Chapter 3: Business Tax Issues

✓ Issue 1: Marijuana-Related Businesses

✓ Issue 2: Business-Use-of-Home Deduction for Day Care Providers

✓ Issue 3: Calculating Cost of Goods Sold on Schedule C (Form 1040)

✓ Issue 4: Maximizing the Qualified Business Income (QBI) Deduction

✓ Issue 5: Partnership Capital Account Reporting Requirements

✓ Issue 6: Like-Kind Exchanges

✓ Issue 7: Involuntary Conversions

PP. 81-129

PP. 82-88

Pg 82-83

• P. 83

2014

The Farm Bill of 2014 –University sponsored research

2018

The Farm Bill of 2018

• THC < .3% Legal

Cannabis is legal in all

states.

True or False

WAGES, COMPENSATION, FRINGE BENEFITS

GROSS INCOME DERIVED FROM

BUSINESS

GAINS FROM DEALINGS IN

PROPERTY

INTEREST, DIVIDENDS

RENTS, ROYALTIESLIFE INSURANCE &

ENDOWMENT CONTRACTS

PENSIONS

DISTRIBUTIVE SHARE OF INCOME

FROM FLOW-THROUGH ENTITY

§ 280E

Prohibits § 162

§ 162C(2) Other illegal payments

Burden of Proof –Secretary of Treasury

Pp 84 & 85

§ 280E CONTINUED

Schedule I and II of Controlled Substance Act

§ 263A (UNICAP) – Disallowed (Practitioner Note Pg. 86)

§ 471 Defines COGS

Pp 84 -86

Non-Cannabis Business

Cannabis Business

Pp 85-86

RESELLERS PRODUCERS DIRECT & INDIRECT COSTS

P 86

§ 471-3(B) RESELLERS

Invoice Costs – COGS purchases

Less Trade Discounts

Transportation Costs

Direct Costs

Accrual Method – may require capitalization

P 86

P 86

Inventory Costs

Raw Materials

Supplies (new or

consumed)

Direct LaborIndirect

production costs

NOT Sales cost or return

of capital

PRODUCTION

COSTS

COGS PRODUCTION

METHODS

FULL ABSORPTION

P 86

Direct Compensation

PTO

Employment Taxes

Unemployment Benefits

P 86

FINANCIAL STATEMENTS -- GAAP

§164 – taxes, other than state, local & foreign

Depreciation & Depletion

Employee Benefits

Strikes, re-work, labor, scrap & spoilage

• Administrative related to

production

• **** Officer’s salaries

related to production

****

• Insurance Costs related

to production

P 87

DIRECT COST 10% OF GROSS

SALES IN MI

COLORADO –

MULTIPLE TAXES

P 87

If a tax practitioner is going to help taxpayers

in the Cannabis Industry, they must

understand the restrictions of §280E

True or False

TAX PAYMENTS & CASH PAYMENTS

EFTPS Required

IRS Taxpayer Assistance Centers

Request penalty relief for not using EFTPS

• Allgreens, LLC v. Commissioner, T.C. Docket No. 13860-14

$ 10,000 Single Transaction Reporting

• P 87

P 88

STATE OF MICHIGAN MARIHUANA LAWS

2008

The Medical Marihuana Act of 2008 (Caregiver Act)

2016

The Medical Marihuana Facilities Licensing Act of 2016

2016

The Marihuana Tracking Act of 2016

2018

The Michigan Regulation and Taxation of Marihuana Act of 2018

2018

Bifurcate from§280E

LICENSES

Marihuana Grower – Class A, B & C

Marihuana Processor

Marihuana Retailer

Marihuana Safety Compliance Facility

Marihuana Secure Transporter

Marihuana Microbusiness

Excess Marihuana Grower

Marihuana Event Organizer

Temporary Marihuana Event

Designated Consumption Establishment

Federal Law supersedes

• RAB 2019-17

MI Regulation & Taxation Act

MI RAB 2019-17

Decoupled from IRC 280E

“…in computing net income for marihuana establishments, deductions from state taxes are allowed for all of the ordinary and necessary expenses paid or incurred during the taxable year in carrying out a trade or business.”

