July 2017

Appeals Court Allows Sexual Harassment Case to Proceed

Posted on July 31, 2017 by Debra Barcuch

Sexual harassment on the job remains a problem in many workplaces.

And most often, charges are filed by female employees against males. But in a recent case, the Tenth Circuit U.S. Court of Appeals rejected a district court’s ruling that a man’s sexual harassment charges against a female supervisor were improperly handled. The appeals court sent the matter back for further review.

Facts of the Case

A male mechanic for a trucking firm sued his employer for sexual harassment caused by his direct supervisor, a female who also was a shareholder in the firm. The employee alleged that he was fired because he refused to have sexual relations with the woman.

The mechanic completed the intake questionnaire that’s required in order to file a claim with the Equal Employment Opportunity Commission (EEOC). He checked the boxes for “Sex” and “Retaliation” as the reasons for his claim, as well as writing out “sexual harassment.”

In response to questions seeking more detailed explanations, the employee wrote “see attached,” referring to a six-paragraph statement he had prepared. The attachment concluded with the statement that he was terminated because he refused to agree to the supervisor’s sexual advances and rejected all such efforts by her.

Change of Form

Apparently, however, the EEOC didn’t receive the attachment, so it used a charge form based on the questionnaire alone. This form laid out the basics of the allegations, which were:

The mechanic was subjected to sexual remarks by his supervisor.
He complained about the sexual harassment to the general manager and other owners.
Nothing was done before the supervisor terminated his employment.

The charge, however, didn’t specify the information that was included in the attachment about unwanted sexual advances.

The EEOC issued a right-to-sue letter and the mechanic sued in federal court. He initially made two claims:

“Quid pro quo” harassment, which occurs when a worker suffers an employment action such as termination for refusing a supervisor’s demands for sex, and
Hostile environment harassment, which occurs when a course of conduct makes a work environment abusive.

He later dropped the hostile work environment claim.

The U.S. District Court dismissed the claim as being deficient because the charge form didn’t include the missing attachment spelling out the quid pro quo allegations. Undaunted, the mechanic appealed.

Different Outcome

The Tenth Circuit Court of Appeals was more sympathetic to the man’s plight. It determined that the charge form contained sufficient allegations to trigger an investigation into:

What the sexual remarks were
Why the employee was fired, and
Whether the two events were connected.

The court noted that the Supreme Court cautioned that the quid pro quo and hostile environment forms of sexual harassment aren’t “wholly distinct claims.” Instead, they’re shorthand for different ways in which such harassment can occur (see Ellerth, 524 U.S. at 754).

The appeals court refused to require that the charge be more specific about the type or form of harassment alleged. (Jones v. Needham , 2017 BL 159166, 10th Cir., No. 16-6156, 5/12/17 )

Background Information

The case highlights the two main types of sexual harassment that are subject to legal action under Title VII of the Civil Right Act:

1. Quid pro quo harassment. This occurs when employment decisions are determined by whether or not a person submits to sexual advances or demands. For instance, an employee may lose a promotion, a plum assignment or even his or her job if he or she doesn’t give in.

Specifically, unwanted sexual advances, requests for sexual favors or other verbal or physical conduct of a sexual nature constitute quid pro quo sexual harassment if:

Submission to such conduct is either explicitly or implicitly made as a term or condition of employment, or
Submission to or rejection of such conduct is used as the basis for employment decisions.

2. Hostile work environment. In this case, sexual harassment conduct makes the workplace intimidating, hostile or offensive to the point where it unreasonably interferes with an employee’s work performance.

In considering whether or not an environment is “hostile,” the courts will weigh several factors, including:

Whether the conduct was verbal, physical or both,
How frequently the conduct occurred,
Whether the conduct was hostile or patently offensive,
Whether the alleged offender was a coworker or supervisor,
Whether others joined in the harassment, and
Whether the harassment was directed at more than one individual.

Timing of a Claim

According to the EEOC, a hostile environment generally doesn’t result from a single incident or a few isolated incidents, unless the conduct is egregious. But a claim of sexual harassment is bolstered if the complaint is made soon after the event, even if it’s made after the worker quits or is fired.

Despite the distinctions between these two types of harassment, neither term is found in either Title VII or its regulations. It’s up to the EEOC to establish if there are grounds for a claim.

It’s a Woman’s (and a Man’s) World

Sexual harassment charges typically involve complaints by a female worker about a male coworker or supervisor.

However, as this case shows, sexual harassment may cross gender and sexual orientation lines. According to the Equal Employment Opportunity Commission (EEOC), both the victim and the harasser can be either a woman or a man and the victim and harasser can be the same sex.

Although there are no exact statistics on the number of men being sexually harassed at work by women or how many actually file claims for sexual harassment, it’s likely that the cases filed with the EEOC represent a fraction of the total number of incidents. Some men may choose not to report sexual harassment or file a claim with the EEOC because they’re embarrassed or afraid of being subject to ridicule.

Nevertheless, claims by males clearly are on the rise. The EEOC reports that

92% of all claims in 1990 were filed by women as opposed to 83% in 2015, representing a 9% increase in claims filed by men in 25 years.

How to Address Potential Construction Project Delays

Posted on July 29, 2017 by Debra Barcuch

It’s trite but true: time is money. And in the construction industry, this saying is particularly pertinent.If a project can’t be completed on time, it may result in penalties and other unwanted repercussions, not to mention the harm to a construction company’s reputation. And, in the worst case scenario, the firm may not get paid at all.

Terms of the Contract

Delays in construction aren’t unusual and are usually covered by the terms of the contract. Typically, contracts set a number of deadlines, with penalties for failing to complete each on time, barring any special circumstances. Of course, looming large is the ultimate deadline — the substantial completion date.

Besides a final payoff, the substantial completion date may affect other matters, including state and local government requirements, payments to third parties, availability of tax incentives and responsibilities to lenders. It can’t be viewed in a vacuum.

The specifics will vary, but the list of elements governed by contract terms likely is to include the following items.

Identification of deadlines.

In some cases, the contract will specify a hard-and-fast calendar due date, such as the end of business at 5 pm (insert time zone) on December 31, (insert year). Alternatively, you might tie the completion date to a specific event such as one year after the municipality issues a building permit or two years after the contract is signed.

If you use a date tied to an event, make sure that the language in the contract is clear. Also, check to avoid deadlines that occur on a weekend or holiday or make appropriate adjustments (for example, the next business day).

Excused delays.

This is often at the crux of conflict between construction firms and clients, so it’s important that excused delays are ironed out in the contract. An “excused” delay is one that couldn’t have been reasonably foreseen before the parties signed the contract.

When possible, be specific regarding events that would result in an excused delay. For example, a strike by vendors providing raw materials might be listed as an excused delay. Conversely, inclement weather might not be allowed as an excused delay, depending on the geographic location of the project.

Excused delays can be a significant negotiating point and your interests may lie in whether your firm is the general contractor or a subcontractor. Although it may be difficult to resolve these issues at the outset, it could save plenty of hassle — not to mention legal fees — by coming to a clear agreement in the contract.

