Practical tax tips: independent contractors, E-filing and more - california tax

California CPA, Nov, 2003 by Leonard W. Williams

The drumbeat continues regarding California's Employment Development Department and independent contractors.

Many TaxTalk participants have been relating their experiences with EDD auditors who are seeking to re-classify clients' independent contractors as employees--and collect large amounts of employment-related taxes, along with penalties and interest.

The most rudimentary advice is to familiarize clients with the rules regarding who qualifies as an independent contractor. But since theory and practice frequently diverge, the matter frequently doesn't come up until the client's annual tax return is being prepared, by which time there's a full year of noncompliance, and about one-third of the year during which the return is being prepared.

Here is what CPAs should convey to their clients regarding the documentation they should maintain in the event of an EDD audit of independent contractors:

1. Invoices on the independent contractor's letterhead or equivalent.

2. The independent contractor's business card.

3. A Yellow Page or business section listing for the independent contractor.

4. An executed independent contracting agreement.

5. A list of the independent contractor's other customers.

6. A copy of the trade or professional license (if one is required) for the type of work being performed.

Notifying the FTB of the Results of an IRS Audit

Someone recently posted a darn good question regarding a final settlement reached with the IRS on a 1998 return. Since the California statute had run out, the questioner hoped to skip notifying the FTB, but he had qualms about that and posted a question about what to do.

The answer: If the FTB isn't notified within six months, or an amended return is not filed, the statute never runs out. (See CA Rev. & Tax Code Sec. 19060).

As for notifying the FTB, one CPA proffers this cost-effective method: Simply send the FTB a copy of the Revenue Agent's Report, with a cover memo saying, in essence, "Here is a copy of what the IRS did; please assess the tax and send a bill." Then he checks the FTB's calculations.

Compulsory E-filing

This is no longer news, but there will be various nuances coming along prohibiting certain returns from being e-filed.

Here is one that was posted by a CPA who does a lot of multi-state returns for entertainers: California will not accept a return for e-filing with more than three Schedule Ss. So many of this CPA's clients, who often have 10 Schedule Ss in their returns, can't e-file. This is not a big loss to the clients, but it does result in the office having the trouble (and expense) of running two parallel processing systems.

U.S. Tax Court: Sec. 152(e)(1) and (2) Apply to Parents who Never Married Each Other

The above section basically says that the custodial parent is entitled to claim a dependency exemption for a child unless he or she signs off on Form 8332, which would allow the non-custodial parent to claim the child.

Beginning in 2000, the IRS had put language on Form 8332 that stated the test doesn't apply to parents who never married each other.

The Tax Court has overruled the IRS and said that the test applies to parents who never married each other. (Jeffrey R. King, et al v. Commis. 121 T.C. No. 12).

Interestingly, the Tax Court's decision was indirectly predicted in an article on the tax aspects of living together authored by you-know-who in Taxation for Accountants (December 1975).

S Corps, Sec. 179 and W-2 Income

Generally, an entity may not take a Sec. 179 deduction on its return if it shows a loss without the Sec. 179 deduction. This is determined at the entity level. So if an individual who either is the sole owner or an investor in an S corporation which shows a loss, but has a W-2 from an unrelated entity, the 1120-S K-1 will not be able to show the Sec. 179 deduction.

However, if the W-2 is from the S corp, the W-2 may be netted against the loss to determine whether or not the S corp has a profit, which might enable the 1120-S K-1 to show a Sec. 179 deduction on line 8 of the K-1. [See Reg. 1.179-2[c](3)0) and (ii)].

May a Corporation's Owner Rent Office Space in His Home to His Wholly Owned Corporation?

Briefly, no, per IRC Sec. 280A[c](6). This section closed what Congress perceived as a loophole opened by Ira Feldman, a CPA, when he prevailed over the IRS in the 9th Circuit in 1986.

In fact, the section is very broad in disallowing such an arrangement between employees and their employer. The alternative many listserve participants have been using is to compute the actual expenses as they would be done via a Form 2106, Employee Business Expenses, and have the corporation/employer reimburse the employee for that amount.

There is no cite for this, but it is believed to be a sound procedure. Thanks to the following CPAs for their participation: Larry Massey, Jim Counts, Steve Duben, Michael Chambers, Steve Kramer, Alvin J. Brown, Dave Aurit, Anita Cottle, Melody Thornton and Ed Zollars.

Leonard W. Williams, CPA is a Sunnyvale-based sole practitioner. A member of CalCPA's Committee on Taxation, the AICPA Tax Division and a former Peninsula Chapter president, you can reach Williams at williams@lwwilliamscpa.com.