Section179.org website who does a fantastic job of explaining this stuff. So, what are the Section 179 deduction limits for passenger automobiles and heavy trucks that don’t meet the list above? That is another really good question!

According to IRS Revenue Procedure 2024-13 for the 2024 tax year, passenger or what are also called light vehicles, have an IRC Section 179 limit of $12,400. When combined with IRC Section 168(k) bonus depreciation $8,000 the total is $20,400.

You say, “so, my heavy SUV doesn’t qualify for a 100% deprecation deduction under Section 179 because of the seating and configuration of the cargo hold, so now what?” Another really good question! Keep ‘em coming! We have the answers.

The order of depreciation is Section 179 expensing, then Bonus Depreciation and then regular depreciation. This means you apply limits, subtract the allowance and then apply subsequent laws to the remaining amounts. A truck or SUV that weighs more than 6,000 pounds is not considered a luxury automobile and therefore is not limited by IRC Section 280F in the same way.

As such, the first-year depreciation deduction for your heavy business automobile would be-

• IRC Section 179 limit of $31,300 for the 2025 tax year according IRS Revenue Procedure 2024-40 which makes inflation adjustments), plus

• 40% Bonus Depreciation (for the 2025 tax year) under IRC Section 168(k), plus

• First year regular depreciation assuming 20% MACRS rate on the remaining cost basis.

Here is a table assuming 100% business use-

Heavy Vehicle	100,000
Section 179 Expense Limit	-31,300
Remainder	68,700
Bonus Depreciation @ 40%	-27,480
Remainder	41,220
First Year Depreciation @20%	-8,244
Total Deduction	-67,024
Marginal Tax Rate	24%
Tax Savings	16,086

As such, that $100,000 Ford F-250 truck that comes in around 6,700 pounds would enjoy a $31,300 + $27,480 + $8,244, or $67,042 deduction in year 1. Wow! That is good news, right? Right! The Hummer Rule is back baby! Do I have to buy a new heavy truck to qualify for the bonus depreciation? No. The old rule was Yes, but the TCJA changed that too. Here is the blurb from the IRS website–

• The taxpayer didn’t use the property at any time before acquiring it (read, new to you not “brand” new or never been used, emphasis emphatically added).

• The taxpayer didn’t acquire the property from a related party.

• The taxpayer didn’t acquire the property from a component member of a controlled group of corporations.

• The taxpayer’s basis of the used property is not figured in whole or in part by reference to the adjusted basis of the property in the hands of the seller or transferor.

• The taxpayer’s basis of the used property is not figured under the provision for deciding basis of property acquired from a decedent.

There you go. The problem remains with luxury passenger automobiles weighing under 6,000. Other things to keep in mind-

• For Section 179 expensing and bonus depreciation, you must have at least 50% business use.

• Section 179 cannot create a loss in the business whereas bonus depreciation may.

• Section 179 has limitations whereas bonus depreciation does not.

• If using bonus depreciation, all property in the same class (e.g., 5-year property) must be depreciated with bonus. You cannot pick and choose, but Section 179 expensing only might yield better results.

By Jason Watson, CPA
Posted Sunday, December 29, 2024

If the business truly owns the car, then it should be titled in the business’s name. Having said this, loan and lease terms might be crummy. Another concern is higher insurance rates. It appears that most auto policies will charge a higher premium for cars owned by a business for business purposes. While the insurance businesses are regulated and must demonstrate the need for the premiums being charged, the higher amount appears to be a money grab.

Some insurance businesses will allow you to title in the business name and your name as joint tenants with rights of survivorship (JTWROS). This satisfies the IRS’s need for titling, and it might allow you to insure the automobile with a personal insurance policy. Talk to your insurance agent.

If you buy the automobile yourself and then transfer it to the business, you might be on the hook for sales tax twice (technically) although recently Departments of Motor Vehicles are understanding that a transaction did not take place. Also, your title might have a lien on it making it challenging to change titling and names.

Under Section 163(j) there is some relief. The automobile may be listed as an asset on the business’s books (balance sheet). Specifically, and in the case of a Partnership or S Corp, since the taxpayer owns both the pass-through entity and the asset, the taxpayer is both the legal and equitable owner of the asset. Therefore, depreciation expense may be deducted, and loan interest may be deducted even if the loan is in the individual’s name.

Leasing or Financing

If your business leases the automobile, the business portion of the lease amount is expensed. However, there are limits to how much can be expensed, especially for expensive or what the IRS would consider luxury automobiles. The disallowed lease payment is called a lease inclusion and is detailed in IRS Revenue Procedure 2016-23. The amount is added back into income and taxed, leaving only the IRS allowed portion as a deductible lease expense. So before you lease that brand new 911, call us. We’ll determine a plan after the joint test-drive.

Also consider that leases are generally bad, especially on business automobiles over $80,000 for three really big reasons. First, the residual value offered on a 36-month lease will be about 60% or $48,000. This is essentially what the leasing business believes the automobile will be worth after 3 years. Yuck #1.

Second, they take the degradation in value ($80,000 minus $48,000) and apply a capitalization rate of 8% to 12%. This is essentially your interest rate. Yuck #2.

Third, they put ridiculous mileage limitations such as 10,000 miles per year with heavy penalties for going over the limit. 10,000 miles is laughable for most modern-day business owners or families. Yuck #3.

Sure, if you lease a more economical automobile such as a Subaru Crosstrek for $30,000 then Yuck #1 goes away. But Yucks #2 and #3 remain. Also, automobile leases are generally not capitalized leases (they do not have a bargain purchase option) and therefore they cannot take advantage of the Section 179 deduction or Bonus Depreciation. Contrast that with your leased copier with a $1 buy-out option… this is considered “financing” or a capitalized lease, and the asset can be listed on your balance sheet, depreciated, painted purple, etc.

Liability

Another consideration- if you are driving the business car and get into an accident, the business might get into a liability rodeo just based on ownership. Proving that at the moment you were driving the car for personal reasons might not matter. We are not attorneys, but this scenario is not beyond possibility.

Personal Use

Lastly, and this is yet another big deal, any personal use must be considered taxable income as an employee of your S corporation. Don’t laugh, it’s true! How do you calculate the amount of imputed income? The easiest and most widely accepted way is to use the Annual Lease Value Table in IRS Publication 15-B Employer’s Tax Guide to Fringe Benefits.

For the 2025 tax year, the lease value of a $50,000 automobile is $13,250 annually. If you use the business-owned automobile for personal use 10% of the time, then $1,325 will be added to your W-2 and taxed as compensation (including Social Security and Medicare taxes, and all the taxes you would expect). Here is the link to IRS Publication 15-B-

wcginc.com/5337

Under the “Cents-Per-Mile Rule,” you can also use the mileage rate of 70 cents (for the 2025 tax year), but there are strong limitations such as the fair market value of the automobile must be below $61,200 (for the 2025 tax year). That will preclude some automobiles. But let’s run the math anyways.

For example, you drove 15,000 miles and 5,000 miles were personal. You would need to add 5,000 miles x 70 cents (for the 2025 tax year) which equals $3,500 to W-2 income. And here’s the personal use kicker- if you are operating your car for less than the standard mileage rate (and you usually do), you will artificially be inflating your income.

Having a mixed use (personal and business) automobile be owned by the business sounds like a lot of work. Everyone at our office likes French fries, but we won’t run a mile for just one. Let’s make sure it’s worth it. Will the tax benefit of depreciation in the first two years offset the additional imputed income? Perhaps.

Keep in mind that it is difficult to justify 100% business use of an automobile if it is the only automobile you own- perhaps in Manhattan, but not for most Americans. Even if you have another automobile at your disposal, it still might not make sense to have your business own it. The question boils down to how many miles you will drive versus your ability to accelerate your depreciation versus your marginal tax rate today and the following years. At the end of this section on automobiles is an overly simplified flowchart to help you decide (or confuse the situation more).

LLC Owned But Using Standard Mileage Rate

If you are operating an LLC without the S corporation election, you might be tempted to use the standard mileage rate. Typically, this would be ill-advised- if you are using the standard mileage rate you are probably better off owning the automobile personally and be reimbursed by the LLC. However, there are situations where this might make sense.

Let’s look at the myriad of rules where using the standard mileage rate method is not allowed.

According to IRS Publication 463, you cannot use the standard mileage rate when you-

• Use five or more cars at the same time (such as in fleet operations), or

• Claimed a depreciation deduction for the car using any method other than straight line (such as MACRS), or

• Claimed a IRC Section 179 deduction on the car, or

• Claimed the special (bonus) depreciation allowance on the car, or

• Claimed actual car expenses for a car you leased, or

• Did not use the standard mileage deduction during the first year of use.

This makes sense. The IRS does not want you to exploit the system by claiming huge amounts of depreciation in the first year, and then switch to the possibly more lucrative standard mileage rate deduction. Here is the link for the IRS Publication 463 (Travel, Entertainment, Gift, and Car Expenses)-

wcginc.com/5330

Again, if your LLC owns the automobile but is using the standard mileage rate and your LLC elects S corporation status for taxation, this asset needs an adjusted cost basis for depreciation within the corporation. Why? As an S Corp where the business owns the automobile, the business can only use actual expenses and depreciation is a part of that.

The calculation for determining the basis of the automobile is quite simple since the IRS publishes the depreciation amount within the standard mileage rate. Here’s the math from IRS Notice 2025-05–

Purchase Price, 2022	50,000
2022 Depreciation @ $0.26 per Mile for 10,000 Miles	2,600
2023 Depreciation @ $0.28 per Mile for 10,000 Miles	2,800
2024 Depreciation @ $0.30 per Mile for 10,000 Miles	3,000
Adjusted Cost Basis end of December 2024	41,600

In this example, if the LLC elects S corporation status on January 1, 2025, an asset would be created on the S corporation’s balance sheet with an adjusted basis of $41,600. The depreciation schedule for an automobile is typically five years, but when you switch from standard mileage rate to actual expenses (e.g., LLC electing S Corp status) the IRS requires you to estimate the remaining useful life. This is another conundrum. In this example, somewhere between two years and five years would be reasonable.

We just went over a ton of stuff under the Business Owns the Automobile section. Please look at a quickie decision tree later in this chapter.

By Jason Watson, CPA
Posted Sunday, December 29, 2024

There are some over-arching themes and concepts for all small business deductions. The business expense must be-

• Ordinary and necessary (IRS Publication 334), and

• Paid or recognized in the current tax year, and

• Directly related to your business, and

• Reasonable, and not lavish or extravagant (IRC Section 162 and IRS Publication 463).

Let’s break these down. An ordinary expense is one that is common and accepted in your field of business, trade, or profession. A necessary expense is one that is helpful and appropriate, although not necessarily required, for your business. In Samp v. Commissioner (Tax Court Memo 1981-706), an insurance agent had a handgun since he traveled to an area with a recent unsolved murder. The Tax Court responded with “A handgun simply does not qualify as an ordinary and necessary business expense for an insurance agent, even a bold and brave Wyatt Earp type with a fast draw who is willing to risk injury or death in the service of his clients.”

You must appreciate a Wyatt Earp reference from a Tax Court judge. Ouch. Clean up on aisle Allstate.

The expense must be paid or recognized in the current year. Expenses that were paid but not deducted in previous years cannot be “caught up” by deducting them today without amending your prior tax returns (which are easy to do, and should be done if there is money to be had). There is some wiggle room by paying expenses in advance. Under the Code of Federal Regulations (CFR), Title 26 (Internal Revenue), Chapter 1, Subchapter A (Income Tax) or Treasury Regulations Section 1.263(a)-4 for short, there is a rule called the 12-month rule. This allows you to deduct in full an amount where the benefit received from paying the expense spans two tax years.