Money.

If delays are caused by factors outside of your control, your firm may require an increase in pricing to meet the specs of the project. Again, your needs may vary based on your role in the process, and you might specify increases for certain types of excused delays and not for others.

Owner-caused delays.

Even though construction firms often cause delays, the fault may lie with the property owner. For instance, an owner might make substantial revisions to the building plans, fail to point out flaws in the design or other problems after work has already started or simply procrastinate when important decisions must be made. Similarly, a subcontractor may be held back by the actions, or inactions, of a general contractor.

As you might imagine, this can turn into a contentious issue, so again it’s best to address contingencies in the contract. It must be established whether the delay is caused by one party or multiple parties and how the penalties and extra costs should be allocated. It’s best to clearly define the terms before problems occur and rely on an exact formula for attributing costs.

Finally, note that delays may occur because the owner fails to make good on certain promises, such as payment at different stages of the project. It’s logical that the construction firm shouldn’t bear the burden of this type of delay and terms in the contract may address these situations.

Notification.

When a delay occurs — by either party to the contract — notification is generally required. Typically, this responsibility is triggered after a designated number of days, such as 30 days after a deadline is missed. Failure to provide proper notification will often result in a waiver of rights and price adjustments.

Not only does this provision ensure that delays are legitimate, it creates a timeline that can be easily verified, thereby ensuring enforcement of contract terms. However, frequent delay notifications may also be a nuisance and hurt the relationships of the parties. Consider this in your negotiations.

Overview of Damages

In a typical situation, one of the parties will suffer damages when delays push back completion of the project. For example:

Damages to property owners. Due to delays, property owners may end up losing rental income, future tenants, public incentives and tax benefits, and financing opportunities, just to name several of the main possibilities. It may also require additional interest costs on loans and other related expenditures.
Damages to construction firms. A firm will likely face additional overhead costs when a project drags on past the stated deadline. In addition, revenue will be lost when crews remain tied up on the job when they could be working elsewhere.

These consequential damages also may be reflected in the contract. However, based on the language of the contract, it may not be possible to recover such damages, especially when they’re speculative in nature. It may be difficult to prove the dollar value with a reasonable certainty, so some costs may have to be absorbed.

Finally, consider the aspect of liquidated damages. These are damages agreed upon in the contact if one party breaches the contract. For instance, liquidated damages may apply if a contractor breaches the contract by missing the substantial completion deadline.

This provision generally stipulates an amount (such as $1,000 for every day the project is late). The amount is usually deducted from the project price. It should be noted that liquidated damages are often contested as to the enforceability of the provision and the calculation of the damages.

Review Closely

Pay close attention when you enter into a deal no matter how profitable it initially appears. Have your legal advisor draw up the contract to help ensure you’re adequately protected in the event of any significant delays.

Airport Delays

Some construction delays have higher profiles than others.

Case in point: Work on the new $1 billion “people mover” and remote rental car facility at Tampa International Airport (TIA) is currently running more than four months behind schedule.

Problems are to be expected, of course, but some of these caught the parties by surprise, such as:

Travelers kept getting in the way of construction crews.
Workers discovered storm drains near the people mover station at the main terminal, so the foundation had to be redesigned.
A soil problem was discovered under the people mover route connecting the remote parking garage and rental car facility with the main terminal. Again, the foundation had to be redesigned.

Initially, the project was supposed to be completed by October 2017. Now TIA officials will gladly settle for an opening before spring break in 2018.

Do You Have a Deductible Business Loss or a Nondeductible Hobby Loss?

Posted on July 28, 2017July 22, 2024 by Debra Barcuch

There’s a fine line between businesses and hobbies under the federal tax code. If you engage in an unincorporated sideline — such as a marketing director by day and an artist on the nights and weekends — you may think of that side activity as a business and hope to deduct any losses on your personal tax return. But the IRS may disagree and reclassify the money-losing activity as a hobby.

Lights, Camera, Action: Film Festivals Classified as a Hobby

The U.S. Tax Court recently concluded that a taxpayer who organized and operated film festivals couldn’t deduct a loss from the activity because he lacked the requisite profit motive. (Eric Zudak v. Commissioner, T.C. Summary Opinion 2017-41.)

The taxpayer was employed as the director of business development for a multimedia company. In 2013, he was paid approximately $240,000, traveled extensively and worked long hours for his employer.

The taxpayer also had an interest in film festivals. He noticed that these events were poorly organized and thinly attended. He believed that college towns would be ideal locations for film festivals, because they could be successfully marketed to students and faculty.

In 2012, the taxpayer established U.S. College Film Festival (CFF). He was the sole owner of this unincorporated organization. In 2013, CFF put on two film festivals that generated a net loss of roughly $32,000 (about $700 of revenue minus $32,700 in expenses). The IRS disallowed the 2013 loss on the grounds that the activity was a hobby rather than a for-profit business.

The taxpayer took his case to the U.S. Tax Court. He showed that CFF’s financial results were improving: In 2014, CFF had about $29,500 of revenue and $63,200 in expenses; in 2015, CFF had a net loss of only about $1,800. Despite these improvements, the court felt there was no profit motive for the activity.

Factors that worked against the taxpayer included the following:

While the taxpayer was able to gather records to support CFF’s claimed expenses, he didn’t maintain those records in a businesslike manner. There was no indication that he’d prepared formal budgets, profit projections or breakeven analyses.
Although the taxpayer had attended a number of film festivals, he had no experience in organizing or operating them. He also didn’t consult anyone with such experience.
The taxpayer had no prior experience managing any kind of small business, so he couldn’t point to previous successes in similar activities.
CFF had a significant loss in 2013 and didn’t make a profit in either of the following two years. While the taxpayer was optimistic that CFF would eventually generate profits, it had not yet done so.
The taxpayer was gainfully employed full-time in a high-paying job that was his primary source of income.
The taxpayer enjoyed organizing, conducting and attending film festivals. He’d also used CFF, at least in part, to showcase a personal film project.

Although the taxpayer devoted much of his free time to planning, coordinating and attending CFF’s events in 2013, the court found that the facts of the case justified the IRS position that the film festival activity didn’t have the requisite profit motive. Therefore, the Tax Court concluded that the IRS had properly classified the activity as a hobby and disallowed the loss for 2013. In general, the hobby loss rules aren’t taxpayer friendly. But there’s a ray of hope: If you heed the rules, there’s a good chance you can win the argument and establish that you have a business rather than a hobby. Here’s some guidance, along with a recent example of a taxpayer who ran afoul of the rules.

Hobby Loss Rules

If you operate an unincorporated for-profit business activity that generates a net tax loss for the year (deductible expenses in excess of revenue), you can generally deduct the full amount of the loss on your federal income tax return. That means the loss can be used to offset income from other sources and reduce your federal income tax bill.

On the other hand, the tax results are less favorable if your money-losing side activity is classified as a hobby, which essentially means an activity that lacks a profit motive. In that case, you must report all the revenue on your tax return, but your allowable deductions from the activity are limited to that revenue. In other words, you can never have an overall tax loss from an activity that’s treated as a hobby, even if you lose tons of money.

