Tax and financial advice from the Silicon Valley expert.

California sales tax relief for small businesses

Thanks to the Supreme Court’s Wayfair decision, retailers that sell tangible personal property to customers located in states where they don’t have a physical presence may be required to collect sales and use tax.  For example, a company located in Nevada that sells furniture to a California customer may be required to collect California sales and use tax and report the sale and pay the tax to California.

The same concept can require a retailer located in one sales tax district, say Santa Clara County, that sells property to a customer located in another district, say Los Angeles County, to collect and remit the sales and use tax to the district where the customer is a resident (in this example, Los Angeles County.)  (This requirement has long applied to sales of motor vehicles.)

Initially, California’s Department of Tax and Fee Administration (CDTFA) issued rules imposing this collection requirement when a taxpayer had in either the preceding or current calendar year either (1) sales into the state or district exceeding $100,000 or (2) 200 or more separate transactions.

The new requirements were proposed to be effective on April 1, 2019.

Smaller retailers complained that the requirements were too burdensome — especially because they might have 200 separate transactions with a small dollar amount.

On April 25, 2019, Governor Newsom approved Assembly Bill No. 147, which provides relief to smaller retailers.

The new threshold for the requirement to collect California state and district sales and use taxes is more than $500,000 of sales of tangible personal property to customers located in California.  (Sales of motor vehicles are still subject to the use tax reporting requirement, regardless of the amount.)

The second threshold of 200 or more separate transactions has been repealed and is disregarded.

The new $500,000 of sales threshold is retroactively effective on April 1, 2019.

A change in the new law this isn’t favorable to small businesses doing business in California is that district sales and use taxes for all districts must be collected and reported when a business reaches the $500,000 threshold for all of California.  Under the previous guidelines, reporting and collection was only required when the $100,000 or 200 transactions threshold was reached for the district.  To help get the rates that apply, the CDTFA has on online lookup tool, Find a Sales and Use Tax Rate by Address.  Here is a link to the tool. https://gis.cdtfa.ca.gov/public/maps/taxrates/  (Spidell’s California Taxletter, May, 2019, p. 3, California adopts $500,000 economic nexus threshold for use taxes.)

Retailers with a physical presence in California are still required to report and collect California sales and use tax and local district sales and use tax.  They only need to be concerned about the $500,000 threshold as it relates to sales to customers located in another district.

The new law also includes a new requirement that requires “marketplace facilitators” that sell goods for other companies on their web sites, like Amazon and EBay, to treat those sales as made by the marketplace facilitator.  The marketplace facilitator will report the sales and collect and remit the sales and use taxes when it exceeds the $500,000 of sales threshold for the State of California and the various districts.

If the marketplace facilitator reports the sale and collects and remits the sales and use tax, the retailer isn’t required to do so.

The marketplace facilitator rules won’t be effective until October 1, 2019.

Some retailers might have to report sales made through a marketplace facilitator from April 1 through September 30, 2019 and their reporting burden may be shifted to marketplace facilitators thereafter.

There may be audit issues with the new marketplace facilitator reporting requirement, because the sales reported on the sales tax report won’t agree to the books and records of the retailer and the marketplace facilitator.

Despite the complexity of the new reporting requirements, many smaller retailers will find a lot to be thankful for in this relief legislation.

IRS issues more proposed regulations for Qualified Opportunity Funds

A great tax benefit enacted as part of the Tax Cuts and Jobs Act of 2017 is the Qualified Opportunity Fund (QOF).

Taxpayers who reinvest capital gains into one of these funds can defer federal income taxes on the reinvested capital gains, including Section 1231 gains from selling business assets that are taxable as capital gains, for up to eight years until the earlier of the date on which the qualified investment is sold or exchanged or December 31, 2026.  In addition, the additional gain relating to the appreciation of the Qualified Opportunity Fund may be tax free, provided an election is made and the investment is held for more than 10 years.

If the QOF is held at least 5 years, 10% of the reinvested deferred gain will be tax free.  If the QOF is held at least 7 years, an additional 5% of the reinvested deferred gain will be tax free.  These adjustments are accounted for as tax basis adjustments — adding the tax free amounts to the taxpayer’s cost of the investment in the QOF.

The IRS issued proposed regulations for these funds during October, 2018.  Now they have issued additional proposed regulations (REG-120186-18 to be published shortly in the Federal Register) and are asking for more feedback from the tax return preparation and consulting community.   Another public hearing is scheduled for July 9, 2019 at 10 a.m.

