Whose Job Is It Anyway?

One of our accountants asked me recently:

R:      Do you think [so and so] qualifies as a real estate professional?

CTG: I do not know [so and so]. Tell me a little.

R:      Husband pulls a W-2.

CTG: How much and how many hours?

R:      Blah blah dollars.

CTG: Works in real estate?

R:      Nah.

CTG: Hours?

R:      Maybe 2,000.

CTG: Is the wife in real estate?

R:      No.

I have told you (almost) everything you need to answer the question.

Let’s look at the Warren case.

James Warren organized Warren Assisted Living, LLC in 2015.

He purchased a group home in 2016.

He started repairing the home almost immediately.

In 2017 he worked at Lockheed Martin for 1,913 hours as an engineer.

On his 2017 tax return he claimed a $41 thousand-plus loss from the group home. He claimed he was a real estate professional.

Warren did not keep time logs.

What sets this up are the passive activity rules under Section 469. As initially passed, that Section considered rental activities (with minimal exceptions) to be “per se” passive.

The passive activity rules would then stifle your ability to claim losses. You – for the most part – had to wait until you had income from the activity. You could then use the losses against the income. 

Well, that caught real estate landlords and others around the country by surprise. When you do one thing, it is difficult to have a Congressional staffer decide that your thing is not a regular thing like the next thing across the street.

Congress made a change.

(c)(7)  Special rules for taxpayers in real property business.

 

(A)  In general. If this paragraph applies to any taxpayer for a taxable year-

 

(i)  paragraph (2) shall not apply to any rental real estate activity of such taxpayer for such taxable year, and

(ii)  this section shall be applied as if each interest of the taxpayer in rental real estate were a separate activity.

 

Notwithstanding clause (ii) , a taxpayer may elect to treat all interests in rental real estate as one activity. Nothing in the preceding provisions of this subparagraph shall be construed as affecting the determination of whether the taxpayer materially participates with respect to any interest in a limited partnership as a limited partner.

 

(B)   Taxpayers to whom paragraph applies. This paragraph shall apply to a taxpayer for a taxable year if-

 

(i)  more than one-half of the personal services performed in trades or businesses by the taxpayer during such taxable year are performed in real property trades or businesses in which the taxpayer materially participates, and

(ii)  such taxpayer performs more than 750 hours of services during the taxable year in real property trades or businesses in which the taxpayer materially participates.

 

In the case of a joint return, the requirements of the preceding sentence are satisfied if and only if either spouse separately satisfies such requirements. For purposes of the preceding sentence, activities in which a spouse materially participates shall be determined under subsection (h) .

The above is called the real estate professional exception. It is a mercy release from the per se rule that would otherwise inaccurately (and unfairly) consider people who work in real estate all day to not be working at all.

It has two main parts:

(1) You have to spend at least 750 hours working in real estate, and

(2)  You have to spend more than 50% of your “working at something” total hours actually “working in real estate.”

If you are a real estate professional, you avoid the “per se” label. You have not yet escaped the passive activity rules – you still have to show that you worked - but at least you have the opportunity to present your case.

The Court looked at Warren’s 1,913 hours at Lockheed. That means he would need 3,827 total hours for real estate to be more than ½ of his total work hours. (1,913 times 2 plus 1).

First of all, 3,827 total hours means he was working at least 74 hours a week, every week, without fail, for the entire year.

Maybe. Doubt it.

Warren is going to need really good records to prove it.

Here is the Court:

Mr Warren did not keep contemporaneous logs of his time renovating the group home.”

Not good, but not necessarily fatal. I represented a client who kept Outlook and other records. She created her log after the fact but from records which themselves were contemporaneous. Mind you, we had to go to Appeals, but she won.

In preparation for trial, Mr Warren created – and presented – two time logs.”

Good grief.

The first log maintained that he worked 1,421 hours at the group home; it was created one week before trial.”

End it. That is less than his 1,913 hours at Lockheed.

The second log maintained that Mr. Warren worked 1,628 at the group home; it was created the night before trial.”

Why bother?

This was a slam dunk for the Court. They did not have to dwell on contemporaneous or competing logs or believability or whether the Bengals will turn their season around. Whether 1,421 or 1,628, he could not get to more-than-50%.

Warren lost.

As a rule of thumb, if you have a full-time W-2, it will be almost impossible to qualify as a real estate professional. The exception is when your full-time W-2 is in real estate, maybe with an employer such as CBRE or Cushman & Wakefield.  At 1,900-plus Lockheed hours, I have no idea what Warren was thinking, although I see that it was a per se case. That means he represented himself, and it shows.

