Claim Your Employee Retention Credit

If you had W-2 employees in 2020 and/or 2021, you need to look at the Employee Retention Credit (ERC).

As you likely know, it’s not too late to file for the ERC. And now is a good time to get this done.

You can qualify for 2020 credits of up to $5,000 per employee and 2021 credits of up to $7,000 per employee for each of the first three quarters. That’s a possibility of $26,000 per employee.

One of our clients—let’s call him John–had 10 employees during 2020 and 2021. He qualified for $260,000 of tax credits (think cash). You could be like John.

You claim and adjust the ERC using IRS Form 941-X, which you can file anytime on or before March 15, 2024, if you file your taxes as a partnership or an S corporation, or April 15, 2024, if you file on Schedule C of your Form 1040 or as a C corporation.

You have three ways to qualify for the ERC:

1. Significant decline in gross receipts. Here, you compare the gross receipts quarter by quarter to those in 2019. To trigger any ERC under this test, you need a drop of more than 50 percent in 2020 and a drop of more than 20 percent in 2021.
2. Government order that causes more than a nominal effect. Here, your best bet is to use the safe harbor for nominal effect. This requires looking at either your 2019 quarterly receipts or your 2019 quarterly hours worked by employees, and seeing that the 2020 or 2021 shutdown order would have affected the 2019 figures by more than 10 percent.
3. Government order causes a modification to your business. Here, you also have a safe harbor. The IRS deems that the federal, state, or local COVID-19 government order had a more-than-nominal effect on your business if it reduced your ability to provide goods or services in the normal course of your business by not less than 10 percent.

The ERC can help all businesses that qualify, even those businesses that did not suffer during the COVID-19 pandemic.

Buying an Electric Vehicle? Know These Tax Law Changes

There’s good and bad news if you’re in the market for an electric or plug-in hybrid electric vehicle.

The good news is that the newly enacted Inflation Reduction Act includes a wholly revamped tax credit for electric vehicles that starts in 2023 and continues through 2032.

The bad news is that the credit, now called the “clean vehicle credit,” comes with many new restrictions.

The clean vehicle credit remains at a maximum of $7,500. But beginning in 2023, to qualify for the credit,

• you will need an adjusted gross income of $300,000 or less for marrieds filing jointly or $150,000 or less for singles; and
• you will need to buy an electric vehicle with a manufacturer’s suggested retail price below $80,000 for vans, SUVs, and pickup trucks, or $55,000 for other vehicles.

But that’s not all. The 2023-and-later credit includes new domestic assembly and battery sourcing requirements.

The new law reduces or eliminates the credit when the vehicle fails the battery sourcing requirements. Currently, no electric vehicle will qualify for the full $7,500 credit. Manufacturers are working feverishly to change this, but it could take a few years.

The new credit is not all bad—it eliminates the cap of 200,000 electric vehicles per manufacturer. Thus, popular electric vehicles manufactured by GM, Toyota, and Tesla can qualify for the new credit if they meet the price cap and other requirements.

And then, starting in 2024, you can qualify for a credit of up to $4,000 when purchasing a used electric vehicle from a dealer (not an individual). But income caps also will apply to this credit.

Also, starting in 2024, you’ll be able to transfer your credit to the dealer in return for a cash rebate or price reduction. This way, you can benefit from the credit immediately rather than waiting until you file your tax return.

If you are locked out of the new credit because your income is too high or you wish to purchase a too-expensive electric vehicle, consider buying a qualifying electric vehicle (assembled in North America) on or before December 31, 2022.

If you buy an electric vehicle for business use in 2023, you have a second option: the commercial clean vehicle credit.

Avoid These Mistakes When Converting to an S Corporation

At first glance, the corporate tax rules for forming an S corporation appear simple. They are not.

Basic Requirements

Here is what your business must look like when it operates as an S corporation:

1. The S corporation must be a domestic corporation.
2. The S corporation must have fewer than 100 shareholders.
3. The S corporation shareholders can be only people, estates, and certain types of trusts.
4. All stockholders must be U.S. residents.
5. The S corporation can have only one class of stock.

Simple, right? But what often appears simple on the surface is not so simple at all.

Don’t Forget Your Spouse

If you live in a community property state, your spouse by reason of community property law may be an owner of your corporation. This can be true whether or not your spouse has stock in his or her own name.

