The Minnesota Real Estate Show Blog
Monday, July 9, 2018
July 2018
Apartment Complex Property Manager Determined to be an
Employee and not an Independent Contractor
(Hampton Software Development, LLC, TC Memo 2018-87)
The IRS recently won a tax court case that reclassified an apartment complex manager (who was being treated as an independent contractor) as an employee subjecting the apartment building’s owner to employment taxes and penalties.
BACKGROUND
Beyond Federal and State income tax, current tax law subjects employers and employees to employment taxes under Federal Insurance Contribution Act (FICA) and Federal Unemployment Tax Act (FUTA). Employers are required to withhold FICA tax, made up of Social Security taxes and Medicare taxes, on all wages paid to employees in addition to income tax withholding, FUTA is required to be paid by employers with respect to wages paid to employees.
To determine whether an individual is classified as an employee or independent contractor, the tax courts have historically looked at the 20 factors developed by the IRS’s common law tests. This court case was no different when applying these factors and the relevancy to the taxpayer’s situation as explained below:
FACTS OF THE CASE
Hampton Development Software, LLC (taxpayer) owned and operated a 60-unit apartment complex in Tulsa, Oklahoma. Hampton engaged Robert Herndon to provide property management services.
Hampton maintained exclusive authority to establish and change rent, policies, rules and regulations that applied to the apartment complex.
As the only person regularly performing services for the apartment complex, Mr. Herndon provided general maintenance services to the apartment complex and the apartment complex grounds, in addition to property management services.
Hampton classified Mr. Herndon as an independent contractor. Hampton did not issue Federal Form 1099-MISC to Herndon for his services. Consequently, Hampton did not withhold or pay employment or unemployment taxes with respect to the services provided by Mr. Herndon.
The IRS audit determined Mr. Herndon to be classified as an employee. In addition to assessing employment taxes on Mr. Herndon’s wages, the IRS assess penalties under Code Sec. 6651(a)(1) and Code Sec. 6651(a)(2) for failure to file a return and pay tax and penalties under Code Sec. 6656(a) for failure to deposit employment and unemployment taxes.
To determine whether Mr. Herndon was classified as an employee or independent contractor, the tax court examined the IRS’s classification factors and broke them down into the following factors:
(1)Degree of control exercised by the employer. Hampton maintained control over Mr. Herndon’s work by determining when and how work was to be performed. Mr. Herndon was given specific instruction as to how the work was to be performed.
(2)Which party invests in the work facilities used by the worker.While Mr. Herndon provided some of his own tools to perform the daily tasks, Hampton owned most of the tools Mr. Herndon used to complete the tasks. For example, Hampton provided Mr. Herndon with a lawn mower and a company credit card to purchase materials and tools as needed.
(3)The worker’s opportunity for profit or loss. Mr. Herndon was paid a set salary regardless of hours worked or how successful Hampton was.
(4)Whether the employer can discharge the worker. Hampton had the right to discharge Mr. Herndon at any time and Mr. Herndon had the right to resign at any time.
(5)Whether the work if part of the employer’s regular business. Mr. Herndon’s services were an integral part of the Hampton business. His management services included replacing tenants, collecting rents, placing advertisements, etc.
(6)The permanency of the relationship. Mr. Herndon provided services to Hampton since Hamptons purchase of the complex. Mr. Herndon also lived on one of the apartments of the complex located adjacent to Hampton’s office.
(7)The relationship the parties believed they had created.Mr. Herndon was compensated differently by outside handyman work than he was by Hampton. He submitted bids instead of receiving a set salary.
(8)Whether the employer provided employee benefits to the worker.Hampton didn’t provide any employee benefits to Mr. Herndon, but did provide him with paid time off.
OTHER POINTS TO CONSIDER
A couple of other points to consider in this case are:
-Regarding the 20 factors applied by the IRS; they are not all encompassing in formulating a concluding opinion
-The taxpayer DID NOT issue any Form 1099-MISC information reporting to Mr. Herndon. During worker classification disputes, a business can seek relief from employment and unemployment taxes under Section 530 of the Revenue Act of ’79 (P.L. 95-600). In order for the business to qualify for relief under Section 530, they must demonstrate all of the following: (1) the employer has not treated the worker as an employee during any period; (2) the employer doesn’t treat any other individual holding a substantially similar position as an employee for any period; (3) the employer files all required federal tax returns on a basis consistent with treating the individual as a non-employee; and (4) the employer has a reasonable basis for not treating the induvial as an employee.
-There was no mention of an Independent Contract signed by Hampton and Mr. Herndon. An Independent Contract is highly recommended in any type of service situation.
