Individual Tax

Um... Chrisley knows best?

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Posted by Amy Frushour Kelly

“…obviously the federal government likes my tax returns because I pay 750,000 to 1 million dollars just about every year so the federal government doesn’t have a problem with my taxes.” Todd Chrisley, star of the reality television program Chrisley Knows Best, made this claim on a national radio program in February 2017, but the Internal Revenue Service and the Department of Justice disagree. On August 13, a federal grand jury indicted Todd and his wife Julie on multiple counts of conspiracy, bank fraud, wire fraud, and tax evasion. The Chrisleys’ accountant, Peter Tarantino, has also been indicted on tax-related offenses.

Keeping in mind that defendants are presumed innocent and it is the government’s burden to prove the defendants’ guilt beyond a reasonable doubt, the allegations are numerous and serious. Let’s break them down:

  • Conspiracy to defraud numerous banks by providing false information, including falsified personal financial statements and fabricated bank statements when applying for and receiving millions of dollars in loans.

  • Using fabricated bank statements and a fabricated credit report that had been physically cut and taped or glued together when applying for and obtaining a lease for a home in California.

  • Conspiring with their accountant, Peter Tarantino, to defraud the Internal Revenue Service.

  • Failing to timely file income tax returns for the 2013, 2014, 2015, and 2016 tax years or timely pay federal income taxes for any of those years.

  • Obstructing IRS collection efforts, which included hiding income, lying to third parties about their tax returns, and (in Tarantino’s case) lying to FBI and IRS Criminal Investigation Special Agents.

Civil fraud penalties are severe: “If any part of any underpayment of tax required to be shown on a return is due to fraud, there shall be added to the tax an amount equal to 75 percent of the portion of the underpayment which is attributable to fraud.” Add to this the likelihood that the Chrisleys and Tarantino will face criminal charges. Federal tax evasion is a felony, punishable by fines and/or imprisonment up to five years. This is the tip of the iceberg. We don’t know what else may be revealed, and the indictment is a list of charges only.

The FBI takes allegations of bank fraud and wire fraud very seriously. Likewise, the IRS and Department of Justice have a zero-tolerance policy for conspiracy and tax evasion. Celebrities are not immune.

What can we learn from this? Obviously, honesty and punctuality are the best income tax strategies. Talk to your trusted advisor and plan ahead so you know in advance whether you’re going to face a problem. Remedies (that are legal!) are available, including payment plans. Finally, work with an accountant who won’t suggest or go along with lying to federal authorities. (Like Raich Ende Malter.)

New York, land of itemized deductions

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Posted by Evan Piccirillo, CPA

As we discussed previously, under the Tax Cuts and Jobs Act (TCJA), most itemized deductions have been suspended or limited for the next eight years. That fact, coupled with the nearly doubled standard deduction, means that most taxpayers will no longer itemize deductions on their federal tax return. Many might be led to infer that we no longer need to gather receipts and other tax deduction documents like we had in the past. You might even be thinking “Finally, something in the TCJA that resembles the simplification that the term ‘tax reform’ would suggest.”

Not so fast… New York State threw us a curve ball.

Prior to 2018, in most cases if taxpayers took the standard deduction on their federal return, then they would have to use the standard deduction on their New York return. Now New York will allow all taxpayers to itemize, even if they take the standard on their federal. In addition, virtually all the categories of itemized deductions that were suspended under the TCJA for federal returns are still allowable for New York returns. This means you will have to provide your tax preparer with:

  • amounts paid for charity

  • personal casualty losses

  • real estate and foreign taxes paid (you still can’t deduct New York taxes on your New York return)

  • interest paid, including mortgage interest

  • medical expenses, if they exceed 10% of federal AGI

  • certain job expenses and other miscellaneous itemized deduction, subject to limits

Many of these deductions are subject to limits for New York that differ from federal limits.  Also, keep in mind that the New York standard deduction is only $16,050 for a married couple while the federal standard deduction is $24,000.  It very well may be the case that taxpayers with itemized deductions that fall between those amounts (and in excess of those amounts) will want to tax advantage of this change in New York.

Although this is actually a benefit for taxpayers (more deductions) it adds yet another layer of complexity to an already tangled web of information and misinformation in the public conversation.  If you were under the impression that your facts lined up in such a way that you were done with tracking personal deductions, it is very likely that you were wrong.

