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What to Do When There is No Clear Answer to Your Tax Question

After your name, address, and Social Security number, the tax code can get muddy quickly. It’s not really that bad, but there are tremendous issues when applying the tax code — and regulations — to your specific tax situation, especially when the answers are less than clear.

We will start with two examples where tax answers are ambiguous. We then move to proper researching methods and resources before ending with solutions to our two examples.

Two Tax Questions With No Clear Answer

Team Building

I have a client that discovered a loophole in the meals and entertainment deductions. Now that COVID is history, meal expenses for businesses have returned to their historical 50% rate of deduction. A $100 business meal expense only provides a $50 deduction on the tax return.

Entertainment expenses are no longer deductible since the 2018 Tax Cuts and Jobs Act.

My client wanted to know how he could turn these nondeductible business expenses into deductions. One way to do this is with team building*. (Team building allows the expenses of employees and their spouses. See the link for details on qualified team building.)

Qualified team building is 100% deductible, meals and entertainment included.

So what did my client do? He decided taking the employees out to a bar/restaurant after work once per week was team building. Meals and beverages all deductible, he hoped.

The concern is that these are nondeductible entertainment and meal expenses. (The real worry was the expense was personal, where my client was entertaining friends, or mostly friends, instead of team building with employees.) Since the deduction is generous in my client’s situation, it is important to get the answer right.

The good news is that we did get an answer.

Augusta Rule

Oh, if you want to fire up a group of tax professionals bring up the Augusta Rule.

For the uninitiated, the Augusta Rule says if you rent out your home or vacation home for 14 or fewer days during the year you do not have to report the income.

This works great for annual local events where there is a high demand for lodging. Renting out your home near a football stadium during home games is one idea. Or renting your home in Augusta, Georgia — where the rule finds its roots — for two weeks or less during the big golf tournament.

Never underestimate the ability of taxpayers to find new uses for a tax strategy, however. Business owners quickly realized they could rent their home to themselves for business events. The business gets a deduction and the taxpayer doesn’t have to report that as income on their personal tax return if they rented their home 14 or fewer days that year. All they need to do is make sure the rent is at the market rate.

We will not go into all the creative ways people have used the Augusta Rule. Instead, we will focus on one narrow issue.

It started when a group of tax professionals on X, under the #TaxTwitter hashtag, were exposed to a TikTok video on the Augusta Rule.

The video indicated you could use the Augusta Rule for business events in your home even if you have an office in the home. The battlelines were drawn. If you have an office in the home, how can you possible use the Augusta Rule as a strategy for reducing taxes? Since you have a home office all year you obviously exceed the 14 days. And taking home office expenses is renting. Right?

Jessica researching tax issues with no clear answer. The paperwork does pile up fast when researching.
Jessica researching tax issues with no clear answer. The paperwork does pile up fast when researching.

Researching Tax Issues

There was a time when I had a large room in my office building with books on the tax code and regulations that went from floor to ceiling. The internet gave me that space back and made research easier if you know how use the new tools correctly.

Tax professionals have significantly more authoritative resources than the DIYers. Still, tax professionals use the same resources everyone else has, too.

For the “quick question” the professional can turn to the Quickfinder or The TaxBook. These two resources are a Reader’s Digest type resource. Many common questions are answered.

When things get serious tax professionals turn to tax services like Thompson Reuters, Wolters Kluwer, or Bloomberg Tax. These and other professional tax research services come with high price tags. These services are designed for tax professionals and would not be a reasonable resource individual taxpayers.

Of course, the IRS is also a treasure trove of tax information.

There are incredible resources online that even the professional resources do not have. Your tax professional will use these free online resources to answer tax questions. You should too.

The most important talent to have when researching is the ability to effectively use search engines. Even in peer groups questions are asked when a simple search engine request would bring the answer.

The catch is asking the right question. Which leads us to the second most important skill when researching, knowing what resource is authoritative and which is not.

There is a lot of junk out there. Social media is a terrible place to get tax advice. But there are seasoned tax professionals on social media that give very good information. However, there is so much bad advice out there that avoiding social media for tax information is best.

Blogs and websites published by attorneys, CPAs, or enrolled agents often contain useful information. The larger CPA firms and law firms generally have well research articles, with citations, that focus narrowly on a topic.

The Tax Advisor is an online resource I have found to have well written articles with accurate information. Most of the articles are not behind a paywall.