Moreover, you must treat the total amount of allowable hobby expenses (limited to income) as a miscellaneous itemized deduction item. That means you get no write-off unless you itemize. Even if you do itemize, the write-off for miscellaneous deduction items is limited to the excess of those items over 2% of your adjusted gross income (AGI). The higher your AGI is, the less you’ll be allowed to deduct. High-income taxpayers can find their allowable hobby activity deductions limited to little or nothing.

Finally, if you’re subject to the alternative minimum tax (AMT), your hobby expenses are completely disallowed when calculating your AMT liability.

Why is the hobby loss issue an IRS hot button? After applying all of the tax-law restrictions, your money-losing hobby can add to your taxable income. That’s because you must include all the income on your return while your allowable deductions may be close to zero.

A Silver Lining: IRS Safe Harbor Rules

Now that you understand why hobby status is unfavorable and for-profit business status is helpful, how can you determine whether your money-losing side activity is a hobby or a business?

There are two safe harbors that automatically qualify an activity as a for-profit business:

The activity produces positive taxable income (revenues in excess of deductions) for at least three out of every five years.
You’re engaged in a horse racing, breeding, training or showing activity, and it produces positive taxable income in two out of every seven years.

Taxpayers who can plan ahead to qualify for these safe harbors earn the right to deduct their losses in unprofitable years.

Intent to Make Profit

If you can’t qualify for one of these safe harbors, you may still be able to treat the activity as a for-profit business and deduct the losses. How? Basically, you must demonstrate an honest intent to make a profit. Factors that can demonstrate such intent include the following:

You conduct the activity in a business-like manner by keeping good records and searching for profit-making strategies.
You have expertise in the activity or hire expert advisors.
You spend enough time to justify that the activity is a business, not just a hobby,
You’ve been successful in other similar ventures, suggesting that you have business acumen.
The assets used in the activity are expected to appreciate in value. (For example, the IRS will almost never claim that owning rental real estate is a hobby even when tax losses are incurred for many years).

The U.S. Tax Court will also consider the history and magnitude of income and losses from the activity. In general, occasional large profits hold more weight than more frequent small profits, and losses caused by unusual events or bad luck are more justifiable than ongoing losses that only a hobbyist would be willing to accept.

Another consideration is your financial status — if you earn a large income or most of your income from a full-time job or another business you own, an unprofitable side activity is more likely to be considered a hobby.

The degree of personal pleasure you derive from the activity is also a factor. For example, running film festivals in lively college towns is a lot more fun than, say, working as a finance executive — so the IRS is far more likely to claim the former is a hobby if you start claiming losses on your tax returns. (See “Lights, Camera, Action: Film Festivals Classified as a Hobby” at right.)

Toeing a Fine Line

Business losses are fully deductible; hobby losses aren’t. So, taxpayers will prefer to have their side activities classified as businesses. Over the years, the Tax Court has concluded that a number of pleasurable activities could be classified as for-profit businesses rather than hobbies, based on the facts and circumstances of each case. Your tax advisor can help you create documentation to prove that you’re on the right side of this issue.

5 Recent Supreme Court Decisions that Could Affect Your Business

Posted on July 27, 2017 by Debra Barcuch

At the end of June, the U.S. Supreme Court adjourned for its summer recess. Here are five recent cases from its 2016 term that may be of interest to business owners and managers.

Will Supreme Court Rewrite Quill?

Recent legislative proposals to impose state and local sales and use taxes on Internet sales across state lines have yet to come to fruition. The latest version of the Marketplace Fairness Act, which has been kicked around for years, appears to have stalled in Congress. Thus, online sellers still have a decisive tax edge over brick-and-mortar stores.

In the landmark Quill case (Quill v. North Dakota, 504 U.S. 298, 1992), the U.S. Supreme Court ruled that states couldn’t impose sales and use tax collection obligations on vendors without an in-state physical presence. It’s possible that the top court may revisit the Quill interpretation next term if Congress doesn’t enact any related legislation before then.

1. Advocate Health Care Network v. Stapleton (S. Ct. No. 16-74, June 5, 2017)

Under the Employee Retirement Income Security Act of 1974 (ERISA), employees are generally protected from unexpected losses in their retirement plans through various safeguards. However, church plans are specifically exempted from ERISA requirements, in order to avoid any entanglement of government and religion.

In this case, a group of employees work for a health care network that operates hospitals and in-patient and out-patient treatment centers in Illinois. The employees are covered under the network’s retirement plan. The network was formed through a merger of two religiously affiliated hospital systems. Although neither system was owned or financially operated by a church, the network remains affiliated with a church.

The employees sued the network. They argued that the retirement plan is subject to ERISA and failing to meet the ERISA requirements is a violation of federal law. The network countered that its plan falls under the exception for church plans. The Seventh Circuit Court affirmed a lower court’s ruling that a church-affiliated organization isn’t a church plan within the meaning of the law.

In a June ruling, the U.S. Supreme Court unanimously agreed that the ERISA exemption for church plans applies to plans maintained by a church-affiliated organization, even if that organization didn’t originally establish the plan.

2. TC Heartland LLC v. Kraft Food Brands Group LLC (S. Ct. No. 16-341, May 22, 2017)

A company organized under Indiana law and headquartered in Indiana sold liquid water-enhancing products that it shipped to Delaware in accordance with two of its contracts. But a major retailer, organized in Delaware with its primary place of business in Illinois, claimed that these products infringed on its patents for similar products.

The company selling the water-enhancing products argued that Delaware lacked jurisdiction over the lawsuit because the retailer isn’t registered to do business in the state, has no business there and doesn’t solicit any business there. A district court ruled that the subsection of the general venue statute allowing a defendant to reside in multiple jurisdictions for purposes of establishing jurisdiction applies to the patent venue statute.

This precedent conflicts with a previous Supreme Court case, Fourco Glass Co. v. Transmirra Products Corp. (353 U.S. 222, 1957). Fourco Glass holds that corporate jurisdiction is limited to the state of incorporation. The Fifth Circuit decided that the Congressional amendments to the general venue statute post-dated Fourco Glass and, therefore, superseded it.

However, in May, the Supreme Court unanimously ruled that the subsection of the general venue statute doesn’t apply to the patent venue statute. Thus, the Fourco Glass case still prevails. In his opinion, Justice Thomas stated that the patent venue statute hasn’t been amended, and it wasn’t meant to dovetail with other venue statutes.

3. Star Athletica, LLC v. Varsity Brands, Inc. (S. Ct. No. 15-866, March 22, 2017)

In the Star Athletica case, the plaintiff is a company that designs and manufactures clothing and accessories used in various athletic activities, including cheerleading. The design concepts for the clothing incorporate several elements — such as colors, shapes and lines — but they don’t consider the functionality of the final clothing. The plaintiff received copyright registration for two-dimensional artwork of designs that were similar to the ones that the defendant company began using.

In its lawsuit, the plaintiff alleged, among other claims, that the defendant had violated the Copyright Act of 1976. The defendant counter-claimed, asserting that the plaintiff had made fraudulent representations to the Copyright Office because the designs at issue couldn’t be copyrighted.