Here is the exact wording allowing the immediate deduction of prepaid expenses for “any right or benefit for the taxpayer that does not extend beyond the earlier of-

• 12 months after the first date on which the taxpayer realizes the right or benefit; or

• The end of the taxable year following the taxable year in which the payment is made.”

Here is the link to the Treasury Regulations on the 12-month rule-

wcginc.com/5415

You’ll need to search for Prepaid Rent, or scroll through a bunch of hoopla.

An example you see often is a one-year rental lease that starts July 1 and ends June 30 the following year. If you pre-paid the entire lease amount, you can deduct the entire amount since the benefit (the use of the rental space) is 12 months. However, let’s say the lease term started February 1 of the following year, but you prepaid the entire amount December 31 of the current year. Since the benefit extends past the end of the following tax year, none of it is deductible in the current year and only a portion is deducted the following year.

Just because you can deduct an expense in one lump sum, doesn’t mean that you should. Remember the conversation about depreciation, tax planning and increased marginal tax rates in the future? Also, this small business tax deduction scheme is usually reserved for those using cash-based accounting.

The expense must be related to your business- that seems obvious. Finally, the expense must not be lavish or extravagant. IRS Publications 463 states “You cannot deduct expenses for entertainment that are lavish or extravagant. An expense is not considered lavish or extravagant if it is reasonable considering the facts and circumstances. Expenses will not be disallowed just because they are more than a fixed dollar amount or take place at deluxe restaurants, hotels, nightclubs, or resorts.” The IRS hasn’t updated to remove the word “entertainment” but you get the idea.

The link for IRS Publication 463 (Travel, Entertainment, Gift, and Car Expenses) is below-

wcginc.com/5330

So, your Board of Directors meeting might spend $500 on catering but a $5,000 expenditure to hold your board meeting in Fiji might be considered lavish and extravagant. Be reasonable out of the gate, and it will be hard for the IRS to knock you off your perch.

Sidebar: S Corps are subject to hobby loss rules in a sense. In other words, if your S Corp loses money each year, the IRS might consider the activity a hobby or an activity not in pursuit of a profit. What are we talking about here? You have an S corporation that earns very little. You contribute additional paid in capital each year to create shareholder basis so you can deduct your automobile or other owner-friendly deductions. You create a tax loss, and since you have basis, you can deduct that loss on your individual (Form 1040) tax returns. Scam. Harsh? Not at all.

By Jason Watson, CPA
Posted Sunday, December 29, 2024

Before we get into the exciting world of automobiles, home offices and traditional business expenses, let’s explore the concept of depreciation. How it works, how it can help, and how it can bite. There are three basic types of depreciation available to small business owners-

• Section 179

• Bonus

• MACRS (or other suitable schedules)

Section 179

Section 179 of the tax code allows you to instantly expense assets up to $1,250,000 (for the 2025 tax year).

Not all property qualifies for Section 179 expensing, namely real estate. Some property is considered Listed Property which has special rules and limits, namely automobiles and computers. To deduct Section 179 expensing, your business must have net income and / or sufficient shareholder basis to absorb it, otherwise whatever is unused is carried forward to later years.

Bonus

Bonus depreciation is also enhanced. It was 50%, but it now 100% for 2018 thru 2022 tax years, and then 80% for 2023, 60% for 2024, 40% in 2025 and 20% in 2026. There are all kinds of rules and interplay between Section 179 and Bonus depreciation.

Now that bonus depreciation is coming back down to earth, Section 179 is becoming sexy again. Even during the good ol’ days of 100% bonus, there were times where Section 179 expensing yielded a better overall strategy especially given the interplay with Section 199A.

MACRS Etc

MACRS is not a depreciation schedule designed for bourbons. Frankly, bourbon shouldn’t be sitting around long enough to depreciate… or spoil as us accountants would say. At our office, Maker’s Mark seems to deplete long before it depreciates or spoils. All kidding aside, MACRS is Modified Accelerated Cost Recovery System which is the default depreciation schedule for most property. So, if you do not use Section 179 or Bonus depreciation, you will be utilizing MACRS depreciation (generally speaking). You can also elect other suitable schedules too but those choices and justifications get more complicated.

If you really want to complicate things, Generally Accepted Accounting Principles (GAAP) do not recognize accelerated depreciation. Therefore, if you have audited financial statements, there will be a difference between “book” depreciation and “tax” depreciation. 99% of the small businesses out there don’t have audited financial statements (or the need for them). But you might run across this if you are buying or selling a business. WCG also does business valuations for divorce cases or economic damages lawsuits, and the “book” to “tax” and vise-versa becomes an important valuation component.

Tax Planning with Depreciation

We are shocked every time a client walks into our office demanding to pay fewer taxes. We smile and tell them that they are the only one. Most people want to pay more taxes, so we find it refreshing when someone wants to pay less. Yes, we’re kidding.

Tax planning with depreciation must be carefully considered. Everyone wants the bird in the hand versus the two in the bush. We get it. But let’s run through some scenarios which might expand your thinking and horizons.

Let’s say you buy a piece of equipment for $200,000 and you deduct the whole thing in the first year using Section 179 depreciation. If your marginal tax rate is 12%, you saved yourself $24,000 ($200,000 x 12%). Nice job. In the next year, your business is growing and you find yourself in the 22% marginal tax rate but you don’t have any depreciation left, so no savings.

Here is a table illustrating Section 179 expensing-

	Allowed %	Depreciation	Tax Savings
Year 1, Savings at 12%	100%	200,000	30,000
Year 2, Savings at 12%	0%	0	0
Year 3, Savings at 22%	0%	0	0
Year 4, Savings at 22%	0%	0	0
Year 5, Savings at 24%	0%	0	0
Year 6, Savings at 24%	0%	0	0
Totals	100%	200,000	30,000

Here is the exact same scenario using MACRS as your depreciation schedule (as opposed to using Section 179)-

	Allowed %	Depreciation	Tax Savings
Year 1, Savings at 12%	20.00%	40,000	4,800
Year 2, Savings at 12%	32.00%	64,000	7,680
Year 3, Savings at 22%	19.20%	38,400	8,448
Year 4, Savings at 22%	11.52%	23,040	5,069
Year 5, Savings at 24%	11.52%	23,040	5,530
Year 6, Savings at 24%	5.76%	11,520	2,765
Totals	100%	200,000	34,291

That is a $4,300 difference! However, this is overly simplified comparison given that $200,000 spans at least two marginal tax brackets. We used this dramatic disparity to drive home the point that you might be leaving money on the depreciation table.

Also, we concede that the time value of money is not at play in these examples. If you take your $30,000 tax savings and invest it wisely, it will outperform the lost tax savings. At a 6% rate of return compounded annually the savings are $10,147 compared to $4,300. But, this means you must invest it and not spend your tax savings on a cruise boat.

Before you call your tax accountant and frantically decline the Section 179 expensing method, consider your income projections. The illustrations above only prove a point if your marginal tax rate is increasing. If you are experiencing an exceptionally good year, and the next few years will have less taxable income, then perhaps using the instant depreciation benefits of Section 179 make sense. Plan! Plan! Plan!

Tax Planning with Depreciation Recapture

Please understand that depreciation is a tax deferral system rather than a tax avoidance system. Huh? When you sell or dispose of an asset, you might have to pay tax on the portion that was depreciated.

For example, you buy a $200,000 piece of machinery and use Section 179 expensing to deduct the entire $200,000 in the first year. Five years later you sell the equipment for $150,000 because you slapped some new paint on it and you are a shrewd negotiator with your buyer. You will now have to recognize $150,000 of taxable ordinary income. Yuck.

Small business owners get trapped in depreciate and recapture loop often. They buy a heavy vehicle and take a big tax deduction. They later sell the vehicle or trade it in, and boom, get hit with a tax bill. As such, and in some sort of knee-jerk way, they purchase another heavy vehicle to fight the new tax bill.

But there is a silver lining with Section 1250 property (real estate)- depreciation recapture is taxed at your marginal tax rate up to a maximum of 25% tax rate. So, you could have depreciated your asset during 37% marginal tax rate years just to pay it all back at 25%. Bonus. Tax planning is a must! How many times have we mentioned that?

You can kick this depreciation recapture can down the road with a Section 1031 exchange (also referred to as a like-kind exchange). Perform your favorite internet search on this topic- way too involved to explain here except that a Section 1031 exchange allows deferral of depreciation recapture and capital gains. And if you think you know what a 1031 exchange is, try learning about a reverse 1031 exchange- where you buy the replacement property first. Yup. It exists.

Keep in mind that a Section 1031 like-kind exchange is limited to real property with the recent tax reform. Section 1245 property (personal) is no longer eligible for like-kind exchanges (there is a small exception when it is tied to real estate that had a cost segregation study performed, but we digress).

What if you think you can be clever, and not deduct depreciation on your asset? IRS is way ahead of you. Way ahead. There is a little known rule called the allowed versus allowable rule and it can bite you in the butt. And it’s not a nibble, it is potentially quite the bite, like Jaws-size (“You’re gonna need a bigger boat”).

Several Tax Court rulings will have a statement similar to “Tax deductions are a matter of legislative grace.” Nice. When have you ever felt the grace of a legislator as you pay taxes? Never. At any rate, let’s extend this statement a bit, and one can infer that tax deductions are not required to be taken which is completely true. And some tax planning can involve not taking tax deductions on tax returns in certain cases (seems weird, but there are narrow examples).

But the IRS assumes that you have deducted depreciation expense in the past so when you dispose or sell your asset, you MUST recapture depreciation even if you didn’t deduct it in the past. That is a big Yuck. We commonly see this when taxpayers own rental properties and prepare their own tax returns. Tax preparation is a profession, not a hobby. Yeah, we said it! We have to, it’s our chosen profession.

There are ways to fix this of course. One way is using Form 3115 Application for Change in Accounting Method. This form is used for a variety of things, and one of the things is to bring your depreciation current through a Section 481(a) adjustment. One of the problems with slapping a whole bunch of depreciation in one tax year is revenue and expense matching- this is one of the cornerstones of accounting principles, so these adjustments need to be detailed correctly. And with rental properties specifically, you might get into passive loss limit problems.

By the way, you can opt out of depreciating real property in Canada. Who knew?

We digress. Back to the chapter’s topic- Tax Deductions, Fringe Benefits!

By Jason Watson, CPA
Posted Saturday, November 4, 2023

We get asked often, “What do you need to prepare my business tax returns?” Or, “what should I be recording or keeping track of throughout the year?” We created a template called the Simplified Business Operations (SBO) Worksheet. While spreadsheets and templates are only meaningful to the spreadsheet designer, you might find value and some helpful hints.

Here is the link to our SBO-

wcginc.com/21

Here is also a checklist of all the things we need beyond revenue and expenses for the preparation of your business tax return-

wcginc.com/2

Even if you don’t use WCG CPAs & Advisors, you might find these tools helpful.

By Jason Watson, CPA
Posted Saturday, November 4, 2023

One of our primary focuses at WCG CPAs & Advisors is ensuring you are paying the least amount of taxes allowed by law. Some of our other primary focuses are helping you build wealth and leverage the most of your financial worlds for you and your family. However, these focuses or objectives are not isolated; they are very much related to each other and intertwined.

