Often times, small business owners find difficulties in obtaining financing for their businesses without putting their personal assets up as collateral. With this, tapping into your home equity is a tempting alternative but should be carefully considered.
In general, interest on debt used to acquire and operate your business is deductible against that business. However, debt secured by your home may be nondeductible, only partially deductible or fully deductible against your business.
Home mortgage interest is limited to the interest on $1 million of acquisition debt and $100,000 of equity debt secured by a taxpayer’s primary residence and designated second home. The interest on the debts within these limits can only be treated as home mortgage interest and must be deducted as part of your itemized deductions. Only the excess can be deducted for your business, provided that the use of the funds can be traced to your business use. This creates a number of problems:
- Using the Standard Deduction – If you do not itemize your deductions, you will be unable to deduct the interest on the first $100,000 of the equity debt, which cannot be allocated to your business.
- Subject to the AMT – Even if you do itemize your deductions, if you happen to be subject to the alternative minimum tax (AMT), you still would not be able to deduct the first $100,000 of equity debt interest, since it is not allowed as a deduction for AMT purposes.
- Subject to Self-Employment (SE) Tax – Your self-employment tax (Social Security and Medicare) is based on the net profits from your business. If the net profit is higher, because not all of the interest is deductible by the business, your SE tax may also be higher.
Example: Suppose the mortgage you incurred to purchase your home (acquisition debt) has a current balance of $165,000 and your home is worth $400,000. You need $150,000 to acquire a new business. To obtain the needed cash at the best interest rates, you decide to refinance your home mortgage for $315,000. The interest on this new loan will be allocated as follows:
New Loan: $ 315,000
Part Representing Acquisition Debt <165,000> 52.38%
Balance $ 150,000
First $100,000 Treated as Home Equity Debt <100,000> 31.75%
Balance Traced to Business Use $ 50,000 15.87%
If the interest for the year on the refinanced debt was $10,000, then that interest would be deducted as follows:
Itemized Deduction Regular Tax $ 8,413 84.13%
Itemized Deduction Alternative Minimum Tax $ 5,238 52.38%
Business Expense $ 1,587 15.87%
There is a special tax election that allows you to treat any specified home loan as not secured by the home. If you file this election, then interest on the loan can no longer be deducted as home mortgage interest, since tax law requires that qualified home mortgage debt be secured by the home. However, this election would allow the normal interest tracing rules to apply to that unsecured debt. This might be a smart move if the entire proceeds were used for business and all of the interest expense could be treated as a business expense. However, if the loan were a mixed-use loan and part of it actually represented home debt (such as a refinanced home loan), then the part that represented the home debt could not be allocated back to the home, and the interest on that portion of the debt would become nondeductible and would provide no tax benefit.
As you can see, using equity from your home can create some complex tax situations. Please contact Dagley & Co. for assistance in determining the best solution for your particular tax situation.
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Do you drive for Uber or Lyft, or are thinking of getting into this business? We’ve outlined what it’s like to work for these types of companies, including taxes, expenses, and write-offs:
Uber and Lyft treat drivers as independent contractors as opposed to employees. However, more than 70 pending lawsuits in federal court, plus an unknown number in the state courts, are challenging this independent contractor status. As the courts have not yet reached a decision on that dispute, this analysis does not address the potential employee/independent contractor issue related to rideshare divers; it only deals with the tax treatment of drivers who are independent contractors, using Uber as the example.
How Uber Works – Each fare (customer) establishes an account with Uber using a credit card (CC), Paypal, or another method. The fare uses the Uber smartphone app to request a ride, and an Uber driver picks that person up and takes him or her to the destination. Generally, no money changes hands, as Uber charges the fare’s CC, deducts both its fee and the CC processing fee, and then deposits the net amount into the driver’s bank account.
Income Reporting – Uber issues each driver a Form 1099-K reflecting the total amount charged for the driver’s fares. Because the IRS will treat the 1099-K as gross business income, it must be included on line 1 (gross income) of the driver’s Schedule C before adjusting for the CC and Uber service fees. Uber then deposits the net amount into the driver’s bank account, reflecting the fares minus the CC and Uber fees. Thus, the sum of the year’s deposits from Uber can be subtracted from the 1099-K amount, and the difference can be taken as an expense or as a cost of goods sold. Currently, a third party operates Uber’s billing, coordinates the drivers’ fares and issues the drivers’ 1099-Ks.
Automobile Operating Expenses – Uber also provides an online statement to its drivers that details the miles driven with fares and the dollar amounts for both the fares and the bank deposits.
Although the Uber statement mentioned above includes the miles driven for each fare, this figure only represents the miles between a fare’s pickup point and delivery point. It does not reflect the additional miles driven between fares. Drivers should maintain a mileage log to track their total miles and substantiate their business mileage.
A driver can choose to use the actual-expense method or the optional mileage rate when determining operating expenses. However, the actual-expense method requires far more detailed recordkeeping, including records of both business and total miles and costs of fuel, insurance, repairs, etc. Drivers may find the standard mileage rate far less complicated because they only need to keep a contemporaneous record of business miles, the purposes of each trip and the total miles driven for the year. For 2017, the standard mileage rate is 53.5 cents per mile, down from 54.0 cents per mile in 2016.
Whether using the actual-expense method or the standard mileage rate, the costs of tolls and airport fees are also deductible.
When the actual-expense method is chosen in the first year that a vehicle is used for business, that method must be used for the duration of the vehicle’s business use. On the other hand, if the standard mileage rate is used in the first year, the owner can switch between the standard mileage rate and the actual-expense method each year (using straight-line deprecation).
