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A Publication of Ketel Thorstenson, LLP
Summer 2022 Volume 28 Issue 2
HOW TO SPOT IRS SCAMS AND HANDLE THEM SAFELY
Inside: How to Spot IRS Scams and Handle Them Safely Page 1-2
Kim Richters, EA, Senior Associate, Tax Department
legitimate IRS phone numbers and will give you information they find online to convince you that you are speaking to a real IRS agent. The intent is to create a sense of urgency and make you believe that if you don’t act immediately to clear up this bogus debt, there will be serious and damaging consequences. They will use threats, intimidation, and bullying to achieve their goal.
Refresher on Principal Residence Gain Exclusion Page 3-4 Converting Your Home into a Rental Property Page 5-6 Employee vs. Independent Contractor – Who’s Who?
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Kim Richters, EA, Senior Associate, Tax Department
It can be daunting to be contacted by the IRS. You may wonder if something was filed incorrectly or was missed, if there are financial consequences, and you may worry how to resolve the issue. Because of this, scammers have started to impersonate the IRS to trick you out of your money. They are betting on the fact that you will be intimidated by IRS contact and will do anything to solve the problem. Scams skyrocket during tax season, but they can and do happen year-round. What are the differences between real IRS contact and a scam? There are two main ways scammers try to contact you: electronically and by telephone. Scammers will use electronic communication such as emails, texts, or even social media to infiltrate your computer or phone to steal your identity. They can spoof
In general, if the IRS is trying to communicate with you, the first contact occurs via written correspondence sent through the U.S. Postal Service. You may receive follow-up correspondence by phone or even an in-person visit, but the first communication will never occur via phone, email, text message, or social media. In fact, the IRS will never text you or use social media to reach you about a tax issue. However, some scammers are sending fake documents through the mail so if you receive correspondence that says it’s from the IRS, scrutinize it closely. How can I tell if something is suspicious? One of the most important things to pay attention to is if they ask you to use a form of payment such as a wire transfer, prepaid debit card, or a gift card and if they ask you to pay anyone else besides the US Treasury. Again, they want to create a sense of
(How to Spot IRS Scams and Handle Them Safely continued on page 2)
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urgency, so they will make threats to arrest or deport you or suspend your driver’s license. They will even fraudulently file a tax return using the taxpayer’s actual bank account and call the taxpayer to demand the funds be transferred to a scammer. The IRS will never threaten arrest, demand payment without an opportunity to question or appeal the amount owed, ask for your debit or credit card numbers over the phone, or call you about an unexpected refund. The hallmarks of a scam email are numerous like, spelling errors, capitalized words in the middle of the sentence, and odd phrasing. The subject line won’t always make sense, and the email address isn’t quite right. For example, it won’t end in “.gov”. It will end in “.com”, which is a quick way to know it is a scam. They will almost always have an attachment or instructions to click a link because that is how they access your computer or phone and compromise your personal information.
What if I receive suspicious electronic communication? When receiving a suspicious electronic communication, be sure not to react right away. Do not reply, open any attachments, or click any links. Forward the email to phishing@irs.gov. If it is a text message, forward the text to 202552-1226, and, if you can, create a new text message to this number and tell them the phone number that contacted you. Finally, delete the email or text permanently. It is also recommended to block the email address and phone number. What if I receive a suspicious phone call? If you receive a call from a suspected scammer that fits the criteria outlined in this article, do not give them any information, and do not confirm anything they ask you. Hang up immediately. Report the call to the Treasury Inspector General for Tax Administration at 800-366-4484 or on their website https://www. treasury.gov/tigta/reportcrime_ misconduct.shtml. Report it to
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the Federal Trade Commission on their website https://reportfraud. ftc.gov/#/?orgcode=IRS. The best course of action at this point is to call the IRS directly at 1-800-8291040 so you can be sure you are speaking with an actual IRS agent, and they can advise you if any of the information was accurate and if any action is needed. Remain vigilant and informed The scammers will never go away. They are continuously becoming more clever in how they present themselves, so it is important to arm yourself with information before it happens. Understand what to look for, how to control your reaction since they are trying hard to upset you into action, and how to contact the IRS yourself. If the person calling you says, “This is your only chance.” or “We cannot help you if you hang up now.”, they are scamming you. If you can, always report these scam attempts to the agencies above.