I hope you didn’t throw away those receipts…

Introducing: the new business loss limitation



Posted by Evan Piccirillo, CPA

A new provision included in the Tax Cuts and Jobs Act introduces the concept of excess business losses (EBLs). Beginning in tax years starting after December 31, 2017, a tax deduction for losses from business activities that exceed $250k for single filers and $500k for married filers are considered EBLs and will be disallowed.

Digging into this piece of hastily-written code section we don’t find much in the way of details, but we do get some important information:

  1. The EBL converts to a net operating loss (NOL) in the following year

  2. EBLs are figured by aggregating the income and loss from trades or businesses that exceed the limit

  3. The limits of $250k and $500k are indexed for inflation

  4. The limitation is applied at the partner or shareholder level in the case of a partnership or S corporation, respectively

  5. The EBL is figured after the other business loss limits: basis, at-risk, and passive activity

  6. This provision is set to expire in 2026

What does it all mean?

Taxpayers may not be able to shelter as much of their other types of income with losses from their active trades or businesses. Also, the NOLs generated from these EBLs are the new flavor of NOL which cannot be carried back, will be carried forward indefinitely, and are limited in their usage to 80% of taxable income. These NOLs are less potent than their predecessors, but the upside is that they don’t expire. We’ll have more on the NOL topic in a future article.

What don’t we know?

  • Does this limitation apply to trusts? The prevailing belief is that it does.

  • Are wages and/or guaranteed payments from sources subject to this limit considered to be trade or business income and therefore aggregated to figure the EBL? It seems they should be included, but this requires further guidance.

  • Will other items of income and loss such as interest income or 1231 gains/losses from sources subject to this limitation be aggregated to figure the EBL? This is also unclear and will require further guidance.

Let’s take a look at a simplified example:

A single taxpayer has nonbusiness income of $400k and net allowable business losses of $350K. Under these circumstances in 2017, this taxpayer would be able to shelter most of their income with the business losses and only pay tax on $50k of income ($400k - 350k = $50k). With the same set of facts in 2018, the taxpayer’s business losses will be limited to $250k and tax will be paid on $150k ($400k – 250k = $150k), resulting in a $100k swing in income. The EBL of $100k will convert to a NOL to be used in future years, which is nice, but this taxpayer still needs to pay tax presently on an extra $100k of income. Not an ideal outcome for our hypothetical taxpayer.

This limitation adds yet another layer of complexity to an already complex tax planning landscape. If your tax situation resembles what you have just read, you should consult with your tax advisor to see if there is anything you can do before the end of the year to account for this potentially expensive tax consequence.

Navigating the Tax Cuts and Jobs Act: Volume 4 – Individual year-end planning

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Posted by Evan Piccirillo, CPA

[Editor’s note: this is one of an ongoing series of articles parsing and clarifying the tax reform commonly known as the Tax Cuts and Jobs Act. Previous articles are linked at the end of the post.]

Nearly everything involving taxes in our country has been acutely affected by the Tax Cuts and Jobs Act (TCJA). Unfortunately, owing and paying tax are still necessary and required in most cases, but on the other hand we are treading on new terrain for year-end tax planning. We will explore some actions taxpayers can make before the end of 2018 that can provide a tax benefit.

Itemized deductions

The only itemized deductions that have survived the TCJA are:

  1. medical expenses in excess of 7.5% of adjusted gross income

  2. state income and real estate taxes, limited to $10k

  3. mortgage interest including home equity interest paid, subject to limits

  4. charity

One of the most impactful changes to individual taxpayers is the limitation on state income tax and real estate tax paid (the so-called SaLT deduction) to $10,000. Many taxpayers, especially those in high-tax states, were itemizing their deductions primarily due to their state tax burden. Couple this limit with the drastic increase of the standard deduction ($24k for married filing joint taxpayers), and you will find most taxpayers will no longer itemize their deductions.

Tax planning points

  1. Bunching deductions. If you have significant deductions that are just below the standard deduction, you might consider “bunching” your deductions, i.e. paying charitable contributions on January 1st and December 31st of year one, and then not making such contributions in year two. As a result, you will itemize deductions in year one and tax the standard deduction in year two, then alternate this method each year.

