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The tax rules of renting out a vacation property

Summer is just around the corner. If you’re fortunate enough to own a vacation home, you may wonder about the tax consequences of renting it out for part of the year.

The tax treatment depends on how many days it’s rented and your level of personal use. Personal use includes vacation use by your relatives (even if you charge them market rate rent) and use by nonrelatives if a market rate rent isn’t charged.

If you rent the property out for less than 15 days during the year, it’s not treated as “rental property” at all. In the right circumstances, this can produce significant tax benefits. Any rent you receive isn’t included in your income for tax purposes (no matter how substantial). On the other hand, you can only deduct property taxes and mortgage interest — no other operating costs and no depreciation. (Mortgage interest is deductible on your principal residence and one other home, subject to certain limits.)

If you rent the property out for more than 14 days, you must include the rent you receive in income. However, you can deduct part of your operating expenses and depreciation, subject to several rules. First, you must allocate your expenses between the personal use days and the rental days. For example, if the house is rented for 90 days and used personally for 30 days, then 75% of the use is rental (90 days out of 120 total days). You would allocate 75% of your maintenance, utilities, insurance, etc., costs to rental. You would allocate 75% of your depreciation allowance, interest, and taxes for the property to rental as well. The personal use portion of taxes is separately deductible. The personal use portion of interest on a second home is also deductible if the personal use exceeds the greater of 14 days or 10% of the rental days. However, depreciation on the personal use portion isn’t allowed.

If the rental income exceeds these allocable deductions, you report the rent and deductions to determine the amount of rental income to add to your other income. If the expenses exceed the income, you may be able to claim a rental loss. This depends on how many days you use the house personally.

Here’s the test: if you use it personally for more than the greater of 1) 14 days, or 2) 10% of the rental days, you’re using it “too much,” and you can’t claim your loss. In this case, you can still use your deductions to wipe out rental income, but you can’t go beyond that to create a loss. Any unused deductions are carried forward and may be usable in future years. If you’re limited to using deductions only up to the amount of rental income, you must use the deductions allocated to the rental portion in the following order: 1) interest and taxes, 2) operating costs, 3) depreciation.

If you “pass” the personal use test (i.e., you don’t use the property personally more than the greater of the figures listed above), you must still allocate your expenses between the personal and rental portions. In this case, however, if your rental deductions exceed rental income, you can claim the loss. (The loss is “passive,” however, and may be limited under the passive loss rules.)

As you can see, the rules are complex. Contact us if you have questions or would like to plan ahead to maximize deductions in your situation.

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Are COVID-19 testing and vaccination programs subject to ERISA?

As of this writing, many public health experts are cautiously optimistic that cases, hospitalizations and deaths related to COVID-19 will continue to trend downward or at least remain at manageable levels in most areas. The United States might finally be moving from pandemic to endemic.

This means that many employers can, at long last, greenlight the full “return to office” plans that they’ve had on hold for months. As part of such a plan, some organizations are considering on-site COVID-19 testing and vaccinations to guard against an outbreak that could cripple productivity or even shut down an office or facility.

A common question that arises in response to the idea is: Will a program offering COVID-19 testing, vaccinations or both be subject to the Employee Retirement Income Security Act (ERISA)?

Two ways to go about it

The answer depends on how the program is structured and operates. Generally, an arrangement is an ERISA welfare benefit plan if it’s a plan, fund or program established or maintained by an employer to provide ERISA-listed benefits, which include medical services. Here are a couple of ways you could go about offering testing and vaccination:

Augment your existing plan. Your organization could offer COVID-19-related services as part of an existing employer-sponsored group health plan, such as major medical coverage, that’s already subject to ERISA. In fact, group health plans and insurers — but not employers themselves — are required to cover certain COVID-19 diagnostic and preventive services, including vaccines. Providing the services through an existing plan, however, means they’d be available only to plan participants, which might not include every employee.

