Category: Small Business

Home Office Tax Deductions Are Fantastic: Learn How To Do It

August 24, 2019 | By: Robert A. Green, CPA | Read it on

Since 1999, the home-office deduction is no longer a red flag — millions of Americans benefit from this deduction each year. Countless taxpayers run businesses from home, and the IRS understands this. The income-requirement rule also limits the use of this deduction for profitable enterprises, which appeases IRS concerns about abuse and hobby-loss businesses. Before the IRS liberalized home-office deduction rules in 1999, a more stringent requirement was that business taxpayers needed to meet clients in their home office. Now, the only requirement is administration work, and another principal office outside the home doesn’t negate the deduction.

Many small-business owners, including traders eligible for trader tax status (TTS), operate from a home office. Some of them also conduct their business from job locations using cloud computing, apps, and mobile devices. They can qualify for the home office expense deduction in this situation, as well. The IRS does not permit investors to take a home office deduction.

Convert personal home costs into business expense deductions. This same concept applies to many other items such as phone, Internet, furniture, fixtures, and more. Keep in mind that business income or TTS trading gains are needed to unlock most home-office deductions. If a business doesn’t have sufficient net income, the otherwise allowable home office deductions are carried over to the following tax years. (In this situation, hopefully, the person remains in the business and has net income in subsequent years to use the carryovers.)

There are several special requirements and rules for the home office deduction. A home office must be exclusively and regularly used for business, meaning children and guests can’t use this room. Report “indirect expenses” on Form 8829 and include every expense and cost related to the home. For example, include depreciation or rent, utilities, insurance, repairs and maintenance, security, cleaning, lawn care, and more.

Include mortgage interest and real property taxes, too, and this home-office portion doesn’t require income. The remaining part of mortgage interest expense and real property taxes are Schedule A itemized deductions.

Real property taxes on Schedule A are part of the new tax law (TCJA) SALT limitation. However, the home office portion or real property tax is not subject to the SALT limitation.

To calculate the home-office deduction, take the square footage of the home office (and all related business areas such as storage, hallways, and bathrooms). Divide that by the total square footage of the home (10-15% is customary). Alternatively, taxpayers can do the apportionment based on the room’s method. Form 8829 multiplies the home-office percentage by the indirect expenses. If the business files a partnership return, report home-office expenses as unreimbursed partnership expenses (UPE) on Schedule E. For S-Corps, use an accountable reimbursement plan before year-end.

Per Thomson Reuters/Tax & Accounting Client Letter (see list below):

“Sales of homes with home offices. If you sell-at a profit-a home that contains, or contained, a home office, the otherwise available $250,000/$500,000 exclusion for gain on the sale of a principal residence won’t apply to the portion of your profit equal to the amount of depreciation you claimed on the home office.”

Depreciation expenses on the home office over the years save taxes at ordinary income tax rates. Recapture of depreciation on a sale of the principal residence is taxed up to a 25% capital gains rate, which is unique to Section 1250 property. Tax deferral is another value. The rest of the home enjoys the exclusion of capital gain up to the limit.

If a taxpayer sells his principal residence at a loss, the net loss is not deductible. However, the recapture of depreciation income might not exceed the loss amount, meaning there is no taxable income from depreciation recapture to report on the tax return.

TCJA capped state and local income taxes, sales taxes, real property taxes, and personal property taxes (SALT) itemized deductions on Schedule A at $10,000 per year (any combination thereof), and $5,000 for married filing separately. TCJA also reduced itemized deduction limits on mortgage interest expenses and casualty losses.

Home office tax benefits for employees
Employers require some employees to work from a home office. The new tax law (TCJA) suspended unreimbursed employee business expenses as itemized deductions. That leaves only one other way to arrange a tax benefit for home office expenses. An employee can seek reimbursement from an employer for home office expenses through an accountable reimbursement plan. The employer deducts home office expenses and does not include this payment on the employee’s W-2 as taxable income.

Our below Thomson Reuters/Tax & Accounting Client Letter for “telecommuting employees” states:

“The convenience of the employer requirement is satisfied if: you maintain your home office as a condition of employment-in other words, if your employer specifically requires you to maintain the home office and work there; your home office is necessary for the functioning of your employer’s business; or your home office is necessary to allow you to perform your duties as an employee properly. The convenience of the employer requirement means that you must maintain your home office for your employer’s convenience, and not for your own. This requirement isn’t satisfied if your use of a home office is merely “appropriate and helpful” in doing your job.”

Client Letters from Thomson Reuters/Tax & Accounting:

  • Home office expense deduction for a self-employed taxpayer
  • Exclusion of gain on sale or exchange of principal residence
  • How the home sale exclusion applies to a residence used for residential and business (nonresidential) purposes or to produce rental income
  • Office at home for telecommuting employees
  • Converting a home into rental property

For access to these Client Letters from Thomson Reuters/Tax & Accounting, please join our email list. We send bulk emails a few times per month and include links to Client Letters.

11 Tax Breaks To Start And Grow A Small Business

November 10, 2014 | By: Robert A. Green, CPA

Join or watch our Webinar: 11 tax breaks to start and grow a small business.

Among the most popular “American dreams” is starting your own business. Entrepreneurship is the bedrock of America’s thriving economy and Congress continues to favor small business with tax breaks. Uncle Sam is patient for income taxes, allowing: upfront and accelerated expensing; paying business taxes on individual tax returns where other business or investment losses and expenses can be applied; lower tax rates (graduated rates) for lower income; and averaging business income over several years with net operating losses (NOLs). Plus America has voluntary tax compliance. America’s tax system is the envy of the world, and it’s the best place to start a business.