Before we run through several tax reduction and tax avoidance ideas, let’s talk about some basic concepts-

There is not a secret tax deduction club that only a few people know about. If there were, it would be like fight club, right? But trust us when we say no one is intentionally not talking about a tax deduction club.

Most people are interested in saving cash when they say they want to reduce or avoid taxes, but saving cash and reducing taxes are not necessarily the same.

Two households, making the exact same income, might have wildly different tax liabilities based on the myriad of variables such as children, mortgage interest, charitable donations, available tax credits, and, Yes, the proficiency of the tax professionals involved. So, just because your neighbor or produce clerk pays x does not mean you will too.

As household incomes travel through the ranges, a lot of things happen. The first $100,000 in income for most households is well-sheltered with itemized deductions and low tax brackets. The next $100,000 in income sees certain tax credits go away, higher tax brackets and fewer available tax deductions such as IRAs and other things (what we call income phase-outs).

In other words, if you go from $100,000 to $200,000 in household income, you will pay way more than double in taxes (you could easily see 2.5 to 3.0 times more). Yuck! The next $100,000 and beyond is completely naked, and is generally purely taxable (unless some tax reduction tactics are deployed). Super yuck!

Tax deductions and tax deferrals are not the same. Tax deferrals are tax bombs later in life; little IOU’s to the IRS and they will eventually call in the chit. But if you use the immediate tax savings to build wealth, then a tax deferral is worth it. Deferring taxes to pay for a cruise vacation might not always be the best approach (then again, live a little!).

You want to match the highest tax deduction to the high income. Let’s say it’s December and you are considering buying a piece of equipment. If next year’s income is going to be significantly higher, wouldn’t it make sense to wait until January to complete the purchase? Probably.

Tax deductions commonly need separation with cash. For example, you can save $2,500 (for example) in taxes right now if you write a check for $10,000 to a charity. That might not make sense if you are more interested in cash than taxes, right? Tax deferrals commonly need separation with cash as well, but at least you get it back. IRA’s and 401k plans (among others) come to mind.

Ok, here we go on those tax reduction and tax avoidance headlines. Some of this might not make sense purely based on the headline. We expand on each of these tax reduction strategies on our webpage (wcginc.com/6177).

• Sell Stock Losers to Offset Gains
• Borrow Against Your Unrealized Stock Gains
• Budget Review, Business Connection
• State Deferrals, Arbitrage
• 401k, SEP IRAs, and IRAs
• Health Savings Accounts (HSA)
• Advanced Tax Planning for IRA’s, Roth IRAs and Roth Conversions
• Donor Advised Fund, Qualified Charitable Distribution
• Optimized Shareholder Salary
• Pass-Through Entity (PTE) Tax Deduction
• Profit Sharing, Defined Benefits Pensions (Cash Balance)
• Accountable Plan Reimbursements
• Prepay Expenses
• Depreciation Optimization
• Switching to Accrual Accounting
• Adding Spouse to Payroll
• Adding Children to S Corp Payroll
• Adding Children to Payroll Family Management LLC
• Consider Yourself a Passive Business Owner
• Short-Term Rental (STR) Loophole
• Cost Segregation on Real Estate
• Real Estate Professional
• 1031 Exchanges (Like-Kind) on Real Estate Transactions
• Tax Free Rental of Your Home
• Medical C Corp
• Permanent Life Insurance Plans
• Conservation Easement
• Captive Insurance
• Family Limited Partnerships (FLP) and LLCs
• Discounted Roth Conversions
• GRATs, GRITs, and Private Annuities

If you want to know about these bulleted items, please visit-

wcginc.com/6177

By Jason Watson, CPA
Posted Saturday, November 4, 2023

We’ve mentioned this previously, and we’ll do it again here. Rule #1- Please get a separate checking account for your business, preferably with the same bank as your personal checking account so transfers (shareholder distributions) are easy. Rule #2- Do not pay for personal expenses or any mixed-use expense with business funds.

This is bad for several reasons- the IRS hates it. It erodes the corporate veil which is already dangerously thin since you are a closely held corporation. Lastly, if you need to re-construct your financials because of a QuickBooks disaster or some other disaster, having your business transactions compartmentalized within a bank account makes life better. All money coming in is income. All money going out is an expense or a distribution.

Do you get the feeling that we’ve said these words before? Like déjà vu? Ever have vuja de? It is the feeling that this has never happened before- opposite of deja-vu. Yes, we did mentioned this before in Chapter 10 on operating your S Corp. Here it is again.

Read Rule #2 again. It is imperative to keep an arms-length perspective on you, the employee, and relationship with the S corporation. If you worked for Google or Ford, you wouldn’t be able to get the business to buy your groceries or pay your mortgage directly. Same thing with your business. Here is another quick table to help you out with the “Which debit card should I use?” question.

Cash Outflow	Checking Account To Use
Car Lease	Personal, unless lease is in business name.
Gas for Car	Personal, unless owned / registered by business
Estimated Tax Payments	Personal, since an S Corp is a pass-through entity
Cell Phone	Personal, reimbursed through Accountable Plan
Home Utilities	Personal, reimbursed through Accountable Plan
Home Office Renovations	Personal, possible partial reimbursement
DSW, Banana Republic	Personal, but it would be nice
Shareholder Distribution	Business
Self-Employed Health Insurance	Business
Out of Pocket Medical	Personal, unless you have an HRA
Accountable Plan Reimbursements	Business
401k Contribution	Business
SEP IRA Contribution	Business, but you should use a 401k instead

Read Chapter 10 on operating your S Corp and specifically the section on Accountable Plans for more information on getting reimbursed as an employee of your S Corp for those expenses that are both personal and business such as cell phones, home offices, internet, etc.

By Jason Watson, CPA
Posted Saturday, November 4, 2023

This chapter is huge, and has a ton of information in it and perhaps it is overwhelming. To reiterate information from the beginning of this chapter there are some over-arching themes and concepts for all small business deductions. The business expense must be-

• Ordinary and necessary (IRS Publication 334), and

• Paid or recognized in the current tax year, and

• Directly related to your business, and

• Reasonable, and not lavish or extravagant (IRC Section 162 and IRS Publication 463).

We want to give you this table to help summarize the business deductions that are clearly not allowed (black), the ones that clearly are allowed (white), and the gaggle of exceptions (grey).

Business Expense	Deduction?
401k Plan	Get $500 tax credit from IRS for starting one. Great way to defer taxes. We can set this up.
Advertising	Yes.
Automobiles	Business use only. Use decision tree to see if you should own it or the business. Depends on price, turnover, miles driven, business use and marginal tax rates. Personal use added to W-2 Box 1, 3 and 5 using Lease Value rates in IRS Pub 15-B.
Business Travel	All kinds of rules. Mix pleasure with business under some circumstances.
Business Meals	50% if business discussion with client, prospect or associate. 50% if traveling away from your tax home on business. 100% for business social gatherings or convenience of the employer (lunch).
Cell Phone	Business use only. Never 100% unless you have second phone. Reimbursed through Accountable Plan.
Client Gifts	Max $25 per recipient per year.
Commissions	Yes.
Commuting Expenses	No. If you have a home office, then commuting becomes business travel and subsequently Yes.
Copier Lease	If the lease can be considered a capital lease, then No. If the lease is an operational lease, then Yes. Depends on the facts and circumstances.
Country Club Dues	No. Don’t throw the book. Not our fault.
Defined Benefits Plan	Get $500 tax credit from IRS for starting one. Great way to defer taxes. We can set this up.
Education	Only if improves your current work skills or necessary for professional credentials (see Tax Court cases above).
Food	50% if business discussion with client, prospect or associate. 50% if traveling away from your tax home on business. 100% for business social gatherings or convenience of the employer (lunch).
Golf Outing	No. Seriously. Let it go.
Guard Dogs	If you are a high risk defense attorney on the East Coast and need a security detail, then Maybe. Must be a bona fide occupational qualification.
Health Reimbursement Arrangement (HRA)	Yes. Need a HRA plan. There are rules. Added to your W-2 Boxes 1, 16 and 14.
Health Savings Accounts (HSA)	Business contributions, Yes. Added to your W-2 Boxes 1, 16 and 14.
Home Office	If regularly and exclusively used for business then Yes. Multiple locations OK provided home office is primarily used for substantial administrative activities. Reimbursed through Accountable Plan.
Insurance	Business liability insurance, Yes. Auto insurance, Yes if the business owns the car. Health insurance, Yes and added to W-2 Box 1. Dental insurance, Yes and added to W-2 Box 1. Eye insurance, Yes and added to W-2 Box 1. Long Term Care insurance, Yes but limited. Disability insurance, No. Otherwise your benefits become taxable income. Life insurance, No. Only in C corporations where the corporation is the owner and beneficiary (no S Corp election!).
Kids On Payroll	Great way of reducing tax liability for the same amount of cash. Must do it correctly and follow state child labor laws.
Legal, Professional Fees	Yes.
Merchant Card Fees	Yes.
Per Diem	Maybe. If employees own more than 10% of a corporation, then No. Sole proprietors and single-member LLCs including partners in partnerships, Yes.
Professional Attire	If the clothing is suitable for everyday use then No. If the clothing is a uniform then Yes. Possible advertising expense. No dry cleaning unless clothing otherwise qualifies.
Profit Sharing Plan	Get $500 tax credit from IRS for starting one. Great way to defer taxes. We can set this up.
Retirement Plan	Get $500 tax credit from IRS for starting one. Great way to defer taxes. We can set this up.
Taxes	Sales tax, Yes. Payroll tax, Yes for business portion. Estimated tax payments, No. Nice try.
Utilities	No, unless you have a separate office location. If using home office, utilities is a part of the deductible basis.
Website	Yes.

There you go. There are tons of variations, exceptions, rules to follow, interpretations, positioning, and many more modifiers that we can’t think of right now. Please contact us if you have any questions or concerns- we love to run through small business tax deductions with owners. And like a good parent, we try to find ways to say Yes. Yes, you can go to Johnny’s house right after you clean your room. Yes, you can deduct that expense provided you document it this way.

By Jason Watson, CPA
Posted Saturday, November 4, 2023

One of the problems facing small business owners is disguised purchase payments. This happens often when a business leases a copier (for example) for 60 months and then has an option to own the equipment after the lease term expires. We’ll talk about that in a second.

The other issue with operating leases is that you cannot depreciate the asset. The most common situation is a leased automobile for the business. Since your automobile lease does not typically qualify as a capital lease, then it is considered an operating lease. The good news is that your lease payment contains the reduction in value (the difference between sales price and residual value), and as such you are receiving some “depreciation” in heavy air quotes with your tax deducted lease payments. The downsides are- a) they are limited to the degradation in value only and b) they are not accelerated.

Back to the capital lease situation. A true lease payment is deductible in full each month, but an installment purchase payment is only deducted to the amount of finance or interest charges.

Here is the blurb from IRS Publication 535–

Lease or purchase. There may be instances in which you must determine whether your payments are for rent or for the purchase of the property. You must first determine whether your agreement is a lease or a conditional sales contract. Payments made under a conditional sales contract are not deductible as rent expense.

Conditional sales contract. Whether an agreement is a conditional sales contract depends on the intent of the parties. Determine intent based on the provisions of the agreement and the facts and circumstances that exist when you make the agreement. No single test, or special combination of tests, always applies.

However, in general, an agreement may be considered a conditional sales contract rather than a lease if any of the following is true.

• The agreement applies part of each payment toward an equity interest you will receive.

