The IRS has recently provided clarity for owners of rental properties on how they can qualify for the new 20% pass through deduction.

As per the IRS, in order to qualify for the new 20% pass through deduction, an activity must raise to the level of being a trade or business. An activity is generally considered to be a trade or business if it is regular, continuous, and considerable.

Determining whether a rental real estate enterprise meets these criteria can be difficult. The IRS has therefore provided a safe harbor whereby an enterprise will be treated as a trade or business for the purposes of the 20% pass through deduction if certain conditions are met.

Under the safe harbor, a rental real estate enterprise will be treated as a trade or business if the following requirements are satisfied during the tax year:

(1) Separate books and records are maintained to reflect income and expenses for each rental real estate enterprise.

(2) 250 or more hours of rental services are performed per year with respect to the rental enterprise. Note that these hours of service do not have to be performed by you personally.

(3) The taxpayer maintains contemporaneous records, including time reports, logs, or similar documents, regarding the following: (i) hours of all services performed; (ii) description of all services performed; (iii) dates on which such services were performed; and (iv) who performed the services. Such records are to be made available for inspection at the request of the IRS. The contemporaneous records requirement does not apply to the 2018 tax year.

For purposes of the safe harbor, rental services include:

• Advertising to rent or lease the real estate
• Negotiating and executing leases
• Verifying information contained in prospective tenant applications
• Collection of rent
• Daily operation, maintenance, and repair of the property
• Management of the real estate
• Purchase of materials
• Supervision of employees and independent contractors.

Some types of rental real estate are not eligible for the safe harbor.

Accordingly, it is very important to maintain contemporaneous records to qualify for the 20% pass through deduction.

Please contact a Roth&Co adviser for further information or discussion about the new safe harbor rule.

If you run your business from your home or perform certain functions at home that are related to your business, you might be able to claim a home office deduction against your business income on your 2018 income tax return. Thanks to a tax law change back in 2013, there are now two methods for claiming this deduction: the actual expenses method and the simplified method.

Basics of the deduction

In general, you’ll qualify for a home office deduction if part of your home is used “regularly and exclusively” as your principal place of business.

If your home isn’t your principal place of business, you may still be able to deduct home office expenses if 1) you physically meet with patients, clients or customers on your premises, or 2) you use a storage area in your home (or a separate free-standing structure, such as a garage) exclusively and regularly for your business.

Actual expenses

Traditionally, taxpayers have deducted actual expenses when they claim a home office deduction. Deductible home office expenses may include:

• Direct expenses, such as the cost of painting and carpeting a room used exclusively for business,
• A proportionate share of indirect expenses, such as mortgage interest, property taxes, utilities, repairs and insurance, and
• A depreciation allowance.

But keeping track of actual expenses can be time consuming.

The simplified method

Fortunately, there’s a simplified method that’s been available since 2013: You can deduct $5 for each square foot of home office space, up to a maximum total of $1,500.

For example, if you’ve converted a 300-square-foot bedroom to an office you use exclusively and regularly for business, you can write off $1,500 under the simplified method (300 square feet x $5). However, if your business is located in a 600-square-foot finished basement, the deduction will still be only $1,500 because of the cap on the deduction under this method.

As you can see, the cap can make the simplified method less beneficial for larger home office spaces. But even for spaces of 300 square feet or less, taxpayers may qualify for a bigger deduction using the actual expense method. So, tracking your actual expenses can be worth the extra hassle.

Flexibility in filing

When claiming the home office deduction, you’re not locked into a particular method. For instance, you might choose the actual expense method on your 2018 return, use the simplified method when you file your 2019 return next year and then switch back to the actual expense method thereafter. The choice is yours.

Unsure whether you qualify for the home office deduction? Or wondering whether you should deduct actual expenses or use the simplified method? Contact us. We can help you determine what’s right for your specific situation.

Directors and officers (D&O) liability insurance enables board members to make decisions without fear that they’ll be personally responsible for any related litigation costs. Such coverage is common in the business world, but fewer not-for-profits carry it. Nonprofits may assume that their charitable mission and the good intentions of volunteer board members protect them from litigation. These assumptions can be wrong.

Asked and answered

Here are several FAQs to help you determine whether your board needs D&O insurance:

Whom does it cover? A policy can help protect both your organization and its key individuals: directors, officers, employees and even volunteers and committee members.

What does it cover? Normally, D&O insurance covers allegations of wrongful acts, errors, misleading statements, neglect or breaches of duty connected with a person’s performance of duties. Examples include:

• Mismanagement of funds or investments,
• Employment issues such as harassment and discrimination,
• Self-dealing,
• Failure to provide services, and
• Failure to fulfill fiduciary duties.

Are there coverage limitations? D&O policies are claims-made, meaning that the insurer pays for claims filed during the policy period even if the alleged wrongful act occurred outside of the policy period. The flip side of this is that D&O insurance provides no coverage for lawsuits filed after a policyholder cancels — even if the alleged act happened when the policy was still in place.

What if we need to make a claim after our policy has been canceled or expired? You might still be covered if you bought extended reporting period (ERP) coverage. It generally covers newly filed claims on actions that allegedly occurred during the regular policy period.