If your spouse is an owner, your spouse has to meet all the same qualification requirements you do. This can raise two issues:

1. If your spouse does not consent to the S corporation election on Form 2553, your S corporation is not valid.
2. If your spouse is a non-resident alien, your S corporation is not valid.

Converting an LLC to an S Corporation

Method 1. To convert your LLC to an S corporation for tax purposes, you can use a method we call “check and elect.” It’s easy—just two steps. First, you “check” the box to make your LLC a C corporation. Then, you “elect” for the IRS to tax your C corporation as an S corporation. Here’s how you take the two steps:

1. File IRS Form 8832 to check the box that converts your LLC to a C corporation.
2. Then file Form 2553 to convert your C corporation into an S corporation.

Method 2. Your LLC can skip the C corporation step and directly elect S corporation status by filing Form 2553.

Loans That Terminate S Corporation Status

Don’t make a bad loan to your S corporation. With the wrong type of loan, you enable the IRS to treat that loan as a second class of stock that disqualifies your S corporation.

Small loans are okay. If the loan is less than $10,000 and the corporation has promised to repay you in a reasonable amount of time, you escape the second-class-of-stock trap.

Larger loans are more closely scrutinized. If you have a larger loan, your loan escapes the second-class-of-stock trap if it meets the following requirements:

1. The loan is in writing.
2. There is a firm deadline for repayment of the loan.
3. You cannot convert the loan into stock.
4. The repayment instrument fixes the interest rate so that the rate is outside your control.

Say Goodbye to 100 Percent Bonus Depreciation

All good things must come to an end. On December 31, 2022, one of the best tax deductions ever for businesses will end: 100 percent bonus depreciation.

Since late 2017, businesses have used bonus depreciation to deduct 100 percent of the cost of most types of property other than real property. But starting in 2023, bonus depreciation is scheduled to decline 20 percent each year until it reaches zero in 2027.

For example, if you purchase $100,000 in equipment for your business and place it in service in 2022, you can deduct $100,000 using 100 percent bonus depreciation. If you wait until 2023, you’ll be able to deduct only $80,000 (80 percent).

Does this mean you should rush out and purchase business property before 2022 ends to take advantage of the 100 percent bonus depreciation? Not necessarily. For many businesses, an alternative is not going away: IRC Section 179 expensing.

Both IRC Section 179 expensing and bonus depreciation allow business owners to deduct in one year the cost of most types of tangible personal property, plus off-the-shelf computer software. Both can be used for new and used property acquired by purchase from an unrelated party. Both also can be used to deduct various non-structural improvements to non-residential buildings after they are placed in service.

Moreover, the two deductions aren’t mutually exclusive. You can apply Section 179 expensing to qualifying property up to the annual limit and then claim bonus depreciation for any remaining basis. Starting in 2023, when bonus depreciation will be less than 100 percent, any basis left after applying Section 179 and bonus depreciation will be deducted with regular depreciation over several years.

But there are some significant differences between the two deductions:

• Section 179 expensing is subject to annual dollar limits that don’t apply to bonus depreciation. But the limits are so large that they don’t affect most smaller businesses.
• Section 179 expensing requires more than 50 percent business use to qualify for and retain the Section 179 deduction. For bonus depreciation, you face the more than 50 percent business use requirement only for vehicles and other listed property.
• Unlike bonus depreciation, Section 179 expensing is limited to your net taxable business income (not counting the Section 179 deduction) and cannot result in a loss for the year.
• The 2022 Section 179 deduction is limited to $27,000 for SUVs. There is no such limit on bonus depreciation.
• You can use bonus depreciation to deduct land improvements with a 15-year class life, such as sidewalks, fences, driveways, landscaping, and swimming pools.

Generally, there is no great need to purchase and place the property in service by the end of 2022 to take advantage of 100 percent bonus depreciation. But there can be exceptions.

For example, if you own a rental property and want to make substantial landscaping or other land improvements, you’ll get a larger one-year depreciation deduction using 100 percent bonus depreciation in 2022 than if you wait until 2023, when the bonus will be only 80 percent.

Entertainment Facility: Perk for You, Your Net Worth, and Your Employees

Imagine this: your Schedule C business buys a home at the beach, uses it solely as an entertainment facility for business, pays off the mortgage, and deducts all the expenses.