The new proposed regulations provide answers to many questions relating to Qualified Opportunity Funds, and are mostly favorable to taxpayers.  I can only cover a few highlights.  My printout of the regulations and preamble is about 168 pages.  Here are a few key points.

  1.  The ownership and operation (including leasing) of real estate is the active conduct of a trade or business.  A triple-net lease is not the active conduct of a trade or business.  This broad acceptance of real estate leases as a trade or business only applies for applying the rules for Qualified Opportunity Funds.

2.  Only net capital gains and net Section 1231 gains (from sales of business assets) that are taxed as capital gains qualify for deferral by reinvestment.  Since net Section 1231 losses are taxed as ordinary losses, the 180-day reinvestment period for net Section 1231 gains begins at the end of the taxable year when the sale of Section 1231 property was closed.

3.  If there is an “inclusion event”, any remaining reinvested deferred capital gains and Section 1231 gains will become taxable if the investment hasn’t already been held until December 31. 2026.

4.  If an S corporation that invests in a QOF has aggregate change of ownership of capital interests of more than 25%, there is an inclusion event.

5.  A conversion of an S corporation to a partnership or disregarded entity or a C corporation is an inclusion event.

6.  A taxpayer’s transfer of a qualifying investment by gift, whether outright or in trust, is an inclusion event.

7.  A taxpayer’s transfer of a qualifying investment to a revocable living trust (grantor trust) is not an inclusion event, because the trust is disregarded for income tax reporting and the taxpayer is considered to continue to own the investment.  The trust becoming irrevocable can be an inclusion event, but see item 8.

8.  The transfer of a qualifying investment to a beneficiary of an estate or trust as an inheritance is not an inclusion event.  Remaining reinvested deferred income is potentially income with respect of a decedent.  The beneficiary steps into the shoes of the decedent relating to when the income will be taxable.

9.  A corporate subsidiary that is a QOF is not eligible to be included in a consolidated income tax return.

10.  A corporate parent that is a QOF is eligible to be included in a consolidate income tax return.

11.  A taxpayer may invest amounts exceeding capital gains and Section 1231 gains that are eligible for deferral in a QOF.  The excess investment will be separately accounted for as a separate interest that is not eligible for QOF tax benefits.  (Any gain relating to that share will be taxable.)

12.  Distributions by QOFs can be inclusion events.  For example, if a QOF partnership or S corporation borrows money and distributes funds exceeding their tax basis to its partners (remember most QOF interests will start with a basis of zero, because there is no tax basis for the deferred gains that are reinvested in the fund), the distributions will be an inclusion event.  (Distributions of operating income should be handled carefully.  Remember you can have positive cash flow when you don’t have taxable income because of noncash deductions, like depreciation.)

13.  Special rules are provided for mergers, recapitalizations and reorganizations.  They are beyond the scope of this summary.  See your tax advisor.

14.  Used property leased tangible property that was previously not used for a depreciable purpose for at least five years can be eligible “original use” QEF property.

15.  The proposed regulations include fairly liberal “substantially all” definitions for various limitations.  They are beyond the scope of this summary.  See your tax advisor.

16.  Leases shouldn’t include prepayments for more than a year.

17.  The proposed regulations include valuation guidelines for tangible property when applying the test requiring 90% of the property of the QOF to be used in the Qualified Opportunity Zone.  The QOF may either use the value for a qualified (audited) financial statement or cost and present value of lease payments as of the inception of the lease.  The property doesn’t have to be revalued each year.

18.  QOFs are required to annually pass a 50% of gross receipts test.  A least 50% of the QOF’s gross income must be earned in a Qualified Opportunity Zone.  Under the regulations, the gross receipts aren’t tested based on where the customer is located, but on where the work is done to produce the products or services.  That means sales from reselling products produced overseas won’t be qualified income.  Just having a post office box located in a Qualified Opportunity Zone doesn’t mean the business is considered to be located there.

19.  Unimproved land won’t be considered qualifying property unless plans are in place to substantially improve the land within 30 months.

The IRS says they will be issuing more proposed regulations for QOFs soon.

These proposed regulations are critically important for taxpayers to realize the tax benefits that they are counting on when making investments in QOFs.

What meals, entertainment and business gifts are 100% deductible?

The deductibility for meals, entertainment and business gifts is a complex area of the federal tax laws that is worth studying.  I am going to highlight some areas where these items are 100% deductible to stimulate further conversation with your tax advisor.  This is not a complete explanation that you can rely on as authority for a tax position.