Often times our research helps us ask better questions before we get the best answer. Earlier this year I published on buying tax credits. The topic was so new that the resources were not plentiful. I went as far as interviewing brokerage companies and large CPA firms on how they were handling the Inflation Reduction Act and the buying and selling of tax credits. That led to better questions, which led to information in other areas of tax law that allowed me to write an accurate article. Later, when the IRS issued final regulations, my research proved correct.

The office manager is on vacation. The boss doesn't like the answer from the CPAs research. What could go wrong?
The office manager is on vacation. The boss doesn’t like the answer from the CPAs research. What could go wrong?

Solutions For Our Examples

In my office I often tell clients that taxes are more crystal ball than science. That is my fancy way of saying “professional judgment” plays a pivotal role when determining the appropriate course when reporting a difficult tax situation.

This is where the DIYers run into issues. The tax professional has experience to draw on. Years of researching tax issues is an advantage unavailable to the DIYers.

Tax professionals and DIYers alike read this blog. I am writing this post with DIYers and new tax professionals in mind. Seasoned pros are aware of this information and more, yet, it is always a good idea to refresh policies and procedures.

The important part here is to understand how to think about a tax situation when determining the correct course. Tax professionals do not always agree. That is okay. Most tax issues have hard and fast answers. It is when we apply these rules to real world situations where the answers becomes clouded.

Now let’s solve our two examples.

Team Building

My first reaction to a business owner taking employees out to dinner and drinks on a regular basis was a hard no. Other preparers in my office felt the same way. There has to be a business purpose. If it is disguised buddies out for the night it is not team building.

Feelings have nothing to do with tax rules!

Is shooting the bull after work team building? Food and entertainment are 100% deductible if it is. If it isn’t, then no deduction. My reasoning is that even the 50% meal deduction is not allowed if there is no business purpose. And there isn’t if the gathering is not team building.

Well, the good news is that my client got the idea of team building from his tax professional. The establishment where they met did serve food and drinks. But it also allowed the business’s team of developers and sales people to work together effectively. Sometimes clients were brought in. Reviewing current products and those in development created efficiencies. It also created a team environment and fostered better client relations.

Yes, the client could have stayed at the office with employees and had the same discussions. But often progress comes when the setting changes. Clients also prefer a meal and a drink when meeting with a supplier.

All this led to more sales. (Note: The deduction is not predicated on some business outcome.)

But I had to have a serious Q&A with my client. I reviewed what a qualified team building event is and is not with him. Yes, some may feel taking employees out for dinner and drinks weekly is team building, even if no scheduled business discussions take place. I happen to disagree (somewhat) with that thought process (because it can easily be abused). It is more than socializing. (It should be noted that qualified team building does allow for employee entertainment. There are limits. For example, a business is allowed one golf outing per year for employees and their spouses.**)

The line can be thin. What about the weeks where no clients attend? What if the discussion on product development is ad hoc?

In my professional opinion, I feel scheduled team building, which allows for formal and nonformal structure, is still team building. The events are regular (weekly). Employees bring issues to the event. Of course, the setting is informal and comfortable. Getting out of the office should be!

It is the overall set of facts and circumstances that led me to believe my client has deductible team building. The expense gets large when tallied at the end of the year. But the team building environment took a very small 5-figure company deep into 7-figures in a few short years.

Not only is it deductible team building. It works!

Augusta Rule

Many from the #TaxTwitter crowd will read this. Many will remember the original bruh-ha-ha. So, yes, I am stepping in it.

Tax professionals were willing to “die on this hill” as they presented their opinion. When bodies begin to accumulate at the upper altitudes of a hill I begin to wonder what all the dying was about. Could someone be dying in vain?

Let’s start with the basics. If you have an office in the home, have you rented your home for more than 14 days during the year?

Well, to be honest, you haven’t rented your home to your business at all. You are merely deducting expenses related to the home office, even if using the safe harbor. If this were a true rental situation there would be an element of potential profit. This is clearly not the case!

While I sided with the fine tax professionals stacking up on the hilltop at the time, I now elect to change my mind. Tax professionals, even seasoned ones, do that more than you think. My current opinion? There is no element of profit or gain from the deduction of home office expenses so there is no rental situation for any days. Therefore, the Augusta Rule can be used in certain instances. (#TaxTwitter peers, let the gutting of the Wealthy Accountant begin!)

All that said, I still take each situation based on facts and circumstances. While I just said I would allow the Augusta Rule if a client with a home office had a summer picnic for clients in his home and back yard, it is not a guarantee. (Note to clients: Do not get mad if I say no in your situation. All decisions are based on professional opinion and final.)

But there is yet another possible issue.