• You get title to the property after you make a stated amount of required payments.

• The amount you must pay to use the property for a short time is a large part of the amount you would pay to get title to the property.

• You pay much more than the current fair rental value of the property.

• You have an option to buy the property at a nominal price compared to the value of the property when you may exercise the option. Determine this value when you make the agreement.

• You have an option to buy the property at a nominal price compared to the total amount you have to pay under the agreement.

• The agreement designates part of the payments as interest, or that part is easy to recognize as interest.

There’s no real value added by exploding all these factors into drawn out explanations. The most common lease problem is the $1 buyout or something similar- be careful what you are getting into with leases that might be disguised as purchases. Not a huge deal, but the accounting and subsequent business deduction will be different.

In the accounting world we call this example a capital lease (as opposed to an operating lease). Here are some more signs of a capital lease to noodle on-

• The ownership of the asset is shifted from the lessor to the lessee (you) by the end of the lease period; or

• The lessee (you) can buy the asset from the lessor at the end of the lease term for a below-market price; or

• The period of the lease encompasses at least 75% of the useful life of the asset (and the lease is non-cancellable during that time); or

• The present value of the minimum lease payments required under the lease is at least 90% of the fair value of the asset at the inception of the lease.

Note all the “or’s”. Again, don’t get too caught up in the technicalities. Just understand that you might have a capital lease that needs further investigation and special handling for your accounting records. Operating leases are simple and deducted in their entirety (such as office rent). Here is the link to the IRS Publication 535 (Business Expenses)–

wcginc.com/5334

One final word; under GAAP accounting, the rules are different for those who are required to follow special accounting procedures. Here is a blurb from RSM (a big fancy accounting and auditing firm) that explains it a bit-

Under the old guidance (ASC 840), operating leases were not recorded on the balance sheet, but under ASC 842 operating leases are required to be recorded on the balance sheet, which results in the addition of more assets and liabilities on the balance sheet. Finance (capital) leases will continue to be recognized on the balance sheet. Certain types of assets are excluded from the new standard–leases relating to inventory, intangibles, and some natural resources. The recognition, measurement, and presentation of expenses and cash flows from a lease will continue to depend on its classification as a finance or operating lease. The classification criteria in ASC 842 does not impact the classification for most leases, however, the bright-line classification of ASC 840 was replaced with a principles-based approach.

Don’t get hung up on this. Most small businesses do not have a GAAP requirement… this news is just for gee-whiz cocktail conversation. The reason for all this? Operating leases are obligations that are not required to be presented on the balance sheet. An automobile lease here and there, no biggie. A fleet of Boeing 737s is certainly a different situation, and as an investor you would want to know the impact on the balance sheet from these legal obligations.

By Jason Watson, CPA
Posted Saturday, November 4, 2023

Let’s briefly discuss recordkeeping, and then jump into a famous New York entertainer named Cohan who ultimately provided a nifty rule that can be used during an IRS audit. To be able to demonstrate a business deduction you need to show the date, the amount and the person or business you paid. A bank or credit card statement, or canceled check, satisfies this. The second element is the business purpose must be documented either through a logbook, planner or accounting software. Proof of payment plus business purpose equals tax deduction.

Do you need receipts? Yes and no. For travel, gifts and meals, if the amount is under $75 then you only need to document the event and business purpose in a logbook or planner. However, if you spend $10 at Costco for some paper, then you need proof of payment plus business purpose documentation. Seems a bit onerous and even contradictory, but it is true.

Enter Cohan vs. Commissioner, 39 F. 2d 540 (2d Cir. 1930). Yes, 1930 and we still use it today. George Cohan gave us “Yankee Doodle Dandy” and “Give My Regards to Broadway”, and he gave us a tax deduction rule. His rule is simple- you can approximate your business expenses and ultimately your business tax deduction. What?! No, it is not that simple.

You must have corroborating evidence that demonstrates your expense. For example, as a Colorado Springs CPA firm, WCG can demonstrate that we prepare so many tax returns which are so many pages in length, and therefore we can approximate our paper costs. Temp. Regs. Sec. 1.274-5T(c)(3) also gives latitude to the IRS to allow substantiation of a business expense by other means.

We have successfully used the Cohan rule in IRS examinations. We have also implemented it during tax preparation when records are incomplete or missing (i.e., one hot mess). Having said that, using estimates and approximations looks bad. Keep good records, please. Do not rely on the Cohan rule or some treasury regulation to save your butt.

The Cohan rule or any type of estimation cannot be used for travel, business gifts and meals. All the good stuff need strict recordkeeping habits. Section 274(d) of the U.S. Tax Code also states that listed property must be substantiated with proper documentation. Listed property includes automobiles, and equipment generally used in entertainment such as cameras and stereo equipment. Seems a bit outdated, but there you go. So, if you are a photographer who drives a car for business while entertaining guests, you will be a master at recordkeeping.

A logbook or planner is very influential during an audit. When a client can show contemporaneous records in a planner that coincides with travel, meals and home office use, the audit lasts about 90 minutes as opposed to four hours with a deficiency notice at the end. Contemporaneous comes from Latin, and means existing or happening during the same period. In other words, as things happen in your world, write them down in a logbook or planner.

Girls are better at this than boys because of purses, which is why we now have European shoulder bags for boys. Yet boys still stink at record keeping. If you are a boy, keep in mind that your DNA precludes you from multitasking. You might be doing two things at once, but that in no way is multitasking. Your contemporaneous record keeping might be more sequential.

By Jason Watson, CPA
Posted Saturday, November 4, 2023

We chatted about business meals earlier in the chapter. The Tax Cuts and Jobs Act of 2017 (TCJA) redefined meals and entertainment. In a nutshell, entertainment was removed as a deduction and meals were left in limbo (bad law writing). As such, the IRS released Notice 2018-76 which essentially restores meals, but not entertainment, back to old law.

IRS Notice 2018-76

Now with the clarification offered by IRS Notice 2018-76, 50% of business meals may still be deducted (100% was only for the 2021 and 2022 tax years) if you follow these guidelines as outlined in the notice-

• The expense is an ordinary and necessary expense under § 162(a) paid or incurred during the taxable year in carrying on any trade or business;

• The expense is not lavish or extravagant under the circumstances;

• The taxpayer, or an employee of the taxpayer, is present at the furnishing of the food or beverages;

• The food and beverages are provided to a current or potential business customer, client, consultant, or similar business contact; and

• In the case of food and beverages provided during or at an entertainment activity, the food and beverages are purchased separately from the entertainment, or the cost of the food and beverages is stated separately from the cost of the entertainment on one or more bills, invoices, or receipts. The entertainment disallowance rule may not be circumvented through inflating the amount charged for food and beverages.

Here is an example of a business meals tax deduction that is allowed (straight from the wizards at the IRS who label everyone as A and B)-

Taxpayer A invites B, a business contact, to a baseball game. A purchases tickets for A and B to attend the game. While at the game, A buys hot dogs and drinks for A and B.

The baseball game is entertainment as defined in § 1.274-2(b)(1)(i) and, thus, the cost of the game tickets is an entertainment expense and is not deductible by A. The cost of the hot dogs and drinks, which are purchased separately from the game tickets, is not an entertainment expense and is not subject to the § 274(a)(1) disallowance. Therefore, A may deduct 50 percent of the expenses associated with the hot dogs and drinks purchased at the game.

There are more examples in the IRS notice, but you get the idea. Old school is now the same school, just make sure you disconnect the meal from the entertainment. And no boosting the meal bill to reduce the entertainment bill just to be able to deduct it- “this hot dog cost $100, but it came with a free baseball ticket.” Ummm… Nope! See #5 above.

Other considerations that are commonly forgotten-

• You can deduct 50% for meals with employees when business is discussed. Common deduction when you add your spouse on payroll (and he or she actually does work).

• You can deduct 50% of the cost of transportation to and from the venue where the meal is consumed. Denver to Aspen on United to eat at Ellina or Campo De Fiori. Yum! Seems reasonable.

• You can deduct 50% of the costs associated with the meal such as taxes and tips, keeping in check with lavish or extravagant. Tipping $500 at McDonald’s for the extra cheese on your whopper, and then asking for a kickback out back behind the dumpster is probably not good. If you do, get a receipt… we’re sure you paid a commission on the kickback (kidding!). This is a trick. McDonald’s sells big macs not whoppers.

For business discussions during a meal, you must have a clear business goal in mind, the discussion must be substantive beyond casual conversation, and you must have an expectation of income or benefit to your business from the meeting. The meeting’s main purpose should be business related with the eating of food being incidental or secondary.

Entertainment has been removed from Section 274 thanks to the Tax Cuts and Jobs Act. Here is a short list of the entertainment activities where the IRS would historically deny a business conversation effectively took place- nightclubs, theaters, sporting events, large social gatherings, hunting or fishing trips, pleasure boating, and Yes, golf outings. The theory is simple- you must be discussing business matters, and in the eyes of the IRS these activities don’t allow for that. Not our argument, so don’t blame us.

You may also deduct as a business tax deduction the cost of meals for business discussions that occurred before or after the meal. For example, after a lengthy day of negotiating a business transaction you take the associate out for a nice dinner to relax. While eating your dinner nothing is discussed about business. Since these two events are so closely related, the cost of the dinner is deducted as a meals expense. The business discussions before or after the meal must be substantial and closely connected (nexus).

Everyday Business Meals

Business owners try to deduct meals they eat while traveling throughout the day. This is not a tax deduction. The theory on this is straightforward- you must eat regardless of owning a business or not. In other words, your meal is not contributing directly to the operations or success of your business. The IRS is clever- they don’t mind giving you a tax deduction today on something that eventually will result in taxable business income through growth and profits in the future.

Be careful about becoming Sutter (we discuss in a later section).

Spouse Business Meals

What happens if your spouse tags along to a business meeting over dinner? Or if the client or business associate brings his or her spouse? Do you have to split the bill up between business and non-business participants? No. The IRS considers the spousal attendance to the meeting to be incidental.

Can your spouse be considered a business associate as an employee? Of course. Before you get all excited about trips to Gallagher’s in Time Square with your spouse to discuss business, we encourage restraint and reasonableness. If the occasional business discussion occurs during a meal, and the meeting’s original intent was business, then this becomes a small business tax deduction at 50%. Position yourself carefully, and Yes, your spouse needs to be an employee.

Office Parties

Now we have three rules.

• You can deduct 100% of the meals you provide your employees if the meal is for the convenience of the employer, such as working lunches, and provided on the business premise.

• You can deduct 100% of the meals you provide related to employee recreation such as holiday parties and picnics (assumed to be off the business premise, and for WCG CPAs & Advisors at Fuzzy’s Taco Shop).

• You can deduct 50% of the meals provided on the business premise where the meals “promote goodwill, boost morale or attract prospective employees” according to IRS Publication 15-B. In addition, the employees cannot include officers, shareholders and anyone who owns 10% or greater interest in the business. So, a one-person S Corp shareholder cannot deduct 50% of his or her meals under this rule. Nice try! Someone did. Someone was caught. Rule was written.

De Minimis Meals

The IRS is generous. They also say that meals, such as coffee and donuts, provided under de minimis rules are not considered imputed income to the employees. How nice?! Here is the blurb form the IRS-

In general, a de minimis benefit is one for which, considering its value and the frequency with which it is provided, is so small as to make accounting for it unreasonable or impractical. De minimis benefits are excluded under Internal Revenue Code section 132(a)(4) and include items which are not specifically excluded under other sections of the Code. These include such items as:

• Controlled, occasional employee use of photocopier. “Bob, making copies.”