-The IRS is not the only agency examining worker classifications. State jurisdictions will raise the issue as well. For example, Minnesota used to follow similar guidelines to the IRS when dealing with worker classification but now focuses on three main categories which essentially distills 20-factor test. These can be found on the Minnesota Department of Revenue website.
1) Behavioral control
2) Financial Control
3) Relationship of the Parties
CONCLUSION
The courts concluded that Mr. Herndon’s relationship did not reflect that of an independent contractor. It was also determined that taxpayer (Hampton) could not obtain Section 530 penalty relief because Hampton was unable to provide proof that the business consistently treated Mr. Herndon as an independent contractor by failing to issue 1099-MISC for his services.
When classifying an individual as an independent contractor, it is important to clearly define the working relationship between the business and the worker and to follow all federal tax return filing requirements. As demonstrated on the Hampton Software Development, LLC case, failing to follow these guidelines can have costly consequences, not just in back payment of employment taxes, but significant penalties imposed by the IRS for failing to comply with tax return filing requirements such as 1099s.
Greg I. Nelson, CPA, MBT; Ryan Kelly, CPA, MBT; Laura Huberty, CPA
Olsen Thielen, CPAs
Tuesday, February 27, 2018
IRS provides guidance on Home Equity Loan interest deductions under recently enacted Tax Cuts & Jobs Act
IRS Information Release 2018-32
News Release 2018-32, 02/21/2018
Interest deduction on Home Equity Loans Still Exists Under New Law
With IRS Information Release 2018-32 the IRS provided some illustrations that address certain situations where taxpayers can still continue to deduct interest paid on home equity loans.
We still anticipate that more guidance may be necessary to address the interest tracing rules relating to home equity interest.
New Tax law
The Tax Cuts and Jobs Act of 2017 suspended from 2018 until 2026 the deduction for interest paid on home equity loans and lines of credit. There was much discussion whether this was a bright line test that applied to all home equity loans or whether the taxpayer could still deduct the interest if the home equity loan proceeds were used to buy, build or substantially improve the taxpayer's home that secures the loan (following the rules/definition of Qualified Indebtedness).
Effective December 15, 2017 (and binding contracts) anyone considering taking out a mortgage may only deduct interest on loans up to $750,000 ($375,000 for married filing separate) of qualified residence loans. The prior limit was $1 million ($500,000 married taxpayer filing separate).
The IRS outlined the following illustrations:
Example 1: In January 2018, a taxpayer takes out a $500,000 mortgage to purchase a main home with a fair market value of $800,000. In February 2018, the taxpayer takes out a $250,000 home equity loan to put an addition on the main home. Both loans are secured by the main home and the total does not exceed the cost of the home. Because the total amount of both loans does not exceed $750,000, all of the interest paid on the loans is deductible. However, if the taxpayer used the home equity loan proceeds for personal expenses, such as paying off student loans and credit cards, then the interest on the home equity loan would not be deductible.
Example 2: In January 2018, a taxpayer takes out a $500,000 mortgage to purchase a main home. The loan is secured by the main home. In February 2018, the taxpayer takes out a $250,000 loan to purchase a vacation home. The loan is secured by the vacation home. Because the total amount of both mortgages does not exceed $750,000, all of the interest paid on both mortgages is deductible. However, if the taxpayer took out a $250,000 home equity loan on the main home to purchase the vacation home, then the interest on the home equity loan would not be deductible.
Example 3: In January 2018, a taxpayer takes out a $500,000 mortgage to purchase a main home. The loan is secured by the main home. In February 2018, the taxpayer takes out a $500,000 loan to purchase a vacation home. The loan is secured by the vacation home. Because the total amount of both mortgages exceeds $750,000, not all of the interest paid on the mortgages is deductible. A percentage of the total interest paid is deductible (see Publication 936).
Summary
With the above illustrations, it becomes clear that interest incurred on home equity loans are still deductible if the home equity loan is secured by the residence and the proceeds are used for that same residence. Outside of a direct relationship between the home equity loan and the secured property home equity loan interest is not deductible. Taking this one step further and how this relationship relates to the tracing rules (for example if home equity loans are used for investment property) remains unclear. Using example 2 where tracing was not allowed in purchasing the vacation home; this would imply that using a home equity loan that is secured by your principal residence for investment property purchase the interest would also not be deductible.
Greg I. Nelson, CPA, MBT; Ryan Kelly, CPA, MBT
Olsen Thielen, CPAs
Wednesday, October 11, 2017
Mortgage broker not qualified as a real estate professional
Mortgage broker not qualified as a real estate professional
Hickam, TC Summary Opinion 2017-66
Passive Loss Rules
Under IRS code section 469 all real estate activities are considered passive and any losses related to such activities are disallowed or can only be offset by passive income. The passive loss rules/limitations are different if a taxpayer qualifies as a real estate professional. If a taxpayer qualifies as a real estate professional and materially participates, the loss disallowance doesn’t apply and the taxpayer’s rental real estate activity, if conducted as a trade or business, is not treated as a passive activity.
