Green Light, Red Light
When trying to determine if one should follow a tax strategy, some want to know if it is “black and white”. What does this mean? The IRS code is written in “black and white”. Black ink on white paper. A more appropriate definition is from The Free Dictionary — “Involving a very clear distinction, without any gradations”. So, what are gray areas? Some will ask is that a gray area that I could use. According to my handy Merriam-Webster, a grey area is “an area or situation in which it is difficult to judge what is right and what is wrong.” Many will look at tax regulations using this lens.
At Stone CPA, we respectfully disagree. A better distinction exists. In understanding the application of the tax rules, you should use a process like the well-recognized stop light. The top light is green and simply means go.
We look for green lights in the tax code. It is specifically allowed by the law. For example, 280 (a)(g) or better known as the Augusta rule state that you may rent your home for up to 14 days and not declare the income received. Really! Sounds too good to be true. The surrounding facts is that when the Masters Golf Tournament began, a shortage in lodging existed in Augusta, GA. Many residents took in boarders only to find out later that it was going to create a taxable situation. They complained to their US Senator who was the Chair of the Finance committee. Now, 280(a)(g) is a prime example of green lights. You can always use a green light to reduce your tax liability.
What about those big red lights — located at the bottom of the stoplight and bigger than the others. It is an act you are specifically not allowed to do. IRS Code Section 274 states “No deduction otherwise allowable under this chapter shall be allowed for any item:
- With respect to an activity which is of a type generally considered to constitute entertainment, amusement, or recreation, or
- With respect to a facility used in connection with an activity referred in subparagraph A (above)”
Do not run this red light. It disallows entertainment expenses, but exceptions do exist. “Recreational, ETC., Expenses for Employees” - IRS 274 (e) (4) allows these expenses for employee morale. For example, you can take your employees to the Avalanche game.
Isn’t the stop light approach the same as the black and white concept. No. You either can or can not do it. What happens if there is no light? Is that a gray area? No. It is simply without any guidance or direction. When you approach an intersection and the traffic sign says no right turn. You know you can get a ticket for making a right turn. If the intersection does not have any traffic sign directing otherwise, you can make a right turn. Our legal system is built on the foundation of English common law principles. Unless you have something in the code specifically forbidding it — a red light. You can do it.
Join us for our Weekly Community Q&A, every Thursday beginning 10 AM MST to get more clarification of what the red and green lights are. We will answer your questions about what you can do.