Valuing Your Employee’s Personal Use of Business Auto

Whether your company supplies business autos to employees primarily as “perks” or as necessary tools to help them get their work done, their personal use of the auto has tax implications for them and for you. That’s because an employee’s personal use of a company auto generally must be treated as non-cash taxable fringe benefit that is also subject to social security taxes. Fortunately, the tax rules give you some flexibility in valuing personal usage of the company car.

Just as there is many leading car brands to chose from, based on your business situation, you can choose from among four valuation methods:

  1. The general fair market value method, which is based on what a person would pay locally to lease a comparable auto for a period of time comparable to the period of time the employee has use of the car;

  2. The lease value method, which assigns an IRS-determined annual lease value to the auto depending on its value when first provided for the employee’s personal use;

  3. The mileage rate method, which values each personal-use mile at a standard business mileage rate designated by the IRS for the year (54.5 cents per mile for 2018); or

  4. The $1.50 per one-way commuting method.

You cannot use the mileage rate method for an automobile (any four-wheeled vehicle, such as a car, pickup truck, or van) if its value when you first make it available to any employee for personal use is more than an amount determined by the IRS as the maximum automobile value for the year. For example, you cannot use the cents-per-mile rule for an automobile that you first made available to an employee in 2017 if its value at that time exceeded $27,300 for a passenger automobile or $31,000 for a truck or van.

You can only use the commuting method if all the following requirements are met.

  • You provide the vehicle to an employee for use in your trade or business and, for bona fide non-compensatory business reasons, you require the employee to commute in the vehicle. You will be treated as if you had met this requirement if the vehicle is generally used each workday to carry at least three employees to and from work in an employer sponsored commuting pool.

  • You establish a written policy under which you do not allow the employee to use the vehicle for personal purposes other than for commuting or de minimis personal use (such as a stop for a personal errand on the way between a business delivery and the employee’s home). Personal use of a vehicle is all use that is not for your trade or business.

  • The employee does not use the vehicle for personal purposes other than commuting and de minimis personal use.

  • If this vehicle is an automobile (any four-wheeled vehicle, such as a car, pickup truck, or van), the employee who uses it for commuting is not a director or highly compensated employee.

The best method for your situation will depend on factors such as the number of annual personal miles driven, value of the car, and the ratio of personal miles to total miles. Sorting through the maze of these rules is not easy. To ensure you find your way through be sure to contact a tax professional who will guide you and also show you how to minimize associated paperwork.

Travel Expense Deductions: Your Burden of Proof

A first step in avoiding costly hassles with the IRS is identifying potential red flags before filing your business tax return. For example, a common source of audit conflict between the IRS and small businesses is the documentation of travel expenses. The IRS often has the edge in these disputes because the tax law spells out detailed rules about how these expenses must be verified and documented. Most companies sincerely attempt to comply and stay out of trouble with the IRS, but often fall short anyway.

Fortunately, that is one problem for which some relief is available due to a provision in the tax law that waives otherwise rigorous substantiation rules when a particular expense is below a certain minimum dollar level. Put simply, employees don’t technically need receipts for non-lodging expenses of under $75 that are reimbursed by their employers. Although this is a big break, it doesn’t mean that all record keeping can be ignored. Receipts are still needed for all lodging expenses (even if the cost is under $75), unless the company pays traveling employees only the IRS-approved per-diem rate. Those incurring the expense still have to record the time, place, business reason, and amount of each travel expenditure (unless a per-diem is used, in which case amounts don’t have to be recorded at all). Businesses should note that an expense for more than $75 unaccompanied by a receipt does not receive a minimum $74.99 deduction by default; an IRS examiner will treat the expense as $0.00 instead.

With this in mind, you may want to consider reviewing your travel expense record keeping and substantiation procedures as you adjust your record keeping practices. Setting up separate procedures for your own internal tracking of expenses probably makes sense, too. For example, you may want to require employees to show you receipts for non-lodging expenses costing less than $75 before approving them, even though businesses are not required to keep them.

Don’t let managing your travel expenses become a horror story for your business. Work with your accounting professional to establish a bookkeeping system that will keep you safe and ensure that you’re appropriately all of your and your employees expenses.

Property Acquired by Gift or Through an Estate

Receiving a gift or a bequest or other inheritance can be unexpected. These types of events, do, however, carry a unique set of federal income, gift, and estate tax rules that must be observed and apply to everyone, not just high-income individuals. Knowing the ruleswill help you prepare for any tax consequences that may ensue upon the ultimate sale or other disposition of the property

The IRS says the recipient of a gift or a bequest pays no gift or estate tax. Those taxes, if they are due, are payable by the donor (the person making the gift) or the estate in the case of a decedent. Generally, no gift tax is due for gifts to any one person that do not exceed $15,000 for 2018 ($30,000 if the gift is given jointly by a husband and wife). Gift tax payable over those amounts can also be avoided by the donor using the unified estate and gift tax lifetime exclusion which the IRS set at $11.2 million for 2018.

