Author: Leon Clinton

Do you operate your business as an S or a C corporation?

Do you drive a vehicle titled in your personal name for corporate business? 

Beware. The Tax Cuts and Jobs Act (TCJA) changed the rules for tax years 2018-2025.

Before the TCJA, you had to pay attention to the use of your personal vehicle for corporate business in order to avoid losing deductions to the 2 percent miscellaneous itemized deduction rule and the alternative minimum tax. 

But now, because of the TCJA, you face a narrow road during tax years 2018-2025 if you want tax benefits for the corporate business use of your personal vehicle.

Big Picture

1. The personal vehicle used for corporate business is a business vehicle to the extent of corporate use.
2. If you don’t want to lose your rightful tax benefits from your business use, your corporation must reimburse you for your business use.
3. Your corporation may reimburse you using the IRS standard mileage rate or actual expenses.
4. When you trade in or sell the vehicle you used for corporate business, you will report a taxable gain or claim a deductible loss on IRS Form 4797.
5. To obtain your reimbursements from your corporation, you submit expense reports under the accountable plan rules.

Make Sure to Do This

You need a mileage log. The mileage log defines the dollar amount of the corporate reimbursement—regardless of whether you seek reimbursement using (a) actual expenses or (b) the IRS mileage method. The mileage log saves you in an IRS audit.

Accountable Plan

Because your corporation is reimbursing you for your personal vehicle, using either IRS mileage rates or actual expenses, it needs an accountable plan.

Reimbursements from the Corporation

A corporation can reimburse an employee for all expenses allowable under sections 161 to 199 of the tax code—which includes Section 179 expensing and Section 168 bonus and other depreciation. 

Here’s what happens when your corporation properly reimburses you for the expenses:

1. You, as the employee, receive the cash reimbursement from the corporation but do not have taxable income from the reimbursement.
2. The corporation gets the full deduction for the reimbursed expenses.
3. If the corporation is an S corporation, then those expenses reduce the corporate income and the corporation passes that reduced income to you—say, as the sole shareholder of your S corporation.

If you are using a personal vehicle for corporate business, please call me on my direct line at 408-778-9651, because we should discuss what’s required.

• By Leon Clinton
• November 11, 2020

With the COVID-19 pandemic still going on, you may be spending more time working from your home office. 

You may have taken some extra rooms for your business use. Is that okay?

Section 280A(c) states that you may claim a home office based on the portion of the dwelling that you use exclusively and regularly for business. Thus, the law dictates no specific number of rooms or particulars regarding the size of the office.

The courts make this rule clear, as you can see in the Mills (less than one room) and Hefti (lots of rooms) cases described below. 

The Mills Case

Albert Victor Mills maintained an office in his apartment from which he conducted his rental property management business. The apartment was small, totaling only 422 square feet. In the office area of the apartment where Mr. Mills had his desk, he also kept tools, equipment, paint supplies, and a filing cabinet.

The court agreed with Mr. Mills’s allocations and awarded the home-office deduction based on his claimed 23 percent business use of the 422-square-foot apartment. 

Planning note. Mr. Mills did not have a single room dedicated to a home office. He had only an area of the apartment where he grouped his office furnishings, equipment, and supplies. If you have a similar situation, make sure your business assets are located in a group.

The Hefti Case

Charles R. Hefti lived in a big house, totaling 9,142 square feet. He claimed that more than 90 percent of his home was used regularly and exclusively for business. 

Based on its review of the rooms, the court concluded that 13 rooms, totaling 19 percent of the home, were used exclusively and regularly for business. 

Insights

The deductible portion of your home for an office includes the area used exclusively and regularly for business. 

Let’s say you have an office in one room and your files in a second room, and you never use these rooms for personal purposes. Further, let’s say you use the office area on a daily basis and the file area in connection with that daily work. 

Both rooms would meet the exclusive and regular use requirements, just as Mr. Mills’s and Mr. Hefti’s offices met these rules.

But Not This

“Exclusive use” means that you must use a specific portion of the home only for business purposes. You must make no other use of the space. 