Significantly, the defendant argued that the plaintiff didn’t have valid copyrights because the designs were for “useful articles,” which can’t be copyrighted. Moreover, because the designs can’t be separated from the uniforms, the designs are impossible to copyright. In response, the plaintiff claimed that the designs were separable and non-functional.

The Sixth Circuit ruled that the Copyright Act allows companies to copyright graphic features of a design, even if the design isn’t separable from a “useful article.” Then the matter was brought before the U.S. Supreme Court.

In a 6-2 vote, the Court decided that copyright protection is allowed if a feature incorporated into the design of a useful article:

Can be perceived as a two- or three-dimensional work of art separate from the useful article, and
Would qualify as a protectable pictorial, graphic or sculptural work — either on its own or fixed in some other tangible medium of expression — if it were imagined separately from the useful article into which it’s incorporated.

Based on this interpretation, the plaintiff prevailed.

4. Czyzewski v. Jevic Holding Corp. (S. Ct. 15-649, March 22, 2017)

In 2008, a trucking company that was headquartered in New Jersey filed for bankruptcy under Chapter 11 of the U. S. Bankruptcy Code. At that point, it owed about $53 million to its first-priority secured creditors and about $20 million to its tax and general unsecured creditors.

Two lawsuits were initiated in U.S. Bankruptcy Court against the trucking company:

The truck drivers alleged that the trucking company violated federal and state Worker Adjustment and Retraining Notification (WARN) laws. Those rules require companies to provide workers with at least 60 days notice before layoffs.
A fraudulent conveyance action was made on behalf of the unsecured creditors. In 2012, the parties to the fraudulent conveyance action negotiated a settlement that dismissed many of the claims. But the settlement left out the drivers. The drivers objected to the settlement because it distributed property to creditors of lower priority under the Bankruptcy Code.

The Third Circuit affirmed the district court’s decision that the Bankruptcy Court had the discretion to approve a settlement scheme outside the Chapter 11 proceedings, even if it didn’t comply with distribution priority scheme under the Bankruptcy Code.

In a 6-2 decision, the U.S. Supreme Court sided with the truck drivers. The Court held that bankruptcy courts may not approve structured dismissals that don’t follow the priority order established in the Bankruptcy Code. While courts have flexibility, settlements must be viewed in light of the claims of affected creditors.

5. Kokesh v. Securities and Exchange Commission (S. Ct. No. 16-529, June 5, 2017)

The Securities and Exchange Commission (SEC) sued a New Mexico-based investment advisor for misappropriating funds from four business development companies. The district court found in favor of the SEC and ordered the advisor to pay $34.9 million for “the ill-gotten gains” connected to the violations. But the advisor argued this “disgorgement” remedy is barred by a five-year statute of limitations.

What is disgorgement? Funds received through illegal or unethical business transactions are disgorged, or paid back, with interest to those affected by the action. Companies that violate SEC regulations are typically required to pay both civil money penalties and disgorgement. In general, civil money penalties are considered punitive, while disgorgement is about paying back profits made from those actions that violated the SEC’s regulations.

The Tenth Circuit held that the usual five-year statute of limitations didn’t apply to this case because the ordered payment was remedial rather than punitive in nature. Therefore, a disgorgement payment may be allowed.

However, the Supreme Court has unanimously reversed the Tenth Circuit ruling. The Court decided that SEC disgorgement functions as a penalty, so it is subject to the five-year statute of limitations. This case is being widely viewed by commentators as a further erosion of the enforcement powers of the SEC.

Why Partnership Tax Status May Sometimes Be Unwanted

Posted on July 26, 2017 by Debra Barcuch

Many business entities are set up as partnerships. Although there are legitimate reasons for some businesses to choose this structure, partnership status may be undesirable for certain activities involving more than one co-owner.

Determining if a Partnership Exists for Tax Purposes

Unsure whether your activity should be classified as a partnership? In 2012, the U.S. Court of Appeals for the Ninth Circuit upheld a 2010 U.S. Tax Court decision that provides guidance on this issue. (William F. Holdner v. Commissioner, 9th Cir., No. 11-71593, October 12, 2012)

In this case, the Tax Court concluded that a profitable farming, ranching and timberland business conducted by a father and son was a 50/50 partnership for tax purposes. In doing so, the court considered the following eight factors:

1. Written or oral agreement of the parties and their conduct in executing its terms.

2. Contributions of money or services by the parties.

3. Control over income and capital and right to take withdrawals.

4. Whether the parties were co-proprietors with mutual obligations to share losses.

5. Whether the venture was conducted in joint names of parties.

6. Whether the parties filed partnership returns or otherwise represented to the IRS or others that they were engaged in a joint venture.

7. Whether separate books were maintained for the venture.

8. Whether the parties exercised mutual control over and assumed mutual responsibilities for the venture.

Keep in mind that this case doesn’t set precedent beyond the 9th Circuit. But other circuits deciding similar cases might look to the 9th Circuit’s reasoning.

Tax-related reasons to avoid partnership status include:

Tax reporting requirements. Partnerships are required to file annual partnership returns on Form 1065 and issue K-1s to the co-owners. If you can avoid partnership status, each co-owner simply reports the tax results from that person’s ownership interest directly on the appropriate form or schedule.

Tax elections. If a partnership exists, certain tax elections must be made at the partnership level (such as the Section 179 election for first-year depreciation). If you can avoid partnership status, co-owners can make tax elections independently at the co-owner level.

Like-kind exchanges. A partnership interest, by definition, is ineligible for tax-deferred like-kind exchange treatment even if the partnership’s only asset is real estate. But, if you can avoid partnership status, co-owners can trade fractional real estate ownership interests in like-kind exchanges.

The Basics

What qualifies as a partnership? For federal income tax purposes, any unincorporated joint venture or other contractual or co-ownership arrangement, in which two or more participants 1) jointly conduct a business or investment activity, and 2) split the income and expenses, will generally be treated as a partnership.

This general rule holds true even when the joint venture or arrangement isn’t recognized as a separate entity under applicable state law. Put another way, a partnership can be deemed to exist for federal income tax purposes even when there’s no partnership under state law.

There are three arrangements that avoid partnership status for federal income tax purposes:

1. Mere co-ownership, rental and maintenance of real property.

2. A mere agreement to share expenses.

3. When, under certain conditions, the IRS allows taxpayers to “elect out” of partnership status that would otherwise be deemed to exist.

Electing out of partnership tax status is available in the following circumstances:

Jointly owned investment property. Here, the parties must 1) own the investment property in question as co-owners, 2) be able to dispose of their shares independently, and 3) not actively conduct a business. In addition, the co-owners must be able to independently calculate their taxable income from the activity without the necessity of calculating partnership taxable income. This provision is often used to elect out of partnership status for real estate co-ownership arrangements.

Real estate co-ownerships under tenancy-in-common and joint tenancy arrangements often involve “mere co-ownership, rental, and maintenance of real property.” This is the first item in the list of arrangements that avoid partnership status (above). Even so, making an affirmative election out of partnership status will remove any doubt about these types of arrangements.