Create a standalone arrangement. You could offer COVID-19 testing and vaccination apart from your existing health plan. In this instance, the program would have to be evaluated for ERISA status on its own.

COVID-19 tests and vaccines are considered medical care, so whether the program must comply with ERISA depends on whether the other conditions for ERISA plan status are met. A program that doesn’t require an “ongoing administrative scheme” might not be considered a “plan, fund or program” subject to ERISA. However, if ongoing administration is necessary, the arrangement is likely an ERISA plan.

Other applicable laws

An ERISA welfare benefit plan that provides medical benefits is a group health plan, making it subject to additional ERISA requirements and potentially triggering application of other laws — including the Affordable Care Act. But you might be able to structure the services to limit your compliance obligations.

For example, offering COVID-19 testing and vaccination through an on-site medical clinic or an employee assistance program could implicate ERISA, including ERISA’s group health plan rules. However, the program might be treated as an “excepted benefit” exempted from many ACA requirements and other group health plan rules.

Employers providing COVID-19 testing and vaccination directly or through an agent can also face more obligations under the Americans with Disabilities Act (ADA). This is because these actions generally involve medical examinations or disability-related inquiries, which fall under the ADA’s purview.

Finally, remember your obligation to maintain the confidentiality of employees’ health information. These obligations apply to employers under the ADA and to group health plans under the Health Insurance Portability and Accountability Act (HIPAA). Also restricted under HIPAA is the ability of a group health plan to disclose employees’ health information to the employer sponsoring the plan.

A wide array

As you can see, there are a wide array of compliance considerations when establishing an employment-based COVID-19 testing and vaccination program. Discuss the details with legal counsel before making any decisions or communicating anything to employees. We can help you evaluate the idea from a cost perspective.

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When inheriting money, be aware of “income in respect of a decedent” issues

Once a relatively obscure concept, “income in respect of a decedent” (IRD) may create a surprising tax bill for those who inherit certain types of property, such as IRAs or other retirement plans. Fortunately, there may be ways to minimize or even eliminate the IRD tax bite.

Basic rules

For the most part, property you inherit isn’t included in your income for tax purposes. Items that are IRD, however, do have to be included in your income, although you may also be entitled to an IRD deduction on account of them.

What’s IRD? It is income that the decedent (the person from whom you inherit the property) would have taken into income on his or her final income tax return except that death interceded. One common IRD item is the decedent’s last paycheck, received after death. It would have normally been included in the decedent’s income on the final income tax return. However, since the decedent’s tax year closed as of the date of death, it wasn’t included. As an item of IRD, it’s taxed as income to whomever does receive it (the estate or another individual). Not just the final paycheck, but any compensation-related benefits paid after death, such as accrued vacation pay or voluntary employer benefit payments, will be IRD to the recipient.

Other common IRD items include pension benefits and amounts in a decedent’s individual retirement accounts (IRAs) at death as well as a decedent’s share of partnership income up to the date of death. If you receive these IRD items, they’re included in your income.

The IRD deduction 

Although IRD must be included in the income of the recipient, a deduction may come along with it. The deduction is allowed (as an itemized deduction) to lessen the “double tax” impact that’s caused by having the IRD items subject to the decedent’s estate tax as well as the recipient’s income tax.

To calculate the IRD deduction, the decedent’s executor may have to be contacted for information. The deduction is determined as follows:

  • First, you must take the “net value” of all IRD items included in the decedent’s estate. The net value is the total value of the IRD items in the estate, reduced by any deductions in respect of the decedent. These are items which are the converse of IRD: items the decedent would have deducted on the final income tax return, but for death’s intervening.
  • Next you determine how much of the federal estate tax was due to this net IRD by calculating what the estate tax bill would have been without it. Your deduction is then the percentage of the tax that your portion of the IRD items represents.