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REFRESHER ON PRINCIPAL RESIDENCE GAIN EXCLUSION
Carrie Christensen, CPA, Manager, Tax Department period ending on the sale date. $500,000 exclusion if • Use Test: You must have used – Either you or your spouse the home as your principal pass the ownership test residence for at least two for the property and years out of the five-year – Both you and your period ending on the sale spouse pass the use test date. You can pass this test • If you are married and file by living in the house for 730 jointly, it is possible for days combined out of a fiveboth you and your spouse year period. The days do not to individually pass the need to be consecutive. ownership and use tests for two separate residences. In What Counts as a Principal this case, you and your spouse Residence? IRS regulations say would qualify for two separate you must evaluate all the facts $250,000 exclusions. Carrie Christensen, CPA, Manager, Tax Department and circumstances to determine whether or not a property is Special Rule for Unmarried With residential real estate your principal residence for gain Surviving Spouses - An unmarried markets surging, significant exclusion purposes. If you occupy surviving spouse can claim the unrealized gains are piling up more than one residence during larger $500,000 exclusion for for many homeowners. If you the same year, the general rule sale of a principal residence that are thinking about selling your is that the principal residence occurs within two years after the principal residence, you may for that particular year is the one spouse’s death, assuming all other be wondering about the tax where you spent the majority requirements were met immediately implications. The good news is of time during the year. Other before the spouse died. that tax laws allow you to exclude relevant factors can include: a home sale gain of up to $250,000 • Where you work Anti-Recycling Rule - The for unmarried taxpayers and up to • Where family members live exclusion is generally available $500,000 for married taxpayers. • The address used on your only when you have not excluded income tax return, driver’s an earlier gain within the twoGain Exclusion Basics license, auto registration, year period ending on the date and voter registration of the later sale. In other words, Ownership and Use Tests • Mailing address for bills you generally cannot recycle the To take full advantage of the and correspondence gain exclusion privilege until two principal residence gain exclusion, years have passed since you last you must pass two tests: the Special Considerations used it. You can claim the larger ownership test and the use if You are Married $500,000 joint-filer exclusion only test. Note that the two tests are if neither you nor your spouse completely independent, meaning • If you are married and file have used the exclusion on an that the periods of ownership separately, you and your spouse earlier sale within the two-year and use need not overlap. can potentially qualify for two period. If one spouse claimed separate $250,000 exclusions. the exclusion within the two-year • Ownership Test: You must have • If you are married and file window, but the other did not, the owned the home for at least jointly, you qualify for the exclusion is limited to $250,000. two years out of the five-year (Refresher on Principal Residence Gain Exclusion continued on page 4)
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When to “Elect Out” of the Gain Exclusion Privilege - You always have the option to “elect out” of the gain exclusion and report the sale profit as a taxable gain. You can retroactively elect out by amending a previously filed return within the three-year period beginning with the filing deadline for the year-of-sale return. This may be beneficial when you have two principal residence sales within a two-year period, with the later sale producing a larger gain. Prorated Gain Exclusion What happens if you sell your home for a large profit after living there for only 18 months instead of the required two years? Or what if you sell your home less than two years after excluding a gain from the sale of a previous residence? The good news is that the IRS allows a prorated (reduced) gain exclusion in certain circumstances when the ownership and use tests or anti-recycling rules discussed above are not met. The prorated exclusion may be large enough to shelter the entire gain. The prorated gain exclusion only applies when the premature sale is due primarily to one of the following reasons: • A change in place of employment – A premature sale is automatically considered to be primarily due to a change in place of employment if the distance between the new place of employment and the former residence is at least 50 miles more than the distance between the former place of employment
and the former residence. - Note that if you are selfemployed and work out of your home, you pass this test if you purchase a new home at least 50 miles from your old home. - If you can’t pass the 50-mile automatic rule, you can still pass this test by obtaining documentation showing the premature sale was primarily due to your change in place of employment, assuming the facts so indicate. • Health reasons – You pass this test if your move is to: - Obtain, provide, or facilitate the diagnosis, cure, mitigation, or treatment of disease, illness, or injury of a qualified individual, or - Obtain or provide medical or personal care for a qualified individual who suffers from a disease, an illness, or an injury • Specified unforeseen circumstances – A premature sale is generally considered to be due to unforeseen circumstances if the primary reason for the sale is the occurrence of an event that you could not have reasonably anticipated. Under the safeharbor rule, a premature sale is deemed to be due to unforeseen circumstances if any of the following events occur: - Involuntary conversion of the residence - A natural or man-made disaster or acts of war or terrorism resulting in a casualty to the residence
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- Death of a qualified individual - A qualified individual’s cessation of employment, making him or her eligible for unemployment compensation - A qualified individual’s change in employment or self-employment status that results in the taxpayer’s inability to pay housing costs and reasonable basic living expenses for the taxpayer’s household - A qualified individual’s divorce or legal separation under a decree of divorce or separate maintenance - Multiple births resulting from a single pregnancy of a qualified individual As you can see, there is much to know about the principal residence gain exclusion. If you are considering selling your principal residence and have questions regarding the tax implications, consult your KTLLP advisor to discuss your unique situation.
