Tax Lawyers Minneapolis

Deductibility of Meals on Schedule C: General Overview

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Virtually every business incurs some type of meal-related expenses. A question arises as to whether such meals are deductible and to what extent. This article provides a general overview of this topic; remember, though, that the deductibility of meals is highly fact-dependent and this article only provides an educational background to this issue, NOT a legal advice.

General Rule

Generally, expenses incurred with respect to the entertainment-related meals are not deductible, unless the taxpayer is able to establish that the expense is directly related to the active conduct of a business or trade.

However, if a meal expense directly precedes or follows a bona fide business discussion (including a convention meeting), then it is deductible if it is established that the expense was associated with the active conduct of a trade or business. The taxpayers needs to be able to establish that this is the case.

Restrictions on the General Rule

The Internal Revenue Code (IRC) places two broad restrictions on the general rule. First, if neither the taxpayer nor the taxpayer’s employee is present at the meal, then, generally, meal expenses are not deductible.

Second, a meals deduction is not allowed where the expense is lavish or extravagant under the circumstances. This topic has been the subject of controversy for some time now as large corporations have engaged in entertaining their important guests in a manner that the IRS may sometime classify as “lavish.”

It is important to point out that these restriction would not apply to certain exceptions to the general rule.

Exceptions to the General Rule

IRC Section 274(e) specifically provides that some exceptions are not subject to the general rule described above and are deductible as ordinary and necessary expenses (as long as they are properly substantiated). The exceptions are:

a. Food and beverages furnished on the business premises primarily to the taxpayer’s employees;

b. Expenses for services, goods, and facilities that are treated as compensation or wages for withholding tax purposes. If the recipient is a specified individual, then the employer’s deduction cannot exceed the amount of compensation reported. IRC Section 274(e)(2)(B) defines who is a “specified individual”; here, it is sufficient to state that it generally means an officer, director, ten-percent shareholder or a related person;

c. Reimbursed expenses: “expenses paid or incurred by the taxpayer, in connection with the performance by him of services for another person (whether or not such other person is his employer), under a reimbursement or other expense allowance arrangement with such other person”. IRC Section 274(e)(3). However, this exception applies only if: (1) services are performed for an employer and the employer has not treated such expenses as wages subject to withholding; or (2) where the services are performed for a person other than an employer and the taxpayer accounts to such person;

d. Expenses for recreational, social, or similar activities (including facilities therefor) primarily for the benefit of employees (other than employees who are highly compensated employees (within the meaning of section 414(q)). See IRC Section 274(e)(4) for further details on treatment of shareholders. The most common example of this exception are company picnics;

e. Expenses incurred by a taxpayer which are directly related to business meetings of his employees, stockholders, agents, or directors. IRC Section 274(e)(5);

f. Expenses directly related and necessary to attendance at a business meeting or convention of any organization described in section 501(c)(6) (relating to business leagues, chambers of commerce, real estate boards, and boards of trade) and exempt from taxation under section 501(a). IRC Section 274(e)(6);

g. Expenses for goods, services, and facilities made available by the taxpayer to the general public. IRC Section 274(e)(7);

h. Expenses for goods or services (including the use of facilities) which are sold by the taxpayer in a bona fide transaction for an adequate and full consideration in money or money’s worth. IRC Section 274(e)(8); and

i. Expenses paid or incurred by the taxpayer for goods, services, and facilities furnished to non-employees as entertainment, amusement, or recreation to the extent that the expenses are includible in the gross income of a recipient and reported on a Form 1099-MISC by the taxpayer.

It is very important to note that exceptions a, e, and f maybe subject to the “50-Percent Limitation” rule.

50-Percent Limitation Rule

Generally, a taxpayer can only deduct 50 percent of the allowable meal and entertainment expenses, including such expenses incurred in the course of travel. The process in calculating the 50-percent limitation involves, first, the calculation of the allowable deductions through the process of exclusion of non-allowable deductions (e.g. lavish portion of the meal) and addition of related expenses (e.g. taxes, tips, room rental, and parking fees) and, then, the 50-percent rule applies. Note that the allowable deductions for transportation costs to and form a business meal are not reduced.

