Q: Is a worker an independent contractor or employee?
A: The question of whether a worker is an independent contractor or employee for federal income and employment tax planning purposes is a complex one. It is intensely factual, and the stakes can be very high. If a worker is an employee, the company must withhold federal income and payroll taxes, pay the employer’s share of FICA taxes on the wages plus FUTA tax, and often provide the worker with fringe benefits it makes available to other employees. There may be state tax obligations as well. These obligations don’t apply for a worker who is an independent contractor. The business sends the independent contractor a Form 1099-MISC for the year showing the amount paid to the contractor (if the amount is $600 or more), and that’s it.
Who is an “employee?” There is no uniform definition of the term.
Under the common-law rules (so-called because they originate from court cases rather than from a statute), individuals are generally employees if the enterprise they work for has the right to control and direct them regarding the job they are to do and how they are to do it. Otherwise, the individuals are independent contractors.
Some employers that have misclassified workers as independent contractors are relieved from employment tax liabilities under Section 530 of the 1978 Revenue Act (not the Internal Revenue Code). In brief, Section 530 protection applies only if the employer: filed all federal returns consistent with its treatment of a worker as an independent contractor; treated all similarly situated workers as independent contractors; and had a “reasonable basis” for not treating the worker as an employee. For example, a “reasonable basis” exists if a significant segment of the employer’s industry has traditionally treated similar workers as independent contractors. Section 530 doesn’t apply to certain types of technical services workers.
Individuals who are “statutory employees,” (that is, specifically identified by the Internal Revenue Code as being employees) are treated as employees for social security tax planning purposes even if they aren’t subject to an employer’s direction and control (that is, even if the individuals wouldn’t be treated as employees under the common-law rules). These individuals are agent drivers and commission drivers, life insurance salespeople, home workers, and full-time traveling or city salespeople who meet a number of tests. Statutory employees may or may not be employees for non-FICA purposes. Corporate officers are statutory employees for all purposes.
Individuals who are statutory independent contractors (that is, specifically identified by the Internal Revenue Code as being non-employees) aren’t employees for purposes of wage withholding, FICA, or FUTA and the income tax rules in general. Qualified real estate agents and certain direct sellers are statutory independent contractors.
Some categories of individuals are subject to special rules because of their occupations or identities. For example, corporate directors aren’t employees of a corporation in their capacity as directors, and partners of an enterprise organized as a partnership are treated as self-employed persons
Under certain circumstances, you can ask IRS (on Form SS-8) to rule on whether a worker is an independent contractor or employee, and I can help you prepare this request.
Q: Can I deduct my gas and mileage expenses?
A: Because you maintain your office in your home, you may be entitled to a special tax break on your commuting costs. For most people, the cost of daily travel between home and a regular work location is a nondeductible commuting expense. However, taxpayers who have an office at home can deduct the daily costs of travel between home and another work location in the same business, regardless of distance and regardless of whether the other location is regular or temporary.
Note that you get this break only if your home is your principal place of business. In other words, you must meet the tests for deducting expenses of an office at home. Give me a call if you aren’t familiar with those tests.
You must be able to substantiate the auto expenses that you claim through adequate records, such as a log or diary. Apps are available for your smartphone, and using these may be easier than keeping records manually. You can either use the standard mileage rate or deduct your actual expenses. To work auto expenses into your tax planning, careful record keeping is of the utmost importance.
If you are an employee and your employer reimburses your travel expenses, you needn’t report the reimbursements as income if they are made under a so-called “accountable plan.” An accountable plan is one that reimburses only deductible business expenses, requires you to substantiate your expenses, and requires you to return amounts in excess of your substantiated expenses. If the plan isn’t an accountable plan, the reimbursement must be reported as income, and your deductible expenses must be claimed as employee business expenses.
If your office at home isn’t your principal place of business, the costs of travel between your home and the first and last business stops of the day are nondeductible commuting expenses. However, the costs of going between home and a temporary work location are deductible, if you have a regular work location away from home. Generally speaking, employment at a work location is temporary if it is realistically expected to last (and does, in fact, last) for no more than a year.
Q: How to deduct your home office expenses?