• Occasional snacks, coffee, doughnuts, etc. Glazed only.

• Occasional tickets for entertainment events (we’ll see if this gets removed after TCJA).

• Holiday gifts

• Occasional meal money or transportation expense for working overtime

• Group-term life insurance for employee spouse or dependent with face value not more than $2,000

• Flowers, fruit, books, etc., provided under special circumstances such as your 103-year-old grandmother died.

• Personal use of a cell phone provided by an employer primarily for business purposes. Don’t even go there on this one!

In determining whether a benefit is de minimis, you should always consider its frequency and its value. An essential element of a de minimis benefit is that it is occasional or unusual in frequency. It also must not be a form of disguised compensation. Therefore, routine dinners with your business partner are not de minimis. It might not qualify for the 50% either unless a business purpose is germane to the meal.

By Jason Watson, CPA
Posted Saturday, November 4, 2023

Let’s start off by saying the IRS despises business travel deductions. They view it as a way to rifle personal expenses through the business, and on some levels they are correct. But then again, the rules allow for it under some circumstances. The easiest way to explain business travel as a small business tax deduction is to run through some examples.

You travel to Tahoe to look at rental properties. None of the expenses associated with this trip is deductible. If and when you purchase a rental property in Tahoe, the expenses associated with your travels will be considered an acquisition cost and added to the basis of the purchased property. Upon sale you will realize the tax benefit of your travels through a smaller capital gain.

You travel to Las Vegas on Tuesday for a conference. At night you take in the sights, attend the conference on Wednesday and return home the same day. Travel is deductible at 100%, hotel is deductible at 100% and meals are deductible at 50% (the normal deduction).

Same Las Vegas trip but you return on Friday, with Tuesday and Wednesday being the only days you attend the conference. Since the business portion of the trip did not exceed half of the overall trip, none of the travel is deductible. However, Tuesday’s and possibly Wednesday’s hotel and meal costs are deductible.

Same Las Vegs trip, but the conference is from Tuesday to Thursday, and you still return home on Friday. Travel is deductible at 100%, and hotel is deductible at 100% provided you demonstrate that returning home on Thursday was not economically feasible. Meals would follow suit with the hotel but at 50% (the normal deduction).

You travel to Miami on Thursday for a conference that starts Thursday and ends on Friday. You also schedule business meetings on Monday. You do not return home on Saturday since it was not economically feasible. Travel is deductible at 100%, hotel is deductible at 100% (including the Saturday and Sunday stay) and meals are deductible at 50%.

This is a generalization, but you get the idea. There are additional exceptions for travel outside the United States and additional rules about side trips (such as seeing Mom on the way home from a business trip). See your Mom (that’s important) we’ll worry about the deduction later!

If your spouse and / or children are employed by the S corporation, and have a genuine need as you for business travel then he or she follows the same rules above. Where business owners get into trouble is the employment part. Your spouse and / or children must have a legitimate position with the business, and a genuine reason for business travel.

Having Junior stuff envelopes is fine, but bringing Junior to a riveting conference on the “evolution of the market economy in the early colonies” probably won’t work. Or have Junior attend a seminar where Vickers argues that Gordon Wood “drastically underestimates the impact of social distinctions predicated upon wealth, especially inherited wealth.” Gotta love that epic bar scene from Good Will Hunting.

By Jason Watson, CPA
Posted Saturday, November 4, 2023

We often get the question What is my tax home? It is a tricky question… and it is one that a lot of taxpayers are very interested in since your tax home is where you will generally pay taxes and commuting to your tax home is not deductible.

One of the best ways to illustrate the issue is a quick review of a recent Tax Court case, Barrett v. Commissioner, Tax Court Memo 2017-195. Barret was a video producer in Las Vegas, Nevada (this is getting good already). His employer constructed offices in Washington, D.C., which required Barrett to travel to and from several times a year. His average stay in Washington was about two weeks.

Barrett claimed about $55,000 in travel expenses and the IRS challenged arguing that his tax home was in Washington and not Las Vegas. However, the Tax Court disagreed with the IRS because Barrett proved that he did substantial work for his employer in Las Vegas in addition to the work in Washington. As such, his tax home was considered Las Vegas and not Washington.

This allowed him to deduct his travel expenses including lodging and meals since he was not commuting to his tax home. A win for Barrett. But… he eventually lost since he could not substantiate his expenses. So while he was allowed to deduct associated expenses, his recordkeeping was shoddy. Shocking.

Another variant of the tax home issue for business income is the deduction of business expenses. We have yet another Tax Court case that is eerily similar to the Barrett case above. In Bigdeli v. Commissioner, Tax Court Memo 2013-148, the taxpayer was an oral surgeon living in Pennsylvania who traveled 130 miles to New York where he worked at a dentist office.

His personal home was Pennsylvania and his tax home was New York. His $55,950 in travel expenses for the two years in question were disallowed because a) they were personal non-deductible commuting expenses and b) his work location and subsequent tax home did not meet the temporary work location rules.

What if Bigdeli had a home office where he performed administrative functions in addition to his primary work functions outside the home? No dice.

There is a derived (some would say contrived) 50 mile radius rule. It is derived from IRC Section 162(h) which defines the local area for state legislators as 50 miles. The federal government defines metropolitan area for IRS employees as 50 miles from an IRS office as detailed in the Internal Revenue Manual 6.550.1.1.7 (revised December 2009). There are other references to 50 miles, so it is a good rule of thumb to use.

How does the 50-mile rule factor into your home office world? To eliminate commuting using an administrative home office argument, your home office must be within 50 miles of your tax home. This is per Revenue Rulings 99-7 and 93-86, including Chief Counsel Advice 200027047 (CCA’s are the IRS’s own attorneys’ recommendation and interpretations).

Some caution here! This is an administrative home office argument… where you primarily do your work outside the home, and regularly and exclusively use a space in your home for administrative duties such as accounting, speaking to your attorney, invoicing, reviewing contracts, etc.

If you perform your primary work functions in both your home office and a work location outside the home, then your tax home will be the location where you spend the most time, perform the most critical functions and earn the most revenue. This is referenced in Chief Counsel Advice 200020055 which refers to Revenue Ruling 93-86 and 75-432, plus Markey v. Commissioner, 490 F.2d 1249 (6th Circuit 1974). Yeah, some old references but current tax law.

So, if you want to deduct travel, lodging and meals expenses associated with multiple work locations, either a) have your home office be within 50 miles of your tax home, b) do the most work in your home office with the outside-the-home work being secondary or c) have the assignment be temporary (under one year in duration).

How about having a W-2 job in Worcester, MA and running a business in New York City? In Sherman v. Commissioner from 1951, the Tax Court ruled that Worcester was Sherman’s tax home and the expenses of travel, lodging and meals associated with his secondary business in New York City were deductible. Win for the taxpayer! A massive one.

Keep in mind the IRS definition of itinerant-

If you do not have a regular or a main place of business or post of duty and there is no place where you regularly live, you are considered an itinerant (a transient) and your tax home is wherever you work. As an itinerant, you cannot claim a travel expense deduction because you are never considered to be traveling away from home.

As mentioned previously, WCG CPAs & Advisors has a lot of Certified Registered Nurse Anesthetists (CRNA) who travel all over the country putting people to sleep on short-term contracts, or stints if you are Formula 1 fan. Unless you return periodically to a place where you regularly live, you will not have a tax home. Without a tax home a lot of travel, lodging and meals deductions go away.

By Jason Watson, CPA
Posted Saturday, November 4, 2023

This is the so-called Masters Rule or Augusta Rule depending on your geographical vernacular which stems from Internal Revenue Code Section 280A(g). It is a unique rule in which homeowners who rent out their property for 14 days or fewer in a tax year are not considered to be engaged in the activity for profit, and therefore do not have to claim the rental income.

Therefore, you find a business connection for renting space in your home for 14 days or fewer. Client parties and presentations are good examples. Board meetings for closely held businesses is a bad example (or at least one that is tough to defend). Having said that, let’s say you have multiple owners and while it appears closely-held, you need a nice place to chat about the business and be off-campus for privacy. An owner’s home makes perfect sense.

WCG has a client who sells Pampered Chef, and she hosts demonstrations and parties once a month for a $1,000 per event. Her S Corp deducts $12,000 in rental expense but the cash received is considered tax-free. She legitimized this with competitive rate offers from banquet halls and the like, plus a contract between her and her S Corp. Perfect!

Additionally, your property’s mortgage interest and property taxes are still deductible. Yeah baby! They call it the Masters Rule allegedly from those who rent out their homes for the Masters Tournament in Augusta, Georgia.

By Jason Watson, CPA
Posted Saturday, November 4, 2023

In deciding whether to own the automobile personally or through your S corporation, here is a set of examples to help you make a decision. It is not a hard and fast set of rules, but will provide some guidance.

First, let’s establish the bookends. On one end is the $80,000 luxury auto that you barely drive, and you recycle automobiles every 2-3 years. This is clearly business owned.

On the other end is the $30,000 modest automobile that you drive a tone of miles, and you keep automobiles for at least 5 years. This is clearly individually owned and reimbursed.

Armed with that information, here we go-

Example 1

You like big fancy cars that cost $80,000 and you only drive 5,000 miles for the business. Degradation of value is a way of life simply based on time so this automobile will go down in value, and as such you might as well get a tax deduction for it. Ergo, have the business own it. In other words, if you have already budgeted for the degradation of automobile value you might as well get a tax deduction for it, right?

Example 2

You are frugal and therefore you like to buy used Subaru’s costing around $20,000… and, you drive the wheels off the thing because you are a real estate agent. Degradation in value is not as severe as example 1, so in this example the small business owner should own the automobile personally and get a mileage reimbursement from the business.

Example 3

You like big heavy trucks that cost $80,000 and you drive 12,000 miles for the business. You would like to save some taxes this year as well (shocking). This is a great example of using Section 179 plus 100% Bonus Depreciation to deduct the full amount of the truck.

Example 4

Same as example 3, but you expect your income to dramatically increase next year versus this year. In this case, have some patience and purchase the truck next year to match the excellent tax deduction against the higher income. We know, patience stinks. Our job is to build your wealth, and save taxes over your lifetime… not just today.

Example 5

You buy a lightly used SUV that weighs over 6,000 pounds for $50,000 and you drive it 6,000 miles per year. Yuck. This is right in the middle of “no man’s land” where the decision is not obvious. Yes, you can deduct the full amount of $50,000 since the Section 179 deduction is not based on a new automobile, just new to you.

But recall that depreciation is a tax deferral… if you sell your business automobile for $40,000 a few years later, you will have depreciation recapture on the $40,000 taxed at ordinary income tax rates up to 25% tax rate. To make matters worse, Section 1031 Like-Kind Exchanges no longer apply to automobiles since the recent tax reform so you can’t trade it in to kick this depreciation recapture can down the road.

It might behoove you then to own this automobile personally and get a mileage reimbursement from the business. Then again, if you have an unusually high income this year perhaps deducting it in full today makes sense. Again, “no man’s land” since the decision now has a ton of variables and what-ifs.

Example 6

Same as example 5 but you keep the automobile for 10 years and drive 15,000 miles. This changes the narrative. Since you will be owning it for so long with so many miles, the mileage reimbursement option is the way to go. In other words, own it personally and get reimbursed for the business miles you drive.