In the following example, the top estate tax rate of 40% is used. Example: At Tom’s death, $50,000 of IRD items were included in his gross estate, $10,000 of which were paid to Alex. There were also $3,000 of deductions in respect of a decedent, for a net value of $47,000. Had the estate been $47,000 less, the estate tax bill would have been $18,800 less. Alex will include in income the $10,000 of IRD received. If Alex itemizes deductions, Alex may also deduct $3,760, which is 20% (10,000/50,000) of $18,800.

We can help

If you inherit property that could be considered IRD, consult with us for assistance in managing the tax consequences.

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Establish a tax-favored retirement plan

If your business doesn’t already have a retirement plan, now might be a good time to take the plunge. Current retirement plan rules allow for significant tax-deductible contributions.

For example, if you’re self-employed and set up a SEP-IRA, you can contribute up to 20% of your self-employment earnings, with a maximum contribution of $61,000 for 2022. If you’re employed by your own corporation, up to 25% of your salary can be contributed to your account, with a maximum contribution of $61,000. If you’re in the 32% federal income tax bracket, making a maximum contribution could cut what you owe Uncle Sam for 2022 by a whopping $19,520 (32% times $61,000). 

More options

Other small business retirement plan options include:

  • 401(k) plans, which can even be set up for just one person (also called solo 401(k)s),
  • Defined benefit pension plans, and
  • SIMPLE-IRAs.

Depending on your circumstances, these other types of plans may allow bigger deductible contributions.

Deadlines to establish and contribute

Thanks to a change made by the 2019 SECURE Act, tax-favored qualified employee retirement plans, except for SIMPLE-IRA plans, can now be adopted by the due date (including any extension) of the employer’s federal income tax return for the adoption year. The plan can then receive deductible employer contributions that are made by the due date (including any extension), and the employer can deduct those contributions on the return for the adoption year.

Important: The SECURE Act provision didn’t change the deadline to establish a SIMPLE-IRA plan. It remains October 1 of the year for which the plan is to take effect. Also, the SECURE Act change doesn’t override rules that require certain plan provisions to be in effect during the plan year, such as the provisions that cover employee elective deferral contributions (salary-reduction contributions) under a 401(k) plan. The plan must be in existence before such employee elective deferral contributions can be made.

For example, the deadline for the 2021 tax year for setting up a SEP-IRA for a sole proprietorship business that uses the calendar year for tax purposes is October 17, 2022, if you extend your 2021 tax return. The deadline for making the contribution for the 2021 tax year is also October 17, 2022. However, to make a SIMPLE-IRA contribution for the 2021 tax year, you must have set up the plan by October 1, 2021. So, it’s too late to set up a plan for last year.

While you can delay until next year establishing a tax-favored retirement plan for this year (except for a SIMPLE-IRA plan), why wait? Get it done this year as part of your tax planning and start saving for retirement. We can provide more information on small business retirement plan alternatives. Be aware that, if your business has employees, you may have to make contributions for them, too.

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The fringe benefit implications of employer-provided cell phones

Successful african businessman working on phone smiling witting in car. Portrait of mature smiling business man in formal clothes using smartphone while sitting on back seat of luxury business car. Senior formal man reading confirmation mail on smartphone and smiling in a taxi.

With so many more employees working remotely over the last couple of years, many employers have had to grapple with whether to provide workers with cell phones or allow them to use personal phones for business purposes.

From a fringe benefits perspective, two questions typically arise when this matter comes up. First, will the IRS view employer-provided phones as a nontaxable fringe benefit — even if employees sometimes use the phones for personal calls? And second, instead of providing phones, could the employer reimburse employees on a nontaxable basis for business use of their personal phones?

Providing the phone

Business use of an employer-provided cell phone may be treated as a nontaxable working condition fringe benefit so long as the phone is provided “primarily for noncompensatory business purposes.” Examples of noncompensatory purposes include the need to be accessible to an employer at any time for work-related emergencies, or to be accessible to customers outside of normal business hours or when away from the office.