Interested in starting your own business? Find a niche in the marketplace in which you can compete with an edge. It’s possible to open a virtual business within weeks. The incredible advances in ecommerce have made it possible to launch a website with an online store and outsource fulfillment and logistics to other entrepreneurs. Borrow money at record low interest rates and get a full tax deduction for interest expense.

GreenTraderTax has been servicing investors, traders and investment managers since 1983. Business traders and investment managers are classic small businesses. Business traders have trading gains and losses rather than revenues. Investment managers have advisory fee revenues. Both have operating expenses and no inventory of products. They share many of the same tax, accounting, entity and retirement plan strategies and solutions.

Small business also generates self-employment income (SEI) or earned income, which in many cases triggers FICA and Medicare taxes — payroll taxes on wages or self-employment (SE) taxes on sole proprietor net income or Schedule K-1 ordinary income from partnerships. Traders do not have SEI on trading gains, with the exception of a futures trader who is a full-scale member of a futures exchange. S-Corps also do not pass through SEI, so the IRS requires “reasonable compensation” for officer/owners of approximately 50% of net income.

If you’re thinking of starting up your own small business, consider these 11 important tax breaks:

1.  Business expenses and NOLs

If you want to see what a country values most, study its tax code. In America, business enjoys the best tax breaks compared to investors and employees. Business expenses are deductible from gross income with few limitations and business losses comprise NOLs, which can be carried back two years and/or forward 20 years. You can choose between the cash or accrual method of accounting. Conversely, investment expenses and unreimbursed employee business expenses (Form 2106) are limited as miscellaneous itemized deductions on Schedule A.

Costs to develop, build or acquire a business or asset are capitalized as an asset. A taxpayer must check to see how the IRS allows expensing of that asset — depreciation or amortization —generally over a prescribed useful life. Obviously, the sooner you can write off an asset via a tax deduction, the more your net income will be reduced.

2.  First-year expensing (100% depreciation) and bonus depreciation

Section 179 “Election to expense certain depreciable business assets” allows 100% depreciation in the acquisition year on qualified Section 179 property. The 2013 limit was $500,000, but “tax extender” legislation lapsed at the end of 2013, so the old limit of $25,000 returns for 2014 with an adjustment for inflation. Hopefully, the 2014 and 2015 Congress will renew a much higher limit for Section 179 retroactively to Jan. 1, 2014. (Postscript on 12/4: —The House just renewed all tax extenders for 2014 and the Senate and White House will probably agree.) Learn more about the Section 179 Deduction on the IRS site, including What Property Qualifies?

3.  Start-up expenditures

Section 195 “start-up expenditures” include costs for “investigating and inquiring” about a new business; they do not include acquisition costs, fixed assets (equipment) or intangible assets (software). Sometimes a larger business may try to disguise acquisition costs as start-up costs and the IRS says no. However, many small business start-ups do have costs for investigating and inquiring about a new business. Business traders take classes before trading and that squeezes into start-up costs. Section 195 rules: file an internal “expense election” to deduct $5,000, plus deduct the rest over 180 months beginning with the month in which the business begins. Tip: start your business activity ASAP so expenses after commencement are unlimited operating expenses. We think capitalizing start-up costs six months from inception is reasonable.

4.  Organizational expenditures

Section 248 “organizational expenditures” are similar to start-up expenditures with an election for a $5,000 deduction and the rest over 180 months beginning with the first month. Organizational expenditures are for forming your business entity with attorneys, accountants and incorporation services. When an attorney provides various services to your company, it’s important to get an itemized breakdown of the fees between organization expenditures, operations, acquisition and personal.

5.  Converting personal expenses to business use

The majority of taxpayer individuals are employees receiving W-2s. Employees don’t have deductions from gross income or adjusted gross income (AGI). They are stuck with restricted itemized deductions for state and property taxes, mortgage and investment interest, charitable contributions and miscellaneous itemized deductions (investment expenses, tax compliance expenses and unreimbursed employee business expenses). Employees get few tax breaks after wasting deductions to thresholds, AMT preferences, the Pease limitation and state restrictions. It’s the opposite for small business: They get deductions from gross income (business and home-office expenses) and adjusted gross income (retirement and health insurance premiums).

Many small business people have an office in their home and they coop one of the family automobiles for business use too. They arrange vacations that can also accomplish some business goals like attending a trade show or convention. They socialize with other entrepreneurs who can help them succeed in their business. They start to blur the lines between business and personal and the end result is a reduction of personal non-deductible expenses and an increase of business expenses. Be sure to follow IRS rules on compliance, documentation, autos, travel and entertainment. It’s wonderful to convert personal-use assets and expenses into business-use assets, unlocking business deduction treatment. Without spending additional money, you convert limited itemized deductions or non-deduction of personal expenses into business tax deductions. Tip: Use GTT Tracker to track expenses and comply with IRS rules for documentation on a contemporaneous basis.

