New 1099-NEC to replace the 1099-Misc for Non Employee Compensation

This form is slated by the IRS to replace the 1099-Misc form now used for Non Employee Compensation.

Business Meals & Entertainment expenses

With great fanfare, the Tax Cuts and Jobs Act (TCJA) eliminated deductions for business entertainment expenses, beginning in 2018. But, not completely.  Despite the fears of a number of tax commentators, guidance recently issued by the IRS preserves deductions for business meals incurred in connection with entertainment, albeit in limited circumstances (IRS Notice 2018-76, 10/3/18).

First, here’s some background information. Prior to the TCJA, you could deduct 50 percent of the cost of qualified business entertainment, as long as you met strict substantiation requirements spelled out in IRS regulations. This covered entertainment that was “directly-related to” or “associated with” the business.

Frequently, the cost of meals and beverages was included in such entertainment. For instance, if meals were held in a clear business setting, like a hospitality suite at a convention, they qualified as directly-related entertainment.

Similarly, if you treated a customer to a meal after a substantial business discussion, you could write off 50 percent of the cost as associated-with entertainment. But then the TCJA repealed the deduction for business entertainment.

Where did that leave deductions for business meals? Clearly, meals incurred while traveling away from home on business, such as a business trip to finalize a contract with a client, remains deductible, subject to the 50 percent limit.

But the rules weren’t as clear for meals incurred in connection with entertainment. Fortunately, the IRS has provided some leeway. In the 2018 Notice, it says that taxpayers may deduct 50 percent of the cost of business meals if:

The expense is an ordinary and necessary business expense paid or incurred during the tax year.  The expense is not lavish or extravagant under the circumstances.  The taxpayer, or an employee of the taxpayer, is present when the food or beverages are furnished.  The food and beverages are provided to a current or potential business customer, client, consultant or similar business contact.

For food and beverages provided during or at an entertainment activity, they are purchased separately from the entertainment or the cost of the food and beverages is stated separately from the cost of the entertainment on one or more bills, invoices or receipts.

Caution: The rules can’t be circumvented by inflating amounts charged for food and beverages in connection with entertainment activities.

To illustrate the new rules, the Notice provides three examples where business taxpayers attended games with business contacts.

Example 1: A taxpayer takes a customer to a baseball game and buys the hot dogs and drinks. The tickets are nondeductible entertainment, but the taxpayer can deduct 50 percent of the cost of the hot dogs and drinks purchased separately.

Example 2: A taxpayer takes a customer to a basketball game in a luxury suite. During the game, they have access to food and beverages, which are included in the cost of the tickets. Both the cost of the tickets and the food and beverages are nondeductible entertainment.

Example 3: The same facts as in Example 2, except that the invoice for the basketball game tickets separately states the cost of the food and beverages. In this case, the taxpayer can deduct 50 percent of the cost of the food and beverages.

The IRS is expected to issue new regulations with more details. In the meantime, you can rely on the 2018 Notice.

Thanks to Ken Berry, esq. for much of this information.

Is that taxable boot?

Clients who are preparing to conduct a 1031 exchange often ask: Is it possible to have an exchange that is partially taxable? Many ask because they are concerned about whether they will be able to line up a property (or properties) of sufficiently high value.

To achieve full tax deferral in an exchange, clients must spend all of the proceeds from their sale and reacquire any debt paid off. But an exchange does not have to result in this outcome. It’s possible to receive some cash (after the exchange) or have some debt relief and still defer a portion of the tax liability. In this post, we will discuss one of the key topics in Section 1031, the topic of boot. 

In technical terms, boot refers to any sort of property received in an exchange that is not of like-kind to the relinquished property. This means it can take a variety of forms, not just cash or debt relief, although these are among the most common types. Here, though, I'll just cover cash boot and mortgage boot. 

Cash Boot

This kind can be received either voluntarily, such as when a taxpayer wishes to extract cash, or involuntarily, such as when a taxpayer is unable to locate a replacement property of sufficiently high value. In the former situation, taxpayers wish to extract a certain amount of cash in order to finance other purchases. This can be done, but the cash will be taxed to the extent of the gain. In the latter scenario, if a taxpayer owns a property valued at $1 million, with a $500,000 basis, and can only locate replacement properties worth $750,000, then they need to be prepared to pay taxes on the cash that will follow. This is often referred to as "buying down."  

As long as the exchange conforms to all of the legal regulations pertaining to receipt, a partial exchange involving cash boot will not result in a failure. In other words, just because cash boot is received doesn’t mean that the remaining gain cannot be deferred.

Mortgage Boot

This type occurs when a taxpayer has an existing mortgage loan that is paid off by the sale and they fail to acquire a mortgage of equal value on the purchase.

Consider this example: A taxpayer owns a property, valued at $1 million, with a $450,000 basis and a mortgage loan of $200,000. When they sell, the mortgage loan will be paid off, so the exchange fund will have approximately $800,000.

However, this doesn’t mean that only $800,000 has to be spent in order to achieve full tax deferral. The taxpayer also has to either acquire a mortgage of at least $200,000 or bring in additional cash to balance out the loan. If they simply use the cash to purchase a property worth $800,000, they will have $200,000 of debt relief, or “mortgage boot,” and this amount would be taxable. To achieve full tax deferral, the taxpayer would need to purchase a property worth at least $1 million and bring in additional cash or acquire a new mortgage loan.

As you can see, there's a good reason clients bring this topic up. They want to know whether they can voluntarily take out cash to finance other things. They also want to know the potential consequences that can follow from a mortgage loan or a buying down in value. The good news is: Partial exchanges are permissible; these won’t necessarily cause the exchange to collapse. But, if full tax deferral is the goal, that taxpayer needs to understand how boot works and how it can avoided. 

Thanks to Jorgen Rex Olsen for this valuable information!

IRS Conference in Washington D.C in July

Had a great time in D.C. at the IRS tax forum.  Heard some very interesting topics such as updates on the Section 199A Qualified Business Income deduction, bonus depreciation allowed and other topics.