COGS remain unchanged

“Only those “ordinary and necessary” expenses paid or incurred after the date of licensure by LARA, as determined by using the taxpayer’s method of accounting used for federal income tax purposes, may be deducted under this provision.”

Licensed by MRA under the MRTMA only

I.R.C. §471only relates to the

Cannabis Industry

True or False

Issue 5: CORA Premium Assistance Credits

COBRA

PREMIUM

ASSISTANCE

CREDIT P 488

§9501(a)(4) – American Rescue Plan Act of 2021

100% reduction in premium

Reduction in hours, OR

Involuntary termination of employment

April 1 through September 30, 2021

I.R.C. §1391 -- Excluded from gross income of recipient

60 days – Employer reimburses Employee

COBRA

PREMIUM

ASSISTANCE

CREDIT PP 488 - 489

Refundable Payroll Tax Credit

Total amount of premium

DOES NOT include any subsidy received by Employer

Example 12.17

Payroll Tax Return – Form 941

Reduce payroll tax deposits

Form 7200 – request advance credit

Qualified Wages for ERC or Family/Sick Leave Credit

Included in Gross Income of Employer

The COBRA Premium Assistance Credit is available through December

31, 2021?

True or False

• Losses more likely due to pandemic

• Income ↓

• Expenses ↑

• Day care for adults as well as children

• IRS Audit Technique Guide – day care providers often overstate the deduction for business use of the home

PP. 89-94

• General rules - regular and exclusive Use

• Meet at least one of three tests:

• If within dwelling unit

• Principal place of business, or

• must be used to meet or deal with patients, clients, or customers, or

• If separate structure – used in connection with taxpayer’s business

• Substantial administrative or management activities may suffice

• Separately identifiable space

• Practitioner Note (p. 90) – not for employee through 2025

P. 89

• Day care for children, adults age 65 and older, or persons who are physically or mentally unable to care for themselves

• “Available for day care use throughout each business day and is regularly used as part of the provider’s routine provision of day care”

• Occasional use for day care not included

• Occasional non-use for day care is permitted

• Used for custodial services not primarily educational or instructional services

P. 90

• Deduction allowed only if any licensing requirements are met

• General rule is allocation based on square footage

• Day care: square footage multiplied by % of time used by day care

• Deduction allowed only to the extent that income exceeds

• direct expenses, and

• Allocable home costs that would otherwise be deductible (interest and taxes)

• Ex. 3.2

• Prep and cleanup time count

• Record-keeping crucial

• No deduction for first phone line

P. 91

• Safe harbor method applies but limited to 300 square feet and time-use %

• ATG reminds auditors to include all living space (basement, maybe garage)

• Practitioner Note

• Standard meal and snack rates available

• Records must track number of children for each meal/snack

P. 93

• COGS

• Cost to produce or acquire inventory

• Gross income under Treas. Reg. §1.61-3:

• Total sales less COGS

• COGS Formula

• Beginning Inventory

• Plus: acquisition and production costs

• Less: Ending Inventory

• Practitioner Note: Small Business Taxpayers - inventory exception

PP. 94-95

• Purchases:

• Raw materials, parts, and merchandise for resale

• Net of discounts and personal/family use

• Labor Costs:

• Includes both direct and indirect labor

• Includes payroll taxes and fringe benefits

• Material and Supply Costs:

• Direct and indirect

PP. 94-95

Other Costs incurred in the resale or manufacturing activity:

• Shipping and handling

• Overhead costs allocable to the resale or manufacturing activity

• Maintenance and quality control

Not included:

• Marketing

• Advertising

• Selling

P. 95

• Sch C, Part III (see Fig. 3.5)

• Taxpayer elects valuation method for year-end inventory:

• Generally, cost

• Could be lower of cost or market value

• Explanation needed for any other method

P. 95

• Lesser of 20% of QBI or taxable income

• May be further limited by wage and capital limit

• SSTB limit may apply

• I.R.C. §199A and regulations

PP. 96-107

• Net income from a US trade or business

• Includes certain self-rentals

• Excludes:

• Dividends

• Interest not allocable to T/B

• Capital gains and losses

• Gains and losses of foreign PHCs

• Annuity income

• Wages and guaranteed payments

• Reduced by one-half SE tax, SEHI deduction, and deduction for contributions to qualified retirement plans

P. 96

QBI deduction is limited to 20% of taxable income before the QBI deduction

Taxable income for this limit does not include net capital gain

P. 97

The QBI deduction is limited to the greater of

• 50% of the W-2 wages with respect to the qualified trade or business; or

• 25% of the W-2 wages with respect to the qualified trade or business, plus 2.5% of the UBIA of all qualified property.