6.  Home-office deductions

The home-office deduction is one of the most powerful deductions for business owners. Since the IRS liberalized home office rules in 1999, taking the deduction is no longer a red flag. You don’t have to meet clients in your home, but you can only deduct home office expenses against business income. The amount not deducted is carried over to the subsequent tax year. Determine the home office percentage by either the square footage method or room’s method, and then deduct that percentage of all home expenses including depreciation or rent. Tip: Most taxpayers would love to write off a big chunk of their home expenses, so make sure you meet the exclusive use requirement to enjoy this juicy tax break.

7.  Retirement plan deductions

Uncle Sam gives generous tax breaks to those saving for retirement. All income growth in retirement plans is tax free until ordinary income distributions are taken in retirement. Set up officer compensation in your S-Corp or C-Corp or guaranteed payments in a partnership, or look to sole proprietorship net income. Establish a high-deductible retirement plan.

We generally recommend an employer 401(k) plan for corporations and partnerships and an Individual 401(k) plan for sole proprietors. The 401(k) elective deferral ($17,500 for 2014 and $18,000 for 2015) is 100% deductible, plus it’s paired with a 25% employer profit-sharing plan allowing a total contribution of up to $52,000 for 2014 and $53,000 for 2015. There’s also a catch-up contribution ($5,500 for 2014 and $6,000 for 2015) for taxpayers age 50 and over. An Individual 401(k) plan has a 20% profit sharing plan, which is not as generous as the employer plan.

High income businesses should consider a defined benefit (DB) plan where much higher amounts can be contributed per year (up to $210,000 for 2014). DB plans require actuaries and attorneys and it takes time to set up. Consider different options for your retirement plan contributions, and whether you have sufficient cash flow to maximize this tax deduction.

8.  Health insurance deductions

Sole proprietors and partners in partnerships have SEI which unlocks a 100% AGI deduction for health insurance premiums on their individual tax return. S-Corps are tricky: Add the individual health insurance of the officer to officer’s compensation and take a 100% AGI deduction for health insurance premiums on the owner’s individual tax return.

For high-deductible ACA-compliant health insurance plans, consider a Health Savings Account plan. If you have significant unreimbursed health expenses, consider a medical reimburse plan. Only a C-Corp can have an MRP, not a partnership or S-Corp for more than 2% owners and attribution rules apply to spouses. If you have a C-Corp, consider other types of fringe benefit plans, too.

9.  Hire family members

Shift income to children over the age of the kiddie tax rules. Hire a spouse to do the elective deferral for your spouse on an employer 401(k) plan.

10.  Active Investors

If you join a small business as an active investor — providing capital and labor — you can navigate around the onerous Section 469 passive-activity loss rules by meeting the material participation standards. Although material participation is similar to “trader tax status” requiring “regular, continuous and substantial” work, there are important differences. Material participation standards provide bright-line tests, whereas trader tax status looks to case law instead. The material participation rules are complex; read them closely and consult an expert afterward. (Read more about our creation of the “Active Investor” tax strategy on our blog Private-Equity Active Investor Tax Breaks.)

Passive investors may only deduct passive activity losses – passed through on Schedule K-1s – against passive activity income. They may not take a net loss in a given tax year, unless they sell the investment fully realizing the loss. Otherwise, they have suspended tax losses. Passive activity net income from pass-through entities is also subject to Obamacare 3.8% Medicare surtax on unearned income (Net Investment Tax, NIT bucket 2). Active investor owners don’t have net investment income for NIT.

11.  Ecommerce/virtual business in a tax-free state

Many taxpayers living in a high-tax state would like to operate their business from a tax-free state to avoid paying state taxes. If you operate a pass-through entity, it doesn’t make any sense since the income is passed to your individual state tax return anyway. To claim you do business in a foreign state rather than your resident state, you shouldn’t have employees, assets and sales in your resident state (known as “nexus” rules). Traders live, work and trade in their home state, so claiming an out-of-state business wouldn’t be feasible, and they use pass-through entities anyway. But it’s different for an ecommerce/virtual business set up in cyberspace.

One idea is to form a C-Corp in Delaware and operate an ecommerce/virtual business that is not landed with sales, employees, inventory or assets in your high-tax resident state. Arrange for the corporation to pay you fees as an agent (not employee). Those working in the corporation as independent contractors — along with the servers — must be located out of your home state.

Enjoy lower corporate tax rates of up to 15% on the first $50,000 of income and 25% on the next $25,000 of income. (The rate is 34% for $75,000 and up.) Avoid state corporate tax and individual tax for many years. After you accumulate large retained earnings, pay a qualifying dividend taxed at lower capital gains taxes up to 20% (federal plus state).

Be your own boss
Most Americans prefer the “security” of a job over the perceived risks of starting and owning your own small business. Putting in a week’s work and get a weekly paycheck seems safer than working hard at a new small business and perhaps losing money.

But many of today’s jobs are not your grandfather’s jobs which often provided a lifetime of pension security. Today’s jobs are more prone to disappear in a flash with outsourcing, mergers, reorganizations, downsizing, productivity improvements (machines taking over), company or product obsolescence and disruptive technologies. Corporate America has grown harsher in its never-ending pursuit of productivity and profit often at the expense of the people. To save a buck, established businesses boot out aging employees just as they reach the pinnacle of individual success and compensation. Starting your own small business is not just a dream — it’s good business.

When I left Ernst & Whiney (now big-four accounting firm Ernst & Young) in 1983 to start Green & Company CPAs, I felt more secure with five founding clients than just one employer. Losing one employer leaves you stranded, but losing one client may not be a problem at all. Entrepreneurs aren’t risk takers; they are risk avoiders. (Read my blog article Traders should think of themselves as entrepreneurs. Some may want to diversify by operating more than one business.)

