This is super helpful! Does this ordering change at all depending on whether you're dealing with federal vs. state tax issues? I'm trying to figure out where state tax court decisions fit in this hierarchy.

Great question! For state tax issues, you'd have a parallel hierarchy, starting with the State Constitution, then State Statutes, State Regulations, State Revenue Rulings, etc. For conflicts between federal and state tax law, federal law generally prevails due to the Supremacy Clause of the U.S. Constitution, but states have significant autonomy in creating their own tax systems. State tax court decisions would only be authoritative for that state's tax laws and wouldn't impact federal tax law interpretation.

IRS Notices and Announcements generally fall below Revenue Procedures in the hierarchy. They're considered "official pronouncements of tax policy" but don't have the same weight as Revenue Rulings or Revenue Procedures. That said, Notice 2020-75 specifically is pretty influential regarding state and local tax (SALT) workarounds since it announced the Treasury's intent to issue regulations on a particular matter. If your tax preparer is citing it, it's probably relevant to your situation, but just know that if it ever directly conflicted with a statute or regulation, those higher sources would prevail.

That's a really good point! We initially chose partnership taxation because our accountant said it was simpler for our first year, but I've been wondering if S-Corp might be better long-term. Are there big differences in the reporting requirements between the two? And if we wanted to switch to S-Corp status, is that complicated?

The reporting requirements are somewhat different. Partnerships file Form 1065 with K-1s for partners, while S-Corps file Form 1120-S with K-1s for shareholders. The bigger difference is how you're taxed - with an S-Corp, you can pay yourself a reasonable salary (subject to employment taxes) and take remaining profits as distributions (not subject to self-employment tax). This can save on taxes. Switching isn't too complicated. You file Form 8832 to elect to be taxed as a corporation, then Form 2553 to elect S-Corp status. The timing is important though - generally you need to file within 2 months and 15 days from the beginning of your tax year for it to be effective for the current year. Otherwise, it takes effect the following year.

Did you have to amend your operating agreement to specify those allocations more clearly? Our agreement just says "50/50" for everything but I've heard the IRS wants more specific details about how different types of income and special allocations are handled.

We didn't have to formally amend our operating agreement, but our accountant recommended creating an addendum that specifically addressed tax allocations. We documented how we handle different income types, guaranteed payments, and special allocations for tax purposes. The IRS does want to see that your allocations have "substantial economic effect" - basically that they reflect actual economic reality and aren't just done to avoid taxes. For a simple 50/50 partnership, you're probably fine as long as you consistently apply that split to all financial aspects of the business.

But aren't there legitimate advantages to being a contractor? I've heard you can deduct all kinds of things as business expenses - home office, car, phone, even meals sometimes. Couldn't those deductions make up for the extra taxes?

There are some legitimate advantages to being a contractor, but they rarely outweigh the costs for most workers. Yes, you can deduct business expenses, but there are strict rules about what qualifies. Home office deductions require exclusive use of that space for business. Vehicle deductions only apply to business use, not personal or commuting. Meal deductions are limited to 50% and must be directly related to business. These deductions rarely offset the additional 7.65% self-employment tax burden, loss of unemployment benefits, lack of workers' comp protection, no paid time off, and no employer-provided health insurance. Plus, you take on all the administrative burden of tax filings, estimated quarterly payments, and keeping meticulous records. For most personal assistants, employee status is financially advantageous unless the contractor rate is significantly higher.

The 20-factor test is actually outdated. The IRS now uses a simplified approach with three categories: Behavioral Control, Financial Control, and Relationship of the Parties. Much easier to understand than the old system. https://www.irs.gov/businesses/small-businesses-self-employed/independent-contractor-self-employed-or-employee

Wait, I thought Section 1231 losses always get ordinary loss treatment regardless of holding period? Isn't the 1 year+ holding period just for determining if gains get capital gains treatment? I've been doing my taxes wrong if that's not the case!

You're right that Section 1231 losses are treated as ordinary losses regardless of holding period. I should have been more precise in my explanation. What I was referring to is that to qualify as Section 1231 property in the first place, the property must be used in a trade or business and held for more than 1 year. Since the OP has held it for 2 years as a rental, it qualifies as Section 1231 property. If it had been held for 1 year or less as a rental, it wouldn't qualify for Section 1231 treatment, and would instead be subject to ordinary income/loss rules for property not used in a trade or business.

I actually haven't heard of cost segregation before. That sounds really useful! Is it something I could still do now even though I've already been depreciating the property as a whole for 2 years? Or is it too late to change how I've been handling the depreciation?

Does claiming the Recovery Rebate Credit also trigger a review? I claimed that for a missing stimulus payment.

Recovery Rebate Credit can definitely trigger additional review, especially if the amount you're claiming doesn't match IRS records. The IRS is extra careful with these credits because there were a lot of issues with improper claims (both accidental and fraudulent) during the pandemic years. The good news is that even with the delay, you should eventually get the refund if you're legitimately entitled to it. But it might take 6-8 weeks instead of the usual 21 days.

Thanks for this info! I checked and I do have that PATH Act hold. Wish the "Where's My Refund" tool would just tell you this instead of the vague "still processing" message.