Now say, 10 years later, without any tax consequence to you, you start using the beach home as your own.

Is this possible? Yes. Are there some rules on this? Yes. Are the rules difficult? No.

Okay, so could you achieve the same result if you operate your business as a corporation? Yes, but the corporation needs to rent the property from you or reimburse you for the facility costs, including mortgage interest and depreciation—because you want the title to always be in your name, not the corporation’s name.

The beach home, ski cabin, or other entertainment facility must be primarily for the benefit of employees other than those who are officers, shareholders, or other owners of a 10 percent or greater interest in the business, or other highly compensated employees. In this situation, you create

• 100 percent entertainment facility tax deductions for the employer (you or, if incorporated, your corporation), and
• tax-free use by the employees.

The employee facility deduction is straightforward. It has three splendid benefits for the small-business owner:

1. You deduct the facility as a business asset.
2. Your employees get to use the facility tax-free.
3. You own the property and can use it personally without tax consequences once you no longer need it for business use. (Note that when you sell, you will have a gain or loss on the sale and some possible recapture of depreciation.)

Vacation Home Rental—What’s Best for You: Schedule C or E?

Do you have a beach or mountain home that you rent out?

If the average period of rental is less than 30 days, you likely have a choice—either

• claim the income and expenses on Schedule C, or
• claim the income and expenses on Schedule E.

When Is Schedule C a Good Choice?

If you show a tax loss on your rental property, Schedule C is a great choice because it allows you to deduct your rental losses against all other income (assuming you materially participate in the rental property).

If you show taxable income on the rental property, Schedule C is not good because it causes you to pay self-employment taxes.

When Is Schedule E a Good Choice?

If you show taxable income on the transient rental, Schedule E is best because you don’t pay any self-employment taxes on Schedule E income.

If you show a loss on your transient rental and you materially participate, you can deduct your losses against all other income, but those Schedule E losses do not reduce self-employment income.

Okay, now you know how to play the game.

IRS in Summary Mode

In recent advice, the IRS stated that rentals of living quarters are not subject to self-employment tax when no services are rendered for the occupants.

But if services are rendered for the occupants, and the services rendered

1. are not clearly required to maintain the space in a condition for occupancy, and
2. are of such a substantial nature that the compensation for these services can be said to constitute a material portion of the rent,

then the net rental income received is subject to the self-employment tax.

Big Tax Break: Qualified Improvement Property

Do you own or lease non-residential (think “commercial”) real property for your business, or rent non-residential real property to others?

If so, interior improvements you make to the property may be fully deductible in a single year instead of over multiple years.

But to be deducted instantly, the improvements must fit into the category that the tax code calls “qualified improvement property” (QIP).

What Is QIP?

Ordinarily, non-residential real property is depreciated over 39 years. And so are improvements to such real property after it is placed in service.

But Congress wants to encourage business owners to improve their properties. So, starting in 2018, the TCJA established a new category of depreciable real property: QIP, which has a much shorter recovery period than regular commercial property—15 years. But even better, for tax years 2021 and 2022, QIP can qualify for that immediate 100 percent bonus depreciation deduction.

QIP consists of improvements, other than personal property, made by the taxpayer to the interior of non-residential real property after the date the building was first placed in service. For example, QIP includes interior improvements or renovations to any of the following:

• Office building (or single offices)
• Restaurant or bar
• Store
• Strip mall
• Motel or hotel
• Warehouse
• Factory

Since QIP applies only to non-residential property, improvements to residential rental property such as an apartment building are not QIP.

Transient Property

Airbnb and similar short-term residential rentals also qualify as non-residential property if they are rented on a transient basis—that is, over half of the rental use is by a series of tenants who occupy the unit for less than 30 days per rental.

QIP Examples

Examples of interior improvements that can receive QIP treatment include the following:

• Drywall
• Ceilings
• Interior doors
• Modifications to tenant spaces (if the interior walls are not load-bearing)
• Fire protection
• Mechanical
• Electrical
• Plumbing
• Heating and air interior equipment and ductwork
• Security equipment

QIP does not include improvements related to the enlargement of a building, an elevator or escalator, or the internal structural framework of a building. Structural framework includes “all load-bearing internal walls and any other internal structural supports.”