The 50-percent rule maybe subject to various statutory modifications based on profession or the nature of activity. For example, the transportation workers may deduct 80 percent. There are also complications with respect to a leasing company and independent contractors.

Exceptions to the 50-Percent Limitation Rule

The 50-Percent Limitation rule is riddled with exceptions.

First, exceptions b, c, d, g, h and i described above (see Exceptions to General Rule section) are not subject to the 50-Percent Limitation rule.

Second, the food expenses classified as de minimis fringe benefits and excludable from the recipient’s gross income are also not subject to the 50-Percent limitation rule.

Third, there are somewhat complicated exceptions related to the tickets to a sporting events.

Fourth, employee’s meal expenses incurred while moving are not subject to the 50-Percent Limitations rule if they are reimbursed by the employer and includible in the employee’s gross income.

There are various other exceptions to the 50-Percent Limitations rule such as food and beverages provided to employees on certain vessels, oil or gas platforms, drilling rigs, and so on.

Conclusion

This article provides a general review of the rules regarding deductibility of meal on Schedule C. However, this is only an educational article and it does NOT offer a tax or legal advice. You should see a tax professional regarding your specific facts.

IRS Form 944 Basics

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General Obligations To Deposit Payroll and Income Tax Withholdings

Under federal law, employers must withhold Social Security, Medicare and Federal income taxes from their employees’ paychecks and deposit them with the federal government (together with the employer’s own payroll tax contributions). In addition to the deposit requirements, the employers are also obligated to file Form 941 every quarter to report the withholdings and make up for any deficiencies in deposits (or receive a refund).

Who Must File Form 944 – the Notice Requirement

Forms 941 can be a burdensome requirement for some very small employers. While computer software has alleviated some of the problems, it has not solved them.

Therefore, the IRS designed Form 944 to assist the smallest employers, which are defined as employers whose annual liability for social security, Medicare, and Federal income tax withholding is $1,000, or less. If the IRS notifies (and this is a crucial point) such an employer that the form is to be filed, the employer may file and pay such taxes only once a year, instead of every quarter.

Notice, the “notification” requirements. If the IRS does not notify you about Form 944, you must file Form 941 each quarter. It is also appropriate to note here the exceptions for agricultural and household employers who follow their own set of rules.

If, for some reason, you do not with to file Form 944, you will need to specifically contact the IRS and make such request. After the IRS notifies you about the changes in your reporting requirements, you can start filing Forms 941. Again, until you receive an IRS notice about the change in your Form 944 filing requirements, you must file Form 944.

Form 944 Reporting Requirements

If you are required to file Form 944, you should report all the following items: wages paid, tips received by employees; federal income tax withheld; both employer’s and the employee’s share of social security and Medicare taxes; any current year’s adjustments to social security for fractions of cents, sick pay, tips, or group-term life insurance; and any credits for COBRA premium assistance payments.

Form 944 Deadline

If you are required to file Form 944, you must file it only once a year. In most situations, it should be filed by January 31 after the end of the calendar year for which you are filing Form 944. Certain extensions are available if timely full payments of deposits were made by January 31.

Complications

Various complications may arise if you are a new owner or you sell (transfer) your business. You will need to contact a tax attorney to discuss how this affects your requirement to file Forms 941 and 944.

Another set of complications may arise if your Form 944 does not match your W3 amount. Usually, this means that there has been a mistake in reporting either on Form 944 or W3.

Finally, it should be remembered that Form 944 is only one requirement for employers. There are other reporting requirements that may apply to you. You should contact a tax attorney to discuss your federal tax responsibilities as an employer.

Penalties

If you fail to comply with Form 944 requirements, various penalties and interest may apply as required by law.

Contact Sherayzen Law Office With Any Questions about Form 944

If you have any questions with respect to Form 944 or if you failed to file Form 944, contact Sherayzen Law Office for professional legal help. Our experienced tax firm will analyze your situation, help you become compliant with all of your federal tax obligations, and provide rigorous representation of your interests during your negotiations with the IRS.