Joint operating agreements. Here, the parties must engage in the joint production, extraction or use of property (such as oil, natural gas, or other minerals). The parties must own the property as co-owners or hold a lease granting exclusive operating rights as co-owners (such as an oil and gas lease).

In addition, the parties must retain the right to separately take in kind their shares of the property produced, extracted or used. They can’t jointly sell the property that is produced or extracted except under an arrangement that doesn’t extend beyond one year. Finally, each party must be able to independently calculate taxable income from the activity without the necessity of calculating partnership taxable income.

Securities dealers. Dealers in securities can also qualify to elect out of partnership status for short periods in conjunction with joint efforts to underwrite, sell or distribute securities offerings.

Limited liability companies (LLCs) generally can’t elect out of partnership status for federal tax purposes. Why? In most states, state law provides that an LLC, not its individual members, owns the LLC’s property. Additionally, most state LLC statutes provide that an LLC member can’t demand a distribution of property.

The Election Process

There are two ways to elect out of partnership status. The first way is for co-owners to make an affirmative election by the due date, including any extension, of the partnership return that would otherwise be required. This generally means the first year of any activities that create tax consequences for the co-owners. The affirmative election is made by filing a blank partnership tax return form that includes only the name or other identification of the organization, its address and a statement containing certain information required by IRS regulations.

The second way to elect out of partnership status is to show that, based on facts and circumstances, the co-owners always intended to be excluded from Subchapter K of the Internal Revenue Code starting with the arrangement’s first tax year.

Important note: The facts-and-circumstances method is not the preferred way to elect out of partnership tax status. That method is a relief provision intended for co-owners that fail to affirmatively elect out using the blank Form 1065 method. The IRS may be reluctant to accept elections made under the facts-and-circumstances method.

Failure-to-File Penalties

If you fail to file a partnership return when it’s required, steep penalties may apply. For tax years beginning in 2017, the monthly penalty for failing to file a partnership return or failing to provide required information is $200 per partner. The penalty can be assessed for a maximum of 12 months.

For example, the maximum penalty for failing to file a calendar-year 2017 Form 1065 for an unincorporated two-person business that must be treated as a partnership would be $4,800 (2 x $200 x 12 = $4,800).

The IRS provides a limited exemption from the failure-to-file penalty, however. This exemption is available to domestic partnerships with 10 or fewer partners — but only when all the partners have reported their proportionate shares of income and deductions on timely filed tax returns.

Need Help?

Deciding when a partnership exists for federal income tax purposes can be tricky. Your tax advisor can help you determine whether you have a partnership and can handle any extra tax filings that may be necessary.

FMLA: The Law that Never Sleeps

Posted on July 25, 2017July 22, 2024 by Debra Barcuch

The Family and Medical Leave Act (FMLA) is often tweaked, adjusted or reinterpreted as cases of alleged abuse continue to pop up and courts are asked to weigh in. With so much change, it’s a good idea to check your policies regularly. Is your company in compliance?

Here’s a very streamlined recap of the top 10 FMLA fundamentals to refresh your memory. (Keep in mind that your state and local laws may have stricter requirements.)

1. Allowable purposes for unpaid leave up to 12 weeks: Attending to the birth or adoption of a child, caring for a family member with a serious health condition, or suffering a health condition that prevents one from performing essential job tasks. (Special rules apply where family members are on active duty in the military.)

2. To be eligible, employees must: Have logged at least 1,250 hours of service during the period before the leave, and have worked for the employer for one year over a period no greater than seven years (that is, employment gaps are permissible).

3. Private sector employers are exempt from the FMLA if: They have fewer than 50 employees overall or at a specific site that’s at least 75 miles away from any of its other employment sites.

4. When taken, the FMLA leave period: Doesn’t have to be a single block of time consisting of consecutive days; intermittent leave may be possible, as well as working on a reduced schedule basis. When leave is intermittent in a nonemergency situation, employees should make a “reasonable effort” to accommodate the operational scheduling needs of the employer.

5. Maintenance of benefits: Employees out on FMLA leave must stay on the employer’s health plan under the same terms (including cost-sharing provisions) as before.

6. Coordination with paid leave benefits: Often it’s possible for employers to require employees taking FMLA leave to use up accrued paid leave time concurrently.

7. When requesting an FMLA-mandated leave, employees must: Give employers a 30-day notice, if the need for the leave was foreseeable, or otherwise as soon as possible. When making an FMLA leave request for the first time, employees don’t need to state that the request is being made under the FMLA. They merely need to provide employers enough information about the purpose of the leave for the employer to independently determine that the leave is sanctioned by the law.

8. Notification requirements: Employers must maintain posted notices about the FMLA; include information about it in their employee handbooks; and, upon request, provide information about employees’ rights and responsibilities under the law.

9. Medical certification: When a leave request is based on a serious medical condition of the employee or the employee’s family member, the employer can request documentation from a health care provider, as well as seek second and third opinions.

10. Job restoration: When employees return from their leave periods, they must be given their original jobs or another position with equivalent pay, benefits, and other employment terms and conditions.

Legal Authority

In an FMLA case, only a U.S. Supreme Court decision can affect the law nationwide. Still, a lower court ruling — even if it occurs in a jurisdiction other than your own — might be influential where you’re located. Below are three noteworthy cases that highlight the need to keep abreast of FMLA legal developments:

Case 1. The court upheld an employer’s decision to terminate an employee while she was on FMLA leave, against the employee’s claim that her termination violated her FMLA rights and was discriminatory. The court accepted the employer’s explanation that it had a sound business rationale to eliminate the employee’s position: The company was shrinking; other employees could assume her duties, and it would have made the same decision if the employee weren’t on leave.

Case 2. The court agreed with an employee’s argument that she was being prevented from gaining the full benefit of her FMLA leave because of her employer’s pattern of making substantial requests of her time while on leave. The court held that it was permissible for the employer to contact employees on leave for certain tasks. Examples include:

Passing along relevant institutional knowledge to new staff,
Providing computer passwords,
Giving closure on complicated assignments, and
Identifying other employees who could fill the void created by her absence.

But it was inappropriate for the employer to contact the employee regularly with questions about her work duties and absences, inputting data, and taking time out to receive training before returning to work. The fact that the employee was terminated shortly after her return to work buttressed her argument that her employer was trying to interfere with her rights.

Case 3. The Ninth Circuit Court of Appeals upheld a lower court ruling in favor of an employer that terminated an employee who claimed her FMLA leave benefits were denied. The employee had requested, and received, a period of leave to care for her sick father. But she’d requested that it not be treated as FMLA leave, but instead as ordinary paid leave. The company agreed.

However, the employee didn’t return to work until two weeks after the date she’d promised to come back and was terminated. She argued that the extra two weeks should have been treated as protected FMLA leave, because her reason for remaining away from work was to care for an ailing family member. The courts drew two conclusions: 1) It’s possible for an employee to seek and receive non-FMLA leave for an FMLA-eligible purpose, and 2) Unauthorized leave cannot automatically become protected FMLA leave without the employee explicitly requesting it on that basis.