  2. For estimated taxpayers, there is no more pressure to get your 4th quarter estimated state tax payment in on or before December 31st since you will likely already exceed the $10k cap, and therefore receive no benefit from paying the estimate two weeks early (they are due January 15th).

Sec. 199A – The 20% Deduction

To put individual taxpayers on more even ground with corporations that now have a 21% flat tax rate, the TCJA provides a deduction of up to 20% of income from pass-through entities. Depending on the income level of a taxpayer and the type of business that generates the income, this 20% deduction may be limited or altogether eliminated. We will discuss this provision in depth in a different article, but we will explore basic tax planning here.

Tax planning points

  1. For s-corporation shareholders, consider adjusting owner’s salaries to maximize the deduction. If a taxpayer’s income is over the threshold and the business is qualified, the 20% deduction may be limited to 50% of the wages paid by the company. Since only the pass-through income and not the wages earned from the company get the benefit of a 20% deduction you would prefer the pass-through income to be as high as possible and the wages paid to be as low as possible. There is a sweet spot in the relationship between the wages and the pass-through income that will offer the optimal deduction assuming the owner’s compensation is still considered to be reasonable.

  2. An alternate limitation is 25% of wages plus 2.5% of depreciable property. Taxpayers might consider making an investment in tangible property for the business before the end of the year, especially in partnerships or sole proprietorships where owners are precluded from paying themselves wages. There are also enhanced accelerated depreciation incentives in the new tax law that make this an even sweeter deal.

Gain Deferral – Qualified Opportunity Zones

An incredible tax deferral tool provided by the TCJA is the advent of qualified opportunity funds (QOFs) which are entities that invest in qualified opportunity zones (QOZs). QOZs are economically depressed areas that have been identified by state governments. The intention of the law is to spur economic investment in these depressed areas. QOFs may present an attractive option for taxpayers that have significantly appreciated property and would like to dispose, but do not want to pay tax on the gain.

Tax planning points

A taxpayer may defer paying tax on a capital gain, if they invest the gain in a QOF within a 180-day window. If specified holding periods are met, those taxpayers may receive a deemed step up in basis of up to 15%, thereby permanently eliminating tax on that portion of the gain. In addition, the appreciation on the investment in the QOF is not taxed if held 10 years.

Bottom line

Only two months remain in 2018, but that is enough time for savvy taxpayers to take advantage of some of the changes to the tax code… and these are just a few of the options available to taxpayers looking to decrease their federal tax liability. As always, consult with your advisor before taking it upon yourself to engage in any of these tactics. Everyone’s personal income tax situation is nuanced, and certain actions may not yield expected results.

The IRS is not amused with states' attempts to circumvent federal tax changes


The recently enacted Tax Cuts and Jobs Act (TCJA) makes some potentially detrimental changes to state and local tax (SaLT) deductions, namely a limitation on the tax deduction of $10k for married filers and $5k for single filers for state taxes.  Prior to the TCJA, there was no such limitation (even though some taxpayers were hit with the Alternative Minimum Tax, but that is a different discussion).  This presents a problem for taxpayers in “high-tax” states: any jurisdiction that imposes a high income tax, a high property tax, or both, such as New York, New Jersey, California, and Connecticut.  The TCJA did not cap the deduction on charitable contributions; in fact, they increased the limit from 50% to 60% of adjusted gross income for certain types of gifts, and even then excess contributions are allowed to be carried over into subsequent years.

If only there was some way to decrease the amount of state taxes paid to say, less than $10K, while at the same time increasing charitable gifts!  State legislators in these high-tax states were quick to cook up a work-around to this change and came up with a doozy.  States will establish state-run charitable trust funds.  Taxpayers would be allowed a state tax credit of some percent (New York provides 85%; New Jersey, 90%) of their contribution to these funds, and in theory, also get a deduction on their federal tax return for a charitable contribution.  Thus, states would shift the character of payment from one category to the other and there will be much rejoicing (and tax deductions).


The IRS wasted little time responding and announced that they will release proposed regulations to provide guidance to taxpayers on how the IRS is the authority on the characterization of charitable contribution and it doesn’t matter what the states say.  The central factors in determining if a charitable contribution is deductible is that it 1) is paid to a qualified organization (which the states’ trust funds can meet) and 2) the deduction must be reduced by any benefit the taxpayer receives.  If you have been paying attention, you will have noticed that, in this arrangement, the taxpayer would receive a benefit for their contribution in the form of a tax credit, and therefore they would have to reduce their charitable contribution deduction by the state tax credit they received.  This results in a net zero benefit to taxpayers.