Form W-2 Penalties

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A W-2 is required to be filed by every employer who is engaged in a trade or business paying remuneration (including noncash payments) of $600 or more for a year in which services are performed by an employee.  A W-2 must be filed for each employee for whom income, Social Security, or Medicare tax was withheld, or income tax would have been withheld if the employee had claimed no more than one withholding allowance (or had not claimed exemption from withholding on Form W-4, Employee’s Withholding Allowance Certificate).

This article will explain some of the various penalties that may apply for failure to comply with IRS rules and regulations for Form W-2.  Use of a third-party payroll service provider or reporting agent usually will not exonerate employers from ensuring that the form is properly and timely filed.

Failure to File Correct Information Returns by the Due Date

A penalty may apply under IRC Section 6721 (failure to file correct information returns) if an employer does any of the following: fails to file timely, fails to include all information required to be shown on Form W-2, includes incorrect information on Form W-2, files paper forms when e-filing is required, reports an incorrect TIN, fails to report a TIN, or fails to file paper Forms W-2 that are machine readable.  An employer may show reasonable cause in order to prevent the imposition of the penalty.

The amount of the penalty is based upon when the employer files the correct Form W-2:

1)  For forms correctly filed within 30 days (by March 30 if the due date is February 28), the penalty is $30 per form; the maximum penalty is $250,000 per year ($75,000 for small businesses).

2)  For forms correctly filed more than 30 days after the due date but by August 1, 2013, the penalty is $60 per form; the maximum penalty is $500,000 per year ($200,000 for small businesses).

3)  For forms filed after August 1, 2013, or for required Forms W-2 that have not been filed; the penalty is $100 per Form W-2; the maximum penalty is $1,500,000 per year ($500,000 for small businesses).

4)  If an employer does not file corrections, and does not meet any of the exceptions to the penalty (explained below), the penalty is $100 per information return; the maximum penalty is $1,500,000 per year.

Exceptions to the Penalty for Failure to File Correct Information Returns

Depending upon the circumstances, the penalty may not apply if an employer can demonstrate that any failure was due to reasonable cause, and not due to willful neglect. In general, a filer must be able to show that the failure was either due to an event beyond its control, or due to substantial mitigating factors; additionally, an employer must show that proper steps were taken to avoid the failure and that it acted responsibly.

The IRS or SSA may also not consider an inconsequential error or omission to be a failure to include correct information.  Errors or omissions concerning the following items, however, are never considered to be inconsequential: A TIN, a payee’s surname, and any money amounts.

Intentional Disregard of Filing Requirements

A penalty of at least $250 per form, with no maximum penalty, will apply in cases in which any failure to file a correct Form W-2 is due to intentional disregard of the filing of correct information requirements.

Failure to Furnish Correct Payee Statements

Under IRC Section 6672 (Failure to furnish correct payee statements), a penalty may apply if an employer fails to provide correct payee statements (Forms W-2) to employees, and is unable to show reasonable cause.  The penalty may apply for any of the following:  An employer fails to provide the statement by January 31, 2013, fails to include all information required to be shown on the statement, or includes incorrect information on the statement.

The amount of the penalty is based on when the employer furnishes the correct payee statement. This additional penalty is applied in the same manner, and with the same amounts, as the penalty for failure to file correct information returns by the due date under IRC Section 6721 (explained above).

Exceptions to the Penalty for Failure to Furnish Correct Payee Statements

A  employer may be able to demonstrate reasonable cause to prevent the imposition of this penalty.  Also, inconsequential errors or omissions are not considered to be a failure to include correct information.   The following items are not considered to be inconsequential errors or omissions: Dollar amounts, a significant item in a payee’s address, and the appropriate form for the information provided, (such as whether the form provided constitutes an acceptable substitute for the official IRS form).

Intentional Disregard of Payee Statement Requirements

A penalty of $250 per W-2 will apply, with no maximum penalty, for any failure to provide a correct payee statement (Form W-2) to an employee due to intentional disregard of the requirements to furnish a correct payee statement.

Civil Damages for Fraudulent Filing of Forms W-2

If an employer willfully files a fraudulent Form W-2 for payments that are claimed to be made to another person, that person may be able to sue for damages.  The IRS estimates this may cost $5,000, or more.

