Tax

I wanted to offer some insights regarding an important tax aspect related to the cleaning services at your home office.

As you have a home office that qualifies for a home-office deduction and you employ a cleaning lady—let’s call her Annie—who maintains both your home and your home office, there are a couple of tax considerations to keep in mind.

First, the amount you pay Annie for her cleaning services can affect your taxes. You pay Annie $200 every two weeks, totaling $5,200 annually. Given that your office is 15 percent of your home, you pay Annie $780 to clean your office and $4,420 to clean your home.

Here are two key questions:

• Should you pay Annie through a W-2 or 1099 for the office cleaning?
• Do you need to pay the Nanny Tax for the home cleaning?

The answers depend on whether Annie is considered an independent contractor or an employee.

Given the conditions of Annie’s work—she cleans with little or no direction, provides her supplies, and cleans many other houses—she exhibits the characteristics of an independent contractor.

Accordingly, for the $780 you paid her to clean your office, you should provide her with a 1099-NEC form. On the personal front, you are not liable for the Nanny Tax because Annie qualifies as an independent contractor.

Please note that if you fail to file Form 1099-NEC, you could face an intentional disregard penalty of $630 or more for each missed form.

If you would like to discuss the Nanny Tax or 1099-NEC requirements, please call me on my direct line at 408-778-9651.

• By Leon Clinton
• June 12, 2023

Are you considering a bold tax position that may significantly reduce your taxes? If approved by the IRS, it’s a win. But if disapproved, be prepared to face a considerable tax penalty.

The IRS imposes a 20 percent penalty for substantial tax underpayment. For instance, if the IRS finds you underpaid your taxes by $50,000, you’ll face a $10,000 penalty in addition to the tax due and interest.

The tax code considers a tax underpayment “substantial” if you understate your tax by over 10 percent or $5,000, whichever is greater. If you claimed the qualified business income (Section 199A) deduction on your return, the 10 percent becomes 5 percent.

To avoid this penalty, you can adequately disclose on IRS Form 8275 the item causing the understatement on your return (or amended return). You’ll need to demonstrate a “reasonable basis” for your tax position, meaning a 20 percent likelihood of success is sufficient.

Filing Form 8275 has an additional advantage. If you underpay your taxes by 25 percent or more, the IRS examination period extends from three to six years. But items disclosed on Form 8275 don’t count as underpayments for the 25 percent threshold. This helps avoid crossing the 25 percent omitted income threshold, maintaining the statute of limitations period at three years.

Some hesitate to file Form 8275, fearing it may trigger an audit. The IRS states this isn’t true, and no evidence suggests that filing the form alone increases audit risk. But it’s worth noting that Form 8275 can provide the IRS with information on what to question on a return, which may concern some practitioners.

Please note that you shouldn’t file Form 8275 for items fully disclosed on your regular tax return forms, such as itemized personal deductions listed on IRS Schedule A or specific business or rental property expenses.

If you have questions about Form 8275, please call me on my direct line at 408-778-9651.

• By Leon Clinton
• June 8, 2023

Here’s some information on how you can help a family member buy a home by making a loan to them while ensuring that you and the family member benefit from a tax-smart loan structure.

With the current national average interest rates for 30-year and 15-year fixed-rate mortgages at 6.81 percent and 6.13 percent, respectively, family loans can offer a much more attractive alternative. By charging the Applicable Federal Rate (AFR) as interest, you can give the borrower a good deal without giving yourself a tax headache.

The IRS issues new AFRs for term loans every month. The rates for April 2023 are as follows:

• Short-term loan (three years or less): 4.86 percent
• Mid-term loan (over three years but not more than nine years): 4.15 percent
• Long-term loan (over nine years): 4.02 percent

Charging at least the AFR for a term loan to a family member allows you to avoid federal income tax and federal gift tax complications.

But if you charge less than the AFR, you may need to navigate some tax complications. Two tax-law exceptions, the $10,000 and $100,000 loopholes, can help you avoid these complications, although they may not be suitable for all home loans.

It is crucial to document the loan with a written promissory note and secure it with the borrower’s home for them to claim deductions for qualified residence interest expenses. Make sure the borrower signs the note and that the note includes details such as the interest rate, a schedule of interest and principal payments, and any security or collateral for the loan.

In conclusion, family loans can provide homebuyers with better interest rates than commercial lenders offer, especially if family members charge the AFR. Remember to consider the loan terms and tax consequences when structuring the loan.

If you would like to discuss the family loan concept, please call me on my direct line at 408-778-9651.

• By Leon Clinton
• June 1, 2023