How do we file a claim? When a legal complaint is filed against your nonprofit, contact your insurer to determine whether the matter is insurable and includes defense costs. Most policies reimburse the insured for reasonable defense costs, in addition to covering judgments against the insured.

How can we keep costs down? Think seriously about the people and actions that should be covered and the amount of protection you need — and don’t need. For example, you probably don’t need coverage of bodily injury or property damage because these claims usually are covered by general liability and workers’ compensation insurance. As with most insurance coverage, D&O premiums are likely to be lower if you opt for higher deductibles.

Making the decision

Not every organization needs D&O insurance. In some states, volunteer immunity statutes provide limited protection for negligence. Such protection, however, doesn’t extend to federal statutes. If you’re unsure, contact us.

While the Tax Cuts and Jobs Act (TCJA) reduces most income tax rates and expands some tax breaks, it limits or eliminates several itemized deductions that have been valuable to many individual taxpayers. Here are five deductions you may see shrink or disappear when you file your 2018 income tax return:

1. State and local tax deduction. For 2018 through 2025, your total itemized deduction for all state and local taxes combined — including property tax — is limited to $10,000 ($5,000 if you’re married and filing separately). You still must choose between deducting income and sales tax; you can’t deduct both, even if your total state and local tax deduction wouldn’t exceed $10,000.

2. Mortgage interest deduction. You generally can claim an itemized deduction for interest on mortgage debt incurred to purchase, build or improve your principal residence and a second residence. Points paid related to your principal residence also may be deductible. For 2018 through 2025, the TCJA reduces the mortgage debt limit from $1 million to $750,000 for debt incurred after Dec. 15, 2017, with some limited exceptions.

3. Home equity debt interest deduction. Before the TCJA, an itemized deduction could be claimed for interest on up to $100,000 of home equity debt used for any purpose, such as to pay off credit cards (for which interest isn’t deductible). The TCJA effectively limits the home equity interest deduction for 2018 through 2025 to debt that would qualify for the home mortgage interest deduction.

4. Miscellaneous itemized deductions subject to the 2% floor. This deduction for expenses such as certain professional fees, investment expenses and unreimbursed employee business expenses is suspended for 2018 through 2025. If you’re an employee and work from home, this includes the home office deduction. (Business owners and the self-employed may still be able to claim a home office deduction against their business or self-employment income.)

5. Personal casualty and theft loss deduction. For 2018 through 2025, this itemized deduction is suspended except if the loss was due to an event officially declared a disaster by the President.

Be aware that additional rules and limits apply to many of these deductions. Also keep in mind that the TCJA nearly doubles the standard deduction. The combination of a much larger standard deduction and the reduction or elimination of many itemized deductions means that, even if itemizing has typically benefited you in the past, you might be better off taking the standard deduction when you file your 2018 return. Please contact us with any questions you have.

Limited liability company (LLC) members commonly claim that their distributive shares of LLC income — after deducting compensation for services in the form of guaranteed payments — aren’t subject to self-employment (SE) tax. But the IRS has been cracking down on LLC members it claims have underreported SE income, with some success in court.

SE tax background

Self-employment income is subject to a 12.4% Social Security tax (up to the wage base) and a 2.9% Medicare tax. Generally, if you’re a member of a partnership — including an LLC taxed as a partnership — that conducts a trade or business, you’re considered self-employed.

General partners pay SE tax on all their business income from the partnership, whether it’s distributed or not. Limited partners, however, are subject to SE tax only on any guaranteed payments for services they provide to the partnership. The rationale is that limited partners, who have no management authority, are more akin to passive investors.

(Note, however, that “service partners” in service partnerships, such as law firms, medical practices, and architecture and engineering firms, generally may not claim limited partner status regardless of their level of participation.)

LLC uncertainty

Over the years, many LLC members have taken the position that they’re equivalent to limited partners and, therefore, exempt from SE tax (except on guaranteed payments for services). But there’s a big difference between limited partners and LLC members. Both enjoy limited personal liability, but, unlike limited partners, LLC members can actively participate in management without jeopardizing their liability protection.

Arguably, LLC members who are active in management or perform substantial services related to the LLC’s business are subject to SE tax, while those who more closely resemble passive investors should be treated like limited partners. The IRS issued proposed regulations to that effect in 1997, but hasn’t finalized them — although it follows them as a matter of internal policy.

Some LLC members have argued that the IRS’s failure to finalize the regulations supports the claim that their distributive shares aren’t subject to SE tax. But the IRS routinely rejects this argument and has successfully litigated its position. The courts generally have imposed SE tax on LLC members unless, like traditional limited partners, they lack management authority and don’t provide significant services to the business.

Review your situation

The law in this area remains uncertain, particularly with regard to capital-intensive businesses. But given the IRS’s aggressiveness in collecting SE taxes from LLCs, LLC members should assess whether the IRS might claim that they’ve underpaid SE taxes.

Those who wish to avoid or reduce these taxes in the future may have some options, including converting to an S corporation or limited partnership, or restructuring their ownership interests. When evaluating these strategies, there are issues to consider beyond taxes. Contact us to discuss your specific situation.