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The Business vs. Hobby solo 401k omnibus thread

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  • #16




    This game completely changes when you try to claim losses or biz expenses. We are not talking about that. If you do a few surveys and try to deduct your car then clearly that is not allowed.
    Click to expand...


    Understood, agreed, not the point of my post. I think the facts and circumstances of the case I linked provide some non-hypothetical insight (N=1 of course) into the discussion we're having here

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    • #17
      Just a note of caution.  If you are a high earner, you are much more likely to get audited.  Despite the rumors that audit % went down, it actually went way up for high earners.  When you pay your 1 year old kid $12k a year for 'modeling', that is more likely than not going to be questioned by the IRS, and while you probably have a relatively low probability of being audited, if and when you do, expect to pay for it.  This might be an OK tradeoff for some, but just bear this in mind.  Same goes for the current thread.  While it is probably not going to be noticed, if and when you end up in an audit, prepare to share your documentation with the IRS to defend your choices.  It all comes down to this.  What's the worst thing that can happen to you? I think the worst thing in this case is the unwinding of a solo 401k plan, and owning all of the taxes on disallowed contributions. If the contribution amounts are high, this can create a problem.  If not, then you are probably looking at some penalties/taxes.  Just like with your regular tax return, you can get away with anything as long as nobody notices. But if you are taking care to make sure that everything is done by the book, this is no different.  As long as you have proper documentation and paperwork, you should not have any trouble. The longer you do something that is borderline questionable, the worse the end result would be if you are ever asked to justify it and you can't.  And it might happen in 5, 10, 15 years, when you least expect it.  IRS is also developing software to examine tax returns, and as that gets more sophisticated, I would expect that more things will be found automatically, and the more money you have in play, the more likely will IRS try to go after you.
      Kon Litovsky, Principal, Litovsky Asset Management | [email protected] | 401k and Cash Balance plans for solo and group practices, fixed/flat fee, no AUM fees

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      • #18




        Just a note of caution.  If you are a high earner, you are much more likely to get audited.  Despite the rumors that audit % went down, it actually went way up for high earners.  When you pay your 1 year old kid $12k a year for ‘modeling’, that is more likely than not going to be questioned by the IRS, and while you probably have a relatively low probability of being audited, if and when you do, expect to pay for it.  This might be an OK tradeoff for some, but just bear this in mind.  Same goes for the current thread.  While it is probably not going to be noticed, if and when you end up in an audit, prepare to share your documentation with the IRS to defend your choices.  It all comes down to this.  What’s the worst thing that can happen to you? I think the worst thing in this case is the unwinding of a solo 401k plan, and owning all of the taxes on disallowed contributions. If the contribution amounts are high, this can create a problem.  If not, then you are probably looking at some penalties/taxes.  Just like with your regular tax return, you can get away with anything as long as nobody notices. But if you are taking care to make sure that everything is done by the book, this is no different.  As long as you have proper documentation and paperwork, you should not have any trouble. The longer you do something that is borderline questionable, the worse the end result would be if you are ever asked to justify it and you can’t.  And it might happen in 5, 10, 15 years, when you least expect it.  IRS is also developing software to examine tax returns, and as that gets more sophisticated, I would expect that more things will be found automatically, and the more money you have in play, the more likely will IRS try to go after you.
        Click to expand...


        Right. But there are no (or minimal) contributions being discussed here. It's all about the IRA rollover.
        Helping those who wear the white coat get a fair shake on Wall Street since 2011

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        • #19




          I’m not advocating breaking any IRS tax laws, but I wonder what the real likelihood of an audit is for this sort of thing. I’d be curious to know how often Johanna or other CPAs have their clients audited. Knock on wood, but I’ve never been audited, although I’m not aware of any red flags that would possibly trigger an audit. Similar to the whole Roth for kids discussion, although that seems like it would be pretty low hanging fruit for the IRS.
          Click to expand...


          I just completed my required 2 hrs of Ethics CE last week?! One theme that ran through the webinar was that audit lottery is absolutely unethical. Many things can be found in an audit that did not "trigger" the audit.