Regular Tune-Ups Advised

New FMLA cases are decided all the time, creating a demand for attorneys who specialize in this corner of the law. Therefore, given the fluidity of FMLA legal interpretation, it’s prudent to periodically review your compliance with the evolving legal standards.

Can Your Research Credits Offset Your Payroll Tax Bill?

Posted on July 21, 2017July 23, 2024 by Debra Barcuch

Does your small business engage in qualified research activities? If so, you may be eligible for a research tax credit that can now be used to offset your federal payroll tax bill.

Which Research Activities Qualify?

To be eligible for the research credit, a business must have engaged in “qualified” research activities. To be considered “qualified,” activities must meet the following four-factor test:

The purpose must be to create new (or improve existing) functionality, performance, reliability or quality of a product, process, technique, invention, formula or computer software that will be sold or used in your trade or business.
There must be an intention to eliminate uncertainty.
There must be a process of experimentation. In other words, there must be a trial-and-error process.
The process of experimentation must fundamentally rely on principles of physical or biological science, engineering or computer science.

Expenses that qualify for the credit include wages for time spent engaging in supporting, supervising or performing qualified research, supplies consumed in the process of experimentation, and 65% of any contracted outside research expenses.

This relatively new privilege allows research credits to benefit small businesses that may not generate enough taxable income to use the credits to offset their federal income tax bills. The IRS recently issued guidance that explains how to take advantage of this election. Here are the details.

Eligibility

Under the Protecting Americans from Tax Hikes Act of 2015, a qualified small business (QSB) can elect to use up to $250,000 of its research credits to reduce the Social Security tax portion of its federal payroll tax bills. Under the old rules, QSBs could use the credit to offset only their federal income tax bills. However, many small businesses owe little or no federal income tax, especially small start-ups that tend to incur significant research expenses.

A QSB is generally defined as a business with:

Gross receipts of less than $5 million for the current tax year, and
No gross receipts for at least one tax year in the five-year period preceding the current tax year.

So the payroll tax reduction election is available to only newer small businesses that may still be in the unprofitable start-up phase.

Timing Issues

The payroll tax reduction election must be made on or before the due date (including extensions) of the QSB’s federal income tax return for the tax year for which the election is to apply. The research credit for that tax year can then be used to reduce the QSB’s federal payroll tax bills, starting with the bill for the first calendar quarter that begins after the date that the QSB files its federal income tax return for the tax year for which the election is to apply.

To illustrate, suppose your business is a calendar-year C corporation that filed its 2016 federal income tax return on April 18, 2017. The company can use its 2016 research credit to reduce its federal payroll tax bills, starting with the third quarter of 2017.

The allowable payroll tax reduction credit can’t exceed the employer’s portion of the Social Security tax liability imposed for any calendar quarter. Any excess credit can be carried forward to the next calendar quarter, subject to the Social Security tax limitation for that quarter.

For QSBs that file only an annual federal payroll tax return (for example, certain agricultural employers), IRS guidance specifies that the payroll tax reduction credit is claimed on the annual payroll tax return that includes the first quarter beginning after the date on which the business files its federal income tax return with which the payroll tax reduction credit election is made.

Tax Return Filing Requirements

QSBs must file specific forms to elect the payroll tax reduction credit for a tax year for which the election is to apply. There are separate forms to attach to your federal income tax return and payroll tax return. In addition, members of a controlled group of corporations must attach a statement showing how each member’s share of the research credit was determined and providing the names and employer ID numbers (EINs) of the other group members.

Many QSBs have already filed their 2016 federal income tax returns without making the payroll tax reduction election. If you need to file an amended return for 2016, IRS guidance suggests that you file it by no later than December 31, 2017.

Need Help?

The new payroll tax reduction credit deal is a welcome change for eligible small businesses that generate research credits. Your tax advisor can help you make the election for your business (or amend your business’s 2016 federal income tax return, if necessary) and help you file payroll tax returns that take advantage of the new privilege. Your advisor can also answer any additional questions you may have about claiming the research credit.

Types of Oil & Gas Investments

Posted on July 20, 2017July 23, 2024 by Debra Barcuch

Business diagram shows change of the prices for oil

Oil and gas investments have unique aspects of finance and taxes that are not seen in any other industry. High oil inventories have driven commodity prices and oil investment prices down, and it may be time to consider adding oil investments to a portfolio. Different entity structures and the accounting methods used make it difficult for investors to get a side-by-side comparison of O&G developers. Investors need to understand the pros and cons of each investment type under consideration, including the impact of accounting methods used, the developer’s strategy with regard to reserves, and finally the potential tax benefits or impacts.

‘Rise early, work late, strike oil.”

This quote was attributed to J. Paul Getty, one of the first U.S. oil tycoons who was once listed as the world’s richest private citizen at $1.2 billion. That was in 1966.

Anyone with dreams of striking it rich through oil and gas investments needs to rise early and work late to choose the right investment option. Investor responsibilities and tax compliance are complex. If it seems like a good way to diversify an already well-rounded portfolio, however, the landscape for investment is certainly looking up.

Over the last decade the U.S. oil and gas industry has undergone somewhat of a renaissance due to technological improvements in hydraulic fracturing, horizontal drilling, drilling fluids, and other techniques, which has allowed U.S. producers to begin to economically unlock the shale oil reserves. The result has been increasing U.S. oil production for the first time since 1970 when U.S. oil production peaked at nearly 9.7 million barrels of oil per day. By 2008, U.S. oil production had fallen to approximately 5 million barrels of oil per day. Currently, U.S. production is on pace to exceed 9.9 million barrels of oil per day by 2018, an increase of nearly 100% in 10 years.

With the resurgence of the U.S. oil and gas industry, investment opportunities abound. I am a tax compliance expert, so this information should not be interpreted as investment advice. This article will briefly touch on the various types of oil and gas investments available today and will discuss the unique accounting and tax attributes related to these types of investments.

Types of Oil & Gas Investment

The following is a brief summary of different types of oil and gas investments. The bullet points outline the pros and cons for investors.