Bottom line
Green & Company and Green NFH helped thousands of traders and others launch new businesses, and we are ready to help you too. We have the expertise you need to assess new business opportunities, structure the business with the right entity and employee-benefit plans, reap small business tax breaks and grow your business with success. What’s your small business American Dream?

Traders Should Think Of Themselves As Entrepreneurs

October 4, 2011 | By: Robert A. Green, CPA

Postscript September 2014: While we no longer operate Green’s Entrepreneur Network, we are focusing on the tax needs of small businesses. Many traders and spouse operate another home-based business. 

Traders may not realize it, but they are entrepreneurs. It’s wise for traders to learn and follow entrepreneur business axioms. What counts most are bottom-line net profits and after-tax cash flow from your trading business over a period of time; not just successful trading strategies. 

Risk taker or avoider?
Many people will say entrepreneurs are risk takers. It’s actually the opposite, — entrepreneurs are “risk avoiders.” Malcolm Gladwell, in his 2010 New Yorker article “The Sure Thing,” made this point in his excellent story on a few very successful entrepreneurs. Ted Turner, founder of CNN and John Paulson, the famous hedge funder who did the Big Short with Goldman Sachs each made billions on what they viewed as a “sure thing.” They mostly used other people’s money rather than their own. 

But, there is no sure thing when it comes to trading. Successful active traders use a plethora of tools, charting services and hedging strategies to limit risk. Traders shouldn’t bet the family farm on a new trading business either and they need the discipline of reversing course after a period of consistent trading losses. 

Once an entrepreneur, always an entrepreneur 
There’s good news during this high unemployment era: It’s not just a choice between trading for yourself or getting a job again. Traders are well suited for seeking other entrepreneurial activities, perhaps related to trading or their prior career skill sets. You don’t have to give up trading for good; you can try out other entrepreneurial endeavors while you restructure your trading business. 

How to balance trading with other activities 
Some active traders keep their full-time jobs and fit trading around their job schedules. Others leave their jobs to pursue trading fulltime. Some traders like to diversify their entrepreneurial activity by trading during market hours and operating another entrepreneurial activity after trading hours. 

Some traders are enamored with the trading industry and they want to launch a trading services business involving trader education, coaching, mentoring, IT, administrative services or blogging. Other traders want to start a brokerage firm, proprietary trading firm or investment management business. 

The common thread through all of this is being an entrepreneur and having financial and business independence. 

Diversification is wise 
Just like an investor should not hold their entire portfolio in one stock, some traders may want to own and operate more than one business activity. Diversification of business activities is a good idea since only a low percentage of traders are able to make a sufficient living from trading over the long-term. Many traders may be successful during certain market conditions, but they may lose their way when market conditions change – which happens fairly often these days. 

Entrepreneurs keep tax breaks 
If a trader falls short of “trader tax status” (business tax treatment), they can retain business tax treatment in another side business. The IRS is not as strict with other business activities as they are with trader tax status. 

Traders want to be able to deduct general business expenses, home-office expenses and AGI deductions including retirement plans and health insurance premiums. Dedicated trading expenses are treated as investment expenses (Section 212) when a trader falls short of trader tax status. Section 212 does not allow home-office expenses. Employees get very few tax breaks and expenses. 

Entrepreneurs need to be virtual and global 
Modern-day entrepreneurs need to take advantage of online tools, services and ecommerce and create a fully equipped home office. With the reach and power of the Internet and online business, entrepreneurs should seek global cooperation and business as well. For example, you can design a great product in America or Europe, manufacture it with a manufacturer in an emerging market and sell it globally, including in high-growth emerging markets too. All of this can be done from a home office over the Internet without employees. 

Entrepreneurs can weave joint venture and contractor relationships over the Internet to create a partner-in-profit relationship rather than an employer-employee relationship. 

Traders are experimental, and most entrepreneurs should be too. 
Most traders experiment with trading by using online broker “demo” or “sim”(ulate) trading systems, before committing precious capital to risky live trading. Other traders “back test” trading strategies and ideas beforehand too. But, the real proof is in the pudding when you go live. Trading in a live account triggers sweat and more emotions, and that risk is very different from the cocky feeling one gets while sim trading. Risk avoidance is important, but undue fear of risk can sink otherwise good traders. 

Successful entrepreneurs conceive of great ideas that suit their skills and passions and they execute them well. Trial and error is a huge part of an entrepreneur’s success. Entrepreneurs should also test new products and services out on friends, family and close business associates. 

A California executive becomes a business trader and sets up a BOO business. 
Sanjay is a high-salaried engineer at a California software company. At age 55, Sanjay and his wife Vainavi are now empty nesters. Sanjay is approaching the end of his career and he feels insecure in his job considering that his company is facing technological obsolescence and management is increasingly offshoring jobs to foreign markets. Vainavi gave up her administrative job a few years ago and she is anxious to work again. Like her name means in English, she is a gold mine of talent.

Sanjay has been trading for several years. He became interested in trading after receiving employer stock options, exercising and holding some and trading options around his core stock positions. As a software engineer, Sanjay got swept up in online trading. It was a natural fit for his engineering skills, mindset and passions. Vainavi helps Sanjay organize and operate his trading activities. 