Exception. One exception to the exclusive use rule is storage of inventory or product samples if the home is the sole fixed location of a trade or business selling products at retail or wholesale.

Example 1. Your home is the only fixed location of your business, which involves selling mechanics’ tools at retail. You regularly use half of your basement for storage of inventory and product samples. You sometimes use the area for personal purposes. The expenses for the storage space are deductible even though you do not use this part of your basement exclusively for business.

Example 2. In Pearson, Dr. Pearson practiced orthodontics in a downtown medical building but retained the dental records of more than 3,000 patients in 36 file drawers (each measuring 26 inches by 14 inches by 12 inches) and had 1,461 boxes containing orthodontic models (each box measuring 10 inches by 6 inches by 2 1/2 inches).

He stored the records in the attic and basement of his home. The areas used for such storage were not separate rooms, and the remaining portions of the attic and basement were used by Dr. Pearson and his family for personal purposes.

The court ruled that Dr. Pearson may not treat the storage areas as home-office expenses because the records were not inventory or samples and Dr. Pearson did not operate a wholesale or retail trade or business from his home.

If you would like to discuss your home-office deduction, please call me on my direct line at 408-778-9651.

• By Leon Clinton
• November 6, 2020

You likely formed an S corporation to save on self-employment taxes. 

If so, is your S corporation salary

• nonexistent?
• too low?
• too high?
• just right?

Getting the S corporation salary right is important. First, if it’s too low and you get caught by the IRS, you will pay not only income taxes and self-employment taxes on the too-low amount, but also both payroll and income tax penalties that can cost plenty. 

Second, in most cases, the IRS is going to expand the audit to cover three years and then add the income and penalties for those three years. 

Third, after being found out, you likely are now stuck with this higher salary, defeating your original purpose of saving on self-employment taxes.

Getting to the Number

The IRS did you a big favor when it released its “Reasonable Compensation Job Aid for IRS Valuation Professionals.”

The IRS states that the job aid is not an official IRS position and that it does not represent official authority. That said, the document is a huge help because it gives you some clearly defined valuation rules of the road to follow and takes away some of the gray areas.

Market Approach

The market approach to reasonable compensation compares the S corporation’s business with others and then looks at the compensation being paid by those businesses to employees who look like you, the shareholder-employee who is likely the CEO.

The question to be answered is, how much compensation would be paid for this same position, held by a nonowner in an arm’s-length employment relationship, at a similar company?

In its job aid, the IRS states that the courts favor the market approach, but because of challenges in matching employees at comparable companies, the IRS developed other approaches.

Cost Approach

The cost approach breaks your employee activities into their components, such as management, accounting, finance, marketing, advertising, engineering, purchasing, janitorial, bookkeeping, clerking, etc.

Here’s an example of how the cost approach works to support a $71,019 salary as reasonable compensation for this S corporation owner whose corporation had $3.5 million in revenue and 19 employees:

Health Insurance

The S corporation’s payment or reimbursement of health insurance for the shareholder-employee and his or her family goes on the shareholder-employee’s W-2 and counts as compensation, but it’s not subject to payroll taxes, so it fits nicely into the payroll tax savings strategy for the S corporation owner.

Pension

The S corporation’s employer contributions on behalf of the owner-employee to a defined benefit plan, simplified employee pension (SEP) plan, or 401(k) count as compensation but don’t trigger payroll taxes. Such contributions further enable the savings on payroll taxes while adding to the dollar amount that’s considered reasonable compensation.

Planning note. Your S corporation compensation determines the amount that your S corporation can contribute to your SEP or 401(k) retirement plan. The defined benefit plan likely allows the corporation to make a larger contribution on your behalf.

Section 199A Deduction

The S corporation’s net income that is passed through to you, the shareholder, can qualify for the 20 percent Section 199A tax deduction on your Form 1040. 

If you would like my help with your S corporation salary, please call me on my direct line at 408-778-9651.

• By Leon Clinton
• November 1, 2020