Business Use Of The Home – Because drivers conduct all of their business from their vehicle, and because Uber provides an online accounting of income (including Uber fees and CC charges), it would be extremely difficult to justify an expense claim for a home office. Some argue that the portion of the garage where the vehicle is parked could be claimed as a business use of the home. The falsity with that argument is that, to qualify as a home office, the space must be used exclusively for business; because it is virtually impossible to justify that a vehicle was used 100% of the time for business, this exclusive requirement cannot be met.
Without a business use of the home deduction, the distance driven to pick up the first fare each day and the distance driven when returning home at the end of a shift are considered nondeductible commuting miles.
Vehicle Write-off – The luxury auto rules limit the annual depreciation deduction, but regulations exempt from these rules any vehicle that a taxpayer uses directly in the trade or business of transporting persons or property for compensation or hire. As a result, a driver can take advantage of several options for writing off the cost of the vehicle. These include immediate expensing, the depreciation of 50% of the vehicle’s cost, normal deprecation or a combination of all three, allowing owner-operators to pick almost any amount of write-off to best suit their particular circumstances, provided that they use the actual-expense method for their vehicles.
The options for immediate expensing and depreciating 50% of the cost are available only in the year when the vehicle is purchased and only if it is also put into business use during that year. If the vehicle was purchased in a year prior to the year that it is first used in the rideshare business, either the fair market value at that time or the original cost, whichever is lower, is depreciated over 5 years.
Cash Tips – Here, care must be taken, as Uber does not permit fares to include tips in their CC charges but Lyft does. Any cash tips that drivers receive must be included in their Schedule C gross income.
Deductions Other Than the Vehicle – Possible other deductions include:
- Cell phone service
- Liability insurance
- Water for the fares
Self-Employment Tax – Because the drivers are treated as self-employed individuals, they are also subject to the self-employment tax, which is the equivalent to payroll taxes (Social Security and Medicare withholdings) for employees—except the rate is double because a self-employed individual must pay both the employer’s and the employee’s shares.
If you are currently a driver for Uber or Lyft, or if you think that you may want to get into that business, and if you have questions about taxation in the rideshare industry and how it might affect your situation, please give Dagley & Co. a call.
Are you a member of the clergy? Well, you may qualify for two unique tax benefits: a tax-free parsonage allowance and exemption from self-employment tax on their ministerial earnings. Here are the details for both.
Parsonage/Rental Allowance Exclusion from Income – A “minister of the gospel” can qualify for the rental allowance exclusion from income if the home or rental allowance is provided as remuneration for services that are ordinarily the duties of a minister of the gospel.
The following are qualifications and details for the exclusion allowance: The allowance is excludable only to the extent that it is used for expenses related to the minister’s housing—e.g. rent, mortgage payments, utilities, repairs, etc. The rental allowance is not excludable to the extent that it exceeds reasonable compensation for the minister’s services. The allowance only applies to the minister’s primary residence. The allowance cannot exceed the fair rental value of the home, including furnishings and appurtenances such as a garage, plus the cost of utilities. The employing organization must designate the allowance by official action in advance of the payment. In addition, for a minister employed by a local congregation, the designation must come from the local church instead of the church’s national organization. The portion of the minister’s business expenses attributable to tax-free income is not deductible. This rule does not apply to home mortgage interest or taxes, which are deductible in full if the minister itemizes deductions. Retired clergy can exclude the rental value of a home or a rental allowance furnished as compensation for past services and authorized under a convention of their national church organization. However, the exclusion does not extend to the widow or widower of a retired clergyperson.
Minister’s Exemption from Self-Employment Tax – A minister who hasn’t taken a vow of poverty is subject to self-employment tax (SE tax) on income from services as a minister. (The church or other employing organization does not withhold Social Security or Medicare taxes from the minister’s compensation.) Non-reimbursed business expenses are deductible in computing earnings subject to SE tax, even though the expenses are deductible only as itemized deductions for income tax computation purposes.
An ordained minister may be granted an exemption from SE tax for ministerial services only. To qualify, the church employing the minister must qualify as a religious organization under Code Section 501(c)(3). Application for exemption is filed with Form 4361, Application for Exemption from Self-Employment Tax for Use by Ministers, Members of Religious Orders, and Christian Science Practitioners.
To claim the exemption from SE tax, the minister must meet all of the following conditions and file Form 4361 requesting exemption from SE tax.
The minister must: Be conscientiously opposed to public insurance because of his or her individual religious considerations (not because of a general conscience), or be opposed because of the principles of his or her religious denomination. File for other than economic reasons. Inform the church’s or order’s ordaining, commissioning, or licensing body that he or she is opposed to public insurance if a minister or a member of a religious order (other than a vow-of-poverty member). This requirement doesn’t apply to Christian Science practitioners or readers. Establish that the organization that ordained, commissioned, or licensed him or her, or his or her religious order, is a tax-exempt religious organization. Establish that the organization is a church or a convention or association of churches. Not have previously elected to be covered by Social Security by filing Form 2031, Revocation of Exemption from Self-Employment Tax for Use by Ministers, Members of Religious Orders, and Christian Science Practitioners.
The Form 4361 application must be filed on or before the extended due date of the return for the second tax year for which the individual has net earnings from self-employment of $400 or more (part of which is from services as a minister). A late application will be rejected.
The time for applying starts over when a minister who was not opposed to accepting public insurance (i.e., Social Security benefits) re-enters a new ministry (e.g., adopts a new set of beliefs that include opposition to public insurance with a different church). However, the IRS has said that there is no second chance to apply for exemption by a minister who is ordained in a different church but whose belief regarding public insurance doesn’t change (i.e., the minister opposed acceptance of public insurance in both faiths).
Careful consideration should be made before applying for the exemption from SE tax since once the decision has been made, the election is irrevocable.
If you have questions related to either of these issues, please give Dagley & Co. a call.
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