Working at Home? Don’t Overlook These Deductions

Whether you claim a business office in the home or are
simply working at home, say because of COVID-19, you likely have some former
personal assets that you now use for business.

Ah, new tax deductions!

Yep. Say you don’t claim a home-office deduction but
now you are working at home and sitting in the fancy chair you inherited from
your grandmother.

Let’s say you use the fancy chair 85 percent for business
purposes. Can you depreciate 85 percent of that chair?

Yes.

Let’s say that grandma’s estate was appraised and this chair
had a value of $10,000 when you inherited it about a year ago. It’s an antique,
so it’s not gone down in value since you inherited it.

Depreciating a Formerly Personal Asset

When you convert the fancy chair to 85 percent business use,
the law sees you as placing the item in service in your business at that time.
That means you can begin depreciating the asset and claiming your tax
deductions.

To determine the basis to use for depreciation, use the
lesser of

• fair market value on the date of conversion from personal
  to business use, or
• adjusted basis of the property (generally the amount you
  paid for the asset plus the cost of any improvements).

With the fancy chair, your adjusted basis is the inherited
value.

But say you bought the chair for $8,000. Suppose it was
worth $10,000 when you converted it to personal use. You would use the $8,000
figure to determine your depreciation deductions.

Bonus Depreciation and Section 179 Expensing

Unfortunately, unlike assets directly purchased for your
business, you may not use Section 179 to immediately expense assets that you
convert from personal to business use.

Bonus Depreciation Is a Different
Story

If you acquire bonus depreciation qualified property for
personal use after September 27, 2017, and convert it to business use this year
(or anytime before 2027), you must use 100 percent bonus depreciation if you
don’t elect out of it.

Example. You purchased an antique clock for $9,300 in
January 2018. Yesterday, you placed the clock in business service by moving the
clock from your entryway to your home office. If you don’t make a formal
election in your tax return to elect out of bonus depreciation, you must claim
a $9,300 depreciation deduction on the antique clock this year.

Basis When You Sell

There’s a trick to basis when you sell converted
property—you use a different rule for calculating losses than you do for
calculating gains:

• Losses. To calculate losses, use your adjusted
  basis (conversion basis as discussed above minus depreciation).
• Gains. To calculate gains, use original cost basis
  minus post-conversion depreciation. In most cases, original cost gives you
  a higher basis and thus less tax. So don’t accidentally use adjusted
  basis.

Note. For inherited assets, your cost basis is the
estate value (generally, the date of death value).

Clarifying Examples

Let’s say you bought a personal use desk/credenza/bookcase
set for $8,000 and then converted it to business use when its fair market
value had fallen to $6,000. Here are the tax consequences for three different
sales scenarios (to make the examples clear, we ignored depreciation):

• Loss. If you sell the desk/credenza/bookcase set for
  $4,000, you have a $2,000 deductible loss ($6,000 – $4,000). Note. This
  is much better than if you sold the desk/credenza/bookcase set as a
  personal asset, which would create a zero deductible loss.
• Gain. If you sell the desk/credenza/bookcase set for
  $10,000, you have a $2,000 gain ($10,000 – $8,000).
• Gray area. If you sell the set for $7,000, you have
  neither gain nor loss on the sale. That’s a decent result—it means no
  taxes for you (but no deductible losses either).

If you have personal assets that you now use for business
and want to make them tax deductible, call me on my direct line (408-778-9651)
and we’ll implement a plan for those new deductions.

Two Correct Ways to Deduct Your Home Office with a Partnership

With the COVID-19 experience, you and your partners may be
doing a lot of work from home or even working from home primarily. Is the
home-office deduction in the mix?

If you operate your business as a partnership, you have two
ways to correctly deduct your home-office expenses.

If you have a tax-deductible home office and operate as a
partner in a partnership, you have two ways to get a tax benefit from the home
office:

1. Deduct the cost as an unreimbursed partner expense (UPE),
   or
2. Get reimbursement from your partnership via an accountable
   plan (think expense report).

Unreimbursed Partner
Expense

As a partner in a partnership, you generally can’t deduct
any of the partnership expenses on your individual tax return—the partnership
should pay for and deduct its own business expenses.

But if your partnership agreement or business policy forces
you to pay for the expense out of pocket with no reimbursement available, then
you can deduct the business expense in full on your individual tax return as a
UPE.

Because the UPE is a trade or business expense, it also
reduces your self-employment tax.

Deducting UPE is even better than taking a typical Schedule
C home-office deduction because you can deduct your full home-office expense even
when the partnership has a tax loss for the year.

Here are the two steps to claiming your UPE deduction:

1. Find your deduction amount using Form 8829 (but don’t
   include it with your tax return).
2. On a separate line on Schedule E, line 28, enter “UPE” in
   column (a) and the expense amount in column (i).

Accountable Reimbursement
Plan

The other option for realizing your home-office deduction is
to have your partnership reimburse you for your home-office expenses under an
accountable plan.

When your partnership does this, the reimbursement is

• tax-free to you, the partner, and
• tax deductible to the partnership, which reduces your
  share of the taxable net income from the partnership.

Here are the three steps to obtaining the reimbursement:

1. Find the reimbursement amount using Form 8829 (including
   depreciation).
2. Submit your reimbursement request with appropriate
   documentation within the time frames required by your partnership’s
   accountable plan policy.
3. Receive a reimbursement check from your partnership.

Why Reimbursement Is Best—Example

John is a 20 percent partner in Rainbow, LLC, which is a
partnership for federal tax purposes. He’s in the 24 percent federal tax
bracket (for this example, we’ll ignore the self-employment tax).