These rules were radically changed by the Tax Cuts and Jobs Act of 2017, effective for amounts paid or incurred after December 31, 2017 until December 31, 2025.  The tax deduction for entertainment expenses has been repealed.  These expenses include any item relating to (1) an activity generally considered to be entertainment, pleasure, recreation, (2) membership dues with respect to any club organized for business, pleasure or other social purposes, or (3) a facility or any portion thereof used in connection with any of the above items.

Under the Act, no deduction will be allowed for expenses associated with providing any qualified transportation fringe to employees of the taxpayer, except as necessary for ensuring the safety of an employee, any expense incurred for providing transportation (or any payment or reimbursement) for commuting between the employee’s residence and place of employment.

The basic rule is that certain business meals are 50% deductible.  Business gifts are deductible up to $25 to a person (spouses are counted as one person) per year.

Under the Act, food and beverages provided on the business premises of the employer for the convenience of the employer as a de minimus fringe benefit are only 50% tax deductible.   Such amounts incurred and paid after December 31, 2025 will not be tax deductible.  The “cafeteria exception” has been repealed.

Under the Act, recreational or social expenses (including facilities expenses) primarily for the benefit of employees other than certain owners and highly compensated employees, such as company picnics and holiday parties, are still tax deductible.  Meals relating to these activities are still 100% deductible.

There are important exceptions that should be separately accounted for on a business’s books and records.

For example,

When a taxpayer is in the business of providing meals and entertainment to customers, such as amusement parks, restaurants and nightclubs, the expenses of providing those goods and services are 100% tax deductible.  This is a form of providing “samples” as a promotional expense

An important exception that I want to focus on is expenses for goods, services and facilities made available by the taxpayer to the general public.  This article was inspired by private IRS letter ruling 9641005, which explains how the limitations apply for a casino.  IRS private letter rulings can’t be relied on as authority for tax positions, but indicate the thinking of the IRS for this situation.

In that ruling, the term “general public” is very broadly interpreted to include a customer or group of customers.  (It may be that casinos as a group have enough political “pull” to get a generous interpretation by the IRS.)

Most of the gaming operations, shows, and restaurant facilities in the casino are providing meals, entertainment and lodging to the general public, and so the expenses of providing them are tax deductible as cost of goods and services sold.

Casinos provide a number of gifts to customers intended to stimulate additional business, called “comps.”

When a casino provides food, drinks and show tickets on its premises as comps to guests who are gambling or lodging on the premises, they are providing tax deductible “samples” to the public, which are 100% tax deductible.  (The same rule applies to restaurants providing complementary meals to customers or reviewers, as I described above.)

Some promotional gifts given to customers may be fully tax deductible.  An example from the Congressional Committee report is cited that if the owner of a hardware store advertises that tickets to a baseball game will be provided to the first 50 people who visit the store on a particular date, or who purchase an item from the store during a sale (gift with purchase), the total cost of the tickets is tax deductible as a business promotion expense.  Casinos commonly give coupon books to their guests and may deduct 100% of the expenses for the coupon items.

Items, such as promotional pens, that cost up to $4.00 with the taxpayer’s name imprinted for which multiple identical items are given are not considered to be business gifts, but simply fully tax-deductible promotional items.

Dinner meetings for groups of customers or prospective customers relating to a business presentation, as we commonly see for financial planners, are 100% tax deductible “public events.”  (Time will tell if the IRS changes its position in light of the Tax Cuts and Jobs Act of 2017.  I believe this exception still applies.)

Things become more involved for comps provided by casinos for activities off their business premises.

For example, sporting event tickets (unless relating to a business promotion) are only deductible for their face value, and under the Act only deductible as gifts subject to the $25 annual limit per customer.

Meals or other entertainment provided off the premises might be 50% deductible if a representative of the casino accompanies the customer for a business deduction.  Otherwise, reimbursements provided to the customer or direct payment by the casino aren’t tax deductible.

Some business expenses that would otherwise be entertainment are classified differently in certain situations.  For example, professional theater critics may fully deduct theater tickets for shows they review, and fashion shows by clothing manufacturers are fully deductible promotional events.

Note the $25 and $4 limitations above are very old, going back to 1954.  This is a good time to write your representatives in Congress that these limitations should be increased or eliminated.

Now is a great time to review your accounting procedures with your tax advisor to assure you are maximizing your tax deductions.  Your business should also segregate entertainment expenses from business meals on its books and records.  If you need assistance in that effort, please call Thi Nguyen, CPA at 408-286-7400, extension 206.

Are you a winner or loser under tax reform?

Many Americans are probably wondering whether they will pay more or less taxes under proposals released by President Trump and the tax-writing committees of Congress.