I suppose one could have a W-2 and work crazy hours and meet the more-than-50% requirement, but your records should be much tighter. And skip the night before thing.

BTW another way to meet this test is by being married.

Look at (B)(ii) again:

In the case of a joint return, the requirements of the preceding sentence are satisfied if and only if either spouse separately satisfies such requirements. For purposes of the preceding sentence, activities in which a spouse materially participates shall be determined under subsection (h) .

If your spouse can meet the test (both parts), then you will qualify by riding on the shoulders of your spouse.

Our case this time was Warren v Commissioner, T.C. Summary Opinion 2024-20.

90 Days Means 90 Days

Let’s return to an IRS notice we have discussed in the past: the 90-Day letter or Notice of Deficiency. It is commonly referred to as a “NOD” or “SNOD.”

If you get one, you are neck-deep into IRS machinery. The IRS has already sent you a series of notices saying that you did not report this income or pay that tax, and they now want to formally transfer the matter to Collections. They do this by assessing the tax. Procedure however requires them (in most cases) to issue a SNOD before they can convert a “proposed” assessment to a “final” assessment.

It is not fun to deal with any unit or department at the IRS, but Collections is among the least fun. Those guys do not care whether you actually owe tax or have reasonable cause for abating a penalty. Granted, they might work with you on a payment plan or even interrupt collection activity for someone in severe distress, but they are unconcerned about the underlying story.

Unless you agree with the proposed IRS adjustment, you must respond to that SNOD.

That means you are in Tax Court.

Well, sort of.

The IRS will return the case to the IRS Appeals with instructions and the hope that both sides will work it out. The last thing the Tax Court wants is to hear your case.

This week I finally heard from Appeals concerning a filing back in March.

Here is a snip of the SNOD that triggered the filling.

Yeah, no. We are not getting rolled for almost $720 grand.

I mentioned above that this notice has several names, including 90-day letter.

Take the 90 days SERIOUSLY.

Let’s look at the Nutt case.

The IRS mailed the Nutts a SNOD on April 14, 2022 for their 2019 tax year. The 90 days were up July 18, 2022. The 18^th was a Monday, not a holiday in fantasy land or any of that. It was just a regular day.

The Nutts lived in Alabama.

They filed their Tax Court petition electronically at 11.05 p.m.

Alabama.

Central time.

90 days.

The Tax Court is in Washington, D.C.

The Tax Court received the electronic filing at 12.05 a.m. July 19^th.

Eastern time.

91 days.

The Tax Court bounced the petition. Since it had to be filed with the Tax Court - and the Tax Court is eastern time - the 90 days had expired.

A harsh result, but those are the rules.

Our case this time was Nutt v Commissioner, 160 T.C. No 10 (2023).

IRS Individual Tax Payment Plans

I anticipate a question about an IRS payment plan this tax season. It almost always comes up, so I review payment options every year. It occurred to me that this topic would make a good post, and I could just send a link to CTG if and when the question arises.

Let’s review the options for individual taxes. We are not discussing business taxes in this post, with one exception. If the business income winds up on your personal return – say through a proprietorship or an S corporation – then the following discussion will apply. Why? Because the business taxes are combined with your individual taxes.

YOU DO NOT HAVE THE MONEY BUT WILL SOON

You do not have the money to pay with your return, but you do have cash coming and will be able to pay within 120 days. This is a “short-term” payment plan. There is no application fee, but you will be charged interest.

BTW you will always be charged interest, so I will not say so again.

YOU OWE $10,000 OR LESS

You cannot pay with the return nor within 120 days, but you can pay within 3 years. This is the “guaranteed” payment plan. As with all plans, you have to be caught up with all your tax filings and continue to do so in the future.

If you are self-employed you can bet the IRS will require that you make estimated tax payments. I have seen this requirement sink or almost sink many a payment plan, as there isn’t enough cash to go around.

The IRS says they will not allow more than one of these plans every 5 years. I have had better luck, but (1) I got a good-natured IRS employee and (2) the combined tax never exceeded $10 grand. Point is: believe them when they say 5 years.

YOU OWE MORE THAN $10,000 BUT LESS THAN $25,000

This is a “streamlined” payment plan. Your payment period can be up to six years.  

As long as your balance is under $25 grand, the IRS will allow you to send a monthly check rather than automatically draft your bank account.

YOU OWE MORE THAN $25,000 BUT LESS THAN $50,000

This is still a “streamlined” plan, and the rules are the same as the $10-25 grand plans, but the IRS will insist on drafting your bank account.