This year, Sanjay has taken trading to a higher level. He’s been very profitable, making even more money than at his day job. Rather than wait another year to face an impending company restructuring, Sanjay has decided to become a full-time trader and entrepreneur. Instead of trying to fit trading into his busy job schedule, Sanjay wishes to make trading his top priority and engage in other entrepreneurial activities as well. Vainavi wants to be Sanjay’s business partner in all these endeavors too. They have saved sufficient money over the years and feel the time is ripe to become entrepreneurs. They want business activities they can pursue until their late 70s. 

Sanjay now day and swing trades securities and options in a new husband-and-wife general partnership account. Vainavi helps with research, administration, accounting and more.

Sanjay’s employer was sorry to see him leave. His ex-boss figured Sanjay could manage some of the company’s offshored jobs sent to India. Sanjay turned down part-time employment but agreed to be a new supplier to his ex-employer instead. Sanjay set up his own Business Operations Office (BOO) based in India, along with local Indian colleagues. Sanjay offered to house his ex-employer’s Indian contractors in his BOO to improve management and security – exactly what his ex-boss wanted in the first place. But in this scenario, the software company encounters less risk. Sanjay leaves much of the Indian-based operations to his Indian-based partner while he focuses on trading and sales of his BOO services – which doesn’t take much time. Vainavi helps out with the BOO business, as she was a career administrator before and this is right up her alley. 

The end result is great. Sanjay and Vainavi beef up trading and make even more money. Sanjay left a negative job scene and replaced it with a new exciting BOO business in India, with his ex-boss and company as his first client. Sanjay and Vainavi plan to get several other good clients for their BOO business too. Having an anchor client with an excellent reputation is a great start. Vainavi is happy to be working more again. 

Sanjay and Vainavi set up two home offices in their children’s former bedrooms. They expense 20 percent of their home for business purposes and deduct much of their travel expenses to India. 

This entire entrepreneurial endeavor is fairly easy and natural for Sanjay and Vainavi, as they were both Internet and computer savvy. They got the additional support they needed on business, tax and legal matters from experts in trading, virtual business and global entrepreneurs — including Green & Company. 

To conceive and expand their trading and BOO businesses, Sanjay and Vainavi benefited from having joined Green’s Entrepreneurs Network, led by Robert A. Green.

Green’s Entrepreneurs Network suggested that Sanjay and Vainavi set up their own proprietary trading firm. They can recruit prop traders in India, managed by and housed in their BOO operation, to trade their own capital or capital raised from other members of Green’s Entrepreneurs Network or other contacts of Sanjay and Vainavi.

Bottom line. 
While trading is an exciting and profitable business for some, it’s unprofitable for others. While most traders hope to hit a home run, that’s simply not feasible for most. Traders often retool, restructure or take some time off from trading. Why not consider other entrepreneurial endeavors during those times? If you love trading because it meets your urge for financial and business independence, you will satisfy that same urge with other types of entrepreneurial activities too. Jobs may be scarce, but entrepreneurial opportunities are not and the world is your oyster. 

Robert Green invites you to join Green’s Entrepreneurs Network. Membership to this entrepreneurial endeavor is free. It’s a win-win: You will learn new ideas, meet new people and gain invaluable experience. This is not a support group for sorrow, but a springboard group for launching and improving successful businesses that are rewarding in terms of profit and passion for our members.

Green energy tax breaks

April 28, 2010 | By: Robert A. Green, CPA

This article will appear in an upcoming “green” issue of Micro-cap Review Magazine (www.Microcapreview.com).

Investors in green businesses need to sort the green hype from the truth. The government knows this difficult reality and has enacted many tax breaks for the green-energy industry over the past few years. Unfortunately, the tax breaks are complex and often wasted. If you’re interested in taking on a green-energy project, or investing in one, consider these ideas for tax savings. The key is learning about the many tax breaks green-energy undertakings are eligible for. 

Green-energy projects resemble hedge-fund structures in legal form, but their business model is far more complicated. Green energy co-generation facilities are expensive, long-term ventures requiring community approval, modern design, complex installation, efficient operations and guaranteed power-purchase agreements with local utilities. 

As a tax writer in the trading and hedge-fund industries, I have an interest in going green for my own social and business purposes. Decades ago, I discovered a unique way to overcome Section 469 passive-activity loss limitations, a tax change that slowed down the private syndication business in real estate and film (the old tax shelters). I created “active investors,” allowing investors to overcome passive-activity rules. This concept is helpful to green-energy syndications now, too. 

Active investors
Our “Green Energy Active Investors” program is an add-on module to a traditional investment-management business structure. With a private-investment limited liability company (LLC) structure, you can allocate many tax breaks to active investors in a separate LLC class, and counterbalance it by allocating more cash flow to passive investors. 

IRS code Section 469 restricts passive-loss deductions to passive-activity income. Most green-energy projects generate losses in the early years and suspending those tax breaks is inefficient and unattractive. Instead, you can set up a vehicle such as an LLC intended for active investors only. Passive investors can buy into a green-energy fund instead. 

Active investors have the opportunity to satisfy the IRS’s rules for “material participation” which navigates around Section 469 passive-activity loss rules. That allows active investors to use pass-through tax breaks, including green-energy tax breaks as well as other business tax breaks. 

The only caveat for some tax breaks including tax losses is the active investors must have sufficient cost basis in the project in order to write off tax losses. Active business owners in pass-through vehicles can only report tax losses up to their cost basis; excess losses are suspended to future years. Active investors can build up cost basis in later years by contributing additional personal-business expenses to the project. 