Publicly traded stocks (such as the major integrated oil companies and large independent oil companies) and ETF’s:

Highly liquid since there is an active trading market
Income and expenses are not passed through to investors.
Company retains any beneficial tax attributes
Cash returned to investors via dividends or stock buy backs
Arguably, the primary goal is increasing value through increasing reserves and production

Master Limited Partnerships (also publicly traded)

Highly liquid since there is an active trading market
Income and expenses are passed through to investors, thus investors are taxed on the operating income of the company
Beneficial tax attributes such as depletion and drilling costs are minimized because of publicly traded partnership/passive activity tax rules
Cash flow is normally distributed to partners on a regular basis

Publicly traded royalty trusts

Highly liquid since there is an active trading market
No exploration risk
Net income passed through to investors
Minimal tax benefits available
Cash flow is normally distributed on a monthly basis

Drilling partnerships (may be issued through a private placement offering, but generally are not publicly traded)

Illiquid – no active trading market
High exploration risk
Income and expenses passed to investors
Beneficial tax attributes such as intangible drilling costs and depletion pass through to investors
Cash flow is normally distributed on a monthly basis

Direct investments in working interests

Illiquid – no active trading market
Exceptionally high exploration risk
All income paid directly to investor and expenses paid directly by investor
Beneficial tax attributes such as drilling costs and depletion
By definition working interests are non-passive (unless owned in an entity that limits liability)

Direct investments in royalties

Illiquid – no active trading market
No exploration risk
Income (net of severance tax and certain marketing/transportation cost) paid directly to investor
Investor is not responsible for exploration, development or production expenses
Beneficial tax attributes limited to depletion

Next, we’ll look at how accounting methods used for publicly traded oil stocks and Master Limited Partnerships (MLPs) can impact how the balance sheet, net income and cash flows are presented on financial statements. In other words, the accounting method can influence how well an investment vehicle appears to be performing.

Continue Reading: A Look at Accounting Methods of Developers

Scott Allen, CPA, joined Cornwell Jackson as a Tax Partner in 2016, bringing his expertise in the Construction and Oil and Gas industries and 25 years of experience in the accounting field. As the Partner in Charge of the Tax practice at Cornwell Jackson, Scott provides proactive tax planning and tax compliance to all Cornwell Jackson tax clients.

Contact him at Scott.Allen@cornwelljackson.com or 972-202-8032.

6 Strategic Steps to Help Spur Manufacturing Growth in 2017

Posted on July 18, 2017 by Debra Barcuch

Former New York City Mayor Ed Koch was famous for asking his constituents, “How am I doing?”

Similarly, leaders in the manufacturing industry like to take the pulse of the sector from time to time, especially after the economic struggles of the last decade and a lull stretching over the past two years.

Although the Institute for Supply Management said its index of national factory activity rose to 57.8 in June, from 54.9 in May, manufacturing is still expected to weaken somewhat after the “Trump Bump” wears off and the Bull market slows.

Are You Proactive or Reactive?

Uncertainty regarding political, social and economic events is a major concern for manufacturers. It’s difficult to project what the remainder of 2017 will bring, but proactive firms aren’t waiting to see what happens next. Here are six strategies that industry leaders are implementing today to help spur growth tomorrow.

1. Incorporate technology. The old way of doing things might not be the best way. For instance, if your firm relies more heavily on new technology, it may be able to replace the outdated models that required firms to sell an entire machine and a service agreement for maintenance and repairs.

Instead, new technology can allow you to offer a combination of services, including real-time monitoring of equipment to determine its maintenance needs, daily collaboration with customers to customize and modify equipment, and predictive performance management for large and small projects.

Bundling these services can lead to a more robust operation. With this approach, manufacturers may solidify customer retention and gain access into more lucrative activities.

2. Adjust pricing models. Successful manufacturers don’t use guesswork to set prices. Traditional pricing models may need to be altered based on changes in the marketplace. One example is the movement from paying for products to paying for performance.

For instance, if performance-based maintenance based on technology becomes common, fewer repair visits will be needed. Although customers may expect more favorable terms, they may also be willing to share some of the risks. Rather than basing pricing on products and fixed maintenance or warranty costs, fee structures may be tied to results.

For example, a manufacturer may be paid more if downtime is effectively reduced or productivity is improved. Some manufacturers prefer a “blended” fee structure that combines traditional fixed pricing and performance-based pricing.

3. Find a partner. If technology isn’t your firm’s strong suit, consider partnering with a third-party provider that can help improve equipment connectivity and data analysis. If you find a good match, it could be beneficial for both parties and lead to additional engagements.

Strategic alliances aren’t risk free, however. So, you need to balance the benefits of collaborating with a partner with your ability to maintain market share. Consider, too, whether your partner will keep up with the rapid advances in technology. There’s also a chance that your firm could eventually compete with your partner, endangering the entire relationship and perhaps defeating its purpose.

4. Mine customer data. If connectivity becomes the backbone of manufacturing in the future, as many have predicted, there will be an influx of data from a multitude of sources, including sensors, integrated equipment and platforms. What’s more, information systems will be able to process the data faster than before.

In light of this technological evolution, manufacturers may be able to achieve a competitive advantage if they hire people who can use this information to help customers improve equipment performance and increase overall productivity. By proactively mining customer data, manufacturers can boost overall revenue.

5. Overhaul IT systems. It can be difficult to manage technology integration and big data analytics if internal IT systems become unwieldy. As company operations expand into new product lines and global markets, IT systems often become tangled and twisted.

To avoid problems, update your IT systems and create a new streamlined infrastructure. As manufacturing technology evolves, it’s critical for IT to communicate throughout the organization with standardized procedures. This can help your firm manage data from thousands of equipment pieces in the field, support supply chains and deliver timely customized reports.

6. Recruit top talent. Unless your firm is located in Silicon Valley or another technology hub, it may not be easy to find IT experts. In many markets, job openings are expected to outpace viable candidates for the foreseeable future. However, a formal technology plan can help you attract high quality talent.

Map out a robust technology strategy with specific benchmarks and goals for, say, the next two or three years. Then share this story with job candidates.

During the recruiting process, don’t just advertise for someone who can read data without emphasizing the manufacturing basics. Balanced capabilities are important, allowing the equipment manufacturers to use smart operational data and sensor analysis in a real-time context. This will drive innovation for improving equipment functionality and performance.

Guaranteed Success?

Will taking these steps at the end of 2017 guarantee success for 2018 and beyond? Of course not. But they’ll likely improve your operation and better position your firm for the challenges that lie ahead.

The Future Is Here

The Industrial Internet of Things (IIoT) has taken over.

Almost every new piece of equipment or technology is equipped with data capture and processing capabilities. Machines can essentially “talk” to one another. For example, the printer on your desk can alert your smartphone if ink runs low.

A recent report by Synchrono, a Minnesota-based software company, identifies how every new upgrade leads to greater use of the IIoT in manufacturing. It indicates that manufacturers that haven’t upgraded systems recently will be faced with added challenges in implementing digital processes. Changing today is critical to meeting tomorrow’s demands.

Unlock the Biggest Possible Deduction for a Home Office

Posted on July 17, 2017July 22, 2024 by Debra Barcuch

The IRS recently issued a reminder about claiming the home office deduction. In particular, it explained a simplified method that offers a time-saving option. But many taxpayers who maintain a home office fare better tax-wise by deducting expenses under the regular method. Others may not be eligible to deduct any home office expenses. Here’s why.

Tax Wisdom of Soliman

Historically, self-employed taxpayers have fought the IRS over the determination of a principal place of business when their work was conducted at multiple job locations. The matter was finally resolved by the U.S. Supreme Court in a landmark, taxpayer-friendly ruling. (Commissioner v. Soliman, 506 U.S. 168, January 12, 1993.)