DOWNSIDE TO THE GUARANTEED AND STREAMLINED PLANS

Have variable income and these plans do not work very well. The IRS wants a monthly payment. These plans are problematic if your income is erratic – unless you sit on a stash of cash no matter whether you are working or not. Then again, if you have such stash, I question why you are messing with a payment plan.

UPSIDE TO THE GUARANTEED AND STREAMLINED PLANS

A key benefit to both the guaranteed and the streamlined is not having to file detailed financial information. I am referring to the Form 433 series, and they are a pain. You have to attach copies of bank statements and provide documentation if you want more than IRS-provided amounts for certain cost-of-living categories. Rest assured that – whatever you think your “essential” bills are – the IRS will disagree with you.

Another benefit to the guaranteed and streamlined is avoiding a federal tax lien. I have had clients for whom the threat of a lien was more significant than the endless collection letters they received previously. Once the lien is in place it is quite difficult to remove until the tax debt is substantially paid.

YOU OWE MORE THAN $50,000

If you go over $50 grand you will have to provide Form 433 financial information, work your way through the cost-of-living categories, fight (probably) futilely with the IRS to spot you more than the tables and then agree on an amount that will pay off the debt over your remaining statute-of-limitations (collections) period.

If you are at all close to the $50,000 tripwire, SERIOUSLY consider paying down the debt below $50,000. The process, while not good times with old friends, will be easier.

YOU CANNOT PAY IT ALL OVER THE REMAINING COLLECTIONS PERIOD

It is possible that – despite the best you can do – there is no way to pay-off the IRS over the remaining statute-of-limitations (collections) period. You have now gone into “partial pay” territory. This will require Form 433 paperwork and working with a Collections officer. If one is badly injured in a car wreck and has indefinitely decreased earning power, the process may be relatively smooth. Have a tough business stretch but retain substantial earning power and the process will likely not be as smooth. 

HOW TO APPLY

There are three general ways to obtain a payment plan:

(1)   Mail

(2)   Call

(3)   Website

There is a charge for anything other than the 120-day plan. The cheapest way to go is to use the IRS website, but the charge – while more if not using the website – is not outrageous.

You use Form 9465 for mail.

The website is https://www.irs.gov/payments/online-payment-agreement-application for online.

Set aside time if you intend to call the IRS. You may want to download a movie.

What Does It Take To Get Reasonable Cause Around Here?

My partner has a difficult IRS penalty issue.

He expects a client to be penalized for more than one year. This complicates how we handle the first year.

The IRS has reorganized its penalty review function to a system called the Reasonable Cause Assistant (RCA). There however is a problem: the system does not work well. The Treasury Inspector General for Tax Administration (TIGTA) reported that RCA was inaccurate 89% of the time in 2012.

Step away from RCA and you still have the following:

 * It used to be that penalties were assessed as a means to encourage voluntary compliance. Many tax pros feel that is no longer the case, and penalties are being used as a means to raise revenue.  An example is the penalty assessed for late filing of a partnership return: $195 per month per partner. Take a 10-person partnership, file a week late and face a $1,950 penalty. There is little consideration for the size of the partnership, its total assets or revenues - or the fact that partnerships do not pay federal taxes.            

* Penalties are assessed even when taxpayers are trying to do the right thing. For example, enter into a reportable transaction, disclose it on your tax return but forget to file a copy with a second office and you will be assessed a penalty. Fail to disclose the transaction at all and you will be subject to the same penalty.

 * The IRS is automatically asserting penalties. For example, for fiscal year 2015, the IRS assessed over 40 million penalties on individuals and businesses. To put that in context, there were approximately 243 million returns filed for the period.

* Many penalties can be waived if the taxpayer can show "reasonable cause," but many tax professionals believe the IRS has so narrowed the definition as to be almost unreachable, unless you are willing to die. To aggravate the matter, the IRS has also instructed its personnel to substitute "first time abatement" (FTA) for reasonable cause as a matter of policy. While the IRS argues that FTA is easier to review and administer than reasonable cause, there exists a high degree of skepticism. Why would a taxpayer automatically burn a "get out of penalty-jail free" card if the taxpayer otherwise has reasonable cause? Wouldn't a taxpayer want to keep that card available just in case?

My partner - by the way - has that last situation: burning his FTA chip without a reasonable-cause backup for the second year. Ironically, he may have reasonable cause for the first year, but that sequence does not follow IRS policy. I anticipate going to Appeals to obtain reasonable cause and preserve the FTA for the second year.