          That said, our clients are rarely audited, period. Audits are rare. When you have a good reputation with the IRS, they are even rarer. That is one reason I am so careful not to sign a return that I would not be able to defend in court with a straight face. And why I put my concerns in writing when we are recommending clients keep better records, send 1099's when required, not make up mileage logs out of whole cloth, get contemporaneous receipts, do report income even when they don't receive a 1099, etc. If something is blatantly illegal (such as not reporting income), I'm not interested in the person's business - if I cannot trust a tiny smudge, I cannot trust that they aren't hiding larger blots.

          When it comes to gray areas, Laura and I will discuss whether we are comfortable or not. We have to both vote yes to file the return. This is not necessarily a morality judgment on the client or prospective client, but something we don't want to risk tainting our reputation (or licenses) over should the random audit ever arise. Preparing your own return? File away! Find a CPA who plays audit lottery? Go for it!

          In closing, as I've posted here before, I'm not exactly black and white - I did deduct a new swimming pool for a client once, after all. If I believe it will stand up on audit and I believe I can argue my case, I'll sign it, whether or not I believe I might lose.
          Our passion is protecting clients and others from predatory and ignorant advisors. Fox & Co CPAs, Fox & Co Wealth Mgmt. 270-247-6087

          Comment


          • #20







            What’s the worst thing that can happen to you? I think the worst thing in this case is the unwinding of a solo 401k plan, and owning all of the taxes on disallowed contributions. If the contribution amounts are high, this can create a problem.  If not, then you are probably looking at some penalties/taxes.
            Click to expand…


            Right. But there are no (or minimal) contributions being discussed here. It’s all about the IRA rollover.
            Click to expand...


            Actually, Kon didn't outline the worst case scenario if the actions are deemed willful in a one-participant plan. The entire plan can be disqualified, resulting in the forced distribution of all assets (contributions and rollovers), rollover ineligible, subject to ordinary income taxes and early withdrawal penalties. These are the same as potential consequences of prohibited transactions in a self-directed plan.

            It is not likely to happen, but is it worth it to risk $500K on a $5 survey, I think not.

            Comment


            • #21
              I mean, sticking with the surveys example, what is the "business or trade" in question, really?  If the survey is explicitly for physicians, then is the business or trade not simply a physician?  Because if we're going to go by 26 CFR §1.183-2(b), then:

              1. one is certainly is a physician for profit

              2. having a MD/DO/MBBS, residency training, etc gives one expertise

              3. puts lots of time and effort into being a physician

              4. idk if "assets increasing in value" really applies (I mean, is one's degree an asset?  I'll settle for 8/9...)

              5. hopefully successful in being a physician elsewhere

              6. has made a gain with otherwise being a physician, as long as one doesn't try to claim excessive losses

              7. has profited in the past and will again in the future from being a physician

              8. being a physician is prob the only income source

              9. there's certainly no pleasure or recreation in being a physician, lol...


              ...so does taking surveys which only physicians can do render one a "survey-taker" as one's business or trade instead of a physician?  Physicians do a lot of things as physicians, not only the direct practice of medical care; one might give lectures, or do administrative work, or expert witness depositions...all directly related to the expertise and experience of a physician.  Would the physician then be re-classified as a lecturer, administrator, or legal consultant as their business or trade?

              When I filed for my EIN, knowing I'd do a variety of physician-related things including but not limited to the practice of medicine, I just put whatever the closest thing was to that.  But is the direct practice of medicine the only thing I can do with my business/trade as a physician in order for it to be net earnings from self-employment?

              Comment


              • #22




                 

                When it comes to gray areas, Laura and I will discuss whether we are comfortable or not. We have to both vote yes to file the return. This is not necessarily a morality judgment on the client or prospective client, but something we don’t want to risk tainting our reputation (or licenses) over should the random audit ever arise.
                Click to expand...


                without betraying confidentiality would you be willing to list a few examples of gray areas that you had to discuss? particularly ones where you had a disagreement on whether or not to file? i'm so curious about this stuff.