Placed in Service

QIP consists only of improvements made after the building was placed in service. But for these purposes, “placed in service” means the first time the building is placed in service by any person. By reason of this rule, you can purchase an existing property that was placed in service by an owner anytime in the past, renovate it before you place it in service, and still get QIP treatment.

But you have to make the improvements. You can’t acquire a building and treat improvements made by a previous owner as QIP.

How to Deduct Qualified Improvement Property

You may deduct the cost of QIP in one of three ways:

• use first-year bonus depreciation,
• use IRC Section 179 expensing, or
• depreciate the cost over 15 years using straight-line depreciation.

As mentioned earlier, QIP placed in service in 2021 and 2022 is eligible for 100 percent bonus depreciation. That is, you can deduct the entire cost in one year, without limit.

Starting in 2023, the tax code reduces bonus depreciation by 20 percent per year until it is completely phased out for property placed in service in 2027.

Selling Your Home to Your S Corporation

The strategy behind creating an S corporation and then selling your home to that S corporation comes into play when

• you want to convert your home to a rental property and take advantage of the exclusions, or
• you need more time to sell the home to realize the benefits of the $250,000 exclusion ($500,000 if filing a joint return).

With this strategy, one question often comes up: If a married couple sells their home to their S corporation to be a rental property, can the owners be the renters?

Answer: No. In this situation, the tax code treats your S corporation as you, the individual taxpayer, and thus you would be renting from yourself, and that would produce no tax benefits.

In effect, the S corporation renting the residence to the owner of the S corporation is the same as homeowners renting their residence to themselves. It produces no tax benefits.         

On the other hand, your S corporation could rent the home for use as a principal residence to your son or daughter or other related party, and the tax code would treat that rental the same as any rental to a third party.

Make Sure You Grab Your Home Internet Deduction

If you do some work at home, you’re probably using your home internet connection. Are your monthly internet expenses deductible? Maybe.

The deduction rules depend on your choice of business entity (proprietorship, corporation, or partnership).

Deduction on Schedule C

If you operate your business as a sole proprietorship or as a single-member LLC, you file a Schedule C to report your business income and expenses. As a Schedule C taxpayer, you may deduct ordinary and necessary expenses, which include business-related internet subscription fees.

You can deduct your use of your home internet whether or not you claim the home-office deduction, as follows:

• If you claim the home-office deduction on your Form 1040, the internet expense goes on line 21 (utilities) of IRS Form 8829 as either a direct or an indirect expense.
• If you do not claim the home-office deduction, enter the business portion of your internet expenses as utilities expenses on line 25 of your Schedule C.

Deduction When You Operate as a Corporation

When you operate your business as a corporation, you are an employee of that corporation. Because of the Tax Cuts and Jobs Act (TCJA), the only way for you to reap the benefits of the home internet deduction (or a home office) is to have your corporation reimburse you for the deduction. In the case of a reimbursed employee expense,

• the corporation deducts the expense as a utility expense, and
• you receive the reimbursement as a tax-free reimbursed employee business expense.

Why is the reimbursement method the only way for the corporate owner to get the deduction? The TCJA eliminated the 2018-2025 deduction for miscellaneous itemized expenses. These include unreimbursed employee expenses, such as internet connection fees.

Deduction When You Operate as a Partnership

If you have deductible home internet expenses and/or a home office and operate as a partner in a partnership, you have two ways to get a tax benefit:

1. Deduct the costs as unreimbursed partner expenses (UPE) on your personal return.
2. Or get reimbursed tax-free from your partnership via an accountable plan (think “expense report”).

Substantiating Your Home Internet Expense Deduction

Where business owners can run into trouble with the IRS is in substantiating their internet expense deduction.

You should have no problem showing the total cost for your home internet connection—just total your monthly bills. The problem is in establishing what percentage of the total cost was for business, because only that percentage is deductible.

Ideally, you should keep track of how much time you use your home internet connection for business and how much time for personal use. A simple log or notation on your business calendar or appointment book—indicating approximately how many hours you were online for business each day while working at home—should be sufficient.

Google it and you can find software and apps that will track your internet use.

Instead of tracking your home internet use every day throughout the year, you could use a sampling method such as that permitted for tracking business use of vehicles and other listed property. There is no logical reason the IRS shouldn’t accept such a sampling for internet use.