The IRS was busy processing tax returns in the first half of 2016, but that does not mean they were sleeping when it comes to new regulations or tax court rulings. Here is just a sample of what the IRS and tax court have been up to so far this year.

Hobby Losses Under the Magnifying Glass

The IRS is increasing its scrutiny of “hobby losses” reported in Schedule C that are being used to offset regular business profits. The red flags the IRS is looking for include several years of losses, zero or minimal gross receipts, and whether or not the taxpayer has other sources of income sufficient for living.

Partners Can’t Be Employees

The IRS issued regulations in May 2016 to clarify previous rulings that partners in an LLC cannot be treated as employees. This addressed a situation in which a partnership formed an LLC that was treated as a “disregarded entity” for employment tax purposes, and to allow the partners to participate in employee benefit plans with favorable tax treatment. Can’t do it.

Charitable Deductions Denied

Several tax court cases decided so far in 2016 resulted in individuals losing their charitable contribution deduction because they did not follow the requirements of Sec. 170 and its regulations. Among the cases were:

• Loss of deduction of cash because of lack of written documentation. Any contribution of $250 or more made by cash or check must be backed by written acknowledgment from the charity or organization receiving the donation.
• A taxpayer was denied a $390 charitable deduction for travel expenses because the taxpayer could not prove they performed any services for their church aside from regularly attending worship services.
• A deduction of approximately $3,500 for the donation of used clothing was denied because the taxpayer lacked documentation and had no proof the clothing was “in good used condition or better” as required by law.
• A $5,300 deduction was denied and an “accuracy related” penalty assessed because the taxpayer could not prove the charity to which the donation was made is a valid Sec. 501(c)(3) organization.
• A clothing salesperson’s deduction of the cost of an expensive suit as “work clothing” was denied, as work clothing must meet three criteria: it must be required or essential in the taxpayer’s employment; it must not be suitable for general or personal wear; and the clothing is not so worn.
• A taxpayer was denied a façade easement donation deduction for failure to include the qualified appraisal on their return. Another taxpayer lost a conservation easement deduction because they lacked sufficient written contemporaneous acknowledgment.

Failure to File Will Cost You More

The penalty for failing to file a tax return has increased from $135 to $205, effective for returns to be filed after 2015. This penalty will be adjusted annually for inflation.

Online Sales Tax in South Dakota

The state of South Dakota now requires online merchants and other remote sellers to collect sales tax on tangible personal property sold into the state, as well as products or services delivered electronically into the state. The sales tax requirement applies for sellers who, in the prior or present calendar year, had gross revenues in South Dakota in excess of $100,000, or 200 or more separate transactions within the state. This state law challenges the 1992 U.S. Supreme Court decision (Quill Corp. v. North Dakota) that held that a state may make a vendor collect sales tax only if it has a physical presence in the state.

If you have a question about these or any other tax topics, please contact Gray, Gray & Gray’s Tax Department at (781) 407-0300.