More than anything, this is posturing by politicians in state and federal positions.  Unfortunately for those of us in high-tax states, we will have to deal with paying taxes to our state and not getting the benefit we were used to getting in the past.  There are other important issues that states will have to address in the wake of the TCJA which we will discuss in future posts.  If you would like to complain about this or other topics, reach out to your trusted advisor, or give me a call.

Tax procrastination: the most dangerous game

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April 15. This is the deadline set by the IRS for filing your personal tax return.  (It’s usually April 15; this year, it happened to be pushed back to April 18, as a result of the 15th falling on a Saturday and then the observance of Emancipation Day in Washington, D.C. the following Monday, but that is a different story).  As most of us know, the IRS allows taxpayers to file an extension granting six additional months (usually to October 15… Because this date falls on a Sunday this year, the extension deadline is October 16).  But, and this is a big but, the extension grants only additional time to file, not additional time to pay. This point should be made abundantly clear to taxpayers, because no one wants to be hit with late payment penalties.  And most of us seem to completely disregard the first five months and push off getting our tax information to our preparers until we glance up at the calendar and realize we are almost out of time.

This is a dangerous game to play, for multiple reasons.

Most preparers have a full docket of work from the end of summer right through the extended due date.  This is due in part to procrastination of taxpayers and preparers, as well as a schedule in which multiple deadlines occur in rapid succession. The deadline for pass-through entities is September 15 (just one month prior to the deadline for personal returns), and trust returns are due September 30 (just two weeks prior).  When some of the information required isn’t available, this can create a butterfly effect.

Not all of the required information may be immediately available, but this is not a good reason to neglect sending over the readily-available information to your preparer.

Add the overwhelming amount of work to the complexity of tax law and expertise required to properly prepare a tax return, and one can see how there is an increased likelihood of errors, omissions, and/or missed opportunities.  This is a serious no-no for tax professionals.

The more time a preparer has to consider options and the presentation of facts, the more value can be added.  Additionally, there is greater opportunity to consider actions that can be taken in the subsequent year (which we are usually in the middle of when we are looking at last year’s information) or future years that can be favorable to the taxpayer.  Timing matters.

For estimated taxpayers, timing is of increased importance.  If your tax liability has changed and the prior year’s tax has been underpaid or overpaid, waiting until the deadline could leave you having paid three quarters of estimated taxes at the incorrect amounts.  This can result in penalties for underpayment of estimated tax or, even worse, giving excess interest-free loans to the government (oh, the humanity!).

None of the above addresses a more intangible issue, which is finality; crossing something off a list.  Getting your return filed offers just such a feeling, and I urge you to experience it.  Your preparer will thank you, too.

Bottom line? Don’t treat the filing of an extension as permission to procrastinate for six months, but rather just a short window to have everything lined up to comfortably make the extended due date in spite of any outstanding information. 

6 ways the IRS and NYS are collecting back taxes

Guest post by Karen J. Tenenbaum, Esq., LLM, CPA, Tax Attorney at Tenenbaum Law, P.C.


Taxpayers who owe money to the IRS or New York State face an expanding arsenal of tools the government is using to collect back taxes. The federal and state governments are using similar tactics, but each with their own twist. Due to the success of some of these methods, taxpayers and tax professionals can expect to see them more often. Here are a few of the top collection tactics.

1) Private debt collectors                                                                   

Both the IRS and New York State have recently started using outside collection agencies to collect delinquent taxes. The IRS uses private debt collectors for tax liabilities of less than $50,000. Private debt collectors are only allowed to locate taxpayers, ask taxpayers if they can pay in full, or set up a five-year Installment Agreement if they cannot pay in full. Despite criticism of the program and collectors’ tactics, they are permitted to contact taxpayers by phone, unlike government agencies. The private agencies cannot collect any actual payments; those are made directly to the IRS. The agencies receive 25% of the funds collected. Currently, the IRS is using four agencies: CDE Group, Conserve, Performant, and Pioneer. Note that taxpayers who have accounts in Offer in Compromise, Installment Agreement, Collection Due Process, and Innocent Spouse Relief status are exempt.