Let’s flip this around. Let’s say you buy fancy vehicles and you recycle them every 2-3 years. Typically this should be owned by the business regardless of mileage since you are taking large degradations in value simply based on time with little consideration to miles. A $100,000 vehicle might be worth $70,000 after 2 years so use this depreciation in value as a tax benefit by owning it in the business.

We have a questionnaire that you can complete, and we can review together to find the best course of action. Here is the link-

wcginc.com/8120

By Jason Watson, CPA
Posted Saturday, November 4, 2023

This might take a bit of getting used to so we will start with a similar situation. If you owned and operated a landscaping business, you might own the heavy equipment personally, and lease it back to the business. This is very common, and is considered a self-rental. Please refer to Chapter 3 (Three Types of Income) to refresh yourself on self-rentals and the handling of the income. As you know, self-rentals are perfectly fine as long as the lease rates being charged are considered market rates and cannot be considered remuneration of services provided (i.e., owner compensation).

The same thing can be accomplished with your automobile. You would lease a car that you own back to your company. This is not considered the same as the company leasing the car from a dealer. This is creating a self-rental arrangement between you and your business. And why would you want to do that?

The usual reason- it might prove to be a better tax position since you are reducing the income of your LLC which is subjected to self-employment taxes. Since we also use the ability to pay salaries as one of components in determining a reasonable salary for you as a shareholder in an S Corp, the leaseback option might influence a small reduction in your salary.

The income tax angle is a wash. A big table is coming up. First, let’s talk about some basic assumptions.

Keep in mind- this arrangement will benefit an LLC through the reduction of self-employment taxes much more than an S corporation. You might be asking why not just elect S corporation status to solve your SE tax troubles? Perhaps your LLC is not generating the $35,000 in net business income after expenses to warrant the S Corp election.

Every year, AAA publishes the annual cost of driving an automobile, and the costs are broken down by small sedan, medium sedan, large sedan, sport utility vehicle and a minivan. From there, costs are established for 10,000 miles, 15,000 miles and 20,000 miles.

Small sedans are Chevy Cruze, Ford Focus, Honda Civic, Hyundai Elantra and Toyota Corolla. Medium sedans are Chevy Impala, Ford Fusion, Honda Accord, Nissan Altima and Toyota Camry. No numbers for a Porsche 911. Sorry. We’re sure the operating costs aren’t too bad, and we’ve recently heard that 911s never depreciate and the service checks are free.

There are certain fixed costs such as insurance, registrations and financing. There are certain variable expenses such as gas, tires and maintenance. Then there are some quasi-variable expenses, namely depreciation. Depreciation accelerates as the mileage per year increases. Think about Kelly Blue Book, Edmund’s or lease rates- the reduction in value due to mileage gets more severe as the mileage exceeds 15,000. Sort of a curvilinear equation.

The lease rate needs some discussion too. If you have a newer, more expensive automobile, you might be able to fetch $600 per month. If you have an older car or a car that is more economical, a market lease rate might be $400. It a challenge to determine the market rate. Is it the rate a rental car agency would charge such as Hertz or Avis? Is it the rate a dealer would charge? Something in the middle? Don’t forget the IRS Publication 15-B (Employer’s Tax Guide to Fringe Benefits) where the lease value is determined by the IRS based on the value of the car. The benefit of ambiguity is the ability to pitch an argument on most numbers.

More tables. More numbers. Yes, tables are only meaningful to the table designer yet consider the following in a non S Corp situation-

Business Miles	5,000	10,000	11,875	15,000	20,000
Personal Miles	5,000	5,000	5,000	5,000	5,000
Total Miles	10,000	15,000	16,875	20,000	25,000
AAA 2014 Costs for Small Sedan	0.597	0.464	0.440	0.397	0.360
less Depreciation, Finance	0.288	0.204	0.181	0.161	0.106
Actual Operating Costs	0.309	0.260	0.259	0.236	0.254
Mileage Rate Method
2015 IRS Mileage Rate	0.575	0.575	0.575	0.575	0.575
Mileage Deduction on Sched C	2,875	5,750	6,828	8,625	11,500
Savings of SE Tax	406	812	965	1,219	1,625
Savings of Income Tax @25% MFJ	719	1,438	1,707	2,156	2,875
Total Savings Using Mileage Reimbursement	1,125	2,250	2,672	3,375	4,500
Lease Method
Annual Lease @ $400/month	4,800	4,800	4,800	4,800	4,800
less Depreciation ($3,160 Year 1)	-3,160	-3,160	-3,160	-3,160	-3,160
Biz Use Expenses Using Actual Costs	1,545	2,603	3,075	3,544	5,076
Savings of SE Tax	897	1,046	1,113	1,179	1,395
Savings of Income Tax @25% MFJ	1,586	1,851	1,969	2,086	2,469
Gain on Net Rental Income @25% MFJ	410	410	410	410	410
Total Savings Using Lease Back Option	2,073	2,487	2,672	2,855	3,454
Delta on Mileage Rate Method	-948	-237	0	520	1,045

Tilt!

We haven’t updated this for 2021 numbers. Out of our client base of 2,700, we only have one business doing this. Have some fun with this, but in the end the other scenarios won’t hurt the brain as much.

The first question is the break-even. That number is 11,875 miles for a small sedan. That means if you drive fewer miles, then a lease arrangement might be a good idea. Conversely, if you drive more miles than 11,875, then using the mileage rate deduction is better. Yes, this is a middle of the road number. Pun intended.

Second question is depreciation and finance. Since you are charging a lease to your business for the use of the automobile, you cannot also add depreciation and finance charges. Those figures make up a large part of AAA’s cost of ownership. You can only pass operational costs proportioned to business use. However, those expenses might be deducted on Schedule E of your individual tax returns, similar to rental properties.

How does the break-even move around? Good question. Frankly, AAA tends to be heavy-handed on the costs. So, if the average costs to operate an automobile go down or is less than what the AAA thinks, the break-even point decreases. If the market lease rate increases from the $400 used above, the break-even mileage increases.

In other words, as the mileage increases, you are amortizing the same fixed costs across more miles, whereas the IRS is giving you a flat rate of 57.5 cents for the 2015 tax year. Low miles? Lease arrangement might make sense since the mileage rate is lower than the actual costs. High miles? Your actual costs are being spread thinner, but the IRS still gives you 57.5 cents. Things to consider.

How does this arrangement reduce my self-employment taxes? Wow. Another good question- you are full of them. Leasing a car back to your business has the most benefit in the garden variety LLC or partnership where all the income is being subjected to self-employment taxes. As you know, an S Corp already sanitizes a bunch of income in the form of a K-1 which is not subjected to self-employment taxes.

So, to reduce your K-1 income in favor of non-passive self-rental income is basically moving money from your right pocket to your left pocket. Both income sources are only taxed at the income tax level. Net zero. But we’ve already discussed that reducing S corporation income through self-rentals might help reduce your reasonable salary. However, this is more apparent in self-rentals or lease arrangements that are not automobiles. The reimbursement allowances, depreciation limits and business use calculations on automobiles versus other self-rental items makes it less lucrative.

Conversely, in an LLC or partnership where self-employment tax is a concern, the automobile lease arrangement is a business expense and directly reduces the income, and therefore reduces self-employment taxes. This arrangement might be a good idea if you are unable to use an S Corp election (foreign investor) or if it doesn’t make sense to (below break-even income).

There is some danger with the lease back to your business option. The biggest challenge is estimating the actual costs to operate your automobile, and the second challenge is estimating your mileage. So, if you are close to the break-even point it might not make sense. And engaging in revisionist history is not an ideal situation either.

Some more commentary. The AAA rate is published each year by the American Automobile Association and takes into account fuel prices, average insurance, registrations, etc.

The previous table assumes a 25% marginal tax rate. This is not a huge consideration, but as marginal tax rates increase the break-even point decreases. For example, on a small sedan, a jump from 25% to 32% in marginal tax rate increases your savings by $400 annually for a person who drives 15,000 miles for business and elects to use the mileage deduction and not the lease arrangement.

Medium sedans. With a slight increase in operating costs and subsequent market lease rates, the break-even is about 13,000 miles. Again, that might be low to some business owners. Hassle versus reward.

What is the net-net?

• The lease arrangement seems like an OK idea with low business miles.
• It seems exotic. It seems like a cool thing to drop at a party as a genius idea. But in the end, it might not be all that. But looking smart can be better than being smart.
• With one vehicle, it only works well in an LLC or partnership where self-employment taxes are being applied to all income.
• With several vehicles (fleet) or machinery, lease-backs can prove to be smart tax planning.

To confirm, however, WCG can model your specific situation.

By Jason Watson, CPA
Posted Saturday, November 4, 2023

This is dead for S Corp shareholders. Thanks to the Tax Cuts and Jobs Act of 2017 all miscellaneous deductions that were once subjected to 2% adjusted gross income limits and then deducted on Schedule A are gone. Obtaining a tax deduction through a mileage deduction on your individual tax return was always a bad idea anyway with the Form 2106 and Schedule A limitations, and now it’s just a memory.

If your business is not taxed as an S Corp, you are still able to deduct mileage on Schedule C of your Form 1040 tax return, or as Unreimbursed Partner Expenses (UPE) on Page 2 of Schedule E. We discuss this elsewhere, but for partners in a multi-member limited liability company who are used to this deduction, electing S corporation status will wreck your world a bit. Rather it being a deduction, it becomes a reimbursement from the business. In turn, that adds some office politics on who is spending what and for what.

By Jason Watson, CPA
Posted Saturday, November 4, 2023

The Sutter rule allows the IRS to disallow a portion of your business meals when they consume a large part of your normal living expenses. In other words, if every meal you eat is a justifiable business meal, it might not matter under the Sutter rule. This rule was created in Richard Sutter v. Commissioner, 21 Tax Court 170 (1953), where Sutter expensed his lunch every day but the court found that “the deduction for the cost of lunches was apparently almost entirely payment for petitioner’s own meals when he attended such functions as meetings of the Chamber of Commerce. There is no evidence that these costs were any greater than expenditures which petitioner would have been required to make in any event for his own personal purposes. They must consequently be disallowed.”

Sutter was audacious- he deducted everything he could think of. It is a great read.

Again be careful. Business meals are low hanging fruit for the IRS. We’ve seen thousands of dollars in tax savings disappear before our eyes during an examination because the client could not demonstrate the business purpose. To not lose an audit, make sure you keep receipts beyond relying on the credit card statement. In addition, keep a log or journal of the person(s) you met with and the topics of discussion. Be very specific. Memories fade, so if you intend to reconstruct this evidence upon receipt of your examination notice from the IRS, think twice. IRS agents are no dummies on meals.

Remember this; pigs get fed and hogs get slaughtered. Be reasonable, people!

By Jason Watson, CPA
Posted Friday, November 3, 2023

A question we entertain almost daily is “I want to save taxes. Should I have the business buy me a car?” Our auto-attendant replies with, “Do you need a car?” If you answer with “Yes” the auto-attendant replies with, “Hold please.” If your “Yes” is not quick or mumbled, or if there is any recognition of hesitation, the auto-attendant is unhappy.

We digress. There are only a few questions you need to ask yourself when considering a car purchase. Are you the type of person who buys new? How long do you typically keep your cars? Is the car 100% business use? How many miles do you plan to drive? There is a decision tree at the end of the automobile section.