UBIA – Unadjusted Basis Immediately after Acquisition

Limit applies above taxable income threshold:

P. 97

• $75,000 QBI x 20% = $15,000 tentative QBID

• Taxable income of $262,450 – subject to wage and capital limit

• Allocable wages $15,000, UBIA $10,000

• Wage and capital limit, the greater of

• 50% x $15,000 = $7,500, or

• 25% x $15,000 + 2.5% x $10,000 = $3,750 + $250 = $4,000

• Brian’s QBID limited to $7,500

• Cross Reference – limitation is proportionate within the phasein range

P. 98

• Above phasein: No QBI, qualified wages, or UBIA allowed from any SSTB

• Proportionate amounts allowed within phasein range

• No SSTB limit below the phasein range

• See list of services considered SSTBs

P. 98

• Gross receipts of $25M or less: SSTB receipts of less than 10% of total receipts

• Limit is 5% if gross receipts exceed $25M

• Ex. 3.6 Benefit of separating non-SSTB (dog food production) from SSTB (vet clinic)

Otherwise, all LLC activity would be treated as SSTB

P. 99

• Treas. Reg. § 1.199A-5(c)(2)

• No splitting off a trade or business to create non-SSTB income by providing services or leasing property to a 50% commonly controlled SSTB

• Income received by non-SSTB from its related SSTB will be treated as SSTB income

• Related party defined under I.R.C. §§ 267(b) and 707(b)

P. 99

• Taxpayer with more than one T/B where one or more are SSTBs may wish to separate them

• Reasonable allocations must be applied consistently

• Practitioner Note: IRS requires

• complete and separate books and records

• each business would be allowed to choose a different method of accounting under Treas. Reg. § 1.446-1(d)(1)

• Ex. 3.7 separates non-SSTB income, wages, and expenses

and creates a $15,000 QBID (see Form 8995-A)

P. 100

• Aggregate to avoid the wage and capital limitation

• Requirements:

• not an SSTB

• business relationship

• common ownership

P. 102

P. 103

• Cross-Reference: attribution rules apply to determine common control

• Practitioner Note: Grouping under PAL rules may be different

• Ex. 3.8 Alice can aggregate catering and restaurant businesses

• Ex. 3.9 Common management of different businesses is not enough

• Ex. 3.10 Residential and commercial real estate are not similar

• Ex. 3.11Two non-SSTB businesses under common control

• Shared boat ownership, accounting and administrative services, common customers

• Rafting business has plenty of wages, fly fishing QBID limited by wages

• Aggregation increases QBID by $100,000

PP. 104-106

• Consistent grouping required in subsequent years

• May add newly acquired or created business

• Otherwise, regrouping requires

• significant change in facts and circumstances

• prior aggregation no longer qualifies

• Reporting – see requirements for attached statement for year of grouping and each subsequent year

• IRS can disaggregate for failure to disclose

• Disaggregation applies for subsequent 3 tax years

P. 106

• 3,946,342 partnership returns were filed (FY 2019)

• IRS stepping up compliance selection

• As of January 1, 2020, must report tax basis capital accounts

• Prior reporting may have been based on GAAP, book, or any other method

• Taxpayers may wish to maintain these additional capital account records for other reasons

PP. 107-114

• Required to meet safe harbor requirements for special allocations under I.R.C. §704(b)

• Increased by

• Money contributed

• FMV property contributed (net of any liabilities)

• Allocated partnership income and gain

• Decreased by

• Money distributed

• FMV property distributed (net of any liabilities)

• Allocated partnership, deductions, losses and nondeductible expenditures

P. 107

• Start out the same as book capital accounts

• However, adjustments include changes in FMV not already reflected in book changes:

• asset appreciation and

• accrual transactions not yet reflected in the book income of a cash basis taxpayer

P. 107

• Similar to book but

• Income and deductions based on income tax rules

• Asset contributions are based on adjusted tax basis (ATB)

• Asset distributions are generally based on ATB

• Asset contributions to charity reduce tax basis capital by the asset’s ATB

• Tax exempt income also increases tax basis capital account

• Nondeductible expenses and any foreign taxes paid will reduce capital account

• Increased or decreased by any basis adjustments under I.R.C. §734(b)

• Practitioner Note – basis adjustments under I.R.C. §743(b) are not included

P. 108

• Ex. 3.12 Initial Capital Accounts – 3 Flavors

• Ex. 3.13 Update for income and distributions

PP. 108-110

• Tax basis capital accounts may be negative if the following items exceed a partner’s equity in the partnership on a tax basis

• Allocated losses

• Cash distributions

• Contributions of debts (or assets subject to debt in excess of the asset’s ATB)

• Practitioner Note – basis in partnership interest:

• Increased by partner’s share of partnership liabilities under I.R.C. §752

• Basis in partnership interest cannot be negative

PP. 109-110

• Ex. 3.14 RPL shows loss on tax return, tax basis capital account goes negative

• Partnership has recourse liabilities of $600,000

• Robert is allocated $200,000 of liabilities under I.R.C. §752

• Basis in partnership interest is therefore $50,000 (-$150,000 + $200,000)

PP. 109-110

Robert’s

Schedule K-1

(Form 1065)

P. 110

Two methods to establish beginning tax basis capital account

• Modified Outside Basis – Ex. 3.15

• Outside basis

• Less: Partner debt share under I.R.C. §752

• Less: Partner’s basis adjustments under I.R.C. §743(b)

• Modified Previously Taxed Capital – Ex. 3.16

• Cash received by partner upon liquidation at FMV

• Plus: Any loss recognized upon liquidation disregarding I.R.C. §743(b) adjustments

• Less: Any gain recognized upon liquidation disregarding I.R.C. §743(b) adjustments

• [Note: Each partner is allocated prorata share of inside basis.]

P. 111

Partnership does not have to report partner tax capital accounts if:

• Total receipts less than $250,000

• Total assets at the end of the tax year less than $1,000,000

• Timely filed and furnished Schedules K-1

• The partnership is not required to file Schedule M-3 (Form 1065)

P. 112

• Penalty for failure to timely file complete and accurate Schedule K-1 (I.R.C. §6698)

• Penalty relief for 2020 under Notice 2021-13

• No penalty for error on beginning tax basis capital account

• No penalty for error on ending tax basis capital account due to incorrect beginning

• “Ordinary and prudent business care” standard is applied

P. 113

• Gain (loss) not recognized

• Property given up and received must be

• Used in a trade or business, or

• Held for investment purposes

• Property must be like-kind

• TCJA eliminated like-kind exchanges of personal property

• Final regulations [T.D. 9935] clarify what is real property

PP. 114-124

• Generally, all real property is considered like-kind

• Property outside the US is not like-kind with property in the US

• Cross-Reference 2017 NITW: very broad qualification of like-kind

• Final regulations define real property as:

• Land and improvements to land

• Crops growing on the land

• Water and airspace – if superjacent to the land

• Leaseholds, easements

• Other property defined as real property under state or local law

• Note: federal definition as real property supersedes contrary law defining as personal

P. 115

• Inherently permanent structures

• Structural components

P. 115

• Lengthy list in regulations

• May be permanently affixed by weight

• If not on the list, apply 5 criteria

1. How affixed

2. Designed to be removed

3. Damage upon removal

4. Indication that it won’t remain affixed

5. Time and expense of removal

• Practitioner Note on equipment – OK to produce income

PP. 115-116

Regulations list structural components

If not on the list, apply 4 criteria:

1. Time and cost to install and remove

2. Designed to be removed

3. Damage caused by removal

4. Whether installed during construction

See Ex. 3.17 and 3.18 (P. 117) – sculpture, 3D printer, and generator are real property

• Considered real property if:• derives its value from real property, and

• is inseparable from the real property

• Includes:

• easements

• stock in a cooperative housing corporation

• certain shares in a mutual ditch, reservoir, or irrigation company (Prop. Regs. were more restrictive)

• Practitioner Note (p. 118) licenses and permits to convey property rights

• Note: other corporate stock and partnership interests do not qualify

P. 117

Allows certain personal property to be included in LKE:

• Property is typically included with the real property in a standard commercial transaction, and

• the aggregate FMV of the incidental property does not exceed 15% of the FMV of the real property.