Gifts to noncitizen spouses and foreign gifts. The first $152,000 of gifts in 2018 to a spouse who is not a U.S. citizen is not included in taxable gifts. A U.S. person receiving aggregate foreign gifts in excess of $16,076 in 2018 must file an information return.

Basis. The basis of property received by gift or bequest is used by the recipient to determine whether there is gain or loss on a subsequent sale or other disposition of the property. These rules can be complex.

Gifts. If a property has been acquired by gift, the basis to the donee (the recipient) for income tax purposes is the same as it would be in the hands of the donor or the last preceding owner by whom it was not acquired by gift (carryover basis). However, the basis for loss is the lower of the carryover basis or the fair market value of the property at the time of the gift. In some cases, there is neither gain nor loss on the sale of property received by gift because the selling price is less than the basis for gain and more than the basis for loss.

In the case of a gift on which gift tax is paid, the basis of the property is increased by the amount of gift tax attributable to the net appreciation in value of the gift. The net appreciation for this purpose is the amount by which the fair market value of the gift exceeds the donor’s adjusted basis immediately before the gift.

Bequests or through intestacy. Property received from a decedent under a will or by operation of law generally enjoys a “stepped-up” basis set at the property’s fair market value at the date of death (or several months after that at the election of the executor). Most recipients of property from an estate find the stepped-up basis advantageous since it lowers the potential amount of capital gain tax due upon the sale of the asset. Depending upon the age of the donor, the advantage of stepped-up basis, therefore, can figure significantly into planning whether to give gifts during a lifetime or wait to pass property through your estate.

Remember, gift giving in the modern world can be tricky for both the giver and the receiver. When you’re faced with these types of situations, it may be best to contact your tax professional.

Educational Tax Breaks More Plentiful Than You May Know

Tax breaks to help you pay educational expenses are some of the most commonly overlooked federal tax breaks. They shouldn’t be. These are very valuable tax breaks, and that can help you maximize your tax savings.

Getting the most from the education tax incentives requires careful planning, particularly because of the interrelationship between many of the rules. Although the IRS provides guidance, some of the IRS’ explanations have complicated matters in some circumstances.

In a previous blog post, we looked Section 529 Plans and Coverdell education savings accounts, so we’ll skip those here and look at some of the other education tax incentives:

American Opportunity Tax Credit. The American Opportunity Tax Credit (AOTC) provides a maximum credit amount of $2,500 per year for four years of post-secondary education The AOTC is computed as 100 percent of up to $2,000 qualified higher education expenses plus 25 percent of the next $2,000 of eligible expenses. The AOTC begins to “phase out” for married couples filing jointly with adjusted gross income (AGI) between $160,000 and $180,000. The AOTC begins to phase out for single individuals with AGI between $80,000 and $90,000. Forty percent of the AOTC is refundable for those lower-income taxpayers with a tax liability smaller than the credit amount.

To qualify for the AOTC, the tuition must be paid on behalf of the taxpayer, the taxpayer’s spouse or the taxpayer’s dependent. An eligible student for purposes of the credit is an individual who is enrolled in a degree, certificate or other program leading to a recognized educational credential at an eligible educational institution. The student must be enrolled at least half-time and must not have been convicted of a federal or state felony for possession or distribution of a controlled substance. Study at many types of post-secondary institutions qualifies for the credit, such as programs for a bachelor’s degree, associate’s degree or another recognized post-secondary credential.

Lifetime Learning credit. The Lifetime Learning credit can be claimed for an unlimited number of tax years. The Lifetime Learning credit equals 20 percent of up to $10,000 in eligible education costs during the tax year. The Lifetime Learning credit is subject to phase-out rules based on adjusted gross income.

The Lifetime Learning credit may be applied to a non-degree program. For example, an individual who is enrolled in a non-degree program to improve job skills may be eligible for the credit. Moreover, the Lifetime Learning credit may be claimed even if the student is not enrolled at least half-time. An individual who is taking just one class at a community college, for example, may be eligible for the credit.

Employer-provided educational assistance exclusion. When an employer pays an employee’s education expenses, the tax consequences depend on the reason for the education. Your employer may have a plan under which it pays for qualified education expenses for college or graduate studies. If it has such a plan, up to $5,250 of education benefits can be excluded from the recipient’s gross income each year. Employer-provided educational assistance can include tuition, fees, books, supplies, and equipment.

Job-related educational expenses. If you are taking a course because it is directly related to improving your job performance and your employer does not cover it, you may be able to deduct it as a miscellaneous itemized deduction if you itemized deductions. Under this deduction, tuition, course materials, and even the cost of transportation to and from class may be deductible. There are some restrictions, however: miscellaneous deductions are deductible only in excess of two percent of your adjusted gross income, and any degree program that qualifies you for a “new trade or business” cannot be deducted under this provision no matter how helpful it also may be to your present job.