If you listen to President Trump’s sales presentations for the plan, everyone will be better off, but it ain’t necessarily so.

The proposals are still rather sketchy.  The taxable income amounts for which the various tax brackets will apply haven’t even been announced.  Here is my speculation about who are some of the winners and who are some of the losers under the proposals.  Since a combination of factors may apply, each family will need their own computations of tax before and after the changes when the details of the plan are ultimately released if Congress is successful in passing tax reform legislation.

Winners

U.S. corporations with accumulated earnings “parked” offshore.  U.S. multinational corporations haven’t brought their cash from offshore subsidiaries to the U.S. to avoid having them taxed.  Under the tax proposal, they would be able to repatriate the cash at low tax rates, payable over up to five years.  This could make the cash available to pay as dividends to U.S. shareholders to make investments in the U.S.  It could also be just a transfer from a foreign bank to a U.S. bank.

U.S. multinational corporations.  Under the proposal, dividends paid to U.S. corporations from offshore subsidiaries that are at least 10% owned by the U.S. corporation would be tax exempt.  U.S. corporations would no longer be subject to tax on their worldwide income, but only their U.S. operations.

U.S. business owners.  The maximum corporate tax rate would be reduced from 38% to 20%.  The maximum tax rate for individuals on business income would be reduced from 39.6% to 25%.  Investments in depreciable assets (equipment) other than structures (buildings) would be currently deductible for at least five years.

Employees with incentive stock options.  The exercise of incentive stock options isn’t subject to the regular tax, but is currently taxable under the alternative minimum tax.  Since the alternative minimum tax would be repealed, the exercise of incentive stock options would be deferred until the stock is sold or there is another disqualified disposition.  The original tax benefit of incentive stock options would be restored.

Healthy retired empty nesters.  Many of these taxpayers already use the standard deduction.  Their standard deductions will increase under the tax proposals, likely resulting in a tax reduction.

Very wealthy families.  The federal estate tax would be repealed.  Very few Americans are currently subject to the federal estate tax at death.  The exemption equivalent for 2017 is $5.49 million per individual, or nearly $11 million for a married couple.  The federal estate tax rate is 40% for the excess.  (Note there is no proposal to repeal the federal gift tax!)

High income individuals.  The maximum income tax rate would be reduced from 39.6% to 35%.  The additional 3.8% tax on net investment income is also proposed to be repealed.

Losers

Very large families.  The personal exemption would be repealed.  The rationale is the larger standard deduction would cover the elimination of the personal exemption, but it is a flat amount.  The dependent exemption for 2017 is $4,050.  With the $12,700 standard deduction for married couples for 2017, a family of three would have a combined deduction of $24,850 — exceeding the proposed standard deduction for married couples of $24,000.

Single parent families.  It appears the head of household filing status, a very significant tax break for single parent families, would be eliminated.

People who live in states with high income taxes.  States with high income tax brackets include California, New York, New Jersey, Minnesota and others.  (Note many of them are “blue” states.)  The deduction for state income taxes would be repealed.

People who pay high real estate taxes.  The deduction for real estate taxes would be repealed, eliminating a significant tax benefit of home ownership.

People in nursing homes.  Since the medical deduction would be eliminated, people who are uninsured or underinsured and pay for long-term care will lose a signficant tax benefit.  (For many of them, their medical expenses eliminates most of their taxable income.)

Employees with employee business expenses.  Employee business expenses are an itemized deduction that would be repealed.

Corporations that issue bonds or borrow money.  The deduction for interest expense for C corporations would be partially limited.

People who pay high legal fees.  Some legal fees now qualify to be deducted as miscellaneous itemized deductions.  This deduction would be repealed.

People who have high investment management expenses.  Investment management expenses for taxable investments are miscellaneous itemized deductions.  This deduction would be repealed.

Tax return preparers.  Actually, pluses and minuses.  Taxpayers will be totally confused by the tax law changes and will seek help in sorting them out.  Many tax returns will be simpler to prepare, resulting in lower fees.  Tax professionals will need to approach planning more from a financial planning point of view.  Tax return preparers who serve high net worth clients will still have plenty of business.  These clients will still have complex tax issues to deal with

Let your representatives in Congress know what you think about these proposals.  Here is a web site with contact information:  https://www.usa.gov/elected-officials

.

What tax rules apply to the sale of a principal residence?

The interview on Financial Insider Weekly to be broadcast in San Jose and Campbell  on Friday, July 28, is with G. Scott Haislet, CPA and attorney at law.   Our interview subject is “Sale of a principal residence.”  The interview will be broadcast at 9:30 p.m. Pacific Time on CreaTV, Comcast Channel 15 in San Jose and Campbell, and will be broadcast as streaming video at the same time at www.creatvsj.org. You can find broadcast times for other San Francisco Bay Area cities and past episodes at www.financialinsiderweekly.com.