Back up for a bit. Remember our previous discussions about tax deductions, and how only a fraction of the money you spend is returned to you? So, back to our auto-attendant, “Do you need a car?” If the answer is “Yes” because your bucket of bolts is getting exceedingly dangerous, then Yes, buy a much-needed car out of a sense of safety. If the answer is “Not really, but I want to save taxes,” then don’t.

Two rules to live by-

• Cash is King (keep it!)

• Depreciation is a tax deferral not a tax avoidance system (typically)

There might be some other external forces at play. For example, if you need a car next year but your income is ridiculously and unusually high in the current tax year, then reducing your income now makes sense. Again, tax modeling and planning is critical.

Ok, you’ve chatted with your car-loving buddies at WCG and we’ve determined that a car purchase should be in your near future, now what? There are all kinds of issues here, so, buckle up as we go through this stuff. There are four scenarios-

• Business Owned Automobile (mixed bag)

• You Own the Automobile, Get Reimbursed By The Mile (clean and elegant)

• You Own the Automobile, Take a Mileage Deduction (silly in an S Corp… oh and by the way, gone with the Tax Cuts and Jobs Act of 2017)

• You Own the Automobile, Lease it Back to Your Business (exotic)

We’ll start with the crowd favorite- Business Owned Automobile. As we go through these, please excuse our interchange of vehicle, automobile and car. They all mean the same thing. If you are being chastised by Tina Watson’s sister for bringing food into her Toyota 4Runner then Turi would use the word “vehicle,” with stark over-annunciation of each syllable like she was talking to someone who doesn’t know English. Then again, there are so many grammatical errors in our book, who are we to complain?

By Jason Watson, CPA
Posted Friday, November 3, 2023

Here is a quick list of the small business tax deductions that the IRS cannot stand. That isn’t phrased correctly. The IRS actually likes these tax deductions since most business owners either incorrectly deduct them or cannot substantiate an otherwise qualified deduction for lack of proper record keeping.

The IRS plays pot odds on the following business deductions since the recovery of taxes is probable and therefore profitable for the government. In poker, if it costs you $10 to bet and there is $100 in the pot, then you can be wrong 90% of the time and still break even. This is the essence of the pot odds: You’re paying a fraction to win a larger sum, and the IRS is no different.

Here we go-

• Meals (shocker)

• Car and Truck Expenses, Mileage Logs (another shocker)

• Travel (abused regularly)

• Home Office (probably not as much anymore)

There are others, but these are the biggies. This should not have a chilling effect on you deducting these expenses. You should not be afraid of an audit. You should not be afraid of losing an audit. You should only be afraid of having an unreasonable or indefensible position. Sure, easy for us to say.

At the same time, if you have legitimate expenses and you can back them up with proof, then happily deduct them. Like Muhammad Ali once said, “It’s not bragging if you can back it up.” Well, the same can be said of small business tax deductions that are at higher risk of audit. If you can back it up then deduct it!

By Jason Watson, CPA
Posted Friday, November 3, 2023

Here is another concept that small business owners miss. Tax deductions only reduce taxable income. If you spend $1,000 and your marginal tax rate is 22%, then you only save $220 by spending $1,000. Every December, we fields hundreds of phone calls and emails from clients asking if they should buy something to save on taxes. Our response is a simple flowchart-

• Do you need the item you are considering? If No, then stop. Don’t buy anything. If Yes, then continue to the next question.

• Is the current year’s income unusually high, or do you expect to earn more next year?

Without sound snarky, why would you buy something on December 31 if your tax rate will only increase the following year? Wait 24 hours, buy the cool thing you need and get a better yet delayed tax deduction. And if you don’t need it, why would you spend money unnecessarily only to get a portion of that back in tax savings? Another way of saying this is- keep some tax deductions in your pocket for next year. You don’t want to be in a position where you ran out of perfectly good deductions in a year of increased taxable income.

Conversely, if your current taxable income is unusually high and you expect it to go down next year then perhaps you should accelerate your timelines for major purchases. WCG can help with the tax modeling and planning.

All too often we hear people at cocktail parties say something silly like “Don’t worry, it’s a write-off.” Remember that money is still leaving your person, and the money you are getting back in the form of a tax deduction is substantially less. Just because it is a “write-off” or a business tax deduction doesn’t mean that you are using Monopoly money. Yes, it is easy to spend someone else’s money but calling it a write-off doesn’t change who owns the money.

Tax credits are in contrast to tax deductions. Tax credits such as $7,500 for buying a cool Porsche Taycan or $13,400 for adopting a child are a dollar for dollar reduction in your tax due. For example, if the computed tax liability is $20,000 and you max out your adoption credit of $13,400, you will only have a tax liability of $6,600. However, if you spend $13,400 in office furniture you will save taxes based on your marginal tax rate- 22% tax rate equates to $2,948. See the difference?

Tax deduction versus tax credit. There are very little tax credits for small businesses, but here are most popular-

• Alcohol Fuels

• Alternative Motor Vehicle

• Disabled Access

• Employer Provided Childcare

• Reforestation

• Qualified Research Expenses (models, patents, environmental testing, etc.)

• Pension Plan Start Up Costs

• Work Opportunity and Welfare to Work

Look these up. These are like college grants and other obscure things that most people don’t chase down. There might be easy money for things you are already doing.

By Jason Watson, CPA
Posted Friday, November 3, 2023

Similar to the 185 reasons to not elect S corporation taxation, there aren’t 185 small business deductions that you cannot take. However, we want to start with the crazy things small business owners try to do since it is such a good springboard for discussion.

100% Cell Phone

Most small businesses operate on a cell phone. However, most small business owners also use his or her cell phone as a personal phone. The minute you get the “Hey honey… we need milk and eggs” text message to your cell phone, it drops from 100% business use to something else.

If you attempt to deduct 100% of your cell phone as a small business tax deduction, the IRS will claim 0% and then force you to demonstrate why it should be something else. Conversely, if you approach this from a position of being reasonable it is extremely challenging for the IRS to argue otherwise. What is reasonable?

We usually start with a single phone line cost of about $150 per month in 2020 dollars. While it might only take $10 to add another line, you would still need to spend $150 for yourself. From there it becomes a preponderance of the facts and circumstances. Some people say there are 40 hours in a work week and there are 168 available hours (24 x 7).

However, this calculus assumes your personal use “density” is the same as your business use “density.” For most business owners, this is not true. You probably talk longer with clients and business associates, than you do friends and family.

Anywhere from 50% to 80% is a good jumping off point. Since this is a mixed-use expense between personal and business, the cell phone charges should be paid by you personally and then reimbursed by the business for the business use portion through an Accountable Plan. See Chapter 10 on operating your S Corp for more details.

We feel compelled to hammer this point home- if the expense is mixed-use, such as cell phones, the bill is paid for with personal funds, and then the business portion is reimbursed to you by the business. Same with automobiles that are shared between personal and business use (we’ll remind you in a bit). Yes, it feels better using business funds, but No, you shouldn’t unless the expense is 100% business.

Automobiles

Automobiles will be discussed in nauseating detail later in this chapter, and there is a decision tree as well to help determine if you should own it or the business. In keeping with the business tax deductions that are disallowed, claiming your only automobile as 100% business use is a tough sell.

Home Office Improvements

You cannot spend $30,000, finish your basement, plop your desk in the middle of it and deduct the $30,000 for two reasons. First, the entire space must be regularly and exclusively used as a home office. This means the theater room must be a conference room, and the wet bar must be the office kitchen. Might be tough in the world of small business tax deductions.

Second, even if the entire basement is designated business use, the $30,000 represents an improvement. Therefore, it must be capitalized as an asset and subsequently depreciated over 39 years. From there, only the business use portion of mortgage interest, property taxes, insurance, HOA dues and utilities are deductible. And if you have an S corporation, then this business expense is reimbursed to you by the business through an Accountable Plan (and therefore deductible by the business as an employee reimbursement expense).

Don’t worry, the projection TV with the non-glare screen was still worth it. We’ll talk more about home offices especially with multiple locations later in this chapter.

Food

More bad news. You cannot deduct your business meals unless you fall under one of two situations-

• You are entertaining a client, prospect or other business associate (or a small group such as 12), and discussing business matters, or

• You are away from your tax home where you require substantial rest (such as an overnight trip), and that trip has a business purpose.

As such, if you cruise through the Starbuck’s drive-through and grab your triple grande vanilla breve on the way to your day meeting, no good. However, if you are traveling away from your tax home when on a business trip, then order the venti. Live a little.

Your small business tax deduction is limited to 50% under both circumstances (the 100% that we enjoyed for all meals was only for the 2021 and 2022 tax years, so we are back to the same old same old).

The theory on this is straightforward- you have to eat regardless of owning a business or not. In other words, your meal is not contributing directly to the operations or success of your business. The IRS is clever- they don’t mind giving you a tax deduction today on something that eventually will result in taxable business income through growth and profits in the future. Think of it this way- if you had a regular W-2 job, you wouldn’t be able to deduct your meals. Why would that change with your shiny new business or S corporation?

In reference to overnight travel or travel away from your tax home, your tax home is the location where you earn income. Here is the word for word description from IRS Publication 17–

To determine whether you are traveling away from home, you must first determine the location of your tax home.

Generally, your tax home is your regular place of business or post of duty, regardless of where you maintain your family home. It includes the entire city or general area in which your business or work is located.

If you have more than one regular place of business, your tax home is your main place of business.

If you do not have a regular or a main place of business because of the nature of your work, then your tax home may be the place where you regularly live.

If you do not have a regular or a main place of business or post of duty and there is no place where you regularly live, you are considered an itinerant (a transient) and your tax home is wherever you work. As an itinerant, you cannot claim a travel expense deduction because you are never considered to be traveling away from home.

Main place of business or work. If you have more than one place of business or work, consider the following when determining which one is your main place of business or work.

• The total time you ordinarily spend in each place.

• The level of your business activity in each place.

• Whether your income from each place is significant or insignificant.

There you have it. Overnight travel away from your tax home will create a nice business deduction for that beer sampler with pretzels and mustard dip. Spicy of course.

Here is a link to IRS Publication 17 (Your Federal Income Tax)-

wcginc.com/5324

Tax homes can get tricky especially if you travel a lot or have multiple job locations. More details are coming up in this chapter when we discuss home offices. Also, we can always help sort through it to find the best tax position.

Also, note the word “itinerant” above. Here is a snippet of the snippet-

If you do not have a regular or a main place of business or post of duty and there is no place where you regularly live, you are considered an itinerant (a transient) and your tax home is wherever you work. As an itinerant, you cannot claim a travel expense deduction because you are never considered to be traveling away from home.

WCG CPAs & Advisors have a lot of Certified Registered Nurse Anesthetists (CRNA) who travel all over the country putting people to sleep on short-term contracts, or stints if you are Formula 1 fan. Unless you return periodically to a place where you regularly live, you will not have a tax home. Without a tax home a lot of travel, lodging and meals deductions go away.

Sidebar: CRNAs certainly take the cake on fun business names like Sleepy Times Ahead LLC and Passing Gas with Class LLC. Either they are clever, or some of the gas meant for the patient was accidentally inhaled by the medical professional. Perhaps it wasn’t accidental. Who uses gas anymore? We digress…

Per Diem

Sole proprietors including single-member LLC owners, and partners are allowed to deduct the federal per diem rate for meals. Lodging can only be deducted using the actual cost of lodging. Where are S corporations? You are not going to like this. Employees of corporations are eligible for per diem allowances, reimbursements and deductions unless this same employee owns more than 10% of the corporation.