New York State is currently contracted with one outside collection agency: Performant Recovery Inc. As with the IRS, taxpayers will continue to make payments directly to the state, not the collection agency.

2) IRS passport revocation

Since the end of 2015, a taxpayer can lose his/her passport if he/she owes the IRS $50,000 or more including penalties and interest. The Secretary of State is permitted to deny the issuance or renewal of a passport or revoke the passport of that individual. The IRS must give notice to the individual involved at the same time it gives notice to the Secretary of State that the taxpayer is “seriously delinquent.”

If the individual is outside the United States, the Secretary of State may also limit a previously issued passport only for return travel to the United States or issue a limited passport that only permits return travel to the United States.

3) NYS driver’s license suspensions

The State can suspend an NYS Driver’s license if the driver owes $10,000 or more in tax, penalty, and interest and there is no collection resolution in place (such as an Installment Payment Agreement, Income Execution, or Offer-in-Compromise). New York State has collected over $715 million in back taxes to date from this program.

An added twist to this tactic is the Multi-State Driver License Compact. Many taxpayers think that if their New York State driver license is suspended, they can simply get one from New Jersey or Florida. However, 45 states and the District of Columbia have entered into the Compact, which is an interstate information exchange. If the taxpayer’s license is suspended in any member state, that suspension will hold in all other member states. The only states not in the program are Georgia, Maine, Michigan, Tennessee, and Wisconsin.

4) Liens

A New York State Tax Warrant is a legal judgment and notice for priority. It is a perfected lien and enables New York State to take certain collection action against a taxpayer’s real and personal assets. A Tax Warrant also ensures that New York will get paid ahead of subsequent creditors. It is a public document, and can be found on the Department of State’s website. It should be noted that there is now a single 20-year statute of limitations on collections, which begins on the first day that a tax warrant could have been filed.

The IRS uses a federal tax lien to collect back taxes. If a tax isn’t paid after a formal request, the Internal Revenue Code grants the IRS an automatic lien, sometimes referred to as a “silent lien” against all of a taxpayer’s property and rights to property. It even attaches to property acquired after the assessment itself.

The IRS files a Notice of Federal Tax Lien in order to establish collection priority. The IRS must collect a tax liability within 10 years from the date of assessment.

5) Levies on wages

In New York, an income execution is a type of levy that is issued against a taxpayer’s gross wages. It is limited to 10% of gross earnings and it remains in effect until the underlying tax liability is satisfied. The state is not required to issue a tax warrant prior to entering into an income execution.

At the federal level, the IRS can also levy on a taxpayer’s wages. Federal wage garnishment is quite harsh, since the IRS takes almost everything. The employer is provided an exemption table to calculate the amount of wages exempt from the levy based on the number of exemptions claimed by the taxpayer.

6) Other levies

New York can collect on a taxpayer’s outstanding liabilities with various types of levies, including: bank levies that last for a 90-day period; levies on third parties, such as customers or tenants; refunds and offsets; and seizure and sale at tax auction. 

The IRS can also levy on property, including bank accounts, provided it meets notice requirements and gives the taxpayer an opportunity to file a request for a collection due process hearing.

In order to avoid or stop these collection actions, both the IRS and New York State offer ways for taxpayers to address their debts. An IRS Installment Agreement or NYS Installment Payment Agreement allows taxpayers who are financially unable to pay the full amount of the liability at once to pay in monthly installments over time. Taxpayers who cannot afford to pay their tax bill may qualify for an Offer in Compromise, wherein the government agrees to accept less than the full amount due of tax, interest, and penalties. Both options have stringent requirements.

If you are facing an audit or collection matter, consult a qualified tax professional.


Karen Tenenbaum, Esq., LL.M. (Taxation), CPA is founder and partner of Tenenbaum Law, P.C., a tax law firm in Melville, New York, which has focused its practice on the resolution of IRS and New York State tax controversies for over 20 years.