Let’s assume John uses Form 8829 and calculates his home-office
deduction as $4,000.

If John deducts the $4,000 as UPE, it puts $960 in his
pocket (24 percent of $4,000).

But if John receives an accountable plan reimbursement from
the partnership, it puts $4,192 in his pocket:

• $4,000 as a tax-free reimbursement, and
• $192 from reduced pass-through income (24 percent of $800,
  which is 20 percent of the $4,000 partnership expense).

If you are a candidate for the home-office deduction and
want to pursue this deduction, please call me on my direct line at 408-778-9651.

Raise Hell: Help Lawmakers Make PPP Expenses Tax Deductible

As you read this, it’s likely that your lawmakers are
working on the next Payroll Protection Program (PPP) package.

And hopefully, in this next package they will include a
provision that allows you to deduct business expenses that you pay with your
PPP money.

Let’s explain. In the CARES Act, Congress said:

For purposes of the Internal Revenue Code of 1986, any
amount which (but for this subsection) would be includible in gross income of
the eligible recipient by reason of forgiveness described in subsection (b)
shall be excluded from gross income.

From what we know, lawmakers thought this meant that the PPP
loan forgiveness was tax-free for you. You probably thought that too. We did.

But then in late April, the IRS issued Notice 2020-32 that
prevents PPP loan recipients from deducting business expenses that were paid
using the PPP monies that gave rise to forgiveness (defined payroll, rent,
utilities, and interest).

Two things to know here:

1. The PPP loan and forgiveness is a good deal even if the
   expenses are not deductible.
2. When the CARES Act was passed, it appears that lawmakers
   thought the PPP monies were tax-free and had not considered that the
   expenses paid with the loan proceeds would not be deductible.

Good-Deal Example

ABC Inc., an S corporation, receives a $100,000 PPP loan,
spends it all on defined payroll, and the lender forgives the $100,000.

On its 2020 tax return, ABC reports no PPP income (remember,
it was tax-free), but it may not deduct $100,000 of payroll expenses. The non-deduction
creates $100,000 of net taxable income that ABC, the S corporation, passes on
to its sole shareholder, Bob.

Let’s say Bob is in the 45 percent tax bracket when you
consider both his federal and state income taxes. Bob pays taxes of $45,000 on
this income.

And let’s say that ABC passes to Bob the $100,000 of
tax-exempt income. This puts Bob ahead by $55,000 ($100,000 – $45,000).

A good deal—sure!

But with passage of the CARES Act, Congress was not making a
good deal—it was providing ABC with money for it to remain afloat and continue
paying its employees during the COVID-19 pandemic.

What If It’s Like We
Thought It Was?

If the payroll were deductible, ABC would be ahead by both
the $100,000 and the tax benefit of the payroll being deductible—giving the
company a better chance of continuing to pay its employees after the PPP loan
and its forgiveness.

Since the S corporation doesn’t pay income taxes, let’s look
at Bob. He would have the $100,000 plus the tax benefit of the payroll
deduction ($45,000).

Here’s the comparison:

• $145,000 if the PPP is as we thought it was
• $55,000 as the IRS has it now

Unfair—Schedule C Taxpayer
Suffers No Tax Bite

To add one more reason to why the business expenses paid
from PPP loan forgiveness monies should be tax deductible, consider this: the
self-employed taxpayer with no employees has his or her loan forgiven based on
his or her 2019 net income.

There’s no spend on payroll.

The self-employed person does not have to spend any PPP
monies on interest, rent, or utilities. He or she can achieve full forgiveness
in 10.8 weeks based solely on the 2019 tax return.

In its “you can’t deduct it” notice (IRS Notice 2020-32),
the IRS invokes IRC Section 265, but Section 265 does not consider how the PPP
treats forgiveness for the self-employed. It applies to expenses incurred for
the purpose of earning or otherwise producing tax-exempt income.

For the Schedule C taxpayer, no such expenses to produce
tax-exempt income need to be paid to achieve 100 percent forgiveness.

Lawmakers Upset with the
IRS

Let’s start with the fact that the IRS has a tough job. In
many cases, the IRS is nothing more than a referee. If lawmakers fumble the tax
law, the IRS has to call it. No choice.

In a letter to Secretary of the Treasury Mnuchin, Senator Chuck
Grassley, chairman of the committee on finance; Senator Ron Wyden, ranking
member on the committee on finance; and Richard E. Neal, chairman of the
committee on ways and means, jointly stated that the IRS got this wrong and
that the intent of the CARES Act was for the PPP to be a tax-free grant.

The IRS has held firm. That puts the ball back into
lawmakers’ hands, and now it’s their turn. This is where you come in.

Give Them a Nudge

Congress is working on additional COVID-19 legislation. And
we suspect that you will see the new legislation enacted into law before
Congress recesses for its summer break on August 8, 2020.

That means things are moving quickly, and if you want your
voice to be heard, you need to speak now.

To help create the action you desire, do this:

• S. 3612 is the Senate bill to make the PPP forgiveness
  money used to pay business expenses tax deductible. To express your yea or
  nay on S. 3612, contact your senators. You can find them at this link: https://www.senate.gov/senators/contact
• H.R. 6821 is the House bill to make the PPP forgiveness
  money used to pay business expenses tax deductible. To express your yea or
  nay on H.R. 6821, contact your representative. You can find him or her at
  this link: https://www.house.gov/representatives

You don’t need to be big and formal about your yea or nay.
You can fax, email, or phone and simply say you support or oppose the bill.
It’s that easy—and it’s effective. Do it.