Contact Sherayzen Law Office for Legal Help With Form W-2 Penalties

If you an employer facing Form W-2, Form W-3, Form 941, Form 940 and other employment-tax penalties, contact Sherayzen Law Office for professional legal IRS representation.  Our experienced tax firm will vigorously represent your interests, creatively explore various defense theories, prepare any necessary tax forms and strive to secure the best resolution possible under the facts of your case.

Form 941 Penalties

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In a previous article, we covered some of the basics of Form 941. In this article, we will explore some of the major penalties that may apply for failure to comply with the requirements of Form 941. These penalties may be severe and, in certain circumstances, may even lead to criminal charges.

Failure to File Penalty

The IRS may apply a failure to file penalty for any month, or part of a month, for which a required return is not filed (disregarding extensions). The penalty is 5% of the unpaid tax due on such return, with the maximum penalty typically 25% of the tax owed.

Failure to Pay Penalty

The IRS may also apply a failure to pay penalty for any month, or part of a month, for which the tax due is paid late. This penalty is 0.5% per month of the amount of the tax. In certain circumstances, individual filers may be able to qualify for a reduced penalty of 0.25% per month, if an installment agreement is in effect. The maximum amount of the failure to pay penalty is also 25% of the tax owed.

Interaction between the Failure-to-File and Failure-to-Pay Penalties; Reasonable Cause Defense

If both of the above-mentioned penalties apply to a given month, then the failure to file penalty will be reduced by the amount of the failure to pay penalty. It is important to note that a “reasonable cause” defense is applicable to these penalties – i.e. if the employer’s attorney is able to demonstrate, in writing, that the failure to file or to pay was due to a reasonable cause, then such penalties will be abated by the IRS.

Interest

Interest may also be charged, in addition to any applicable penalties. Interest begins to accrue from the date due of the tax owed on any unpaid amount.

Penalty Rates for Amounts not Properly or Timely Deposited

In general, penalties may also apply if a filer does not make required timely deposits, or if the amounts deposited are less than required. If a filer is able to establish a reasonable cause defense and demonstrates that the failure to comply with the requirements was not due to willfully neglect, then the IRS will not impose the penalties. In certain other circumstances, the IRS may also agree to waive penalties.

For amounts that are not timely or properly deposited, the following penalty rates will apply:

2% – Deposits 1 to 5 days late.
5% – Deposits 6 to 15 days late.
10% – Deposits 16 or more days late.
10%- Amounts paid within 10 days of the date of the first IRS notice requesting the tax due.
10% – Deposits paid directly to the IRS, or paid with a tax return.
15% – Amounts unpaid more than 10 days after the date of the first IRS notice requesting the tax due, or the day on which an IRS
notice and demand for immediate payment was received by afiler, whichever is earlier.

Late deposit penalty amounts are calculated from the due date of the tax liability, and are determined using calendar days.

Trust Fund Penalty

If income, Social Security, or Medicare taxes that are required to be withheld are not withheld or paid, a filer may be personally liable for the Trust Fund Penalty. Important note: use of a third-party payroll service provider or other type of agent will not relieve a required filer of the responsibility of ensuring that deposits are timely and properly deposited, and that returns are filed.

The Trust Fund Penalty is the full amount of the unpaid trust fund tax. The penalty may be imposed on any person determined by the IRS to be responsible for collecting, accounting for, and paying over required taxes, and who acted willfully in not doing so, and the penalty may apply to individuals personally if such unpaid taxes cannot be collected from the employer or business directly.

Criminal Penalties

Those who fail to comply with the bank deposit requirements for the special trust account for the U.S. Government may also be charged with criminal penalties. We will cover the criminal penalties in more detail in future articles.

Averages Failure to Deposit (FTD) Penalty

The IRS may also assess an “averaged” failure to deposit (FTD) penalty of 2% to 10% for filers who are scheduled to make monthly deposits, and who do not properly complete Part 2 of Form 941 when a tax liability listed on Form 941, line 10, equals or exceeds $2,500. The IRS may also assess an “averaged” FTD penalty of 2% to 10% for scheduled semi-weekly depositors who show a tax liability on Form 941, line 10, equaling or exceeding $2,500, and who fail to complete Schedule B of Form 941, fail to attach a properly completed Schedule B of Form 941, or improperly complete Schedule B of Form 941.