A taxpayer qualifies as a real estate professional if: (1) more than half of the personal services that the taxpayer performs during that year are performed in real property trades or businesses in which he materially participates with 5% ownership; and (2) the taxpayer performs more than 750 hours of services during that tax year in real property trades or businesses in which he or she materially participates.
"Real property trade or business: the term "real property trade or business” means any real property development, redevelopment, construction, reconstruction, acquisition, conversion, rental, operation, management, leasing, or brokerage trade or business.”
Taxpayer situation
During 2011 and 2012 the taxpayer brokered real estate mortgages and other loans as an independent contractor for a mortgage brokerage company. During this time, the taxpayer brokered and originated loans for clients to buy real estate, refinanced existing loans, and secured reverse mortgages, commercial loans and sometimes construction loans. Taxpayer did not operate, develop, construct, or rent real estate in brokering mortgages or originating loans.
During this same period, the taxpayer actively managed and maintained three rental real estate properties. The taxpayer claimed he was a real estate professional for tax purposes by brokering and originating mortgages.
Decision
Chief Counsel Advice 201504010 states that a real estate agent who brings together buyers and sellers of real property can be deemed a real estate professional who is engaged in a real property brokerage trade or business, however a mortgage broker who is a broker of financial instruments is not engaged in a real property brokerage trade or business.
Despite this Chief Counsel Advice, the IRS contended the IRC 469 is clear that mortgage brokerage and loan origination services were not real property trades or businesses. IRS argued that the CCA, rather than establishing a new interpretation of the law, correctly relied upon the statute.
The Court, basing its conclusion on its interpretation of the Code and not on the Chief Counsel Advice, determined that services related to brokering and originating loans do not fall under the definition of operation or brokerage of real property. Neither his mortgage brokerage services nor his loan origination services constituted real property trades or businesses for purposes of IRC 469.
Conclusion
Although the taxpayer worked closely with real property with brokerage services and loan origination services, this did not qualify him as a real estate professional under the real estate passive loss rules. The passive loss rules under IRC 469 continue to be very complex. Proper tax planning involves the proper fact gathering.
Greg I. Nelson, CPA, MBT; Ryan Kelly, CPA, MBT, Mark Angell, CPA, MBT
Olsen Thielen CPAs
Greg Nelson, CPA, MBT
Friday, August 18, 2017
Taxpayers incorrectly claim a deduction for depreciation
Taxpayers incorrectly claim a deduction for depreciation
Allocation of Land and Building
Nielsen, TC Summ. Op. 2017-31
Tax Law Background
Section 167(a) allows as a depreciation deduction a reasonable allowance for the exhaustion, wear, and tear of property used in a trade or business. The purpose of the deduction for depreciation is to allow the taxpayer to recover over the useful life of the property its cost or other basis.
The depreciation deduction for any tangible property generally is to be determined by using the applicable depreciation method, the applicable convention, and the applicable recovery period. Generally, depreciation is computed by using the cost of the property as its basis.
If depreciable property and non-depreciable property such as real property are bought for a lump sum, the cost must be apportioned between the land and the building (including improvements).
In making this allocation, the IRS regulation 1.167(a)-5 provides: In the case of the acquisition on or after March 1, 1913, of a combination of depreciable and non-depreciable property for a lump sum, as for example, buildings and land, the basis for depreciation cannot exceed an amount which bears the same proportion to the lump sum as the value of the depreciable property at the time of acquisition bears to the value of the entire property at that time. The relevant inquiry is the respective fair market values of the depreciable and non-depreciable property (land) at the time of acquisition.
Situation
Taxpayer lived in California and owned several rental properties. The taxpayer purchased 3 properties and included the total purchase price of each property in its depreciable basis. The applicable County assessor’s office showed values of the land ranging from 31% to 44%. The taxpayer agreed that there should be an allocation of land but also argued that the County assessor’s value was excessive.
Decision
The Tax Court concluded that the taxpayer incorrectly included non-depreciable land in the basis for the depreciation deduction for these rental properties. The taxpayer was unable to show any burden of proof as to the value of land so the County assessor’s value was allowed.
Conclusion
When purchasing real property; there needs to be a reasonable method when allocating the cost between buildings and land. Make sure to use a reasonable valuation method of allocation such as a qualified real estate appraisal or even perhaps the County tax records.