W-8BEN: Keep more of the pie for yourself


When it comes to getting their piece of the pie, the U.S. Government has done everything within its power to make the world so small that there’s nowhere for a non-compliant taxpayer to hide. Because U.S. taxation is based on worldwide income, all amounts earned globally are subject to U.S. tax and reporting. Even if you’re not a U.S. citizen or a resident, you’re still subject to U.S. tax on any amount earned from U.S. sources. However, the U.S. identified two major issues within its worldwide system:

  • Foreigners weren’t reporting and paying taxes on U.S. source income
  • U.S. taxpayers weren’t reporting their worldwide income and income-producing assets

The IRS responded by adding two new chapters to the Internal Revenue Code for new special reporting related to foreign assets and income.


Let’s put that title into layman’s terms: a U.S. person (“person” in the tax code sense) must withhold tax on income earned by foreigners. The types of income covered by Chapter 3 are commonly referred to as “FDAP” income (fixed, determinable, annual, and periodical). “FDAP” income usually consists of dividends, interest, rents, royalties, etc. Any U.S. person who’s paying out FDAP income to a non-U.S. person generally has the responsibility to withhold 30% of the income and remit it to the government.

This chapter was created to compel non-U.S. taxpayers to report income earned from U.S. sources. The tax due is withheld by an agent (the payer) and remitted to the government in lieu of the foreign person filing a tax return (sometimes). The withholding agent uses Forms 1042 and 1042-S to report the withholding.


To folks “in the know", parts of this chapter are referred to as “FATCA” reporting (Foreign Account Tax Compliance Act) or sometimes erroneously as “FACTA”. This chapter is directly responsible for both the foreign financial asset reporting on Form 8938 and all of the associated headaches. However, there’s another key component to the chapter: the manner in which foreign institutions exchange information with the U.S. government about U.S. persons. More often institutions are entering agreements with the U.S. to disclose information about the financial holdings of their customers… bad news for the willfully non-compliant.

This chapter is designed to compel U.S. taxpayers to report their worldwide income through a system of compliance for non-U.S. institutions holding U.S. taxpayer assets. The chapter separates non-U.S. institutions into two distinct classes: “Foreign Financial Institutions (FFI)” and “Nonfinancial Foreign Entities (NFFE).” Each includes different types of subclasses, but the general idea is that the withholding responsibilities are determined on whether the institution is a bank or something else.

So what? What about my piece of the pie?

The new reporting requirements mandate that participating withholding agents do the following:

  • Disclose pertinent information to the IRS about assets held within their institutions
  • Withhold money and remit it to the U.S., if applicable

As a result, more taxpayers are entering into offshore voluntary disclosure programs, and the IRS is collecting more U.S. tax. Which brings us to the BEN forms.

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What are BEN/BEN-E forms? Do they involve pie?

No. The pie was a metaphor. Sorry to get your hopes up.

The W-8BEN series (Certificate of Foreign Status of Beneficial Owner for United States Withholding and Reporting) is a group of forms created to document the status of a person that would potentially be subject to U.S. withholding tax by a withholding agent and remember: 30% by default. When a foreign person is the ultimate beneficiary of U.S.-source income, they are generally subject to withholding. The BEN series is a way of tracking that withholding requirement for withholding agents. W-8BEN forms are filed for individuals, and W-8BEN-E forms are filed for entities. There are a number of other forms in the series, but we’ll focus on these two. Although complex, the BEN forms serve three distinct functions:

  • Establish that you are not a U.S. person (for Chapter 4 purposes)
  • Claim that you are the beneficial owner of the income subject to the withholding
  • Claim a reduced rate of withholding or exemption from withholding based on treaty benefits

The third function is key, because it can allow a non-U.S. person to reduce or even eliminate the amount of withholding required by the withholding agent. This keeps your client’s money in their pockets and out of the hands of the government; more pie on their plate.

I just received one of these forms. Now what do I do?

The forms (especially the W-8BEN-E) can be daunting, even to an experienced professional. But they’re worth the time and effort it takes to fill them out accurately. They’re a valuable means to reduce potential withholding on income. Ignoring these forms can cause the institution to withhold at the max 30% rate. Not good. When faced with one of these forms, take a deep breath and contact your trusted accounting professional for help. You’ll be glad you did.

Is it time for you to make the mark-to-market election?

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Investors and traders are treated differently by the IRS

If the markets reach a tipping point and crash, how will you be affected? The tax implications will depend on whether you're an investor or a trader who has made a mark-to-market election under Section 475 of the Internal Revenue Code. Traders who seek treatment under Section 475 can gain advantages in a down market, and here's why.

