Author: Leon Clinton

Here’s a client story that I believe you will find of interest.

Facts

Henry and Heide own an S corporation 50-50. For more than five years, the corporation has operated a successful $10 million-a-year restaurant. 

Henry, Heide, and Harry formed a new S corporation that started a new restaurant in June 2021. The ownership is 35 percent for Henry, 35 percent for Heide, and 30 percent for Harry. 

During the four months of June through September of 2021, the new restaurant had gross receipts of $300,000. During the quarter ending December 31, 2021, the restaurant had gross receipts of $800,000. So for it’s seven months of operation it has $1.1 million in gross receipts.

Question

Will the new S corporation’s restaurant qualify for the start-up employee retention credit (ERC) of up to $50,000 for the fourth quarter? 

Answer

Yes. Here’s why.

The new restaurant is a new business that started after February 15, 2020, with a new set of owners and its own set of books. It clearly qualifies as a new business—the first step to qualifying as a recovery start-up business.

The second step is for average annual gross receipts to not exceed $1 million—using tax law’s calculation which in this case excludes the fourth quarter. 

The tax code calculated average annual gross receipts for 2021 that precede the calendar quarter for which the restaurant determines the credit are $900,000 and therefore do not exceed $1,000,000. Here’s how you make the calculation: $300,000 x 12 ÷ 4 = $900,000. Also, note that you apply the gross receipts test to the four-month period of existence because that’s how long the new restaurant had been in existence before the last quarter of 2021.

You don’t have to aggregate the new restaurant with the existing restaurant because the two S corporations fail the single employer test. 

Under the single employer test, corporate taxpayers that are members of a controlled group of corporations are treated as a single employer. A brother-sister controlled group of corporations is two or more corporations where

1. five or fewer persons who are individuals, estates, or trusts own at least 80 percent of the total voting power of all classes of stock entitled to vote, or the total value of shares of all classes of stock of each corporation; and 
2. the same five or fewer persons, taking into account ownership only to the extent that it is identical with respect to each corporation, own more than 50 percent of the total voting power of all classes of stock entitled to vote, or the total value of shares of all classes of stock of each corporation.

Because Henry and Heide each have 35 percent ownership in the new corporation and they have 50 percent each in the existing corporation, the corporations are not a controlled group.

Key point. Had Henry and Heide formed the new corporation 50-50 (no third-party Harry), they would have had to aggregate the two corporations. The aggregation would make them exceed the $1 million in gross receipts and would have denied them any ERC for a recovery start-up business. 

A Sad Deal

The requirement to aggregate along with the $1 million in receipts limit means that few new businesses will qualify for the recovery start-up business ERC.

From a compliance and clarity standpoint, it’s sad that the IRS in Notice 2021-49 did not address the aggregation rule other than with a mention in an afterthought manner on page 11. We all would have liked an example or two.

If you would like to discuss the ERC, please call me on my direct line at 408-778-9651.

• By Leon Clinton
• February 8, 2022

When you use a home for both rental and personal use, regardless of that home’s location at the beach or in the city, you run into the tax code’s vacation home rules that make that home either a residence or a rental property. 

It’s a residence when you

• rent it for more than 14 days during the year and
• use it for personal purposes for more than the greater of 14 days or 10 percent of the days that you rent the home out at fair market rates.

Example. You own a beachfront vacation condo. During the year, you rent it out for 180 days. You and members of your family stay there for 90 days. The property is vacant the rest of the year except for seven days at the beginning of winter and seven days at the beginning of summer, which you spend maintaining the property. Your condo falls into the tax code–defined personal residence because

• you rented it out for 180 days, which is more than 14 days, and 
• you had 90 days of personal use, which is more than 14 days and more than 10 percent of the rental days. 

Disregard the 14 days you spent maintaining the place.

The fundamental principle that applies when your vacation home is a personal residence is that expenses other than mortgage interest and property taxes allocable to the rental use cannot exceed the gross rental income from the property. In other words, rental operating expenses and depreciation cannot cause a tax loss on Schedule E of your Form 1040 for the year in question.

If you have such a property and want to discuss some planning strategies for its use, please call me on my direct line at 408-778-9651.

• By Leon Clinton
• February 4, 2022

Do you have a sideline activity that you think of as a business? 

From this sideline activity, are you claiming tax losses on your Form 1040?

Will the IRS consider your sideline a business and allow your loss deductions?

The IRS likes to claim that money-losing sideline activities are hobbies rather than businesses. The federal income tax rules for hobbies have been anti-taxpayer for years, and now an unfavorable change enacted in the Tax Cuts and Jobs Act (TCJA) made things even worse for 2018-2025. 

If you have such an activity, we should have your attention. 

Here’s the deal: if you can show a profit motive for your now-money-losing sideline activity, you can classify that activity as a business for tax purposes and deduct the losses. 

Factors that can prove (or disprove) such intent include:

• Conducting the activity in a business-like manner by keeping good records and searching for profit-making strategies.
• Having expertise in the activity or hiring advisors who do.
• Spending enough time to justify the notion that the activity is a business and not just a hobby.
• Expectation of asset appreciation: this is why the IRS will almost never claim that owning rental real estate is a hobby, even when tax losses are incurred year after year.
• Success in other ventures, which indicates that you have business acumen.
• The history and magnitude of income and losses from the activity: occasional large profits hold more weight than more frequent small profits, and losses caused by unusual events or just plain bad luck are more justifiable than ongoing losses that only a hobbyist would be willing to accept.
• Your financial status: “rich” folks can afford to absorb ongoing losses (which may indicate a hobby) while ordinary folks are usually trying to make a buck (which indicates a business).
• Elements of personal pleasure: breeding race horses is lots more fun than draining septic tanks, so the IRS is far more likely to claim the former is a hobby if losses start showing up on your tax returns.

If you would like to discuss the profit motive, please call me on my direct line at 408-778-9651.

• By Leon Clinton
• February 1, 2022