What if our home office bound taxpayer has a nice home and a separate building we will call a mother-in-law suite. If a home office is considered rent, can we still use the yard and MIL suite as a gathering place and invoke the Augusta Rule?

Remember, the Augusta Rule is not only for your main home. A vacation home also counts. Is the MIL suite enough of a separation from the main home to be considered a vacation home and therefore qualify for the Augusta Rule? Not all tax professionals will agree! The real question is: Will the IRS agree in an audit? I think the odds are good. But, then again, there are no guarantees in taxes.

In this situation I come down firmly on the side the Augusta Rule apples. The MIL suite is not the main home where the home office is.

Final Notes

It is my opinion tax professionals are too conservative. We take strict positions where the IRS would have no problem with the deduction. This doesn’t happen at major corporations. They know what they can deduct and deduct it.

But before all the DIYers go charging out to amend their returns, note that every position I take is based on researched facts and circumstances. I did not pull the deduction out of thin air. And, as we saw with he Augusta Rule, I periodically change my mind. Considering how complex the tax laws are, it is a wonder more tax professionals don’t change their position more than they do.

To my peers and DIYers alike, do the research. Keep your research records with your tax papers (because you might need them later DIYers) or in the digital filing cabinet for the client (tax professionals). Also include your reasoning. In an audit the IRS may or may not agree. It goes with the territory. But at least you have reasonable ground to stand on.

The “right” answer is not always the one shot from the hip. As you research you will often change your opinion. Be honest. I know you want a deduction, but you also want the answer to be honest, just in case the IRS agent wants to give it a look-see.

* It is important to read the link if you want a better description of team building.

** I take the golf outing example from Senior Tax Research Manager Yunnice Chang, as reported by Cain Watters & Associates. Note this is not a favorite resource of mine. It is used for illustrative purposes only. Cain Watters is an advisory service for dental professionals.

Robert McCombs

Wednesday 29th of May 2024

My wife retired from a nation-wide retailer when she was 55 years old and will turn 59-1/2 in October 2024. She has a sizeable 401k (some in traditional and some in Roth), which she left with her employer, with about 10% being in the company fund. I have tried to understand the Net Unrealized Allocation (NUA) rules, but the more I read the more confused I get. When I first read about it I thought when she turned 59-1/2 she could have the company fund portion of the 401k into company stock. She could then sell the company stock and only pay taxes on the cost basis (what she bought it for ($19,600)) versus paying taxes on what it is worth (approx. $44,400 presently). I also think she would owe capital gains, but since she bought it over a year ago and our taxable income is less than $94,050 the capital gains would be $0.00. As I reread about NUA I get confused on what she has to do with the rest of her 401k. Does she have to also withdraw all of it, roll it over to an IRA (both traditional and Roth), or leave it in her employer fund? Withdrawing it would easily require her to pay 37% tax, which we don't want to do as we don't need the money to live on and it would be a huge waste to pay that much in taxes. My goal is to try to get most of it converted to a Roth before she turns 75 to forego RMDs and only pay 12% taxes since that is the bracket we are currently in. I think we can convert around $35,000-$40,000 per year and stay in the 12% bracket.

So to shorten it:

1. Can we use NUA to convert the company fund to company stock, sell it and pay the taxes on the cost basis vs. current value and also pay capital gains (which I think will be zero)? 2. Do we have to also withdraw all of the funds in her account, or can we roll them over to an IRA (traditional and Roth) or leave them in her employer 401k fund (where we can convert them from traditional to Roth over the next 15 years wherever they are located)?

Respectfully, Robert U.S. Navy Disabled Veteran

Robert

Monday 3rd of June 2024

@Keith Taxguy, EA,

Thank you. You have me the answer I needed, "Unfortunately, using the NUA strategy requires you take a lump-sum distribution of all plan assets at once." With her 401K approaching mid six digits paying 37% taxes on money we don't need, is foolish in my humble opinion. I'll stick to my plan to convert 35K-40K to her Roth account over the next 15 years. Thank you again.

Respectfully, Robert U.S. Navy Disabled Veteran

Keith Taxguy, EA

Wednesday 29th of May 2024

Robert, NUA (I assume you mean Net Unrealized Appreciation, not Accumulation) is the difference between the basis and the market value at the time of distribution. However, there can be triggering events, such as: reaching 59 ½, separation from service, disability, or death.

Unfortunately, using the NUA strategy requires you take a lump-sum distribution of all plan assets at once.

Here is a link to a Fidelity article which does a good job explaining the details of NUA.

I also highly recommend you hire a competent and qualified tax professional to help you with this. There are too many variables for me to give you concrete answers without knowing every detail.