The Dow Industrial Average is on an unprecedented rally, exceeding 22,000 and continuing for more than eight years. But the simple truth is that bull market streaks always come to an end. The extended low-interest rate policy and quantitative easing program set by the Fed have assisted the climb of the market indices, but authorities are now debating how to end these programs and normalize economic policy. Looking forward, both investors and traders need to employ the best investment and tax strategies to maximize gains and minimize the damage from the impending bear market.

Whether you’re defined as an investor or a trader by the IRS, it’s critical to use advanced tax planning and good record-keeping.

Are you an investor or a trader?

Investors are defined as individuals who seek to profit from capital appreciation, dividends, and interest. When they hold assets longer than a year and a day are rewarded with preferential tax rates (generally 15%-23.6%). Otherwise, the gain is taxed at the ordinary rate (as high as 39.6%). Excess losses can be used against ordinary income from other business activities, limited to only $3,000 per year; the remainder is carried forward. Investment expenses incurred, such as trading programs, software, and conferences are limited to an amount that exceeds 2% of adjusted gross income and are not deductible at all for alternative minimum tax purposes. In a volatile or bear market, managing losses can be tricky for the investor. Under Sec. 1901, losses are further limited: the investor’s repurchase of a security that would otherwise be reported as a loss within 30 days of sale (a “wash sale”) is disallowed and added to the basis of the security, which will only be allowed upon ultimate disposition of said security.

Trader status is less clearly defined, but court decisions offer some guidance. Traders are individuals who seek to profit from daily market movements; their activity must be substantial; and it must occur with continuity and regularity. The trader treats the buying and selling of securities as if carrying on a business activity.

Here’s where traders can tip the scales in their favor: individuals who qualify as traders may make a Sec. 475 mark-to-market election. The timing is important to understand: the election must be filed by April 15 with the preceding year’s tax return or extension (e.g., to be effective for 2017, a statement must have been filed with your 2016 tax return or extension by April 15, 2017). Relief is technically available for late elections, but taxpayers are not frequently successful in receiving that relief. Form 3115 should be filed with the 2017 tax return to change accounting methods.

Advantages of the mark-to-market election

Taxpayers who have made the mark-to-market election benefit in several ways:

  • Losses are unlimited (as opposed to the $3,000 limit)
  • Investment expenses are 100% deductible
  • No self-employment tax
  • Wash sale rules don’t apply

Keep in mind, though, that traders report all gains and losses as ordinary income or loss, so there is the potential for an increase in rate on those gains from the preferential tax rates previously mentioned.

No self-employment tax              

There is no IRC section or regulation dealing specifically with self-employment tax on traders, but case law findings now support the position that traders are not subject. This is a tax issue that has shifted over time. As an example, the $8.1 million first prize for the Main Event World Series of Poker that was captured by a New Jersey accountant was subject to both income and self-employment (Social Security and Medicare) taxes, which added up to a staggering 47.11% tax bite. The IRS reasoned that there was no distinction between a gambler or active trader who devotes his full-time on the exchanges for his livelihood. Trading should be regarded as a trade or business and subject to self-employment taxes. However, the IRS more recently advised that individuals who qualified for trader status “occupy an unusual position under tax law because they engage in a trade or business [that] produces capital gains and losses.” In 1999, an IRS letter stated that “self-employment tax does not apply since the sale of a capital asset is involved and is only ordinary because of the mark-to-market election.”

Bottom line

If you engage in short-term trading and qualify for trader status, you can take advantage of some significant tax treatments. Don’t forget traders can have it both ways and take advantage of the investor’s preferential long-term capital gains rates on securities in held-for-investment accounts, but proper records must be kept. A trader who seeks this benefit must separate the respective brokerage activities into different accounts. Contemporaneous records should document how the trader intends to treat each security at the time of purchase.

The analysis and interpretation of IRS rulings and court decisions is critical in helping taxpayers decide if their activities will qualify for trader status. Before making the Sec. 475 election, talk to a CPA.

Further reading

Wanna be a real estate pro? Not so fast.

Thinking of becoming a real estate pro? You’ve heard the term and about the potential tax benefits to being classified as such. You’re thinking that you want in on this sweet, sweet tax exception action. If you’re seriously considering becoming a real estate professional, you need to...