A: If you’re an employee who “telecommutes”—that is, you work at home, and communicate with your employer mainly by telephone, e-mail, fax, electronic data transfer, express mail services, etc.—you should know about the strict rules that govern whether you can deduct your home office expenses.
You may deduct your home office expenses if your home office is for the convenience of your employer (see below), and if you meet any of the three tests described further below: the separate structure test, the place for meeting patients, clients or customers test, or the principal place of business test.
If you do qualify, you may compute your home office deductions (described below) on a special worksheet. You report the expenses on Schedule A as below-the-line miscellaneous itemized deductions that are deductible only to the extent that they (together with all other miscellaneous itemized deductions) exceed 2% of your adjusted gross income.
Convenience of the employer requirement. The convenience of the employer requirement is satisfied if:
you maintain your home office as a condition of employment—in other words, if your employer specifically requires you to maintain the home office and work there;
your home office is necessary for the functioning of your employer’s business; or
your home office is necessary to allow you to perform your duties as an employee properly.
The convenience of the employer requirement means that you must maintain your home office for your employer’s convenience, and not for your own. This requirement isn’t satisfied if your use of a home office is merely “appropriate and helpful” in doing your job.
Under the above rules, if your employer requires you to telecommute, and doesn’t make on-premises office space available for you, your maintenance of a home office for telecommuting will probably be treated as for the convenience of the employer. Otherwise, it’s not clear whether your home office will be treated as satisfying this requirement. Therefore, if you can, you should get your employer to put in writing that it’s a requirement of your job to work from an office in your home.
Separate structures. You may deduct the costs of a separate structure used as a home office that is not attached to your “dwelling unit.” In other words, the “separate structure” must be an unattached structure on the same property as your home—for example, an unattached garage, artist’s studio, workshop, or office building. To qualify for the deduction, the separate structure must be used exclusively and on a regular basis in connection with your activities as an employee. In addition, you must maintain the home office in the separate structure for the convenience of your employer.
Home office used for meeting patients, clients, or customers. Alternatively, you may deduct your home office expenses if you use a home office, exclusively and on a regular basis, and for the convenience of your employer, to meet or deal with patients, clients, or customers of your employer in the normal course of your duties as an employee.
Principal place of business. In addition, you may deduct your home office expenses if you use your home office, exclusively and on a regular basis, as the principal place of business for your work as an employee, and if you maintain the home office for the convenience of your employer.
While there have been many disputes between IRS and taxpayers about whether taxpayers’ home offices qualified as their principal places of business, a telecommuter should have no problem establishing that the home office is his or her principal place of business—if the telecommuter does the most important part of his or her work in the home office, and spends most of his or her work time there.
Exclusive and regular use requirements. As noted above, whether the home office is in a separate structure or is a principal place of business (which doesn’t have to be in a separate structure), the home office must be used exclusively and on a regular basis in connection with your work as an employee.
The exclusive use requirement means that you must use your home office solely for the purpose of carrying on your work as an employee. Any other use of the home office will result in loss of all deductions for your home office expenses.
For example, if you work in a spare bedroom that contains your desk, computer, fax, files, etc., and if you don’t use that bedroom for anything but your work, that room passes the exclusive use test. But if you also use the room to sleep occasional overnight guests, it fails the exclusive use requirement. And if you use the room exclusively for work during your regular workday, but the room reverts to other uses at nights and/or on weekends, it also fails the exclusive use test.
The regular basis requirement means that you must use the home office in carrying on your business on a continuous, ongoing or recurring basis. Generally, this means a few hours a week, every week. A few days a month, every month, may do the trick. But occasional, “once-in-a-while” business use won’t do.
Luckily, a tax planning expert can help you figure out whether your home office satisfies the exclusive and regular use tests, and suggest things you might do to make sure that you do pass these tests—for example, removing non-business furniture and fixtures, not letting guests use your home office, keeping the kids out, etc.
What you get if you qualify for home office deductions. If your home office is your principal place of business under the rules noted above, the costs of traveling between your home office and other work locations in the same trade or business, regardless of whether the other work location is regular or temporary, and regardless of its distance, are deductible transportation expenses, rather than non deductible commuting costs.