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CONVERTING YOUR HOME INTO A RENTAL PROPERTY Josh Newman, CPA, Senior Associate, Tax Department to the IRS using Schedule E on your Form 1040. However, there are several deductions available to reduce the net income that is subject to tax. These deductions include insurance, property taxes, utilities, repairs, professional fees, property management fees, travel, and depreciation.
Josh Newman, CPA, Senior Associate, Tax Department
Are you thinking about moving into a new home and renting out your current home? Here are some things to consider. Let’s start with the many nontax factors to consider when deciding whether to sell or rent out your current home. Do you need cash from the sale to fund the down payment on a new home? If so, you have no choice. Are there sentimental reasons not to sell? If the market is very soft, you may want to rent and wait for prices to rebound. Once you sort through all the nontax factors, here are some tax related items to consider. As discussed further below, don’t turn a large excludable gain into a taxable one by failing the “2 out of 5” year rule. Even if you rent it for a while, you may still want to sell within the 5 year window. If you rent, everyone loves the tax deductions! Income from a rental property must be reported
Depreciation is a very powerful tool in reducing tax liability on a rental property. When you convert a personal residence into a rental property you must first determine the cost basis of the property. This is determined by using the lesser of the initial cost of the property plus major improvements or fair market value at the date of conversion. The basis is then divided into land, building, furniture fixture and equipment (FF&E), land improvements, etc. Land cannot be depreciated, but we get to deduct the cost of the building over 27.5 years. FF&E and land improvements can be deducted in full in year one utilizing bonus depreciation under current law. Keep in mind any depreciation taken on the property will be recaptured at higher rates rather than long term capital gains in the year of sale. Rental properties can provide positive cash flow while producing a tax loss due to depreciation expense, what a great deal! However, these losses are not always deductible in the year they are created. Losses created by rental properties are considered
passive and are only deductible if you meet one of the following criteria: 1) Qualify for the special $25,000 allowance – If your modified adjusted gross income is less than $150,000 and you actively participate in the rental activity, you may be able to deduct some or all of your rental losses up to $25,000, 2) You have other passive activities that produce income during the year, or 3) You sell the rental activity during the year which allows you to deduct current year losses as well as any losses suspended from previous years. The good news is that any disallowed passive losses can be carried forward indefinitely until a future year in which you qualify to use them. If you sell the property for more than your net tax basis, you have created a gain. Is this gain taxable? If so, how much of it is taxable? As is the answer to so many tax questions, it depends! There are a few different ways to address a possible tax bill when deciding to sell your rental property. 1.Read Carrie Christensen’s article in this KT Addition regarding the ability to exclude gains on sale of a primary residence. If you qualify for the “2 out of 5” year rule, your gain should be excluded. 2.While I won’t be covering it in detail in this article, a Section
(Converting Your Home into a Rental Property continued on page 6)
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1031 “Like-Kind Exchange” can be a powerful tool to defer tax if you no longer want to own this rental property (and you flunk the “2 out of 5” year rule) but are still willing to own an investment property. This would delay any taxes until the replacement property is ultimately sold. Section 1031 exchanges are a complicated process and you should consult with your tax professional before you choose this route.