P. 118

• Simplest LKE

• No gain recognized

• Basis of exchange property carries over to replacement property

• Practitioner Note – Related party exchanges okay – watch 2-year trigger

• Gain is recognized to the extent of boot received (cash, unlike property)

• Practitioner Note: QI may hold cash and acquire replacement property

• Ex. 3.20 –

• Rob realizes gain of $40,000 but only recognizes gain of $5,000.

• Basis of new property is Rob’s carryover basis ($10,000)

PP. 118-119

• Payment of boot

• Does not trigger gain or loss to transferor

• Increases basis of the replacement property

• Assumption of liabilities by transferee

• Considered boot received by transferor

• If debt is assumed as well as given up, only net is considered boot (paid or received)

P. 119

Same recapture property exchanged

• Any gain recognized will be ordinary up to recapture amount

• Any remaining recapture potential carries over to replacement property

• Ex. 3.21

• Exchanged green house and received a greenhouse plus $5,000 cash

• Realized gain of $27,355, all ordinary due to accumulated depreciation of $37,355.

• Recognized gain of $5,000 due to boot received – all ordinary

• Remaining recapture potential of $22,355 carries over to replacement property

• $62,645 ATB of exchange property also carries over to replacement property

P. 120

P. 122

All

ordinary

• Different recapture rules

• Gain recognized will be realized as ordinary even without boot received

P. 123

• No gain recognized if involuntarily converted to similar property.

• If cash is received, and taxpayer purchases similar or related property, taxpayer may elect to defer gain.

• Gain is recognized to the extent proceeds are not reinvested.

• Loss must be unexpected and unusual but need not be sudden.

• Ex. 3.24 sale of trees dying after a Pine Beetle infestation

• Not applicable if damaged property could be repaired – Ex. 3.25 fire damage

• Condemnation is the most typical non-casualty involuntary conversion

PP. 124-129

• Government acquires under right of eminent domain for public use

• Government pays a condemnation award treated as sales price

• Taxpayer can also sell to third party under a threat of condemnation

• Calculate gain as usual – deducting any expense of litigating award amount

• Gain can be deferred by reinvesting proceeds

Note: Cost of restoring remaining part of property to former usefulness qualifies

• Ex. 3.26 Straight up condemnation for $25,000, $15,000 gain

PP. 125-126

• Planning Pointer – voluntary sale of related property may qualify

• Severance Damages

• Decrease in value to remaining (non-condemned) property

• Reduce basis of remaining property

• Payments in excess of basis create gain but are eligible for deferral

P. 126

• Property must be similar or related in use

• A controlling interest (≥ 80%) in a corporation owning such property qualifies

• Business or investment real property meeting the LKE property requirements qualifies

• Any tangible property held for productive use in a trade or business qualifies in a federally declared disaster area

• Ex. 3.27 Not personal residence for grocery store

• Basis of replacement property reduced by gain deferred (Ex. 3.28)

PP. 126-127

• Replacement period begins on the date of disposition or on any earlier threat or imminence of condemnation.

• Replacement period generally ends 2 years after the end of the tax year in which any gain is realized.

4 years for personal residence and contents in federal disaster area

Extension can be requested

Generally limited to 1 additional year

Replacement property still under construction may justify

• Different rules for livestock

P. 127

• Gain is reduced by available exclusion under I.R.C. §121

• Taxpayer may defer any remaining gain

• Proceeds in excess of exclusion amount must be reinvested

• Ownership and use period of converted residence tack on to replacement residence

P. 128

• No reporting is required if taxpayer receives property

• Receipt of cash triggers reporting

• Report taxable gain on Schedule D or Form 4797

• With reinvestment and election defer gain, attach statement of details to return

P. 129