If your use of your home office qualifies under any of the above rules, you may take business expense deductions for the following:
the “direct expenses” of the home office—e.g., the costs of painting or repairing the home office, depreciation deductions for furniture and fixtures used in the home office, etc.; and
the “indirect” expenses of maintaining the home office—e.g., the properly allocable share of utility costs, depreciation, insurance, etc., for your home, as well as an allocable share of mortgage interest, real estate taxes, and casualty losses.
Amount limitations on home office deductions. The amount you may deduct as home office expenses is subject to limitations based on the income attributable to your use of the home office, your residence-based deductions that aren’t dependent on use of your home for business (e.g., mortgage interest and real estate taxes), and your business deductions that aren’t attributable to your use of the home office.
Example: Say your home office occupies 20% of the space in your home. This year, your salary (earned entirely from your work in the home office) is $50,000. The mortgage and real estate taxes on your home total $20,000, $4,000 of which is allocable to the home office. You have $10,000 of additional home office expenses (depreciation, utilities, etc.). And you have $5,000 of expenses that aren’t attributable to the use of your home office (supplies, express mail charges, copying charges, etc.). To figure out whether you can deduct your home office expenses, you first subtract the home-office portion of the mortgage and real estate taxes, $4,000, from your salary. This leaves you with $46,000. Then, from this, you subtract your expenses that aren’t attributable to your use of the home office, $5,000. This leaves you $41,000. If this figure exceeds the amount of your remaining home-office expenses, here $10,000, you can deduct all of those expenses. If this figure is less than your remaining home-office expenses, your deduction is limited. For example, if your remaining home-office expenses were $45,000 instead of $10,000, you’d only be able to deduct $41,000 instead of the full amount. And the computation gets even more difficult if you earn your salary both in your home office and at other locations, because the limitation formula only takes into account the income attributable to the use of the home office.
Any home office expenses that can’t be deducted because of the above amount limitations may be carried over and deducted in later years.
Computers and related equipment. If your use of your home office qualifies under any of the rules discussed above, you may deduct the unreimbursed cost of computers and related equipment that you use in the home office, and the deductions are not subject to the “listed property” restrictions that would otherwise apply.
Effect of home office deductions on later sales of your principal residence. You should be aware that, if you claim any depreciation deductions with respect to the home office, when you sell the residence, any gain attributable to the depreciation deductions will not be eligible for the otherwise available $250,000/$500,000 exclusion for gain on the sale of principal residences. Also, the exclusion won’t apply to the portion of your gain allocable to a home office that’s separate from the dwelling unit or to any gain allocable to a period of nonqualified use (i.e., a period that the residence is not used as the principal residence of the taxpayer or his spouse or former spouse) after Dec. 31, 2008.
Q: How to deduct business website expenses?
A: The business use of websites is widespread, but IRS has not yet issued formal guidance on when Internet website costs can be deducted.
Fortunately, established rules that apply to the deductibility of business costs in general, and formal IRS guidance that applies to software costs in particular (the “software guidelines”), provide a taxpayer launching a business website with some guidance as to the proper treatment of the costs. Here is a brief discussion of some relevant principles:
The time for deducting website design costs (i.e., costs of the website’s overall structure, functionality and appearance) depends on whether the costs are costs of “software” within the meaning of the “software guidelines.” Generally, the portions of the website’s design that are produced from sophisticated programming languages (for example, the “C++” language widely used in website design) will qualify as “software.” On the other hand, there is some doubt as to the extent to which the portions of a design produced from HTML (hypertext markup language) will qualify as “software.”
Website design costs that are “software” costs are deductible under “safe-harbor” rules. The deductibility of website design costs that are “software” costs is governed by the following “safe-harbor” rules.
Generally, if the individual or company launching the website “purchases” the design (i.e., acquires the design from a contractor who is at economic risk should the software not perform), the design costs are amortized (ratably deducted) by that individual or company over the three-year period beginning with the month in which the website is placed in service. Also, non-customized computer software qualifies as “section 179 property,” and is thus eligible for the Code Sec. 179 elective expensing deduction that is generally available only for machinery and equipment (and some building improvements). The deduction is limited to $510,000 for tax years beginning in 2017 ($500,000 in 2016). The limits are reduced by the cost of other section 179 property for which the election is made. Also, the election is phased out for taxpayers placing more than $2,030,000 of section 179 property into service during a tax year beginning in 2017 ($2,010,000 in 2016). Non-customized software is also eligible for a 50%-of-cost depreciation deduction (50% bonus depreciation) unlimited by any dollar amount. The bonus depreciation for an item of software is reduced to take into account any portion of the item’s cost for which a Code Sec. 179 election is made, and regular depreciation deductions are reduced to take into account both the bonus depreciation and any Code Sec. 179 election.