If the noncompensatory business purposes test is met, the value of any personal use of an employer-provided phone will be treated as a nontaxable “de minimis” fringe benefit. However, an employer-provided phone will fail the test — and trigger taxable income — if the phone is provided as a substitute for compensation, or to attract new employees or boost staff morale.

Reimbursements for personal phones

The IRS has indicated that it will analyze the reimbursement of employees’ expenses for their personal cell phones similarly. Reimbursements generally won’t be considered additional income or wages so long as three conditions are met:

  1. The employer has substantial business reasons for requiring employees to use their personal phones and reimbursing employees for that use.
  2. The reimbursements are reasonably related to the needs of the employer’s operations and are reasonably calculated not to exceed the expenses that an employee typically incurs in maintaining the phone.
  3. The reimbursements aren’t a substitute for a portion of an employee’s regular wages.

So, let’s say an employer reimburses an employee for a basic cell phone plan that charges a flat monthly rate for a specified number of minutes of domestic calls, and some of those minutes are used for personal calls. In such a case, the portion of the cost attributable to personal use can be deemed a nontaxable “de minimis” fringe benefit if all three requirements noted above are met.

Further info

These rules also apply to “similar telecommunications equipment.” Although the IRS doesn’t define that phrase with complete clarity, the agency has affirmed that tablet devices are eligible. Our firm can provide further information and help you decide which fringe benefits are best for your organization.

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Going private

Private vs Public words on paper arrow pinned on cork board. Business Concept

Recently, the news media has given a lot of attention to initial public offerings using special purpose acquisition companies (SPACs). But there’s another major transaction that’s gaining momentum amid the economic chaos caused by the COVID-19 pandemic: privatizations. Going private (also known as delisting) has many benefits, including:

  • Reduced accounting, regulatory and governance costs,
  • Fewer liability risks, and
  • Greater freedom to pursue long-term growth — rather than focusing on short-term profits to appease investors on Wall Street.

Should your company go private? To answer this question, it’s important to understand how these transactions work and how they must be reported to the Securities and Exchange Commission (SEC).

SEC requirements

Under SEC rules, a company can elect to deregister its equity securities when they’re held by fewer than 300 shareholders of record, or fewer than 500 shareholders of record if the company doesn’t have significant assets. Depending on the facts and circumstances, a company may no longer be required to file periodic reports with the SEC once the number of shareholders of record drops below those thresholds.

In going-private transactions, a tender offer is typically used to purchase the shares of minority shareholders. However, the transaction can also take the form of a merger, a reverse stock split or a private equity buyout. The goal is to reduce the shareholder base to a level where the company may elect to terminate its status as a public company.

The SEC scrutinizes going-private transactions to ensure that unaffiliated shareholders are treated fairly. A company that’s going private — together with its controlling shareholders and other affiliates — must, among other requirements, file detailed disclosures pursuant to SEC Rule 13e-3.

Detailed disclosures

To comply with SEC Rule 13e-3, companies executing a going-private transaction must disclose:

  • The purposes of the transaction, including any alternatives considered and the reasons they were rejected,
  • The fairness of the transaction, both substantive (price) and procedural, and
  • Any reports, opinions and appraisals “materially related” to the transaction.

The SEC’s rules are intended to protect shareholders. Some states also have takeover statutes to provide shareholders with dissenters’ rights. Such a transition results in a limited trading market to be able to sell the stock.

Failure to act with the utmost fairness and transparency can bring harsh consequences. SEC scrutiny can lead to costly damage awards and penalties if your company is guilty of treating minority shareholders unfairly or making misleading disclosures.

What’s right?

With interest rates low and market volatility high, now may be a good time for struggling public companies to consider delisting. Contact us to discuss the pros and cons of going private. We can help you comply with the SEC rules and structure your transaction in a manner that ensures transparency, procedural fairness and a fair price.

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