Greg I. Nelson, CPA, MBT; Ryan Kelly, CPA, MBT
Olsen Thielen, CPAs
Greg Nelson, CPA, MBT
Friday, August 18, 2017
Work in Exchange for Economic Gain is Taxable Income
Work in Exchange for Economic Gain is Taxable Income
Welemin, TC Summ. Op. 2017-54
Tax Law Background
The fair market value of goods and services received from another person in a barter arrangement is treated as gross income for tax purposes.
The term "gross income” is broadly defined in the code to include all income from whatever source derived. Gross income encompasses compensation for services, including fees, commissions, fringe benefits, and similar items.
Situation
The taxpayer Welemin and his family rented a home in an apartment in California. Mr. Welemin was a handyman by trade. The taxpayer was falling behind on rent payments. To avoid eviction the taxpayer made an informal arrangement with the lessor to provide repair and maintenance services in exchange for reduced rent. The lessor issued a 1099-Misc for $12,000, and the taxpayer disagreed both with this amount, and the fact that he should have to report it as gross income. The taxpayer intentionally omitted this income from his tax return.
Decision
The court ruled that Mr. Welemin should have reported his services rendered as taxable income. Due to the omission of the income altogether, it was concluded that the taxpayer was also liable for an accuracy related penalty.
Conclusion
Bartering is a taxable transaction. If engaging in barter transactions, be sure to properly report these transactions as the fair market value of services received in gross income. Note that the payor is also responsible for submitting the year end Form 1099-MISC to the payee.
Greg I. Nelson, CPA, MBT; Ryan Kelly, CPA, MBT
Olsen Thielen, CPAs
Greg Nelson, CPA, MBT
Tuesday, August 2, 2016
Taxpayers qualifies for Home Sale Exclusion due to increased family size
Private Letter Ruling 201628002
Tax Law Background
A taxpayer can exclude up to $250,000 of gain ($500,000 for married taxpayers filing jointly) from the sale or exchange of a home owned and used by him/her as a principal residence for at least two of the five years before the sale.The full $250,000/$500,000 exclusion does not apply if, within the 2-year period ending on the sale date, there was another home sale by the taxpayer to which the exclusion applied, but the taxpayer may still be eligible for a reduced maximum exclusion when his/her failure to satisfy the ownership and use requirements is primarily due to the occurrence of unforeseen circumstances
Situation
Facts: Taxpayers were married and had a daughter when they first purchased their residence. Their residence is a condominium with two small bedrooms and two baths. The child's bedroom also served as the Husband's home office as well as a guest room. After the purchase of their residence, the Wife became pregnant and gave birth to a son. The taxpayers moved out of within the 2 year exclusion period and purchased a new residence.
The taxpayers requested a ruling that the gain on the sale of their residence may be excluded under the reduced maximum exclusion.
Decision
The Private letter Ruling concluded that the occurrence of unforeseen circumstances was the primary reason for the sale and that the suitability of their residence materially changed. Accordingly, the gain on the sale of residence can be excluded under the reduced maximum exclusion of gain.
Conclusion
Note that a Private Letter Ruling applies specifically to that taxpayer’s situation. It does not establish a safe harbor for all taxpayers. It does however; give taxpayers in similar situations the opportunity to request their own Private Letter Ruling to determine if they can qualify for the reduced principal residence exclusion under the unforeseen circumstances test.
Greg Nelson, CPA, MBT; Ryan Kelly, CPA, MBT; Mark Angell, CPA, MBT
Olsen Thielen CPAs
August 2, 2017
Greg Nelson
Saturday, March 5, 2016
Certificate of Rent Paid - Minnesota
Certificates of Rent Paid (CRP)- What is my obligation as
a landlord?
Minnesota
Department of Revenue has recently issued a bulletin (3/4/16) concerning the
CRPs.
Certificates of Rent Paid (CRP)
All
rental property owners, managers, or operators must provide a Certificate of
Rent Paid (CRP) to each person who rented from them during the previous year
unless they are qualify for the specific exemptions.
CRPs
are due January 31
What
if my tenant didn't receive a CRP or received an incorrect CRP?
If
a landlord refuses to issue a CRP, or fix an incorrect CRP, the tenant may
request a Rent Paid Affidavit (RPA) from us. To request an RPA, call the MN
Department of Revenue at 651-296-3781 or 1-800-657-9094 (toll-free). The
tenant will need to provide information about themselves and their landlord
when requesting an RPA
For more explanation and guidance here is the link: http://www.revenue.state.mn.us/individuals/prop_tax_refund/
Greg Nelson, CPA, MBT and Mark Angell, CPA, MBT
Olsen Thielen CPAs
March 5, 2016
Greg Nelson - Olsen Theilen CPAs
Saturday, March 5, 2016
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