Deduction for interest on education loans. Student loan interest of up to $2,500 a year is deductible whether or not you itemize your deductions. The deduction is completely phased when a taxpayer’s modified AGI exceeds certain thresholds. Only those legally obligated to make the loan payments may deduct them. Individuals who are claimed as dependents on another person’s return cannot take this deduction. Qualified educational institutions for the student loan interest deduction are generally ones that participate in federal student aid programs.

IRAs. The Tax Code also allows individuals under age 59 1/2 to take distributions from an IRA for qualified higher education expenses without having to pay the 10 percent early withdrawal penalty. The qualified education expenses generally must be for the IRA holder, his or her spouse, or a child (including a foster child). Qualified education expenses include tuition, books, and supplies. Room and board is also a qualified expense if the individual is at least a half-time student. An eligible education institution is generally one that participates in federal student aid programs.

There are many federal education tax incentives. All of the incentives must be coordinated; that is, you may not be able to take every one. You generally cannot use education expenses to claim a double benefit. Many taxpayers make genuine and honest mistakes when trying to coordinate the education incentives without help from a tax professional. These mistakes are very costly. If you are considering claiming any of the education incentives, be sure to contact your tax professional.

Power of Attorney for Estate and Gift Tax Savings

Aging is often associated with social security and fixed incomes. However, as people live longer, the incidence of dementia or other mental disability becomes more of an estate planning problem. Often, the elderly have the foresight to appoint an attorney in fact under a power of attorney (POA) to act for them in financial and medical matters. In most of these cases, however, the attorney-in-fact is usually an adult child, which unfortunately sets up the ready-made problem of whether gift giving under a POA is appropriate, especially if one of the gift recipients is the adult child who holds the power of attorney.

In a “private letter ruling” issued by the IRS, the IRS allowed the annual gift tax exclusion amount ($15,000 for 2018) to be taken in a situation involving gift giving by an attorney-in-fact to herself and to her children. Such a series of gifts can reduce the size of the eventual taxable estate by the amount of the annual exclusion for each gift. To be entitled to the power to make tax-free gifts in this relatively common situation, however, the IRS appears to require the presence of additional circumstances that may not be common for many taxpayers.

Power of Attorney Typical Example

A mother executed a durable power of attorney designating her spouse as agent and, in the alternative, her daughter. After the spouse died, the daughter, acting under the POA, created two trusts on her mother’s behalf: (1) a qualified personal residence trust that conveyed the residence to the daughter at the termination of the trust term and (2) a trust for the benefit of the daughter’s children. Both transfers were reported on gift tax returns and the applicable tax was paid.

In addition to specific authority to act in enumerated circumstances, such as to endorse checks, collect rents, and execute deeds, the POA granted “the authority generally to do, execute and perform any other act, deed, matter or thing whatsoever, that ought to be done, executed and performed, or that, in the opinion of the agent ought to be done, executed or performed in and about the premises, of every nature and kind whatsoever, as fully and effectually as the Decedent could do if personally present.”

The daughter had been named in her mother’s will as the sole beneficiary of the estate. The decedent had a history of making gifts, some of which were in excess of the annual exclusion amount. In fact, these gifts were in excess of any gift given through the daughter’s exercise of the power of attorney. The mother died with an estate much larger than the total value of all the gifts that had been made by her daughter.

IRS Gauges POA Using Four Criteria

The IRS’s analysis of whether the gifts were complete for tax purposes hinged upon its determination of whether a state court would likely determine whether the gifts made by the daughter on behalf of the decedent were authorized under the power of attorney. The IRS used the following criteria:

  • Is the power to make gifts specifically authorized under the power of attorney? If not, the taxpayer has a higher burden to prove that gifts are authorized.
  • Are the beneficiaries of any gift also the beneficiaries under the decedent’s will? The identity of such beneficiaries would point toward the decedent’s intent to authorize such gifts.
  • Does the person who executed the power of attorney have sufficient assets to take care of living expenses or would not otherwise become economically disadvantaged after the gifts are made?
  • Was there a previous gift-giving program in place prior to the exercise of the POA that indicates that the subsequent gifts were consistent with the history of gift giving? In the ruling under consideration, the gifts were consistent, since over the years the mother had made substantial gifts.

Specificity May Help Avoid Tax Litigation

One way to avoid tax litigation may be to draft a power of attorney that sets out not only the specific power to make gifts, but also conveys the grantor’s intent that the attorney in fact should, if appropriate, continue a certain gift-giving plan. This would be particularly helpful when an estate is just within the taxable range (or it has the potential for doing so). Of course, the more common situation may be one in which the grantor is not as concerned (particularly when the power is granted) about maximizing estate and gift tax savings as the potential heirs, one of whom is given the power of attorney. Without the added history of gift giving and a large estate, this latter situation may continue to draw IRS scrutiny.

If you need any further explanation of how a properly-drafted power of attorney may save estate taxes, be sure to get in touch with your qualified tax professional.

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