The averaged FTD penalty is calculated by distributing a total tax liability listed on Form 941, line 10, equally throughout the tax period. As such, deposits and payments may not be counted as timely because the actual dates of tax liabilities may not be accurately determinable.

Contact Sherayzen Law Office for Legal Help With Negotiating Form 941 Penalties

If you are facing Form 941 penalties, contact Sherayzen Law Office NOW. While the exact options available to you will depend on your particular fact pattern, our experienced tax firm will rigorously represent your interests in IRS negotiations and strive to reduce such penalties, exploring all viable legal options.

Taxation of Oil & Gas Royalty Interests

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The recent oil boom in regions such as the Bakken Oil Field has created millionaires overnight based upon royalty interests in oil and gas leases of investors. While fortunes can be made from such payments, it is important to understand that there may be various potential risks involved, as well as numerous taxes. This article will generally discuss three common types of royalty interests, and taxation of payments received from such interests.

Oil and Gas Interests Royalties

There are generally three main types of royalties received for oil and gas interests: standard royalty interests, overriding royalty interests, and working interests

Standard Royalty Interests

A standard royalty interest (also called a “landowner’s royalty”) entitles an owner of mineral rights (a lessor in a lease) to an agreed-upon part of the total oil and gas production attributable to the lease, minus reasonable production costs of the producer (the lessee in a lease). Royalties are usually expressed as a percentage or a fraction of the total production of the well.

Drilling and producing oil and gas wells entail certain types of costs. Unless stated otherwise in a lease, exploration, marketing and production costs are generally paid by the production company, whereas post-production costs may be shared by the landowner with the production company. Depending upon the terms of the lease, certain post-production costs incurred that add value to the oil and gas drilled at the wellhead prior to the place of sale (such as various treatment, compression, processing and transportation costs) may be deducted by the lessee when calculating the royalty payment amount. Additionally, royalty interest payments may be subject to various federal, state and county taxes (which will be detailed later).

Overriding Royalty Interests

Another type of royalty is the overriding royalty interest. A holder of such interest is entitled to a share of the production revenues from a well, free of production and monthly operating costs. Like a standard royalty interest, overriding royalty interests are subject to taxes and post-production costs. Unlike standard royalty interests, holders of overriding royalty interests do not own the underground minerals, and they will not have any ownership rights once well production ends. Overriding royalty interests can be both assigned from holders of a working interest (defined below), as well as created by a leaseholder who retains an override after assigning a leasehold to a working interest owner.

Working Interests

A working interest is the interest obtained by a lessee under an oil and gas lease. Under this interest, holders fully participate in production revenues based upon the percentage of working interest that is owned along with other investors. Unlike royalty interests, holders of working interests fully participate in the profits generated from successful wells. However, owners of working interest are generally directly liable for payment of the applicable share of drilling costs, and other associated costs, such as operating, leasing and exploration costs. Working interest holders generally do not own the underground minerals. Working interests may offer significant tax advantages.

Taxation of Royalties

Landowners must pay taxes on royalties received from production companies, in addition to numerous other potential taxes. Under the Federal income tax, royalties are considered to be ordinary income. However, royalty owners may generally deduct up to 15% of their income received from mineral interests through depletion allowances.

Most states in which oil and gas are produced also levy a severance tax on such production. These taxes are deducted from royalties received, and are calculated based upon either the value of the production, or the production volume, depending upon the state’s tax laws. Additionally, many counties also levy annual ad valorem taxes based upon the value of oil and gas wells in production.

Contact Sherayzen Law Office for Tax Help With Oil and Gas Royalty Interests

This article is intended to give a brief summary of these issues, and should not be construed as legal or tax advice. Federal, state and local taxation planning and reporting often necessitates an experienced understanding of complex regulations, statutes, and case law, and penalties for failure to comply can be substantial. If you have further questions regarding your own tax circumstances, Sherayzen Law Office offers professional advice for all of your tax needs. Email [email protected] or call (952) 500-8159 for a consultation today.