Active investors may incur expenses including travel, meals, entertainment, supplies, home-office expenses, dues, publications, research, furniture, fixtures and equipment, professional fees and more. These expenses can be contributed to the company and added to the investor’s cost basis. The active investor can deduct these expenses on his or her individual tax return (Schedule E) as “unreimbursed partnership expenses” (UPE). This is safer than deducting these expenses on the company level. If the active investor is overly aggressive on expenses, it’s not at the risk of the LLC vehicle or the other investors. This applies to material participation standards as well: Each investor needs to make that assessment and is responsible for that determination, not the LLC. 

Consider setting up special-purpose green-energy investment funds (Green Fund LLCs). You can have multiple classes of LLC membership interests. Each green energy project should be owned in a special-purchase vehicle formed in the local state and city; we’ll call it the “Project LLC.” The Green Fund LLC can own a portion of the Project LLC to get pass-through tax breaks, or it can own the equipment and lease it to the Project LLC. In addition, you can set up a management company to service the Green Fund LLC and Project LLC. You can earn and collect management and performance fees.

Special-purpose local Active Investor LLC vehicles can be set up too. These can own interests in the Green Fund LLC, Project LLC, and management company LLC if desired.

Recruit active investors to overcome “Not in my back yard” 
Often, a big obstacle in these projects is people in various communities take the “Not in my back yard” (NIMBY) stance. Although many Americans may embrace the green energy agenda, far too many don’t want a green energy project in their neighborhood. 

This is where the active investors come into play. Set up active-investor vehicles in local communities in which you are trying to sell a green energy project. Recruit local builders, architects, contractors, attorneys, accountants, doctors, quasi town officials, politicians, media owners, promoters and more as active investors. These VIPs can help convince their neighbors to vote “yes” on green-energy projects. 

Give your local active investors the lion’s share of the up front tax breaks. (Remember, active investors need to have cost basis to reap these tax benefits.) They will put up some cash and incur their own expenses, providing tax savings even beyond the green-energy tax breaks. The green-energy tax breaks offset the cash investment; this plus the active-investor tax breaks makes the investment a home run. And, local active investors help overcome the NIMBY problem. 

Green-energy tax breaks
There are many sources for green-energy incentives: federal, state, county and local governments; quasi-governmental organizations dedicated to making green-energy projects happen; utilities offering co-generation guaranteed power purchase agreements; private green energy investment funds; and more. 

For current federal incentives, see the U.S. Department of Energy (USDE) page “Tax Breaks for Businesses, Utilities, and Governments” at:
http://www.energy.gov/additionaltaxbreaks.htm
http://www.energy.gov/media/HR_1424.pdf

For state, county and local incentives see:
The Database of State Incentives for Renewable Energy (DSIRE).


Federal incentives generally include tax credits for the production of electricity from, and facilities that use, wind, refined coal, geothermal, biomass, solar, and combined heat and power systems. In some cases, a subsidy can replace a credit.

Tax credit bonds are attractive incentives too. Public sector bond issuers obtain 0-percent interest-rate financing. The investors in the bonds receive tax credits in lieu of bond interest payments. The Recovery Act materially expanded the national limits on bond principal. Find out if your project qualifies for this financing incentive and the limit available in your state. 

Although there’s a long list of incentives, note that some expire soon when you consider the long timetable for making a green-energy project operational. This highlights the inherent problems with tax incentives. Can businesses count on an extension of these breaks?

Co-generation guaranteed power purchase agreements
The most important element of any new business is the consistent generation of cash flow revenues. Co-generation guaranteed power purchase agreements (PPAs) solve this need. 

A utility provider is a valued partner. It can offer specifications and a coveted co-generation guaranteed PPA to automatically buy all the power you generate at a fair and regulated price for resale to their customers. Connect to their grid, turn the switch on and you’re in business. 

PPAs vary by utility and state. Before you consider a local project, check the available agreements in your targeted communities. Speak with your local utilities about becoming partners. Click here to learn more about power purchase agreements.

However, it’s crucial to know the risks here. Co-generation revenues and tax incentives are only tapped when a project is approved and underway. Significant development costs before this time may not be recouped from incentives and co-generation if the project never becomes operational.

Bottom line
Think green: Consider a green-energy project and related business, go green and make green. The tax incentives in this arena can be like picking juicy fruit off a green tree. 

Private-Equity Active Investor Tax Breaks

November 19, 2008 | By: Robert A. Green, CPA

Diversify your time and money with a tax-advantaged “Active Investment.” A green technology active investment might give you a 100-percent return within the first few years with the tax breaks alone. Later success will be the icing on the cake!

By Robert A. Green, CPA

This year may be a good time to consider another family business activity—either starting your own new business, expanding one or joining other entrepreneurs as an Active Investor. 

Many traders were emotionally and financially stressed out in 2008 with the market meltdown and perfect storm of volatility. Even seemingly steady employment is a risky proposition in this dangerous job market with layoffs happening fast and furious. Some traders may want to consider diversifying both their assets and their personal employment. 

Now may be the time to start your own business, and you don’t have to do it alone. Recruit other Active Investors, or join other business entrepreneurs in their business as an Active Investor yourself. As an Active Investor all you will risk is a little money (as little as $25,000) and some time and effort (as little as 100 hours per year). 

