A Job, A Gig and Work Expenses

 

The case is straightforward enough, but it reminded me how variations of the story repeat in practice.

Take someone who has a W-2, preferably a sizeable W-2.

Take a gig (that is, self-employment activity).

Assign every expense you can think of to that gig and use the resulting loss to offset the W-2.

Our story this time involves a senior database engineer with PIMCO. In 2015 he reported approximately $176,000 in salary and $10,000 in self-employment gig income.  He reported the following expenses against the gig income:

·      Auto      $14,079

·      Other     $12,000

·      Office    $ 7,043

·      Travel    $ 6,550

·      Meals     $ 3,770

There were other expenses, but you get the idea. There were enough that the gig resulted in a $40 thousand loss.

I have two immediate reactions:

(1)  What expense comes in at a smooth $12,000?

(2)  Whatever the gig is, stop it! This thing is a loser.

In case you were curious, yes, the IRS is looking for this fact pattern: a sizeable (enough) W-2 and a sizeable (enough) gig loss.

In general, what one is trying to do is assign every possible expense to the gig. Say that one is financial analyst. There may be dues, education, subscriptions, licenses, travel and whatnot associated with the W-2 job. It would not be an issue if the employer paid or reimbursed for the expenses, but let’s say the employer does not. It would be tempting to gig as an analyst, bring in a few thousand dollars and deduct everything against the gig income.

It’s not correct, however. Let’s say that the analyst has a $95K W-2 and gigs in the same field for $5k. I see deducting 5% of his/her expenses against the gig income; there is next-to-no argument for deducting 100% of them.

The IRS flagged our protagonist, and the matter went to Court.

We quickly learned that the $10 grand of gig income came from his employer.

COMMENT: Not good. One cannot be an employee and an independent contractor with the same company at the same time. It might work if one started as a contractor and then got hired on, but the two should not exist simultaneously.

Then we learn that his schedule of expenses does not seem to correlate to much of anything: a calendar, a bank account, the new season release of Stranger Things.

The Court tells us that his “Travel” is mostly his commute to his W-2 job with PIMCO.

You cannot (with very limited exception) deduct a commute.

There were some “Professional Fees” that were legit.

But the Court bounced everything else.

I would say he got off well enough, all things considered. Please remember that you are signing that tax return to “the best of (your) knowledge and belief.”    

Our case this time was Pilyavsky v Commissioner.

An Engineer Draws A Tax Penalty

We have spoken in the past about clients I would not accept: one with an earned income credit, for example. The tax Code requires me to go all social worker, obtaining and reviewing documents to have reasonable confidence that there is a child and said child lives in given household. There are penalties if I do not.

Not happening.

Did you know that I can be penalized for not signing a tax return as a paid professional? Yep, it is in Section 6694 for the home gamers.

I saw a penalty recently under Section 6701. That one is a rare bird.

The 6701 penalty can reach someone who is not a preparer but who “aids,” “assists” or “advises” with respect to information, knowing that it will be used in a material tax situation.

Here is an example: you gift majority control of your (previously) wholly-owned business to your kids. This would require a valuation, which in turn requires a valuation expert. That expert is probably not preparing the gift tax return, but the preparer of the gift tax return is relying – and heavily – on his/her work.

The penalty is $1,000 for each incident. Pray that you are not advising a corporation, as then it goes to $10,000 per incident.

The IRS recently trotted out Section 6701 in Chief Counsel Advice (CCA) 201805001. Think of a CCA as an IRS attorney advising an IRS employee on what to do.

The situation here involved a “tax-consultant engineer” who analyzed a taxpayer’s assets to determine the classification of property for depreciation purposes.

In the trade, we call this type of work “cost segregation.”

If you have enough money tied-up in certain types of depreciable assets, a “cost seg” may be a very good idea.

What drives the cost seg is an abnormally-long tax life for commercial property: usually 39 years.  It is a tax fiction, divorced from any economic analysis to build or not build or from a bank decision to lend or not lend.

The grail is to “carve out” some of that 39-year property into something that can be depreciated faster. There is room. The parking lot and landscaping, for example, can be depreciated over 15 years. Upgraded wiring to run equipment can be depreciated with the equipment. The additional plumbing at a dentist’s office? Yep, that gets faster depreciation.

But it probably requires a cost seg. Realistically, an accountant can do only so much. A cost seg really needs an engineer.

The engineer in this CCA must have left the plot, as the IRS was nearly out-of-its-mind over his classification into five-year property. The word they used was “egregious.”

Unfortunately, we are not told what he “egregiously” misclassified.

We are however told that he is getting the Section 6701 chop.

What is the math on this penalty?

Well, his misclassification affected five years of individual returns. The penalty would be 5 times $1,000 or $5,000 for each individual client. Hopefully this was a one-off, as $5 grand should be enough to get his attention.

Can you imagine if it had been a corporation?