Let's talk about the Carolyn Rogers (Rogers v Commissioner) case.

Carolyn lived in New York. In 2006 she had a small business (Talk of the Town Singles) which she operated from her cooperative. In 2006 there was a fire which rendered the place uninhabitable.

She moved. In 2007 there was another fire, one she appears to have caused herself. The local newspaper called her out, and she was thereafter harassed by people in her neighborhood.

She moved to the YWCA until 2010. She did not have a pleasant time there, and in 2009 she fell off a subway platform and fractured her skull on the rails. She was in the hospital for days, and she continued to suffer from dizzy spells thereafter.

Prior to this period, she had a record of filing timely returns. She also made significant efforts to correctly prepare her tax returns, consulting books and references and more than once contacting the IRS. She did not use a paid preparer.

The IRS penalized her for not filing a 2009 return.

She explained that the insurance company settled the second fire in 2009, and she lost a bundle. According to her research, the casualty loss would wipe out her income, and she was therefore below the filing threshold. She did not need to file.

The IRS then trotted technical guidance on a casualty loss. While the layperson might think that the loss would be deferred until the insurance is settled, the tax Code uses a different test:

* If an insurance claim is not paid in the year of casualty AND there is a reasonable prospect of recovery, then the loss is deferred until one can determine the amount of recovery.

* If there is no hope for insurance - or the prospect of recovery is unreasonable - then the loss is deductible in the year of the casualty.

 The IRS said that she came under the second rule. She knew that insurance would not cover the full loss from the 2007 fire. The loss was therefore deductible in 2007.

COMMENT: There is enough "what if" to this rule that even a tax professional could blow it.

The IRS wanted penalties for not filing that 2009 return.  

The Tax Court reviewed her filing history and her chaotic life. It noted:

Petitioner's error (regarding the proper year of deduction of the portion of a casualty loss for which there is no reasonable prospect of recovery from insurance) is considerably different from the errors made by a taxpayer whose failure to file, late filing, or late payment is chronic. Erroneously deducting a loss in a year later than the correct year is not usually considered to be a blatant tax avoidance technique ..."

Ouch. The Court did not appreciate the IRS wasting its time.

Taking into account all of the facts and circumstances, we conclude that petitioner exercised ordinary business care and prudence under the difficult circumstances in which she was living at the time leading up to the due date of her 2009 return...."

The Court found reasonable cause. She owed the tax, but she did not owe the penalties.

The IRS should have found reasonable cause too. It is troubling that it didn't.

IRS Does Not Want You To Call Next Week

So I am reading the following headline:

      IRS Asks Taxpayers to Resist Calling Next Week

I am wondering when our tax system became a Saturday Night Live skit.

The IRS does have a point. Next week includes Presidents Day and is usually one of the busiest weeks for the IRS phone lines.

The IRS wants people to instead to visit the website www.irs.gov and take advantage of the online tools there.

I try to be sympathetic – I truly do. However I cannot help reflect that we never see the following headlines:

Chick fil-A Asks Customers To Stay Away

Apple Has Nothing To Sell You

Honda Asks Potential Buyers Not To Visit Dealerships

Why the difference between the government and an actual-operating-accountable- produce-something-legitimate-or-we-go-out-of-business company?

If you even have to ask ….

Talking About 2014 ObamaCare Employer Taxes

I have been reviewing two ObamaCare employer taxes that are scheduled to kick-in in 2014. It’s more than a year away, but let’s say you call me and we meet for coffee. It’s a business meeting. With cheesecake.

I’ll start the conversation off:

Me:                  If an employer has enough employees, then the employer is expected to provide health benefits.

You:                 What constitutes “enough employees?”

Me:                  More than 50 full-time employees. Full-time is defined as 30 hours per week, by the way.

You:                 So if I have less than 51 full-time employees, I escape the tax?

Me:                  Yes.

You:                 What if I have more than 50?

Me:                  Depends.

You:                 On what?

Me:                  On whether any employee receives a government subsidy.

You:                 And I am supposed to know this how?

Me:                  Trust me, you’ll find out.

You:                 What if I have more than 50 employees but no one gets a subsidy?

Me:                  How did you accomplish that, Houdini?

You:                 All my employees have their insurance covered by their spouse.

Me:                  Congratulations, Harry.

You:                 What if one divorces and gets a subsidy?

Me:                  You have a problem.

You:                 What problem?

Me:                  Your penalty will be either $2,000 or $3,000, depending.

You:                 Depending on what?