The convergence of a new presidential administration, expanding technology industries, stronger environmental advocates and more environmentally aware consumers are adding up to big things for the new green jobs economy. This may be the perfect time to consider an exciting highly-tax-advantaged investment in green energy. Join the green energy revolution and receive a boat load of tax breaks at the same time! 

The Powerful Active Investor Tax-Benefit Plan
Active Investors invest a small amount of cash, plus some time and effort and their own home-based expenses. Spending between 100 and 500 hours per year is the key to unlocking these business tax benefits and avoiding the passive activity loss deferral rules (see material participation rules below). 

Converting your home-based expenses to business-use is the “tax juice”—the added tax write-offs that ensure you make all your cash investment money back no matter what the economic outcome. In other words, even if the business fails, you make money after tax benefits.

More Tax Benefits Going Green
Congress should pass accelerated tax benefits with either 100-percent first-year depreciation (at very high investment levels), or at least very accelerated depreciation, plus up front tax credits too.

An Active Investment in a green project could lead to a full return of cash investment based on tax advantages alone in the first three years. 

Active Investors and “Trader Tax Status” Have Much in Common Tax-Wise
Active Investor business tax breaks are similar in many ways to business tax breaks based on “trader tax status,” but there are a few key differences. 

Business traders and Active Investors both need to materially participate in their business activity in order to be allowed ordinary business tax loss treatment. Business traders generally spend more than four hours per day, which is generally close to 1,000 hours per year. 

Portfolio trading and investment companies are not subject to “passive activity loss” rules; rather they are subject to the “trading rule.” All other types of businesses are subject to passive activity loss rules. Passive activity loss rules only allow passive activity losses to offset passive activity gains and not any other type of income (like earned income, portfolio income and other income). 

Under the trading rule, even passive investors in a hedge fund (that has trader tax status) are allowed business loss treatment on all expenses other than investment interest expense. Investors in other types of businesses only overcome the passive activity loss rules if they can demonstrate “material participation” in that business activity.

Trader tax status and other types of business status share other key terms in common. For example, the material participation requirement within the passive activity loss rules states “the taxpayer is involved in the operations of the activity on a regular, continuous, and substantial basis.” Business traders must trade on a “frequent, continuous, regular and substantial” basis too. 

But this is where these paths part ways. Trader tax status is not clearly defined in the tax code, and it’s left to the tax court to interpret. Conversely, the passive activity loss rules clearly define “material participation.”

Material Participation Defined
Per RIA, “An individual is treated as materially participating in an activity for the taxable year if he satisfies any one of seven tests set forth in Reg § 1.469-5T(a)”

The five tests that are most likely to apply to active investors include: 
• the individual participates in the activity for more than 500 hours during the year;
• the individual’s participation in the activity for the taxable year constitutes substantially all of the participation in such activity of all individuals for the year (including individuals who are not owners of interests in the activity);
• the individual participates in the activity for more than 100 hours during the taxable year, and his participation in the activity for the taxable year is not less than the participation in the activity of any other individual (including individuals who are not owners of interests in the activity) for the year;
• the activity is a “significant participation activity” (i.e., a trade or business activity in which the individual significantly participates in the activity for more than 100 hours during the taxable year ( Reg § 1.469-5T(c) )) for the taxable year, and the individual’s aggregate participation in all significant participation activities during the year exceeds 500 hours;
• based on all the facts and circumstances, the individual participates in the activity on a regular, continuous, and substantial basis during the year. An individual does not satisfy the facts and circumstances test if he participates in an activity for 100 hours or less during the taxable year [list reprinted from Reg § 1.469-5T(b)(2)(iii)].

Many Active Investors in green energy projects may not need to devote a significant amount of time and effort and they may qualify under the second and third bullet points above, in connection with the 100-hour standard. 

Many green technology projects are not expected to be operated like a traditional 9 to 5 business. To be successful, this type of project may simply require assigning many sub-tasks to different Active Investors, such as technology procurement, sale to a school, installation arrangements and more. 

Both partners’ time is counted, even if only one of the spouse’s names is recorded as the investor. 

The “Trading Rule” versus “Passive Activity Losses”
Trader tax status (business treatment) gives full ordinary loss deductions, including home-office, education, start-up expenses, margin interest and much more. Conversely, investment expenses (under Section 212) are very limited, only allowed in excess of 2 percent of Adjusted Gross Income (AGI), and not deductible at all against the Alternative Minimum Tax (AMT). 

Passive activity losses are even worse than investment expenses; they are only deductible against passive activity income. Unless an investor has many passive activity investments in place, passive investors suffer loss deferral over many years until they close down a particular investment.

Notice that because of the trading rule, passive activity investors can’t generate passive activity income with hedge fund investments either. Otherwise, it would be too easy for passive investors to use up their passive activity losses. 

In the mid 1980s, Congress enacted the passive activity loss rules to kill off the tax-shelter industry, which had proliferated on real estate and filmmaking syndicates. Perhaps Congress should consider revising passive activity loss rules now to help spur growth. Bringing back some tax benefits in connection with real estate might also help a real estate market in serious price decline. There are even more onerous special passive activity loss deferral rules just for rental real estate too. 

Home-Based Business Expenses (the Tax Juice)
One of the best tax advantages for Active Investors and business traders is deducting home-office expenses, travel, meals, entertainment and other fixed or personal-type expenses (converted to business use) without restriction or limitation.