3.Once you have two homes, you then could sell your personal home instead of the rental property. If cash flow is what you need and your situation is right, selling your personal residence instead of the rental property could allow you to exclude all of the gain and provide you with the funds you need. Remember you need to meet the requirements to exclude the gain on sale of your personal residence for this to work.
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4.You could continue to rent out the property until you pass away, at which point the inheritor of the rental property would get the basis stepped up to fair market value. As always, each situation is unique and you should speak with your tax professional prior to converting your personal residence into a rental property.
EMPLOYEE VS. INDEPENDENT CONTRACTOR – WHO’S WHO? Hannah Sheffield, CPA, Senior Associate, Tax Department independent contractor. The IRS has compiled a “20 Factor Test” to help determine whether a worker is an employee or an independent contractor. The most important factors are in bold.
Hannah Sheffield, CPA, Senior Associate, Tax Department
How do I determine whether a worker is an employee or an independent contractor? The easiest way to answer this question is, do I have control over that individual? If the answer is yes, then they should most likely be considered an employee. If the answer is no, then they should most likely be considered an
1. Instructions to worker If the employer has the right to control and direct the worker regarding the detail and means by which a task is achieved, the worker is generally considered an employee. 2. Training 3. Integration into business operations 4. Requirement that services be rendered personally 5. Hiring, supervising, and paying assistants 6. Continuity of the relationship (permanency) 7. Setting the hours of work
8. Requirement of full-time work 9. Working on employer premises 10. Setting the order or sequence of work 11. Requiring oral or written reports 12. Paying worker by the hour, week, or month 13. Payment of worker’s business and/or travel expenses 14. Furnishing worker’s tools and materials If the business furnishes sufficient tools, materials, and other equipment to complete tasks, then it’s generally considered an employeeemployer relationship. 15. Significant investment by worker 16. Realization of profit or loss by worker
(Employee VS. Independent Contractor - Who’s Who? continued on page 7)
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(Employee VS. Independent Contractor - Who’s Who? continued from page 6)
17. Working for more than one business at a time If the worker performs services for a number of unrelated businesses at the same time, the worker is generally considered an independent contractor. 18. Availability of worker’s services to the general public 19. Firm’s right to discharge work 20. Worker’s right to terminate relationship Let’s use an example to help understand the differences. Ted mows lawns and pulls weeds for XYZ once a week from May through October. He provides his own lawnmower and can perform these tasks at any time as long as it’s once a week. Ted also does this for five other businesses in town. He does his billing and scheduling from his own home office. Should
Ted be considered an employee or independent contractor? He is an independent contractor. Why? In the grand scheme of things, he has control over what he does. XYZ hired him to do a specific task, but he has the authority to choose when and how that task is completed.
$600 or more for services performed then the business will need to issue a Form 1099 to that independent contractor for the year.
If on the other hand, Ted worked for a company that owned several apartments, mowed for them 4 days a week, used the company’s vehicles and mowers, and was paid an hourly wage--he undoubtedly is an employee.
The biggest risk to an employer is to incorrectly treat a worker as a contractor, when in fact they are an employee. The employer could be subject to federal employment taxes, penalties, and interest. Also, federal and state unemployment taxes and worker compensation insurance. To add to the misery, the penalties and interest might amount to more than the actual tax.
The next big question, why does it matter? If the worker is considered an independent contractor the amounts paid to that individual are not subject to federal income tax withholding, but the independent contractor may have to pay self-employment tax. Also, if you pay the independent contractor
All in all, determining whether a worker is an employee, or an independent contractor is a little tricky and convoluted. Please reach out to your tax professional at KTLLP if you have questions or want to discuss in more detail the differences between an employee and an independent contractor.
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The KT Addition is a publication of Ketel Thorstenson, LLP. It is published for clients, advisors and friends of the firm. The technical information included is necessarily brief. No final conclusions on these topics should be drawn without further review and consultation with a professional. Direct any inquiries, email changes or problems with your newsletter to the editor in Rapid City. Editor: tanya@ktllp.com