What should you know about California real estate change of ownership?

The interview on Financial Insider Weekly to be broadcast in San Jose and Campbell  on Friday, July 21, is with G. Scott Haislet, CPA and attorney at law.   Our interview subject is “Real estate reassessment change of ownership in California.”  The interview will be broadcast at 9:30 p.m. Pacific Time on CreaTV, Comcast Channel 15 in San Jose and Campbell, and will be broadcast as streaming video at the same time at www.creatvsj.org. You can find broadcast times for other San Francisco Bay Area cities and past episodes at www.financialinsiderweekly.com.

How can you save income taxes with a tax-deferred Section 1031 exchange?

The interview on Financial Insider Weekly to be broadcast in San Jose and Campbell  on Fridays, July 7 and 14, is with G. Scott Haislet, CPA and attorney at law.   Our interview subject is “Section 1031 exchanges.”  The interview will be broadcast at 9:30 p.m. Pacific Time on CreaTV, Comcast Channel 15 in San Jose and Campbell, and will be broadcast as streaming video at the same time at www.creatvsj.org. You can find broadcast times for other San Francisco Bay Area cities and past episodes at www.financialinsiderweekly.com.

President Trump’s tax proposals and you

On April 26, the Trump administration released an outline of its tax proposals for Congress.  The proposal includes a steep tax cut for corporations and businesses from 35% (39.6% for individual owners) to 15%.  The maximum rate for individuals (other than for business income) would be reduced from 39.6% to 35%, and the 3.8% net investment income tax and the alternative minimum tax would be repealed.  The thresholds for the tax rates haven’t been specified.

No “border tax” for imports is proposed at this time.  Corporations would move from a tax on worldwide taxable income to a “territorial” tax system, which would subject them to U.S. tax only for U.S. income.

On the deductions side, the standard deduction would be doubled to $24,000 for a married couple, and all itemized deductions would be repealed except the deduction for home mortgage interest and charitable contributions.  (So with almost all deductions repealed, who needs an alternative minimum tax?)

A side effect of the increased standard deductions and repealing the deduction for real estate taxes is to eliminate the tax benefits of home ownership for almost all Americans except for those in very high cost areas like the San Francisco Bay Area.

With the high standard deduction, most taxpayers won’t receive a tax benefit for making charitable contributions.

For many taxpayers who live in states like California, the state income tax deduction is their biggest tax deduction.  It would be eliminated under this plan, and they might discover they will pay higher income taxes under these proposed changes.

Although the Trump administration proposes to provide more tax benefits for child care, single parents will probably find that is more than offset by a tax increase from the elimination of head of household status.

Another feature of the proposal is to repeal the federal estate tax, which currently only applies to the very wealthy, since a married couple already has almost an $11 million exclusion.  The proposal didn’t specifiy whether the federal gift tax would be repealed or not.

Many details still need to be provided, and the devil is in the details.  The bare bones of this proposal would result in a huge tax windfall for the wealthy and tax deficits for the nation.

These proposals are only the beginning of a huge negotiation battle in Congress.  Let your representatives in Congress know the changes that you favor and the changes you oppose.  Here is a web site with contact information.  https://www.usa.gov/elected-officials

How to appeal an IRS audit

The interview on Financial Insider Weekly to be broadcast in San Jose and Campbell this Friday, March 17, is with Martin Schainbaum,  attorney at law.   Our interview subject is “Appealing your IRS audit.”  The interview will be broadcast at 9:30 p.m. Pacific Time on CreaTV, Comcast Channel 15 in San Jose and Campbell, and will be broadcast as streaming video at the same time at www.creatvsj.org. You can find broadcast times for other San Francisco Bay Area cities and past episodes at www.financialinsiderweekly.com.

How to handle an IRS audit

The interview on Financial Insider Weekly to be broadcast in San Jose and Campbell on Fridays, March 3 and 10, is with Martin Schainbaum,  attorney at law.   Our interview subject is “I’m being audited by the IRS!  Now what?”  The interview will be broadcast at 9:30 p.m. Pacific Time on CreaTV, Comcast Channel 15 in San Jose and Campbell, and will be broadcast as streaming video at the same time at www.creatvsj.org. You can find broadcast times for other San Francisco Bay Area cities and past episodes at www.financialinsiderweekly.com.

Tax and financial advice from the Silicon Valley expert.