Me:                  Depending on whether you offer no insurance or offer unaffordable insurance.

You:                 So if I offer no insurance it will cost me $3,000 multiplied by some number?

Me:                  No.

You:                 You are getting on my nerves.

Me:                  The penalty for not offering health insurance is $2,000.

You:                 Per employee?

Me:                  No. You get to exclude the first 30 employees.

You:                 Huh?

Me:                  I didn’t write this stuff.

You:                 Say I have 55 full-time employees. What is it going to cost me?

Me:                  (55 minus 30) times $2,000 = $50,000.    

You:                 What if I fire 5 employees?

Me:                  Then you meet the 50-employee limit and have no tax.

You:                 Seriously?

Me:                  Yep.

You:                 Even if an employee gets government subsidy?

Me:                  Did you ever work at Bain Capital?

You:                 What is this “unaffordable” insurance thing?

Me:                  If the insurance exceeds a certain percentage of the employee’s family income, then the insurance is deemed “unaffordable.”

You:                 What is that percentage, oh beacon of despair?

Me:                  9.5% of household income.

You:                 Household income, what is that?

Me:                  An easy answer would be to add the husband and wife’s income.

You:                 How am I to know the spouse’s income?

Me:                  Trust me, you’ll find out.

You:                 How?

Me:                  When the government notifies you about the subsidy.

You:                 I am really starting to dislike you.

Me:                  Hey, I’ve got feelings here.

You:                 So if I see to it that all my employee’s spouses are doctors and engineers, then I can avoid the penalty?

Me:                  You have escaped yet again, Harry.

You:                 Say that I don’t escape. What is my tax?

Me:                  Well, you get to do two calculations. You pay the lower number.

You:                 Are you charging me for this aggravation?

Me:                  Yes.

Me:                  The first calculation is to multiply every employee receiving a subsidy for your unaffordable insurance by $3,000.

You:                 Then what?

Me:                  You do the same calculation as if you offered no insurance at all.  You know, the $2,000 calculation.

You:                 Huh, what’s the difference?

Me:                  The $2,000 calculation excludes the first 30 employees. Then it is just multiplication.

Me (cont’d):    The $3,000 calculation counts only those employees receiving a subsidy.

You:                 So if I offer unaffordable insurance, but no one gets the subsidy, my tax is zero?

Me:                  I am in awe, Harry.

You:                 What if I set up two companies, with neither having more than 50 employees?

Me:                  They already thought of that angle. No go if the companies are related. You owning both makes them related.

You:                 What if I increase my portion of the insurance to, you know, keep it “affordable?”

Me:                  That would work.

You:                 I would have to reduce the actual salaries or eliminate bonuses and raises to make the numbers work.

Me:                  Were you grades too high for community organizing?

You:                 What are other companies doing?

Me:                  Depends on the company. Some companies are too large for the 50 employees to mean anything. Still… Did you hear about Darden Restaurants?

You:                 Darden is who?

Me:                  Think Red Lobster and Olive Garden.

You:                 Are you charging me by the word?

Me:                  I’ll ignore that. Anyway, according to the Orlando Sentinel the company intends to reduce its maximum schedule to 28 hours per week per employee in “selected” restaurants. They told the newspaper that this is "just one of the many things we are evaluating to help us address the cost implications healthcare reform will have on our business."

You:                 Wow, that seems harsh.

Me:                  Where do you have that money tree planted, exactly?

You:                 How does an employee get a subsidy, exactly? Is that what sets this whole thing off?

Me:                  By “whole thing” you mean “unaffordable?”                      

You:                 I am going to hit you.

Me:                  There are two conditions. We already talked about the first one: the 9.5% of household income.

You:                 You mean 9.5% of a number that I have no hope of knowing or finding out?

Me:                  Yep, that one.

You:                 Do I want to know the second one?

Me:                  If you want your head to blow off.

You:                 What…? You have to tell me now.

Me:                  The second condition is that your employee’s household income ….

You:                 Which I do not know, right?

Me:                  Right. Now continuing where I was …. Your employee’s household income must be less than 400% of the federal poverty level.

You:                 You said 400%. I thought accountants were supposed to be good with numbers.

Me:                  I am. And it’s 400%.

You:                 Seriously?

Me:                  You are way too sharp to ever be hired by CNN.

You:                 So… what is 400% for a husband and wife?

Me:                  Close to $90 grand.

You:                 $90 grand! I didn’t make that last year! Or the year before!

Me:                  Maybe you can qualify for the subsidy.

You:                 I think I am going to fire you as my CPA.