If, instead of being purchased, the website design is “developed” (designed in-house by the individual or company launching the website or designed by an independent contractor who is not at risk should the software not perform), the individual or company launching the website can choose among alternative treatments, including, but not limited to, “currently deducting” the costs (deducting the costs in the year that the costs are paid, or accrued, depending on the taxpayer’s overall accounting method) or amortizing the costs under the three-year rule, combined with bonus depreciation, as discussed above for a “purchased” design.
Website design costs that aren’t costs of “software” are deductible in accordance with useful life. The time for deducting website design costs that are costs of portions of the design that aren’t “software” depends on the expected “useful life” of these non-software portions of the design. Thus, these costs must be amortized over the number of years that it is expected that the non-software portions of the design will be used in the business (except if it is expected that these non-software portions of the design will have a useful life of no more than a year, in which case the costs can be currently deducted.)
Website content that is advertising is generally currently deductible; the treatment of other content costs will vary. Advertising costs are, generally, currently deductible. Thus, the costs of website content that is advertising are, generally, currently deductible. Website content that isn’t advertising will be currently deductible, or amortized over a multi-tax year period, depending on its useful life.
The deductibility of some website costs that are business start-up costs is limited. Where website costs that would otherwise be currently deductible are paid or accrued before a business begins, the costs are deductible only upon the termination or disposition of the business, unless the taxpayer elects to (1) deduct up to $5,000 of the costs in the year that the business starts and/or (2) amortize the costs over a period of 60 months or more beginning with the month that the business starts.
The above principles, and others that affect the deductibility of website costs, suggest ways in which the individual or company launching the website can “take charge” of the treatment of website costs. For instance, an individual or company who contracts for a website design that qualifies as software, and who seeks the favorable tax treatment that applies to the costs of “developed” software, can, if acceptable as a business matter, include, in its written agreement with the developer/contractor, terms that will put the risk that the software won’t perform on the individual or company. Another example of a way to manage the tax treatment of website costs is detailed, descriptive allocations of costs, both in contracts and in internal records.
If you are considering launching a business website, I will be pleased to discuss with you further, and help you implement, the above planning steps or others that will help you manage the tax treatment of your website costs.
Q: How to make contributions deductions for the care of the ill, needy, or infants?
A: In general, when inventory is contributed to charity, the deduction is based on the cost (basis) the corporation had in the inventory. Thus, if the donated inventory costs $10,000, the deduction will be limited to $10,000, even if the value of the inventory is higher.
However, under special rules applicable to regular (“C”) corporations, if the inventory is donated to an organization that will use it to aid the ill, needy, or infants, the deduction will be increased by half of the difference between basis and value (with an upper limit of twice the basis). (Similar rules apply to qualifying book donations by C corporations to public schools, and to donations of food by any trade or business of the taxpayer.)
For example, if the donated inventory basis is $10,000 and its value is $16,000, the deduction will be $13,000: the $10,000 basis, plus half of the $6,000 excess of value over basis. But if the basis is only $4,000 and the value is $16,000, the deduction can’t exceed $8,000 (the $4,000 basis × 2) under these rules.
There’s no dollar limit on how much inventory you can give away under these rules, but the regular overall deduction limit for corporations still applies. So the total charitable deduction for the year can’t exceed 10% of corporate taxable income (as determined with several modifications for these purposes). Contributions in excess of the 10% limit are carried forward and may be used during the next five years (subject to the 10%-of-taxable-income limitation each year).
To take advantage of the special rules for inventory contributions for the ill, needy, or infants, certain additional requirements must be met and the donee must provide you with a written statement.
If you are looking for assistance with your business’s tax planning, contact Jeff Pickering, CPA. Our tax planning experts are always happy to assist new and returning customers and answer any of your questions.