                Comment


                • #23










                  What’s the worst thing that can happen to you? I think the worst thing in this case is the unwinding of a solo 401k plan, and owning all of the taxes on disallowed contributions. If the contribution amounts are high, this can create a problem.  If not, then you are probably looking at some penalties/taxes.
                  Click to expand…


                  Right. But there are no (or minimal) contributions being discussed here. It’s all about the IRA rollover.
                  Click to expand…


                  Actually, Kon didn’t outline the worst case scenario if the actions are deemed willful in a one-participant plan. The entire plan can be disqualified, resulting in the forced distribution of all assets (contributions and rollovers), rollover ineligible, subject to ordinary income taxes and early withdrawal penalties. These are the same as potential consequences of prohibited transactions in a self-directed plan.

                  It is not likely to happen, but is it worth it to risk $500K on a $5 survey, I think not.
                  Click to expand...


                  Is that how audits and tax court work? On the one hand the person being audited has realized no tax benefits of creating this plan merely moved money from one 401k to another fully planning to continue to invest and then pay taxes at withdrawal. On the other hand you are saying the penalty could be complete obliteration of the 401k plan with all ensuing income taxes and penalties.

                  That seems like a draconian sanction for a victimless crime. Is there not some sort of provision in tax law for the punishment to fit the crime?

                  If the intention of the IRS was to ban "sham" solo 401k plans couldn't they just set a simple income limit and say that nothing qualifies as business income until it crosses X threshold? You have said in other threads that you think it's both ethical and advisable for taxpayers to do certain things (e.g. bdrIRA) and if Congress wants to stop them they should change the laws. Doesn't that apply here? What is different about this argument than the argument that people made against bdrIRA as a violation of the step doctrine?

                  Comment


                  • #24
                    there are lots of businesses that don’t make a profit; sometimes never. So an income limit is not possible.

                    heck, see the tax court example I posted earlier in this thread

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                    • #25







                      Bear in mind the IRS cares about this criteria NOT to keep you from opening a solo 401(k), but to keep you from claiming a business loss indefinitely for your hobbies.
                      Click to expand…


                      That to me is the open and shut case here.

                      The rule seems to be in place (reasonably) to prevent business loss claims from sham businesses carried out with no inclination to grow, market, or even profit but rather to deduct material goods.
                      Click to expand...


                      Quite a few years ago, I used to do taxes for the IRS' VITA program on base and in the local community.  The ridiculous business loss claims (and the inevitable IRS audits that followed) often had us on the phone with the IRS.  Much like jacoavlu's musician case, I had a guy start his own church while deployed, tried to claim his family vacations as missionary trips and common household purchases as church supplies.  200+ thousand in unpaid taxes/penalties over 4 years, and the first his wife back in the US knew about it was when she got the letter from the IRS.  CPA?  Pfft, let's got to the VITA site to figure this out.

                      As you mentioned earlier, it's often open and shut, but even the IRS will admit that there's plenty of gray area.   Another thing to think about - The IRS always gave us the rule of thumb (when talking about stuff like surveys, ebay sales, etc) that if it didn't declare a profit in 3 years time, it was a hobby and much of the self-employment retirement options were not available.  I had one guy flat out tell me that any return filed with 3+ years of net business losses were flagged for review.  Of course this was back in the early 2000's so who knows what they do now.

                      I'm with you when it comes to business taxes.  I've found a very talented CPA who matches my desire to always stay on the white side of grey when claiming.  Like Johanna, he told me flat out that he won't file anything that he can't defend in court.  I like that.  Still, his expertise has saved me a ton of money and is well-worth what we pay him.

                       

                       
                      I should have been a pair of ragged claws. Scuttling across the floors of silent seas.

                      Comment


                      • #26
                        The most interesting line from the Summary Opinion I posted, the engineer with $69,097 in business deductions on various Schedule C’s related to music activities over two years and no gross receipts, is found in the footnotes:

                         

                        “Respondent does not dispute that petitioner’s music activities constituted a trade or business within the meaning of sec. 162.”

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