This means that most S corporation shareholders are hosed, and can only deduct (or get reimbursed) for actual meal costs. IRS Revenue Procedure 2011-47 has this limitation and IRS Publication 463 states in part “A per diem allowance satisfies the adequate accounting requirements for the amount of your expenses only if…you are not related to your employer.”

You are related to your employer if-

• Your employer is your brother or sister, half-brother or half-sister, spouse, ancestor, or lineal descendant,

• Your employer is a corporation in which you own, directly or indirectly, more than 10% in value of the outstanding stock, or

• Certain relationships (such as grantor, fiduciary, or beneficiary) exist between you, a trust, and your employer

Therefore, the question becomes, if you are an LLC being taxed as an S corporation, are you a corporation where you own stock or an limited liability company where you own a membership interest. We believe these are one in the same in this context. Don’t fret. You can still deduct 50% of your meals when traveling; you just need to use actual expenses and not per diem allowances.

Country Club Dues

Nope. The IRS does not care how many times or how much you entertain your clients, prospects and business associates at your country club. The membership dues are not allowed. However, the specific out-of-pockets expenses associated with qualifying meals incurred at your country club are deductible. There are some other devils in the details, but this is the general gist. Also, recall that since the Tax Cuts and Jobs Act of 2017, entertainment is no longer deductible.

Don’t confuse this with other types of dues such as Chamber of Commerce or other professional organizations such as BNI. Those dues are 100% deductible although there is some scuttle butt about BNI since a portion of the dues are likely for meals.

Client Gifts

Yuck, more IRS publications stuff on the way. In IRS Publication 463, here is the blurb on client gifts-

You can deduct no more than $25 for business gifts you give directly or indirectly to each person during your tax year. A gift to a business that is intended for the eventual personal use or benefit of a particular person or a limited class of people will be considered an indirect gift to that particular person or to the individuals within that class of people who receive the gift.

If you give a gift to a member of a customer’s family, the gift is generally considered to be an indirect gift to the customer. This rule does not apply if you have a bona fide, independent business connection with that family member and the gift is not intended for the customer’s eventual use.

If you and your spouse both give gifts, both of you are treated as one taxpayer. It does not matter whether you have separate businesses, are separately employed, or whether each of you has an independent connection with the recipient. If a partnership gives gifts, the partnership and the partners are treated as one taxpayer.

$25 is the maximum per year per person. The second paragraph explains you cannot give $100 to a family of four (as an example), unless you have a separate bona fide relationship with each family member. Here is the link to IRS Publication 463 (Travel, Entertainment, Gift, and Car Expenses)-

wcginc.com/5330

In a recent IRS audit that we represented, the client presented a $1,000 receipt for forty $25 VISA gift cards along with forty names of clients, prospects and business associates, including the business connection to each. Excellent documentation frankly. The IRS agent accepted the business deduction as is, yet quietly we wondered if any of those names actually received the gift cards. We didn’t bring it up. Interesting indeed.

Keep this in mind as well- note that the IRS refers to individuals in their little pontification above. Gifts to another business are limitless. So, if your client is a business and you want to express your gratitude, theoretically there is no limit provided an individual is not the designated recipient.

Promotional items that are under $4 in unit cost and have your business name or logo on them are not considered gifts and do not contribute to the $25 maximum.

Commuting Expenses

It is unfortunate, but expenses associated with your commute to work are not deductible. Tolls and parking are the common ones small business owners attempt to deduct. There is a subtle difference to be aware of- driving from a work location to your client’s place of business is not commuting. Commuting is driving from your home to your office or client’s place of business.

You can solve a lot of problems surrounding commuting expenses by qualifying for a home office. Then your commute is from the bedroom to the home office. If you shower, then the commute is from the bathroom to the home office.

All kidding aside, or least most of it, the tax benefit of the home office deduction is not too low, not too high. In our experience, about $250 or so of cash in your pocket benefit comes from the additional deductions associated with a home office. But! Where the big benefit comes from is the deduction of travel expenses; without a home office, your mileage or automobile expenses to your first client is not tax deductible. However, with a home office, this drive is now considered travel between work locations. Huge difference!

We do a deep dive into the home office deduction in a bit.

Professional Attire

The tax code is very clear on this. Anything that you can convert to everyday use is considered personal, and therefore not tax deductible. Many business owners want to deduct dry cleaning expenses or Men’s Warehouse purchases, but they usually cannot. We know you are rocking it in the double-breasted vest without a coat look, but the IRS doesn’t have fashion sense and therefore doesn’t care. However, there are some exceptions (of course there are).

WCG CPAs & Advisors prepares several tax returns for pilots, flight attendants, military personnel, nurses and firefighters. These uniforms are not suitable for everyday use and / or are protective in nature (such as steel-toed boots), and therefore are small business tax deductions. We also have a handful of models and actors as clients, and their clothing is considered theatrical costumes not suitable for everyday use.

Many small business owners will embroider a nice golf shirt or something similar. This can be deducted as either clothing not suitable for everyday use or advertising depending on the IRS agent who is bent out of shape about your tax returns.

The maintenance such as alterations and laundering of deductible clothing is also tax deductible. Shoes, socks, nylons, haircuts, watches and the like are all disallowed. Forget about it. In Mary A. Scott v. Commissioner (Tax Court Summary Opinion 2010-47), a Continental Flight Attendant was denied shoes, socks, nylons and hair product as unreimbursed employee business expenses. Here is the link-

wcginc.com/2010

It’s a fun case and a quick read.

Loan Payments

Many businesses have loans, either for automobiles, business equipment or lines of credit. However, having an expense category of “Loan Payment” is a dead giveaway that the business owner doesn’t understand that only the interest portion of the loan payment is deductible.

Think of it this way- if you lent your buddy $50,000 and he or she shockingly pays you back the $50,000 plus $10,000 in interest, only the $10,000 would be income to you. The $50,000 would be what we nerdy accountants call a return of capital.

Yet another way to look at this- your small business tax deduction must be recognized as income by another entity (either business or person), unless that entity is a charity. So, for the IRS to allow you to deduct mortgage interest on your home mortgage as an example, the lender must recognize the interest as income. Your deduction = someone else’s taxable income.

Zeus and Apollo

Let’s say you are a hotshot private investigator driving a red Ferrari 308 GTS in Hawaii. Can you deduct two Dobermans as business expenses? Possibly. We recently worked with a client who is a criminal defense attorney where we demonstrated that the need for security dogs was a bona fide occupational qualification. In other words, the dogs provided security to the criminal defense attorney so he was able to perform his job. Stop laughing, it was L-E-G-I-T. Not because of the creativity, but because of the argument’s position.

Another way to look at these obscure examples- the IRS allows you to deduct most things if they eventually lead to the generation of taxable income. Think of investment fees. Think of Zeus and Apollo who allowed the attorney to continue taking on high-risk, high-profit (taxable) defense cases.

Conclusion

Enough about the stuff you can’t do, or at least enough of the business deductions you need to carefully position yourself with, let’s talk about the stuff you can do. There are several small business tax deductions that are common, yet overlooked or misapplied.

By Jason Watson, CPA
Posted Friday, November 3, 2023

Section 199A deduction also known as the Qualified Business Income deduction arises from the Tax Cuts & Jobs Act of 2017. This is a significant tax break for small business owners but there are rules and limits of course.

Section 199, without the A, is the section covering Domestic Production Activities Deduction. Section 199A is seemingly modeled after this (or at least a portion was ripped off by legislators) since the mathematics and reporting is similar between Section 199A and Section 199.

Section 199A Qualified Business Income deduction is a deduction from gross income on Line 13 on Page 1 of your individual tax return (Form 1040) for the 2020 tax year. Please recall that it is a deduction on your tax return since there are personal limitations. Therefore, two owners of the same business might have different results.

Calculating the Qualified Business Income Deduction

The basic deduction is 20% of net qualified business income which is huge. If you make $200,000, the deduction is $40,000 times your marginal tax rate of 24% which equals $9,600 in your pocket. Who says Obamacare isn’t affordable now? Here is the exact code-

(2) DETERMINATION OF DEDUCTIBLE AMOUNT FOR EACH TRADE OR BUSINESS. The amount determined under this paragraph with respect to any qualified trade or business is the lesser of-

(A) 20 percent of the taxpayer’s qualified business income with respect to the qualified trade or business, or

(B) the greater of-

(i) 50 percent of the W-2 wages with respect to the qualified trade or business, or

(ii) the sum of 25 percent of the W-2 wages with respect to the qualified trade or business, plus 2.5 percent of the unadjusted basis immediately after acquisition of all qualified property.

This is just a primmer… or if you’ve read this book from the beginning then you already know this. For more crazy details refer to our two chapters dedicated to the Section 199A deduction.

By Jason Watson, CPA
Posted Friday, November 3, 2023

Before we get into which tax deductions and tax moves you can take, there are some basic concepts to help formulate your thinking.

Marginal Tax Rate

Quick lesson on small business tax deductions. When you write a check and it has a tax savings element (office expense, 401k, IRA, charity, etc.) it is not a dollar-for-dollar savings. For example, if you are in the 22% marginal tax bracket, you must write a check for $4,000 just to save $880 in taxes. Keep this in mind as you read this information on tax deductions. Also keep in mind that cash is king, and that perhaps paying a few more taxes today with the added flexibility of cash in the bank can be comforting. More on this later in the chapter.

Cash Savings or Tax Savings

You can save $50,000 today! Yes, today! You just need to write a $150,000 check to your church. Huh? That might not sound like the best idea to a lot of people since so much cash is leaving. Another way to look at this is this- most people say “I want to save taxes” but really what they are saying is “I want to save cash.”

In other words, most people are in the cash-saving business not the tax-saving business. If we can do both, great. However, most tax-savings moves take cash, and cash is what you want to keep. Please keep this concept in mind as you review business deductions below.

Building Wealth

At the end of your life, you’ll measure your financial success on the wealth you built not the tax you saved. We agree that a part of wealth building includes tax savings, but be careful not to sacrifice wealth for the thrill of a tax deduction (or deferral). Here is an example- let’s say you stuff all your available cash into a tax-advantaged retirement account such as a 401k. A few years go by and a great rental comes on the market but your cash is all tied up in a 401k. So, you sacrificed potential building of wealth by not having an intermediate investment strategy for the sake of tax deferrals.

The Trick

Here’s the trick. The Holy Grail if you will. You need to find a way to deduct money you are already spending. Read that again. For example, if you have a travel budget then you are already comfortable with a certain amount of money leaving your person. Let’s find a way to deduct it through your business.

Automobile depreciation? Same thing. You are already comfortable with automobiles losing thousands of dollars in value especially in the early years, so let’s a find a way to make this degradation in value a tax windfall.

The remainder of this chapter is written to help educate yourself so the money you are already spending can be positioned in such a fashion that it becomes a legitimate small business tax deduction. Remember that the greatest trick the devil ever pulled was convincing the world he didn’t exist. The second greatest trick was finding a way to deduct the expense. You gotta love The Usual Suspects. Classic!

By Jason Watson, CPA
Posted Friday, November 3, 2023

Ahh.. the good stuff. Yes, you work hard. Yes, you want to be able to get a little extra from your hard work and your business. Yes, you want this to be tax-advantaged. We get it. This chapter will discuss the 185 tax deductions you cannot take, explain how to position yourself on allowable small business tax deductions, and then get into hot topics such as automobiles, home offices, deducting MBAs, Cohan rule and other fun things.

This chapter is long, but it might be the most worthwhile (or at least sought after).