Home-based expenses can be pure tax savings. Unlike out-of-pocket expenses for trading or business services, home-based expenses are already fixed as part of your personal life. By simply converting them to business-purpose, you generate tax savings without spending more money on the expenses. 

An Active Investor can deduct home office and other expenses as “unreimbursed partnership expenses” (UPE) on their Schedule E in the same manner that proprietary traders report their K-1 income and UPE.

Hard to Get a Bank Loan? Active Investors Can Help
In addition to tax savings, Active Investors can provide many powerful advantages, including a convenient way to finance your business, when more traditional sources of lending or investing have dried up. 

As you know, banks are not lending much to small businesses now during this credit crisis and recession. Private-equity firms went overboard buying public companies using bank debt, which contributed to the credit crisis and market meltdown. Private equity firms are not investing much now. Vendor financing and leasing is also very difficult to arrange in these times, as companies don’t have sufficient cash flow to help their customers more than in the past. 

Therefore, raising money for your venture with Active Investor tax-advantaged equity can be a smart business decision in this economic environment. 

With an Active Investor program, you probably don’t need to spend much money on legal fees, since you probably don’t need a private placement memorandum or other investment documents, as is traditional in private equity and hedge fund deals. You should try to recruit a good attorney as an Active Investor too, saving even more cash flow. 

As an Active Investor, you save on interest costs, which can be a significant drain on cash flow during a recession economy. In general, small business loan interest rates are sky high during this credit crisis. It also can be hard to get a SBA lower-rate loan too. 

Think of Active Investors as self-raised private-equity loan with extreme tax advantages. 

The Tax Power of Green
President Obama and the Democratically-controlled Congress have promised to make a good start at converting America from dependency on foreign-oil to a U.S.-home-grown green energy job economy. In addition, going green will help fix our environment, which is also reaching the tipping point. 

It’s pretty likely that the Democrats will pass significant fiscal tax benefits. Tax rates are also headed up for upper-income individuals, which makes tax-advantaged investing even more valuable to them. Upper-income investors can probably part with a good chunk of change to invest in your project as well.

An Example for Going Green (with Lots of Tax Breaks)
Here’s an example of how a trader can suggest a green energy project in his or her local community: 

Contact a local elected official, or write a letter to the editor in the local paper suggesting that a local school or other quasi-government building add solar-energy panels and/or wind power energy systems to their properties to both lower energy costs and protect the environment at the same time. 

Point out the tax benefit situation. The school or government entity won’t benefit from income tax breaks related to green energy, because it’s a non-profit institution that doesn’t pay taxes. That’s a real shame, considering that Congress has and will continue to pass significant new tax breaks for businesses using green technologies. 

Invite other community residents and businesses to partner with you in a management company to purchase the green technologies and lease them back to the school/government for their use. 

Mention that you and your co-Active Investors will do much of the work required to make the project happen in a successful manner. Briefly point out the Active Investor tax advantages. Say you want to recruit local professionals (attorneys, accountants, engineers, physicians), local tradespeople (builders, contractors, plumbers, electricians, masons, and landscapers), and business managers, public relations and marketing people to partner on the project. Point out that this project is great public relations for these local business people. With local involvement as owners, there is more incentive to keep the projects on budget and with excellent quality. 

Recruit school children to promote and sell the green energy project to the town residents. The biggest impediment to green energy projects is objection from the local community—the infamous NIMBY (Not in My Back Yard) objection. 

Towns and schools are being charged much higher interest rates in this environment on new projects, because the bond guarantors are in distress too. Active Investor equity is the key to success in this regard.

This plan saves interest and energy costs, and it helps the environment too. It will be a great working lesson for school children—and it’s their future at stake too.

Wind Farms in Iowa
If local objections are too stiff, consider a green energy project in a more friendly green-business state. 

For example, wind farms are growing fast with great success in Iowa. In fact, one Iowa factory—who was facing closure after its jobs moved to Asia—converted to a wind power equipment manufacturer. The equipment is very heavy and best to ship and assemble on local wind farms. 

Iowa wind farms have proliferated along with corn-ethanol farms. Even with energy prices headed lower, they both are still economical. And again, Active Investor tax benefits alone can make it a worthwhile investment. Energy prices are expected to rise again once we recover from the recession. 

Green Gold or Black(Oil) Decay?
In his groundbreaking book, Hot, Flat and Crowded, author and New York Times columnist Thomas Friedman predicts that billions of people around the globe will join the American-type of energy consumption demand curve, which will dwarf energy supplies, including new green energy too. He says it’s imperative that we start making green energy quickly. Without it, he goes on to say, our environment is a sure loser. 

President Obama has stated that green technologies, green jobs and the green economy and environment can’t wait for the return of higher oil prices. The green revolution must start immediately ushered in with consistent fiscal incentives and all the help American citizens can provide. It’s our future at stake!

Use Active Investors in Any Business.
If you think green energy is just “pie in the sky,” then use Active Investors in any small business that you like. 

The same powerful tax advantages apply no matter what the business is. Maybe your business won’t have as many accelerated tax breaks and/or tax credits as going green, but even basic tax breaks together with the home-based expense tax benefits make Active Investors a winning formula for any business. 

Bottom Line
Picture a business model that raises cash equity along with key labor support, and the pressure is not on you for compensating your equity-workers—you instead leave that to Uncle Sam—your other partner-in-profit.