Background

Dr. Soliman, an anesthesiologist, performed services in three hospitals for about 30 to 35 hours a week. He didn’t have an office in any of the hospitals. His only office was a room in his condominium where he worked two to three hours a day. During that time period, he would work on administrative matters, such as:

Contacting patients, surgeons and hospitals by telephone,
Maintaining billing records and patient logs, and
Preparing treatments and presentations.

However, Dr. Soliman never saw any patients at his home office.

Under the view of the Supreme Court in this case, later codified by a 1997 tax law, home office deductions should be allowed where:

The individual taxpayer uses a home office to conduct administrative or management activities of his or her business, and
The business has no other fixed location where the individual conducts substantial administrative or management activities.

Thus, Dr. Solimon was allowed to deduct his home office expenses. This ruling opened the door to home office deductions for taxpayers in other walks of life — such as landscapers and plumbers — who do administrative work at home and perform actual services at multiple locations. Regular and Exclusive Use

Most home-related expenses, such as utilities, insurance and repairs, aren’t deductible. But if you use part of your home for business purposes, you may be entitled to deduct a portion of these everyday expenses, within certain limits.

In general, you’ll qualify for a home office deduction if part of your home is used “regularly and exclusively” as your principal place of business. Here’s an overview of these two tests:

1. Regular use. You must use a specific area of your home for business on a regular basis. Incidental or occasional business use is not regular use. The IRS considers all the facts and circumstances for this determination.

2. Exclusive use. You must use a specific area of your home only for business. This area can be a room or other separately identifiable space. It’s not necessary for the space to be physically partitioned off from the rest of the room. However, you don’t meet the requirements for the exclusive use test if the area is used both for business and personal purposes.

Rules for Employees

If you’re an employee, the home office must be used for the employer’s convenience. In essence, this requirement should be spelled out in an employment contract with the company. For this reason, home office deductions are more likely to be claimed by self-employed taxpayers than employees who work for an unrelated business.

Typically, you won’t qualify for deductions if you bring work home at night from your daytime office, either. Consider the relative importance of the activities performed at each place where you conduct business and the amount of time spent at each business location.

Principal Place of Business Tests

Your home office will qualify as your principal place of business if you 1) use the space exclusively and regularly for administrative or management activities of your business, and 2) don’t have another fixed location where you conduct substantial administrative or management activities. (See “Tax Wisdom of Soliman” at right.)

Examples of activities that are administrative or managerial in nature include:

Billing customers, clients or patients,
Keeping books and records,
Ordering supplies,
Setting up appointments, and
Forwarding orders or writing reports.

Other Ways to Qualify

If your home isn’t your principal place of business, you may deduct home office expenses if you physically meet with patients, clients or customers on your premises. To qualify, the use of your home must be substantial and integral to the business conducted.

Alternatively, you can claim the home office deduction if you use a storage area in your home — or if you have a separate free-standing structure (such as a studio, workshop, garage or barn) that’s used exclusively and regularly for your business. The structure doesn’t have to be your principal place of business or a place where you meet patients, clients or customers.

Two Methods: Actual Expenses vs. Simplified

Traditionally, taxpayers deduct actual expenses when they claim a home office deduction. Deductible home office expenses may include:

Direct expenses, such as the cost of painting and carpeting a room used exclusively for business,
A proportionate share of indirect expenses, such as mortgage interest, property taxes, utilities, repairs and insurance, and
A depreciation allowance.

Keeping track of actual expenses can be time consuming. Fortunately, there’s a streamlined method that’s allowed under a tax law change that went into effect in 2013: You can simply deduct $5 for each square foot of home office space, up to a maximum total of $1,500.

For example, if you’ve converted a 300-square-foot bedroom to an office you use exclusively and regularly for business, you can write off $1,500 under the simplified method (300 square feet x $5). However, if your business is located in a 600-square-foot finished basement, the deduction under the simplified method will still be only $1,500 because of the cap on the deduction under this method.

As you can see, the cap can make the simplified method less beneficial for larger home office spaces. But even for spaces of 300 square feet or less, taxpayers often qualify for a bigger deduction using the actual expense method. So, it can be worth the extra hassle.

Hypothetical Example

To illustrate how this might work, let’s assume that your 3,000-square-foot home is your principal place of business. You use a 300-square-foot bedroom as your home office. For 2017, you expect to have $1,500 of direct expenses for your home office plus $10,000 of indirect expenses for the entire home, including utilities, insurance and repairs. (For simplicity, we’ll disregard mortgage interest and property taxes that would be deductible on Schedule A, “Itemized Deductions.”) Based on IRS tables, you’re also entitled to a $500 depreciation allowance.

Using the simplified method, you’re eligible to deduct $1,500, as described above. But, if you keep the required records to deduct your actual expenses, you could deduct $3,000 for your home office — $1,500 in direct expenses, $1,000 in indirect expenses (10% of $10,000) and $500 in depreciation. That’s double the maximum amount you could deduct with the simplified method. The deduction would be even greater if the home office space were larger.

Flexibility in Filing

When claiming the home office deduction, you’re not locked into a particular method. For instance, you might choose the actual expense method in 2017, use the simplified method in 2018 and then switch back to the actual expense method thereafter. The choice is yours.

This is a valuable tax-saving opportunity for many taxpayers, especially those who are self-employed and work from home. Consult with your professional tax advisor regarding what’s right for your personal situation.

Unlock the Potential of Your Business

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Facts of the Case

Change of Form

Different Outcome

Background Information

Timing of a Claim

It’s a Woman’s (and a Man’s) World

Terms of the Contract

Identification of deadlines.

Excused delays.

Money.

Owner-caused delays.

Notification.

Overview of Damages

Review Closely

Airport Delays

Lights, Camera, Action: Film Festivals Classified as a Hobby

Hobby Loss Rules

A Silver Lining: IRS Safe Harbor Rules

Intent to Make Profit

Toeing a Fine Line

Will Supreme Court Rewrite Quill?

1. Advocate Health Care Network v. Stapleton (S. Ct. No. 16-74, June 5, 2017)

2. TC Heartland LLC v. Kraft Food Brands Group LLC (S. Ct. No. 16-341, May 22, 2017)

3. Star Athletica, LLC v. Varsity Brands, Inc. (S. Ct. No. 15-866, March 22, 2017)

4. Czyzewski v. Jevic Holding Corp. (S. Ct. 15-649, March 22, 2017)

5. Kokesh v. Securities and Exchange Commission (S. Ct. No. 16-529, June 5, 2017)

Determining if a Partnership Exists for Tax Purposes

The Basics

The Election Process

Failure-to-File Penalties

Need Help?

Legal Authority

Regular Tune-Ups Advised

Which Research Activities Qualify?

Eligibility

Timing Issues

Tax Return Filing Requirements

Need Help?

‘Rise early, work late, strike oil.”

Types of Oil & Gas Investment

Continue Reading: A Look at Accounting Methods of Developers

Are You Proactive or Reactive?

Guaranteed Success?

The Future Is Here

Tax Wisdom of Soliman

Background

Rules for Employees

Principal Place of Business Tests

Other Ways to Qualify

Two Methods: Actual Expenses vs. Simplified

Hypothetical Example

Flexibility in Filing

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